On December 16, 2009, the SEC approved revised disclosure rules relating to executive compensation and corporate governance practices at public companies in Release 33-9089. The final rules became effective February 28, 2010, and will impact the 2010 proxy season for most registrants.
The final rules cover the following areas:
Compensation Risk Disclosure
Disclosure is required if the risks associated with the company's compensation policies and practices for employees (including those for nonexecutive employees) are "reasonably likely to have a material adverse effect" on the company. A company is not required to affirmatively state that its compensation policies do not pose any risks that meet this standard.
To comply with this requirement, companies generally will need to review their compensation programs and assess the materiality of the risks associated with those programs. The SEC has identified the following as examples of situations that may trigger disclosure:
- Where a business unit of the company carries a significant portion of the company's risk profile.
- Where a business unit has compensation structured significantly differently than other units within the company.
- Where a business unit is significantly more profitable than others within the company.
- Where the compensation expense for a business unit is a significant percentage of the unit's revenues.
- Where compensation practices vary significantly from the overall risk and reward structure of the company, such as when bonuses are awarded upon accomplishment of a task, while the income and risk to the company from the task extend over a significantly longer period of time.
The disclosure is required to be contained in a separate narrative section in the proxy statement (not in the Compensation Discussion Analysis or CD&A). The separate section emphasizes that the narrative discussion applies to compensation policies and practices for all employees. Smaller reporting companies that do not file a CD&A are exempt from the requirement.
If disclosure is required, the issues that may need to be addressed include, for example:
- The general design philosophy for compensation policies covering employees whose behavior would be most affected by the incentives established by the policies.
- The company's risk assessment or incentive considerations, if any, in structuring its compensation policies or in awarding and paying compensation.
- How the company's compensation policies relate to the realization of risks resulting from the actions of employees in both the short term and the long term (such as through claw-back policies or imposing holding periods).
As noted above, 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). In light of the attention that has been focused recently on compensation-related risk, companies may want to consider whether to voluntarily disclose that they performed such a risk analysis.
Stock and Option Valuation
The final rules require 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.
Awards subject to performance conditions 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.)
The rule change is 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.
Companies may wish to prepare revised summary compensation tables early in the proxy drafting process so that both management and the compensation committee will have ample time to consider how the new rules will affect this particular disclosure.
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 final rules may require the company to identify the consultant and to disclose the aggregate fees paid to the consultant, as follows:<
- 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 information required to be disclosed is
- 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 (or compensation committee) 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 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 or form of executive or director compensation," services that are limited solely to (1) advising on broad-based, nondiscriminatory plans or (2) providing noncustomized 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.
The final rules require expanded disclosure about incumbent directors and director nominees. New disclosures will be required in the following areas:
- Qualifications. The proxy statement must include a description of the specific "experience, qualifications, attributes or skills" that led the board to determine that the person should serve as a director of the company.
- Other Directorships. The proxy statement must disclose the director/nominee's directorships with other public companies or registered investment companies within the past five years, instead of only current directorships as under existing rules.
- Legal Proceedings. The new rule extends from five years to 10 years the time period for disclosure of legal proceedings involving directors, director nominees, executive officers, and individuals chosen to become executive officers.
- Diversity. The new rule requires disclosure of whether, and if so how, the nominating body considers diversity in identifying nominees for directors. If there is a diversity policy, the disclosure must include how the policy is implemented and the nominating body's assessment of the effectiveness of the policy. Diversity may include matters other than race, gender, and national origin, such as professional experience.
Consistent with the emphasis of disclosing compensation risk management issues, the final rules require disclosure of the board's role in oversight of the company's risk management process. A company must describe the board's involvement in "risk oversight" of the company. The new risk oversight disclosure will need to address, for example, whether the board oversees risk management at the board or committee level. This disclosure also must discuss how the board's involvement in risk oversight affects the board's leadership structure. 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 final rules require a description of the company's 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 final rules transfer 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. A company must disclose the results of a shareholder vote on Form 8-K within four business days following the date of the meeting at which the vote was held. 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.