- SEC Expands Proxy Disclosure Requirements
- February 9, 2010 | Author: Bryan T. Allen
- Law Firm: Parr Brown Gee & Loveless, A Professional Corporation - Salt Lake City Office
The U.S. Securities and Exchange Commission (“SEC”) has adopted and published final rules that expand the required disclosure of compensation and corporate governance matters in proxy materials and mandate prompt reporting of shareholder voting results.
For proxy statements and Forms 10-K filed on or after February 28, 2010, the new rules require an SEC reporting company to:
- Report stock and option awards at their total grant date fair value in the Summary Compensation Table or Director Compensation Table, as applicable, in the year awarded. Under the prior rule, such items were reported in the Summary Compensation Table and Director Compensation Table based on their annual financial statement accounting expense over the service period of the award. To allow easier year-to-year comparisons most reporting companies will have to re-compute under the new method the option and other stock award costs they reported in prior year Summary Compensation Tables or Director Compensation Tables under the old method. The change in the method of computing option and stock award compensation may impact the determination of a company’s “named executive officers.”
- Report performance awards in the Summary Compensation Table or Director Compensation Table based on the grant date estimate of the compensation cost of such awards to be recognized over the applicable service period, based on probable outcome of performance conditions, without regard to risk of forfeiture. Summary Compensation Table or Director Compensation Table footnote disclosure is required for the maximum value of such awards.
- Discuss in a separate disclosure outside the Compensation Discussion and Analysis (“CD&A”) how the company’s overall compensation policies for employees generally (not just its executives) may affect its risk management practices or risk-taking incentives if the risks arising from those compensation policies are reasonably likely to have a material adverse effect on the company.
- Describe the specific qualifications that led to the conclusion that a person should serve as a director.
- Describe the board’s leadership structure, including whether and why the company has chosen to combine or separate the Chairman of the Board and the CEO positions.
- Describe how the board oversees and monitors risk, including the manner in which such monitoring is conducted and the effect that monitoring has on the board’s leadership structure.
- Expand the disclosure of the legal proceedings to which directors, director nominees and executive officers have been subject and the other directorships held by directors and director nominees.
- Disclose how diversity is considered in the director nomination process.
- In the case of a compensation consultant retained by the compensation committee (or by management if the compensation committee has not retained a compensation consultant), disclose the fees paid to compensation consultants if the fees for non-executive compensation services to the company (other than services relating to 401(k) and other broad-based plans) exceed $120,000 during the company’s prior fiscal year, subject to certain exceptions.
- Report the results or preliminary results of a shareholder vote on Form 8-K within four business days of such vote.
The enhanced disclosure requirements will apply to companies that have a class of equity securities subject to SEC proxy rules, but not to foreign private issuers. The new rules apply to all definitive proxy statements, securities registration statements, and other filings made on or after February 28, 2010, except for the requirement to restate prior years in the reporting of stock and option awards in the Summary Compensation and Director Compensation Tables, which applies only to reporting companies with a fiscal year ending on or after December 20, 2009.
EXPANDED COMPENSATION DISCLOSURE
Summary Compensation Table and Directors Compensation Table
The new rules revise how and when stock and option awards are reported in a proxy statement’s Summary Compensation Table and Director Compensation Table, as applicable. Currently, companies are required to calculate and disclose equity-based awards in the Summary Compensation Table and Director Compensation Table based on the awards’ value recognized for financial statement reporting purposes with respect to a fiscal year. Under the new rules, equity-based awards must be included in these tables when granted during the fiscal year (regardless of the service period to which they relate) and companies must calculate and disclose the awards’ aggregate grant date fair value, computed in accordance with Accounting Standards Codification Topic 718, Compensation Stock Compensation (“ASC Topic 718”) promulgated by the Financial Accounting Standards Board (formerly referred to as SFAS 123R). Under this new approach, the incremental fair value of options or stock appreciation rights repriced or materially modified during the fiscal year must be included in the table in accordance with ASC Topic 718.
