SEC Adopts New Executive Compensation and Corporate Governance Disclosure Requirements for 2010 Proxy Season
At an open meeting on December 16, 2009, the Securities and Exchange Commission (SEC) approved by a 4-1 vote enhanced executive compensation and corporate governance disclosure that public companies must make in their proxy statements and their Annual Report on Form 10-K. The final rules are largely consistent with the proposed rules issued on July 10, 2009, but with several key modifications.
The SEC did not adopt the proposed rules governing the proxy solicitation process. The SEC is deferring consideration of these proposals pending its review of the proxy access proposals. At the meeting adopting these new rules, Chairman Mary Schapiro stated that the SEC intends to consider the proxy access rules in early 2010.
Enhanced Compensation Disclosure
Compensation Policies and Practices Regarding Risk Taking. The new rules require a company to discuss and analyze its compensation policies and practices for employees generally, including non-executive officers, to the extent that the compensation policies and practices create risks that are reasonably likely to have a material adverse impact on the company.
- Standard. Disclosure is only required if the policies or practices are “reasonably likely to have a material adverse effect” on the company. This standard is intended to parallel the “reasonably likely” disclosure threshold in the Management’s Discussion and Analysis rules. A company does not need to affirmatively state that its compensation policies and practices do not create the types of risk covered by the new rule. In considering whether any disclosure is necessary, companies may take into account offsetting measures or controls.
- Separate from Compensation Discussion and Analysis (CD&A). The new disclosure will not be included in the CD&A to avoid potential confusion since it applies to all employees, not just named executive officers.
- Smaller Reporting Companies. Smaller reporting companies will not be required to provide the new disclosure.
Examples That May Require Disclosure. The new rules provide illustrative examples of situations that may trigger this disclosure, including, among others, 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 different than other units within the company
- at a business unit that is significantly more profitable than others within the company
- at a business unit where the compensation expense is a significant percentage of the unit’s revenues
- 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
Issues to Discuss and Analyze. The new rules provide examples of the types of issues that companies should discuss and analyze, as follows:
- the general design philosophy, and manner of implementation, of the company’s compensation policies and practices for employees whose behavior would be most affected by the incentives established by the policies and practices, as these policies and practices relate to or affect risk taking by those employees on behalf of the company
- the company’s risk assessment or incentive considerations, if any, in structuring its compensation policies and practices or in awarding and paying compensation
- how the company’s compensation policies and practices relate to the realization of risks resulting from the actions of employees in both the short term and the long term, such as through policies requiring claw-backs or imposing holding periods
- the company’s policies regarding adjustments to its compensation policies and practices to address changes in its risk profile
- material adjustments the company has made to its compensation policies and practices as a result of changes in its risk profile
- the extent to which the company monitors its compensation policies and practices to determine whether its risk management objectives are being met with respect to incentivizing its employees
Stock Awards and Option Grants. The new rules require the Summary Compensation Table and the Director Compensation Table to report stock awards and option grants based on aggregate grant date fair value of awards granted during the year, rather than the dollar amount of accounting expense recognized during the year.
- Performance Awards. The value of performance awards reported in the Summary Compensation Table, Grants of Plan-Based Awards Table and Director Compensation Table will be computed based upon the probable outcome (rather than the maximum outcome) of the performance conditions as of the grant date. However, footnote disclosure of the maximum value will also be required in the Summary Compensation Table and Director Compensation Table assuming the highest level of performance conditions is probable.
- Recomputation of Prior Year Amounts. Companies with a fiscal year ending on or after December 20, 2009, must present recomputed disclosure for each fiscal year required to be included in the Summary Compensation Table. Companies will not, however, need to include different named executive officers for the preceding years based on the recomputation.
Directors and Director Nominees. The new rules require additional disclosure regarding directors and director nominees.
- Experience and Qualifications. Companies must disclose the particular experience, qualifications, attributes or skills that led the board to conclude that the director or nominee should serve as a director of the company.
- Additional Directorships. Companies must disclose any directorships at public companies held by directors and nominees during the past five years (instead of currently held directorships).
- Legal Proceedings. Companies must disclose any legal proceedings involving directors, director nominees and executive officers during the past 10 years (instead of five years). The new rules also expand the types of legal proceedings that must be disclosed to include:
- any judicial or administrative proceedings resulting from involvement in mail or wire fraud or fraud in connection with any business entity
- any judicial or administrative proceedings based on violations of federal or state securities, commodities, banking or insurance laws and regulations, or any settlement to such actions
- disciplinary sanctions or orders imposed by a stock, commodities or derivatives exchange or other self-regulatory organization
Board Leadership Structure. Companies must discuss their board leadership structure and the reasons why they believe that it is an appropriate structure for their company.
- Combined CEO and Board Chair Positions. Companies must disclose whether and why they have chosen to combine or separate the principal executive officer and board chair positions. If these positions are combined and a lead independent director is designated to chair meetings of the independent directors, a company must disclose whether and why it has a lead independent director, as well as the specific role the lead independent director plays in the leadership of the company.
- Role in Oversight of Risk. Companies must disclose the board’s role in the oversight of risk, such as through the whole board, a separate risk committee or the audit committee. The disclosure may include, if relevant, how the board receives information from the individuals who supervise the day-to-day risk management of the company.
Board Diversity. Companies must disclose whether, and if so how, a nominating committee considers diversity in identifying nominees for director.
- Policy Regarding Diversity. If the nominating committee (or the board) has a policy with regard to the consideration of diversity in identifying director nominees, companies must disclose how this policy is implemented and how the nominating committee (or the board) assesses the effectiveness of the policy.
