• SEC Proposes New Requirements for Executive Compensation and Related Party Disclosure
  • March 10, 2006
  • Law Firm: Dinsmore & Shohl LLP - Cincinnati Office
  • On January 27, 2006, the Securities and Exchange Commission (the "SEC") proposed rules that would, among other things, amend disclosure requirements for executive and director compensation, related party transactions, director independence and other corporate governance matters. The proposals are intended to make proxy statements, reports and registration statements easier to understand and provide investors with "a clearer and more complete picture of the compensation" earned by a company's principal executive officer, principal financial officer, and the three other highest compensated executive officers. While the new rules will not apply to the 2006 proxy season, companies should familiarize themselves with the changes in preparation of their adoption.

    I. Executive and Director Compensation

    The new rules combine the currently utilized system of tabular disclosure with increased reliance on narrative disclosures. Under the proposal, compensation disclosure would begin with a narrative providing a general overview in the form of a Compensation Discussion and Analysis. This narrative will provide the material factors underlying each company's compensation practices and policies in respect to both the separate elements of executive compensation and executive compensation as a whole.

    In addition to the Compensation Discussion and Analysis, the proposal provides for three broad categories of executive compensation disclosure, including:

    (i) A revised Summary Compensation Table disclosing compensation with respect to the last three fiscal years and requiring disclosure of a single figure for total compensation for named executive officers, supplemented by tables reporting Grants of Performance-Based Awards and Grants of All Other Equity Awards;

    (ii) A table disclosing holdings of equity-based awards as of the end of the last fiscal year, as well as a table disclosing recent vesting or exercise of equity-based awards during the last fiscal year; and

    (iii) A table disclosing retirement and other post-employment benefits, including retirement and defined contribution and other deferred compensation plans.

    The proposal requires narrative disclosure, when appropriate, to supplement the information provided in the tables outlined above. In addition, a Director Compensation Table, similar to the proposed executive Summary Compensation Table, would disclose director compensation.

    II. Related Person Transactions, Director Independence and Other Corporate Governance Matters

    In addition to amending executive compensation disclosures, the proposal would significantly revise the disclosure provisions regarding related person transactions under Item 404 of Regulation S-K "Certain Relationships and Related Transactions" by adopting a more principle-based scheme. The proposal consists of four parts, including:

    (i) Item 404(a) would contain a general disclosure requirement for related transactions, including those involving indebtedness;

    (ii) Item 404(b) would require disclosure regarding the company's policies and procedures for review, approval or ratification of related person transactions;

    (iii) Item 404(c) would require disclosure regarding promoters of a company; and

    (iv) New Item 407 (described below).

    Specifically, proposed Item 404(a) would consolidate current Items 404(a) and 404(c). Under the proposed rule, a company must provide disclosure of any transaction since the beginning of the company's last fiscal year or any currently proposed transaction in which (i) the company was or is to be a participant; (ii) the amount involved exceeds $120,000; and (iii) any related person had, or will have, a direct or indirect material interest. This reflects several changes from current disclosure requirements. First, the proposal calls for disclosure if a company is a "participant" in a transaction, rather than the current use of the term "party." Second, the proposal increases the current $60,000 threshold for disclosure to $120,000 to adjust for inflation. Finally, the proposal would include a single defined term for the term "related persons."

    New Item 407 would consolidate current corporate governance disclosure requirements, including director independence, information relating to the number of board meetings and attendance, and specific disclosures relating to nominating and auditing committees. In addition, proposed Item 407 would require disclosure of director (and director nominee) independence, along with a description of any relationships not otherwise disclosed that were considered when determining whether each director (and director nominee) is independent.

    III. Form 8-K

    Effective August 2004, the SEC adopted amendments to Form 8-K that significantly expanded the number of events reportable on Form 8-K while reducing the reporting deadline for most Form 8-K disclosure items to four days after a triggering event. In its proposal, the SEC recognized that executive compensation disclosures are more frequent and accelerated than those included in a company's proxy statement and that such disclosures fall short of the "unquestionably or presumptively material" standard as was the goal of the expanded Form 8-K.

    In response, the proposal would amend Item 1.01 of Form 8-K to eliminate employment compensation arrangements and locate all such disclosures under a single Item 5.02.

    IV. Plain English Disclosure

    The proposal would require that companies prepare disclosures relating to executive and director compensation, related person transactions, beneficial ownership and corporate governance using plain English principles, which include:

    (i) Presentation of information in clear, concise sections, paragraphs and sentences;

    (ii) Use of short sentences;

    (iii) Use of definite, concrete, everyday words;

    (iv) Use of active voice;

    (v) Avoidance of multiple negatives; and

    (vi) Use of descriptive headings and subheadings.

    The full text of these principles, along with the text of the proposed rule, can be accessed at http://www.sec.gov/rules/proposed/33-8655.pdf. Comments on the proposed rule must be received by the SEC on or before April 10, 2006.