While the SEC recognizes that the new method will affect the identities of a company’s named executive officers, it believes that using the full grant date fair value calculation is more useful and informative than the financial statement recognition method because “aggregate grant date fair value disclosure better reflects the compensation committee’s decision with regard to stock and option awards.” The SEC also recognizes that circumstances may occur where a reporting company may grant large one-time, multi-year awards or make other compensation decisions that would cause the named executive officers to change for a particular fiscal year. Where a large equity grant results in the omission from the Summary Compensation Table of an executive officer whose compensation otherwise would have been subject to reporting, the SEC recommends that the company consider including compensation disclosure for that displaced executive officer to supplement the required disclosures.
The final rules contain a new instruction regarding awards that are subject to performance conditions. Specifically, the grant date fair value of these awards should be calculated and disclosed based upon the probable outcome of such conditions. The grant date value should be consistent with the estimate of aggregate compensation cost to be recognized over the service period determined as of the grant date under ASC Topic 718, excluding the effect of estimated forfeitures. If the amount reported in the Summary Compensation Table or Director Compensation Table, as applicable, is less than the maximum potential value of such award, the company must disclose in a footnote to the table the value of the award at the grant date assuming that the highest level of performance conditions will be achieved.
Companies with a fiscal year ending on or after December 20, 2009 must present in the Summary Compensation Table recomputed compensation for the two fiscal years preceding that fiscal year for the named executive officers to reflect the grant date fair market value basis of prior awards. This requirement to restate will apply even if the named executive officer would not have been a named executive officer in the prior two fiscal years based on the grant date fair value methodology. Issuers will not need to re-determine the named executive officers for those prior years or to amend prior years’ already-filed disclosures.
Note that under the new rules, the individual grant date fair market values of options and other stock awards is still required to be reported in the Grants of Plan-Based Awards Table and in footnotes to the Director Compensation Table, as applicable.
Risk Management - Narrative Disclosure about a Company’s Compensation Policies and Practices
The final rules require a company to provide narrative disclosure regarding its policies and practices of compensating its employees, including non-executive officers, as they relate to risk management practices and risk-taking incentives, to the extent the risks arising from those compensation policies and practices are “reasonably likely to have a material adverse effect” on the company. No disclosure is required unless the “reasonably likely to have a material adverse effect” threshold is met. This additional disclosure will be included in a separate proxy statement section under the heading “Compensation Policies and Procedures,” and will not be included in the Compensation Disclosure and Analysis section .
The final rules emphasize that the type of disclosure required under this requirement will depend on the particular company and its compensation policies. As a guide, the rule contains a non-exhaustive list of situations where compensation policies and practices may have the potential to raise material adverse risks to companies. The list includes, among other things, the existence of 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 where compensation is structured significantly differently than it is at other units within the company;
- at business units that are significantly more profitable than others within the company;
- at business units where compensation expense is a significant percentage of the unit’s revenues; and
- that vary significantly from the overall risk and reward structure of the company, such as bonuses that 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.
Similarly, the final rules do not contain any specific issues that a company must discuss and analyze but, rather, includes a set of “illustrative examples” that a company should consider addressing if it determines that disclosure regarding such policies or practices is required. These examples include:
- the general design philosophy 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 such policies and practices that relate to or affect risk-taking by those employees on behalf of the company, and the manner of their implementation;
- 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 policies requiring claw-backs or imposing holding periods;
- the company’s policies regarding adjustments to its compensation policies to address changes in its risk profile;
- material adjustments the company has made to its compensation policies or practices as a result of changes in its risk profile; and
- the extent to which the company monitors its compensation policies to determine whether its risk management objectives are being met with respect to incentivizing its employees.
ENHANCED CORPORATE GOVERNANCE DISCLOSURES
The new rules include a number of amendments designed to expand corporate governance disclosure in proxy statements, securities registration statements, and other filings.
