• SEC Adopts Amendments to Executive Compensation Disclosure, Including New Compensation Discussion and Analysis Section
  • August 23, 2006
  • Law Firm: Nixon Peabody LLP - New York Office
  • On August 11, 2006, the Securities and Exchange Commission released final rules regarding the disclosure requirements for executive and director compensation, related party transactions, director independence, and other corporate governance matters. The final rules are designed to, among other things, provide shareholders with a clearer and more complete picture of director and officer compensation. They are also designed to add transparency to key financial relationships among companies and their executive officers, directors, significant shareholders, and the immediate family members of those individuals. The final rules are available at the SEC’s website at http://www.sec.gov/rules/final/2006/33-8732.pdf.

    We will be releasing a number of Securities Law Alerts that address the changes required by the new rules and highlight the actions you should consider taking now to prepare for next proxy season. This Securities Law Alert will review the amendments to executive compensation disclosure, in particular the newly required Compensation Disclosure and Analysis section.

    These revised executive compensation disclosure requirements apply to disclosure for fiscal years ending on or after December 15, 2006 in reports on Form 10-K, registration statements, proxy statements or information statements that are required to include Item 402 executive compensation disclosure, and registration statements that are filed on or after December 15, 2006.

    What is the Compensation Discussion and Analysis section?

    The Compensation Discussion and Analysis section “CD&A” is a narrative overview at the beginning of the compensation disclosure in proxy statement which puts into context the compensation disclosure provided elsewhere and explains the material elements of the particular company’s compensation for named executive officers. This overview, which must be in plain English, should not be mere boilerplate disclosure. Rather, the discussion should be comprehensive and reflect the individual compensation circumstances and policies of the company, including not just cash compensation, but also company policies, programs and practices regarding the awarding of stock options and other equity-based instruments to compensate executives.

    The CD&A does not address the deliberations of a compensation committee and is not a report of that committee.

    The CD&A disclosure requirement does not apply to companies that are small business issuers or foreign private issuers.

    What types of information should be included in the CD&A?

    The CD&A should focus on the material principles underlying the company’s executive compensation policies and decisions and the most important factors relevant to analysis of the policies and decisions. Although the CD&A should address the information contained in the compensation tables and related narrative disclosures that follow to the extent helpful in the analysis and discussion of the compensation polices, it should not merely repeat information from the tables and related narrative disclosures. Again, the SEC notes that boilerplate language should be avoided.

    The SEC has indicated that the following examples are issues that would potentially be appropriate for a company to address in given cases in the CD&A:  

    ·         Policies for allocating between long-term and currently paid out compensation;
    ·         Policies for allocating between cash and non-cash compensation;
    ·         For long-term compensation, the basis for allocating compensation to each different form of award;
    ·         How the determination is made as to when awards are granted, including awards of equity-based compensation such as options;
    ·         What specific items of corporate performance are taken into account in setting compensation policies and making compensation decisions;
    ·         How specific elements of compensation are structured and implemented to reflect these items of the company’s performance and the executive’s individual performance;
    ·         The factors considered in decisions to increase or decrease compensation materially;
    ·         How compensation or amounts realizable from prior compensation are considered in setting other elements of compensation (e.g., how gains from prior option or stock awards are considered in setting retirement benefits);
    ·         The impact of accounting and tax treatments of a particular form of compensation, both to the company and/or the named executive officer (including, but not limited to, the company’s Internal Revenue Code Section 162 (m) policy);
    ·         The company’s equity or other security ownership requirements or guidelines and any company policies regarding hedging the economic risk of such ownership;
    ·         Whether the company engaged in any benchmarking of total compensation or any material element of compensation, identifying the benchmark and, if applicable, its components (including component companies);
    ·         The role of executive officers in the compensation process;
    ·         Company policies and decisions regarding the adjustment or recovery of awards or payments if the relevant company performance measures upon which they are based are restated or otherwise adjusted in a manner that would reduce the size of an award or payment; and
    ·         The basis for selecting particular events as triggering payment with respect to post-termination agreements (e.g., the rationale for providing single trigger for payment in the event of a change in control).

    The SEC emphasizes that these examples must be tailored to the company and are not exclusive. In some cases the information in the examples above may not be material to investors in light of a company’s particular situation and need not be included in the CD&A. In other cases there may be material aspects of the compensation policies of a particular company that are not reflected in the examples listed above; these aspects must nonetheless be discussed in the CD&A.

    Must the CD&A describe the compensation policies as they are applied to each named executive officer?

