On December 16, 2009, the SEC approved revised disclosure rules relating to executive compensation and corporate governance practices at public companies. The final rules will be effective February 28, 2010 and will impact the 2010 proxy season for most registrants. The SEC Division of Corporation Finance has also published new Compliance and Disclosure Interpretations (CDIs) regarding transition to the final rules for the 2010 proxy season.
The final executive compensation and governance disclosure rules generally track the rules originally proposed by the SEC in July 2009 (previously discussed in our 7/16/09 WorkCite article. The final rules cover the following areas:
Compensation Risk Disclosure
The July 2009 proposed rules would have required public companies to discuss and analyze in their CD&As their compensation policies generally (including policies for non-executive employees) if risks arising from those policies “may have a material effect” on the company. The SEC’s final rules echo this requirement substantially as proposed, with these primary changes.
- The disclosure has been moved from the CD&A to its own separate section. This change was designed to emphasize that the narrative discussion applies to compensation policies and practices for all employees. Smaller reporting companies that do not file a CD&A will still be exempt from the requirement.
- The vague “may have a material effect” standard for determining when disclosure is required has been replaced by a narrower “reasonably likely to have a material adverse effect” standard. The new standard is intended to parallel the MD&A disclosure rules, including the limitation to “adverse” effects.
- Companies will not be required to affirmatively state that their compensation policies do not pose any risks that are reasonably likely to have a material adverse effect on the company. As a result, companies that conclude they do not have any compensation risks that meet the “reasonably likely to have a material adverse effect” standard can omit any discussion of compensation risk in their proxy (unless they are subject to the executive compensation restrictions of the Troubled Assets Relief Program, which specifically require a discussion in the proxy of compensation risks and actions taken to mitigate that risk).
Stock and Option Valuation
The proposed rules would have required public companies to disclose the aggregate grant-date fair value of all stock and option awards made during a year in the Summary Compensation Table (and related Director Compensation Table) in accordance with FASB ASC Topic 718 (formerly FAS 123R), rather than the incremental annual value reported for the year’s financial statement purposes. Performance awards (as defined in FASB ASC Topic 718) would have been required to be disclosed as though maximum performance criteria had been achieved. The SEC’s final rules adopt this position substantially as proposed, with these principal changes.
- Performance awards will be required to be disclosed at the full fair value based on the probable outcome of the performance criteria on the grant date. However, the effect of forfeitures will be excluded. The amount disclosed in the tables will represent the estimate of compensation cost to be recognized over the life of the award for accounting purposes (except for disregarding forfeitures). Disclosure of the maximum potential payout based on attainment of the maximum performance criteria will be made in a footnote to the Summary Compensation Table (or Director Compensation Table) instead of the tables.
- The rule change will be in effect for disclosures for fiscal years ending on or after December 20, 2009 for reports filed on or after February 28, 2010. Prior year compensation reported in the Summary Compensation Table will need to be recomputed for each named executive officer in accordance with the new rules. For example, for a company with a calendar fiscal year, the new rules will be in effect for the 2010 proxy reporting about the 2009 fiscal year, and the compensation figures reported for 2007 and 2008 for each named executive officer for 2009 will need to be recomputed. Companies are not required to include different named executives for prior years based on the recomputed compensation figures or to amend prior filings. However, if an individual will be a named executive officer for 2009 based on the new disclosure rules and was also a named executive officer for 2007 but not 2008, disclosure of the individual’s compensation under the new rules for all three years is required.
- The SEC decided not to adopt additional proposed changes to the salary and bonus disclosures in the Summary Compensation Table and to the grant-date fair value disclosure for individual awards in the Grants of Plan Based Awards Table.
Fee Disclosure for Compensation Consultants
For a compensation consultant who played a role in determining or recommending the amount or form of executive or director compensation and also provided additional services to a company, the proposed rules would have required the company to identify the consultant and to disclose the aggregate fees paid to the consultant along with a description of the additional services. The SEC’s final rules include this requirement with modifications that limit the scope of the disclosures.
- Fee disclosure will not be required in any case if the fees paid to the consultant for additional services to the company did not exceed $120,000 during the preceding fiscal year.
- If the board of directors (or compensation committee) retains the consultant and the consultant performs additional services to the company with fees exceeding $120,000, then additional disclosure is required. The disclosure will be: The amount paid for executive compensation consulting;The amount paid for other services;Whether the decision to retain the consultant for any services was made by the board of directors (or compensation committee), or was instead made by management; and Whether the board of directors (or compensation committee) approved the additional services.