The rules amend applicable regulations to require additional disclosures about directors or director nominees in a company’s proxy statement and annual reports. Companies will now be required to include in their proxy materials a discussion of the “specific experience, qualifications, attributes or skills that led to the conclusion that the person should serve as a director for the [company] at the time that the disclosure is made, in light of the [company’s] business and structure.” This disclosure will also be required in the proxy soliciting materials for any director nominees nominated by shareholders. The new rule further provides that, if material, “this disclosure should cover more than the past five years, including information about the person’s particular areas of expertise or other relevant qualifications.” These new disclosures will be required for all nominees and for all directors, including those not up for re-election in a particular year, and are in addition to the current requirements that companies briefly describe the business experience during the past five years of each director nominee and that companies discuss the minimum qualifications and specific qualities or skills that the nominating committee believes are necessary for one or more directors to possess.
The final rules also make three additional changes to disclosures related to directors, director nominees, and executive officers, as follows:
- Companies will have to disclose all directorships in public companies held by any director or director nominee during the preceding five years, even if that person no longer serves on the other board. Under the current rule, directors and nominees have been required to disclose only their current directorships.
- The period for which directors, director nominees and executive officers are required to disclose their involvement in certain legal proceedings, such as bankruptcy proceedings, and being subject to certain orders such as securities law judgments, is extended to ten years from five.
- Finally, the list of legal proceedings and orders required to be disclosed by directors, director nominees, and executive officers is expanded to include: 1) any judicial or administrative order, judgment, decree or finding (not subsequently reversed, suspended or vacated) relating to an alleged violation of mail or wire fraud or fraud in connection with any business entity; 2) 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 action; and 3) any sanction or order (not subsequently reversed, suspended or vacated) of any self-regulatory agency, registered entity or equivalent organization.
Each of the changes noted will apply to a company’s proxy and information statements filed on Schedules 14A and 14C, annual reports filed on Form 10-K, and any registration statements on Forms 10, S-1, S-4 and S-11.
New Information about a Board’s Leadership Structure and the Board’s Role in Risk Oversight
The new rules require a brief description of a board’s leadership structure and why the company believes the structure is appropriate given its specific characteristics or circumstances. In particular, companies must discuss whether and why they have chosen to combine or separate the Chairman of the Board and the CEO positions. If these positions are combined, the company must disclose whether it has a lead independent director and what specific role that director plays in the leadership of the board.
Companies will also be required to disclose the extent of the board’s role in the risk oversight of the company, such as how the board administers its oversight function and the effect that this has on the board’s leadership structure. The SEC has not prescribed specific issues to be discussed in this regard; rather, the SEC views this disclosure requirement as giving companies the flexibility to describe how the board administers its risk oversight function, such as through the whole board, or through a separate risk committee or the audit committee, for example. The SEC suggests that, where relevant, companies may want to address whether the individuals who supervise the day-to-day risk management responsibilities report directly to the board as a whole or to a board committee or how the board or committee otherwise receives information from such individuals.
The final rules require companies to disclose the role of diversity in the process by which candidates for director are considered for nomination by a company’s nominating committee (or by the board if there is no nominating committee). Specifically, companies must disclose whether, and if so how, the nominating committee (or the board) considers diversity in identifying nominees for director. If the nominating committee (or the board) has a policy with regard to the consideration of diversity in identifying director nominees, the company must describe how this policy is implemented, as well as how the nominating committee (or the board) assesses the effectiveness of its policy. The final rules do not define the term “diversity” for purposes of this new disclosure, based on the SEC’s belief that “companies should be allowed to define diversity in ways that they consider appropriate.” The SEC also notes that “some companies may conceptualize diversity expansively to include differences of viewpoint, professional experience, education, skill and other individual qualities and attributes that contribute to board heterogeneity, while others may focus on diversity concepts such as race, gender and national origin.”