    The CD&A should be sufficiently precise to identify material differences in compensation policies and decisions for individual named executive officers, where appropriate. Where policies or decisions are materially similar, officers can be grouped together. Where, however, the policy or decisions for a named executive officer are materially different, in the case of a principal executive officer for example, his or her compensation should be discussed separately.

    What time period does the CD&A cover?

    While the CD&A must cover compensation for previous fiscal year, discussion of post-termination compensation arrangements, ongoing compensation arrangements, and polices that the company will apply on a going-forward basis may also be required. In addition, the CD&A may cover actions regarding executive compensation that were taken after the last fiscal year’s end or before the last fiscal year. Discussion of this additional information should be included to the extent it is necessary or helpful for a fair understanding of the named executive’s compensation in the past fiscal year. 

    Must the CD&A disclose target levels for specific performance-related factors?

    The CD&A instructions note that the CD&A need not disclose target levels with respect to specific quantitative or qualitative performance-related factors considered by the compensation committee or the board of directors, or any other factors or criteria involving confidential trade secrets or confidential commercial or financial information, the disclosure of which would result in competitive harm to the company.   To the extent a performance target has otherwise been disclosed publicly, non-disclosure pursuant to this instruction would not be permitted.

    The standard for determining whether or not disclosure would result in competitive harm to the company is the same standard as that which currently applies to confidential treatment requests for confidential trade secrets or confidential commercial or financial information that otherwise is required to be disclosed in registration statements, periodic reports and other documents filed with the SEC. A company is not, however, required to submit a confidential treatment request to rely on the instruction. 

    To ensure that the compensation disclosure is meaningful even when target information is excluded, a company that has excluded target information must discuss how difficult it will be for the executive or how likely it will be for the company to achieve the undisclosed target level or other factors. This disclosure will be reviewed by the SEC which may ultimately determine that the company will be required to disclose publicly the factors or criteria used.

    Finally, if a target level applies a non-GAAP financial measure, the disclosure will not be subject to general rules regarding disclosure of non-GAAP financial measures. The company must, however, disclose how the target number is calculated from the audited financial statements.

    Will the CD&A be considered “furnished” or “filed”?

    The CD&A will be considered part of the proxy statement and any other filing in which it is included. Accordingly, it will be considered filed with, rather than furnished to, the SEC and subject to Regulation 14A or 14C and to the liabilities of Section 18 of the Exchange Act. 

    Is the CD&A covered by the certifications of the principal executive and financial officers?

    To the extent the CD&A and any of the other executive compensation information is included in or incorporated by reference into a periodic report, the disclosure would be covered by the certifications that principal executive officers and principal financial officers are required to make under the Sarbanes-Oxley Act of 2002.   Given that the CD&A is not meant to address the deliberations of the compensation committee (and is not a report of the compensation committee), the principal executive and financial officers will not be certifying as to the deliberations of the compensation committee. The principal executive and the principal financial officers may, however, “look to” the Compensation Committee Report, described below, in providing their certifications as required under Exchange Act Rules 13a-14 and 15d-14.

    Companies should be aware that a company’s controls and procedures apply to the preparation of the company’s proxy statement and Form 10-K, including the CD&A. 

    Is a compensation committee report still required?

    The Compensation Committee Report, in its old form, is no longer required. The SEC is, however, requiring a new Compensation Committee Report, similar to the Audit Committee Report, which must state whether:

    ·         the compensation committee has reviewed and discussed the CD&A with management; and
    ·         based on the review and discussions, the compensation committee recommended to the board of directors that the CD&A be included in the company’s annual report on Form 10-K and, as applicable, in the company’s proxy statement or information statement.

    The Compensation Committee Report:

    ·         will be required to be included or incorporated by reference into the company’s annual report on Form 10-K so that it is presented along with the CD&A when that disclosure is provided in the Form 10-K or incorporated by reference from a proxy or information statement;
    ·         will only be required one time during any fiscal year;
    ·         must include the name of each member of the compensation committee below the disclosure; and
    ·         will be considered furnished to, rather than filed with, the SEC.

    In addition, the principal executive officer and the principal financial officer will be able to look to the Compensation Committee Report in providing their certifications as required under Exchange Act Rules 13a-14 and 15d-14.

    Is a performance graph still required?


    The performance graph will still be required, although it will not be presented as a part of executive compensation disclosure. The requirements for the performance graph will be moved from the “Executive Compensation” disclosure in the proxy statement to the “Market Price of Dividends on the Registrant’s Common Equity and Related Stockholder Matters” in the company’s Annual Report on Form 10-K.