- The amount paid for executive compensation consulting;
- The amount paid for other services;
- Whether the decision to retain the consultant for any services was made by the board of directors (or compensation committee), or was instead made by management; and
- Whether the board of directors (or compensation committee) approved the additional services.
- If the board of directors (or compensation committee) has not retained a consultant but management has retained an executive compensation consultant, disclosure would be required for additional services under the same rules as if the board of directors had retained the consultant.
- If the board of directors (or compensation committee) on the one hand, and management on the other, have each retained their own separate unaffiliated consultants, then disclosure of any fees paid to management’s consultant will not be required even if management’s consultant performs additional services for the company and even if the fees exceed $120,000 during the preceding fiscal year.
- A description of the additional services provided by the consultant to the company is not required, regardless of the amount of the fee paid for the services. The proposed rules would have required such a description.
- In determining whether a consultant has “played a role in determining or recommending the amount of form of executive or director compensation,” services that are limited solely to (i) advising on broad-based, non-discriminatory plans, or (ii) providing non-customized information (or customized information derived from parameters not developed by the consultant and on which the consultant does not provide advice), such as general compensation surveys, are not treated as compensation consulting services.
Enhanced Director and Nominee Disclosure
The proposed rules would have required expanded disclosure about incumbent directors and director nominees. The SEC adopted the final rules regarding this requirement generally as proposed. The new disclosure will focus on the specific experience, skills and qualifications that qualify an individual to serve as a director for the company. The new disclosures represent a significant expansion given that companies currently are required to provide only brief biographical data for the previous five years for a director or nominee. In addition, any directorships held at public companies within the past five years will be disclosed instead of only current directorships under existing rules. The SEC has extended to ten years (from five years) the time period for disclosure of legal proceedings involving directors, director nominees, executive officers and individuals chosen to become executive officers. The primary differences from the proposed rules are:
- A major new requirement is added to disclose whether, and if so how, a nominating committee considers diversity in identifying nominees for director. If the nominating committee or board has a policy on considering diversity, the disclosure will include how the policy is implemented and how the body assesses the effectiveness of the policy. For this purpose, diversity may include factors other than race, gender and national origin, such as diversity of viewpoints or professional experience.
- The disclosure of experience, qualifications, attributes or skills that qualify a person to serve on a board committee will not be required.
- The specific reference to “risk assessment skills” of a director or nominee has been eliminated.
Consistent with the emphasis of disclosing compensation risk management issues, the proposed rules would have required disclosure of the board’s role in the company’s risk management process. The final rules are substantially like the proposed rules, except for some language changes. Principally, references in the proposed rules to “risk management” have been changed to “risk oversight” as being more descriptive of the board’s function as to risk. The new risk oversight disclosure will need to address, for example, whether the board oversees risk management at the board or committee level. The disclosure will be focused on the organization and process, and will not require disclosure of actions taken by the board.
Board Leadership Structure
The SEC’s proposed rules considered expanding Item 407 of Regulation S-K and Item 7 of Schedule 14A to require a description of the company’s leadership structure. The SEC adopted this requirement in the final rules without substantive changes, other than a change to refer to “board leadership structure”. A company will be required to explain why the board 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 will be required to disclose whether it has a lead independent director and the role the lead independent director plays in the board’s leadership.
Form 8-K Reporting of Voting Results
The SEC’s proposed rules considered 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. This change was adopted in the final rules. The main impact of the transfer is to accelerate substantially the disclosure of shareholder votes. If final voting results are not available within four business days, the rules require a Form 8-K filing of the preliminary voting results. An additional Form 8-K filing would be made when the voting results are final.
The new rules are effective for any registrant with a fiscal year ending on or after December 20, 2009 that files its Form 10-K report or definitive proxy statement on or after February 28, 2010. A registrant with a fiscal year ending before December 20, 2009, or a registrant with a fiscal year ending on or after December 20, 2009 but that files both its 10-K and definitive proxy statement before February 28, 2010, is not required to comply with the new requirements. A registrant that is not required to comply may voluntarily choose to comply, provided that if it decides to comply with the new stock and option reporting requirements for the Summary Compensation Table, it must comply with all of the other new requirements as well. A new registrant that files its first registration statement on or after December 20, 2009 is also required to comply.
Reopened Comment Period on Proxy Access Proposal
In other actions, the SEC has reopened the comment period until January 19, 2010 on the proposal to change the rules for a company to include shareholder nominees for director in a proxy. The proposed rules would generally require a company to include disclosures about eligible director nominees submitted by eligible shareholders in the company’s proxy materials, so long as the shareholders are not seeking to change the control of the company or to gain more than a limited number of seats on the board. The details of the proposal are covered in our previous 6/30/09 WorkCite article.