Compensation Consultant Disclosures
Under current regulations, companies are required to disclose in their proxy materials any role played by compensation consultants in determining or recommending the amount or form of executive and director compensation, the identity of those consultants, whether they were engaged directly by the compensation committee, the nature and scope of their assignment, and the material elements of the instructions or directions given to them. The final rules expand this disclosure in certain circumstances to address possible conflicts of interest where the compensation consultant provides additional services to the company.
Specifically, if the compensation consultant was engaged by the compensation committee (or persons performing the equivalent functions) to provide advice or recommendations on the amount or form of executive and director compensation and the consultant or its affiliates also provided additional services to the company for fees in an amount in excess of $120,000 during the fiscal year, the company will be required to disclose:
- the aggregate fees for determining or recommending the amount or form of executive and director compensation and the aggregate fees for the additional services;
- whether the decision to engage the compensation consultants or their affiliates for the other services was made, or recommended, by management; and
- whether the compensation committee or the board approved the other services of the compensation consultants or their affiliates.
Companies are not required to include a description of any additional non-executive compensation consulting services provided by the compensation consultant and its affiliates, but the SEC indicates in the final rule that a company may include such a description “where such information would facilitate investor understanding of the existence or nature of any potential conflict of interest.”
If the compensation committee (or persons performing the equivalent functions) has not engaged a compensation consultant, but management has engaged a compensation consultant to provide advice or recommendations on the amount or form of executive and director compensation and such consultant or its affiliates has provided additional services to the registrant in an amount in excess of $120,000 during the fiscal year, the company will be required to disclose the aggregate fees for determining or recommending the amount or form of executive and director compensation and the aggregate fees for any additional services.
The new rules would not require additional disclosures in situations where both the compensation committee (or persons performing equivalent functions) and management have engaged separate compensation consultants, so long as the compensation consultant retained by the compensation committee (or persons performing equivalent functions) and its affiliates did not provide additional services in excess of $120,000 during the fiscal year. This exclusion applies even if the compensation consultant retained by management receives in excess of $120,000 of compensation for the other services. The SEC indicates that this exclusion is appropriate since the compensation committee’s engagement of its own compensation consultant mitigates any potential conflict of interest. The final rules include an exception whereby disclosure is not required if the compensation consultant’s only role in recommending executive or director compensation is in connection with consulting on non-discriminatory broad-based plans that are generally available to all salaried employees (such as 401(k) and health insurance plans) in which executives and directors may participate.
The final rules also contain an exception whereby disclosure is not required if the compensation consultant’s role in determining or recommending executive or director compensation is limited to providing information (such as surveys) that either is not customized for a particular company or that is customized based on parameters that are not developed by the consultant, and about which the consultant does not provide advice; this particular exception would not be available, however, if the compensation consultant provides advice or recommendations in connection with the information provided in the survey.
Expedited Voting Results
Under the existing rule, companies are required to disclose the results of a shareholder vote in their next filing on either Form 10-Q or Form 10-K. Consequently, disclosure has often been delayed by up to three months following a shareholder vote. To prevent such delays, the new rules require the results or preliminary results of the vote to be reported in a Form 8-K within four business days after the day on which the meeting ended.
Because the final rules generally will be effective for the 2010 proxy season, companies should immediately begin taking actions to integrate these changes into their policies and procedures. For example, companies should consider:
- revising their directors’ and officers’ questionnaires to reflect the changes to the disclosures concerning directors and executive officers;
- confirming that no new disclosures will be required as a result of the expanded legal proceedings and orders disclosure;
- adopting procedures to track the services provided by, and the fees paid to, compensation consultants and their affiliates;
- discussing with the nominating committee how to explain more fully its rationale for recommending a director nominee or incumbent director and how board diversity is determined and implemented; and
- evaluating who the “named executive officers” will be under the grant date fair value reporting method.