The Securities and Exchange Commission recently released new proposed rules concerning compensation and corporate governance disclosure for public company proxy statements and other SEC filings. The SEC intends these proposed amendments to improve corporate disclosures and allow shareholders to make more informed voting and investment decisions.
This Update provides a high‑level overview of the proposed rules and a more detailed summary of the key components of the proposed rule changes and the SEC's comment requests relating to executive compensation disclosure.
Timing for SEC Final Rules – Expected for 2010 Proxy Season
The comment period for the proposed rules ends on September 15, 2009. The SEC anticipates that the proposed rules will be finalized on an expedited basis and be effective for the 2010 proxy season. The final rules may change based on responses to the more than 80 specific and general requests for comment the SEC posed in the rulemaking release.
Executive Summary of the SEC's Proposal
The SEC proposes requiring enhanced disclosure in four main areas:
- Enhanced Compensation Disclosure. The SEC's proposal would require companies to disclose how overall compensation policies and practices for employees generally create incentives that can materially affect the company's risk and management of that risk. In addition, the proposal would reverse the "December surprise" and require companies to disclose the value of stock options and stock awards for named executive officers based on the aggregate grant date fair value of awards granted during the year, rather than based on the value recognized during the year for financial statement reporting purposes. Finally, the proposal would require companies to disclose fees paid to compensation consultants, and their affiliates if the compensation consultant or affiliates are not independent.
- Enhanced Director and Nominee Disclosure. The SEC's proposal would require companies to disclose director and nominee experience, qualifications, attributes or skills that the company or other proponent believes qualifies that director or nominee to serve on the board of directors and as a member of a board committee on which the director serves, in light of the company's business and structure. In addition, companies would disclose all public company board membership held by a director or nominee at any time during the past five years, rather than only current board memberships. Finally, the "look back" period for required disclosure of legal proceedings involving directors, nominees and executive officers would be extended from five to ten years.
- New Governance Disclosure Regarding Board Leadership Structure. The SEC's proposal would require companies to disclose the board's leadership structure, including whether the board has chosen to combine or separate the chairman and CEO positions, the reasons for those decisions, whether the board has a lead independent director and the duties of the lead independent director. In addition, companies would also disclose the board's role in the company's risk management process and the effect this involvement has on the company's leadership structure.
- Accelerated Reporting of Shareholder Voting Results on Form 8-K. The SEC's proposal would require companies to disclose shareholder voting results on a Form 8-K, rather than on the Form 10-Q for the quarter in which the shareholder meeting was held (or Form 10-K for the fourth quarter).
Enhanced Compensation Disclosure
The SEC is proposing changes to Items 402 and 407 of Regulation S-K.
New Disclosure Regarding Relationship of Compensation to Risk Management. The SEC proposal would amend Item 402 of Regulation S-K to broaden the Compensation Discussion and Analysis to require disclosure about how a company's overall compensation policies for employees create incentives that could affect the company's risk and management of that risk. The SEC notes in the proposing release that under the current rules, companies are required to discuss in the CD&A the level of risk that a company's named executive officers might be encouraged to take to meet their incentive compensation targets, to the extent such risk considerations are a material aspect of the company's compensation policies. The proposals add a new section to the CD&A rules that requires the company to discuss and analyze its broader compensation policies and overall actual compensation practices for employees generally, including nonexecutive officers. Significantly, however, this disclosure applies only if the risks arising from the company's compensation policies or practices may have a material effect on the company.
Because of the materiality qualifier, the SEC provides a nonexclusive list of situations that may trigger disclosure, depending on the particular company and its compensation structure. These situations include compensation policies and practices:
- at a business unit of the company that carries a significant portion of the company's risk profile;
- at a business unit with compensation structured significantly differently than other units within the company;
- at business units that are significantly more profitable than others within the company;
- at business units where the compensation expense is a significant percentage of the unit's revenue; or
- that 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.
If a company determines that disclosures are necessary, the SEC, consistent with the principles-based approach of the CD&A, provides a nonexclusive list of the types of issues that would be appropriate for a company to discuss and analyze. The level of detail required will necessarily depend on the particular facts at the company and within its various business units.