- Definition of Diversity. The SEC noted that companies are allowed to define diversity in any manner that they consider appropriate.
Compensation Consultant Fees. In addition to the current rule which requires disclosure regarding the role of compensation consultants in recommending executive or director compensation, the new rules require expanded disclosure of the fees paid to compensation consultants.
- Consultant Hired by Board. If the board, compensation committee or its equivalent engaged a compensation consultant to provide recommendations regarding executive or director compensation, and the consultant also provided non-executive compensation consulting services, the company must provide fee and related disclosure where the fees for the non-executive compensation consulting services exceed $120,000 during the company’s fiscal year.
- If the $120,000 threshold is met, disclosure of both the aggregate fees paid for the executive compensation consulting services and non-executive compensation consulting services is required
- Disclosure is also required as to whether management recommended or made the decision that the consultant provide the non-executive compensation consulting services and whether the board approved of these services.
- Consultant Hired by Management/Company. If the board has not engaged its own compensation consultant, but a compensation consultant is providing both executive compensation consulting services and non-executive compensation consulting services to management or the company, the company must provide fee and related disclosure where the fees for the non-executive compensation consulting services exceed $120,000 during the company’s fiscal year.
- Different Consultant for Board and Management Exception. If both the board and management have engaged different compensation consultants, then fee and related disclosure for consultants that work with management is not required.
- Broad-Based Plan or Non-Customized Survey Exception. Disclosure is not required where the compensation consultant provides services involving broad-based non-discriminatory plans or information, such as surveys, that are not customized for the company or are customized based on parameters that are not developed by the consultant.
- This exception would not be available if the consultant provided advice in connection with the survey.
Reporting a Shareholder Vote on Form 8-K. Companies must disclose the results of a shareholder vote within four business days after the meeting in a Form 8-K, rather than in the next Form 10-Q or 10-K.
- Results Not Available. If final results are not available within four business days, companies must file an 8-K disclosing the preliminary results within four business days. Companies must then file an amended Form 8-K four business days after final results are known.
In order to comply with the new rules, companies should consider taking the following actions when preparing disclosure for their Annual Report on Form 10-K and proxy statement:
- analyze risks arising from the compensation policies and practices for all employees, including executive officers, to determine whether they are reasonably likely to have a material adverse impact on the company
- analyze the board’s role in the oversight of risk management such as how the board receives information from persons who supervise day-to-day risk management of the company; consider whether to develop policies and procedures for risk management
- recompute the value for stock awards and option grants in the compensation tables based on the aggregate grant date fair value
- revise director and officer questionnaires to obtain the additional information regarding experience and qualifications, directorships at public companies and legal proceedings
- analyze the board leadership structure (combined or separate CEO and board chair positions) to determine whether the current structure is appropriate for the company, including, if the CEO and board chair positions are combined, analyzing whether the company should have a lead independent director to chair meetings of the independent directors and what role the lead independent director should play in the leadership of the company
- discuss with the nominating committee its policy regarding diversity in identifying director nominees and assess its effectiveness; if the nominating committee does not have a diversity policy, it should consider whether to adopt one
- identify and review services provided by all compensation consultants hired by the company (whether hired by the board, a committee of the board or management) and the fees for these services; consider whether to adopt pre-approval or monitoring policies with respect to services provided by compensation consultants
- confirm that the transfer agent can provide information on voting results within four business days after the meeting
Effective Date and Transition Interpretations
The new rules will be effective February 28, 2010, and with regard to the change in reporting of equity awards, will apply for years ended on or after December 20, 2009. On December 22, 2009, the Division of Corporation Finance issued Compliance and Disclosure Interpretations (CDIs) regarding how this effective date applies to filings made at or around the time of the effective date. The CDIs provide the following:
- If a company’s fiscal year ends after December 20, 2009, its Form 10-K and proxy statement must be in compliance with the new rules if filed on or after February 28, 2010.
- If a company files a preliminary proxy statement and it expects to file the definitive proxy statement on or after February 28, 2010, then the preliminary proxy statement must be in compliance with the new rules, even if filed before February 28, 2010
- If a company files its Form 10-K before February 28, 2010, and its proxy statement after February 28, 2010, the proxy statement must be in compliance with the new rules.
- If a company’s fiscal year ends before December 20, 2009, its Form 10-K and proxy statement do not need to be in compliance with the new rules, even if filed after February 28, 2010.
- Companies that are not required to comply with the new rules may voluntarily comply.
- However, companies that voluntarily comply with the Summary Compensation Table and Director Compensation Table amendments (which are the revisions to the reporting of equity awards) must also comply with all other applicable Regulation S-K amendments adopted
- Companies may provide the other new disclosures without having to comply with all of the new requirements.
- Reporting companies whose fiscal year ends before December 20, 2009, do not need to comply with the new Regulation S-K amendments until the filing of their Form 10-K for fiscal year 2010.
- Accordingly, any Securities Act or Exchange Act registration statements filed before the 2010 Form 10-K is required to be filed would not be subject to the Regulation S-K amendments.
- Registration statements filed by new issuers on or after December 20, 2009, must be in compliance with the new Regulation S-K amendments for them to be declared effective on or after February 28, 2010.
- The four-business day requirement in Form 8-K to report the results of a shareholder meeting applies to meetings held on or after February 28, 2010, even if the proxy statement was mailed before that date.
- If the meeting takes place before February 28, 2010, the 8-K is not required.