SEC Proposes New Executive Compensation and Governance Disclosures

July 16, 2009

The SEC has proposed expanding executive compensation disclosure requirements for reporting companies. A major focus of the proposed rules, released July 10, 2009, is the relationship between compensation policies and risk management.

The additional disclosures would affect disclosure of compensation policies and their impact on risk taking; stock and options awards; director qualifications; company leadership structure; the board’s role in the risk management process; and compensation consultants. The proposed rules also include amendments to Form 8-K and expand proxy disclosures. The SEC anticipates that the new requirements will be effective for the 2010 proxy season.

Compensation Policies

The proposed rules would broaden the Compensation Discussion and Analysis (CD&A) to include a risk management discussion if the risks from compensation policies and practices have a material effect on the company. This disclosure would include material risks for any employee group, not just executive officers. For example, the disclosure might be triggered if a business unit carries a significant portion of the company’s risk profile or has different compensation policies that affect risk management.

When disclosure is required, companies may need to address:

  • The general design philosophy of compensation policies as they relate to risk taking.
  • Risk assessment in structuring compensation policies.
  • How compensation policies relate to the realization of risks resulting from the actions of employees in both the short and long term, through, for example, claw-backs and holding periods.
  • The policy for adjusting compensation policy to address changes in the company’s risk profile.
  • Material adjustments made to compensation policies in response to changes in risk profile.
  • The extent to which risk management objectives are consistent with employee incentives.

In general, the proposed rules reflect the SEC’s current view that compensation policies and attendant risks are a primary cause of the current economic climate and the need to expand risk management disclosure. SEC reporting companies will need to evaluate whether risk disclosure is required and, if so, how and why their current compensation policies and structures relate to risk management.

Risk Management Process

Consistent with the theme of disclosing risk management issues, the proposed rules would require disclosure of the board’s role in the company’s risk management process. This could include, for example, whether the board oversees risk management at the board or committee level. The disclosure would be focused on the organization and process, and would not require disclosure of actions taken by the board.

Leadership Structure

The SEC has proposed expanding Item 407 of Regulation S-K and Item 7 of Schedule 14A to require a description of the company’s leadership structure. In particular, each company would be required to explain why the leadership structure in place at the time of filing is best for the company, including why the principal executive officer and board chair positions are combined or separate. Moreover, each company would be required to disclose whether it has a lead independent director and the role the lead independent director plays in the company’s leadership.

Stock and Option Awards

The proposed rules would include disclosure of the aggregate grant date fair market value of stock and option awards, instead of the dollar amount recognized for the fiscal year for all outstanding awards. The disclosure itself would continue to be made in the summary compensation table. The intent is to reflect compensation decisions made in a single year. The transition to the new form of disclosure will be addressed in the final rule.

Director Qualifications

The proposed rules would amend Item 401 of Regulation S-K to require expanded disclosure about incumbent directors and director nominees. The new disclosure would focus on the specific experience, skills and qualifications that qualify an individual to serve as a director for the company and on any committee. The new disclosures represent a significant expansion given that companies currently are required to provide only brief biographical data for the previous five years. In addition, any directorships held at public companies within the past five years would be disclosed instead of only current directorships under existing rules. The SEC has also proposed extending from five years to ten the time period for disclosure of legal proceedings involving directors, director nominees, executive officers and individuals chosen to become executive officers.

Compensation Consultants

The proposed rules also aim to address concerns about potential conflicts of interest and independence of compensation consultants. If the compensation consultant provides additional services beyond providing executive and director compensation recommendations, then the following information must be disclosed:

  • The nature and extent of additional services.
  • Aggregate fees paid for the additional services and separately for the executive and director compensation recommendations.
  • Whether the decision to engage the consultant for additional services was made or approved by management.
  • Whether the board approved the provision of additional services by the consultant.

Form 8-K Requirements

In what may be an effort to prepare companies for future say-on-pay requirements, the SEC has proposed transferring the requirement to disclose the voting results of any matter submitted to shareholders for vote from Form 10-Q and Form 10-K to Form 8-K. The main impact of the transfer is to accelerate substantially the disclosure of shareholder votes.

Under existing rules, companies must disclose voting results in the Form 10-Q filed for the quarter in which the meeting is held or, if the meeting is held during the company’s fourth quarter, in the company’s Form 10-K. The proposed rules would require companies to disclose voting results on Form 8-K within four business days after the end of the meeting, with limited exceptions.

Potential Future Developments

The SEC’s announcement of the proposed rules also seeks comment on other issues that provide insight into the future direction of the SEC on executive compensation disclosure. One issue raised is whether the CD&A should require disclosure of performance targets on an after-the-fact basis, regardless of whether it may result in competitive harm. Another issue is whether the CD&A should be a part of the Compensation Committee Report and whether the Report should be filed rather than “furnished” (which would increase potential liability for the statements in the Report).

Another topic is whether information about the compensation expertise of compensation committee members should be disclosed. The release also asks whether there should be additional disclosures regarding the internal pay equity of a company (i.e., the ratio of compensation of executive officers to compensation of rank and file employees).

Effective Date

The proposed rules would be effective for the 2010 proxy season. The deadline for comments is 60 days after publication in the Federal Register.

For additional information or assistance in evaluating your company’s current compensation and reporting practices, please contact the authors or any member of the McGuireWoods Executive Compensation or Securities & Corporate Finance teams.