Changes to Reporting of Stock Options and Stock Awards. The SEC's proposed rules would scuttle a highly criticized component of the equity compensation rules adopted in 2006 that requires companies to report the value of equity awards in the Summary Compensation Table and Director Compensation Table based on the dollar amount recognized for financial statement reporting purposes during the covered year in connection with all outstanding equity awards. Under the revised Item 402 of Regulation S-K, companies would report amounts only for option awards and stock awards granted during the covered year, based on the full aggregate FAS 123R grant date fair value of the awards—which effectively represents a return to the compensation rules as amended in August 2006 and reverses the subsequent December 2006 amendment. The SEC believes this method of reporting will enable investors to better evaluate both the amount of equity compensation awarded for a year and the bottom line total compensation figure, and better align the identification of named executive officers with company compensation decisions. Because the grant date fair value would now be reported in the Summary Compensation Table and Director Compensation Table, the proposal would also remove the requirement to report the aggregate grant date fair value of each individual equity award in the Grants of Plan-Based Awards Table and the corresponding footnote disclosure to the Director Compensation Table.
The proposed rules would also revise Instruction 2 to the salary and bonus columns of the Summary Compensation Table to provide that any amounts of salary or bonus forgone at the election of a named executive officer for an equity award are now reportable in the column applicable to the form of award elected.
Additional Disclosure Regarding Compensation Consultants. To help investors better assess the role of compensation consultants and potential conflicts of interest, the SEC is proposing changes to Item 407 of Regulation S-K that would require companies to disclose fees paid to compensation consultants and their affiliates if the compensation consultants or their affiliates play any role in determining or recommending the amount or form of executive or director compensation and provide additional services to the company. Specifically, the company would be required to report the following information:
- the nature and extent of all additional services provided to the company or its affiliates during the last fiscal year by the compensation consultant and its affiliates;
- the aggregate fees paid for all additional services, and the aggregate fees paid for work related to determining or recommending the amount or form of executive and director compensation;
- whether the decision to engage the compensation consultant or its affiliates for nonexecutive compensation services was made, recommended, subject to screening or reviewed by management; and
- whether the board or the compensation committee approved all of these services in addition to executive compensation services.
The proposed rules clarify that the above disclosure is not required where the consultant's only role is consulting on broad-based plans available generally to all salaried employees that do not discriminate in favor of executive officers or directors (e.g., 401(k) plans or health insurance plans).
Enhanced Director and Nominee Disclosure
The SEC proposal would amend Item 401 of Regulation S-K to expand the disclosure requirements regarding the qualifications of directors and nominees, past directorships held by directors and nominees, and the time frame for disclosure of legal proceedings involving directors, nominees and executive officers. The SEC designed this proposal to assist investors in determining whether and why a director or nominee is a good fit for the company and to allow companies flexibility in disclosing material background information on the directors and nominees.
Director and Nominee Qualifications. Under this proposal, companies would have to disclose a director's or nominee's specific experience, qualifications or skills that qualify that person to serve as a director and committee member, which could include:
- a director's or nominee's risk assessment skills and any specific past experience that would be useful to the company;
- the director's or nominee's particular area of expertise; and
- why the director's or nominee's service as director would benefit the company at the time the company files this information with the SEC.
This expanded disclosure would apply to incumbent directors, to director nominees who are selected by a company's nominating committee and to any nominees put forward by other proponents.
Past Directorships. The SEC proposal would require companies to disclose all public company directorships held by each director and nominee at any time during the past five years. The current rules require that companies disclose only current director positions. The SEC intends this additional disclosure to allow investors to better evaluate the relevance of a director's or nominee's past board memberships or professional or financial relationships that might pose a potential conflict of interest.
Legal Proceedings. The SEC also proposes to expand the disclosure of legal proceedings involving directors, nominees and executive officers from five years to ten years. The SEC offered this expansion to provide investors with more extensive information regarding an individual's competence and character. A company, however, would not be required to report legal proceedings if such information is not material to the evaluation of the director nominee.
New Board Governance Disclosure
The SEC proposal would add a new section to Item 407 of Regulation S-K to impose two additional disclosure requirements.
Leadership Structure. In an effort to provide investors with insights about why a company chose a particular leadership structure, the proposed rules would require a company to disclose its leadership structure and explain why it believes such structure is appropriate given the company's specific characteristics or circumstances at the time of filing. In particular, a company must disclose:
- whether and why the company has chosen to combine or separate the principal executive officer and board chair positions; and
- whether and why the company has a lead independent director as well as the specific role the lead independent director plays in the company's leadership.
Board's Role in the Risk Management Process. The SEC proposal would require additional disclosures about the board's role in the company's risk management process. The company would be required to provide information about how the company perceives the role of its board and the relationship between the board and senior management in managing the company's material risks. In making the disclosures, a company would consider the following questions:
- How does the board implement and manage its risk management function: through the board as a whole or through a committee (e.g., the audit committee)?
- To whom do the persons responsible for overseeing risk management report: directly to the board as a whole, to a committee such as the audit committee, or to one of the other standing committees of the board?
- Does the board, or a board committee monitor risk and, if so, how?
Accelerated Reporting of Shareholder Voting Results on Form 8-K
The SEC proposes adding a new item to Form 8-K to require a company to disclose the results of a shareholder vote within four business days after the date on which the vote occurs. In situations such as contested elections where a company may not have definitive results within four days after the meeting date, the company would be required to report the preliminary voting results on Form 8-K within four business after the preliminary voting results are determined. Once the company certifies the final voting results, the company must then file an amended report on Form 8-K to disclose those final results. This proposal would eliminate the current requirement to report shareholder voting results on the Form 10-Q for the quarter during which the shareholder meeting is held (or Form 10-K for the fourth quarter).
Proxy Solicitation Process
The SEC's proposed rules would also revise the proxy solicitation rules to provide clarity to soliciting parties and assist shareholders in receiving timely and complete information.
|SEC Comment Requests
Extensive Comments Solicited. The SEC is soliciting comments on an extensive list of questions relating to this proposal, including whether the disclosure requirement should be limited to companies of a certain size, such as large accelerated filers, or companies in particular industries, such as financial services, or a limited class of employees, such as executives, and whether the proposal properly identifies the situations where compensations policies may induce risk-taking behavior.
Transition Issues. Because the Summary Compensation Table covers the most recent fiscal year and the two prior fiscal years, the SEC has stated that its goal is to facilitate year-to-year comparisons in a cost-effective way. The SEC has asked for comments on an approach to transition that would require recomputed disclosure for each of the preceding years for named executive officers who appear in the table, so that the option awards and stock awards columns would present the applicable full grant date fair values for all years presented, and the total compensation column would be recomputed correspondingly. Significantly, companies would not be required to include different named executive officers for any preceding fiscal year based on the recomputation of total compensation. The SEC has also asked if there are other preferable ways to address the reporting of equity awards, citing a rulemaking petition that would report the annual change in value of awards, which could be a negative number if market values decline.
Identifying Named Executive Officers. Noting that the financial statement recognition model was adopted in part to address the potential for single large grants with multiyear vesting to distort identification of named executive officers, the SEC is seeking comments on whether and, if so, how the new rules should address this variability.
Discouraging Performance-Based Awards. Another issue raised by the SEC is whether the new requirement to report full grant date fair value would discourage the granting of performance-based equity awards. This issue is heightened by the SEC's current published guidance that all performance awards should be reported at maximum rather than target value.
Eliminating Some Disclosure. Expressing its concern about the growing length of proxy statement disclosures, the SEC is also soliciting comments on whether any current disclosures are unnecessary in light of the proposed amendments, and whether there are other initiatives it should consider that would improve proxy statement disclosure, particularly with respect to disclosure regarding executive compensation. Many commentators have suggested that the current requirement for listing all outstanding stock options by expiration date and exercise price, which sometimes requires several pages of dense disclosure, be moved from the Outstanding Equity Awards at Fiscal Year-End Table to the Form 10-K. The SEC cites as examples of initiatives that might be considered:
You can find a copy of the full text of the SEC's proposed rule release at http://www.sec.gov/rules/proposed/2009/33-9052.pdf. You can find discussions of other recent cases, laws, regulations and rule proposals of interest to public companies on our website.