• SEC Proposes Significant Changes to Compensation Disclosure Requirements
  • February 17, 2006 | Authors: J. Chase Cole; James H. Nixon
  • Law Firm: Waller Lansden Dortch & Davis, LLP - Nashville Office
  • The Securities and Exchange Commission (SEC) recently issued a much-anticipated, far-ranging proposal to significantly revise the required disclosure regarding executive and director compensation for publicly-held companies. Filings for the 2006 proxy season will not be impacted although companies will benefit from careful review and consideration of the proposed changes.

    The proposal is the first extensive reworking of the disclosure rules for executive and director compensation since 1992, and the overarching intent of the proposal is to provide a clearer and more complete picture of compensation. Responding to investor concerns that the existing disclosure scheme was overly complex and outdated, the SEC proposes to continue the tabular approach adopted in 1992 but to seek broader-based tabular presentations that include all elements of compensation along with improved narrative disclosure.

    I. Compensation Discussion and Analysis

    The SEC proposes to require narrative disclosure (similar to Management's Discussion and Analysis of Financial Condition and Results of Operations) of the material principles underlying a company's compensation policies in an introductory section labeled "Compensation Discussion and Analysis" (CD&A). CD&A would be an overview to place other compensation disclosure into context by explaining the material factors relevant to an analysis of a company's compensation policies, including the objectives of such policies, the elements of compensation, how the company determines the amount of each element, and how each element fits into the overall compensation objectives of the company.

    Boilerplate disclosure is expressly prohibited under the proposal, which sets forth examples of issues appropriate for coverage in CD&A such as policies for allocating between long-term and current compensation, policies for allocating between cash and non-cash compensation and among different forms of non-cash compensation, and how the determination is made as to when an equity-based award is granted. Such detailed disclosure raises the specter of exposing sensitive business information, and the SEC plans to avoid that possibility by including an instruction that a company is not required to disclose target levels with respect to specific quantitative or qualitative performance factors. CD&A would replace the existing Compensation Committee Report and Performance Graph, and would be covered by the certifications made in periodic reports by a company's executive officers. Unlike the Compensation Committee Report, CD&A would not be made over the names of the Compensation Committee members.

    II. Compensation Tables for Named Executive Officers

    While the current tabular presentation framework is preserved with the proposal, the tables are reorganized and streamlined. The new Summary Compensation Table would cover the named executive officers' compensation for the last three years, including a new total compensation column. The proposed addition of a total column responds to investor and analyst concerns that the current disclosure scheme does not provide a method for computing aggregate compensation in a manner that is accurate or readily comparable across years or companies. Additionally, the proposal seeks to improve the disclosure of perquisites and other personal benefits and provides that such benefits in excess of $10,000, instead of the current $50,000, must be disclosed. No bright line definition of perquisites is provided, but factors for the analysis are included and examples of benefits that would, and would not, be deemed perquisites are provided. The Summary Compensation Table is supplemented by two tables that disclose additional information about grants of performance-based awards and grants of all other equity awards.

    Two new tables would present information about equity exercises and holdings for named executive officers during the most recent fiscal year. One table would focus on awards that remain outstanding, either unexercised or unvested, and the second table would disclose amounts realized from the exercise or vesting of equity awards.

    The proposal also strives to achieve more helpful disclosure of post-employment compensation by creating new tables that estimate annual retirement payments under defined benefit plans, nonqualified defined contribution and other deferred compensation plans. Finally, the proposal contains new requirements with regard to termination or change in control provisions including disclosure of specific aspects of any arrangement that provides for payments following such an event.

    Generally, the tables must be accompanied by meaningful narrative disclosure that sets out material factors necessary to an understanding of information disclosed in the tables.

    III. Director Compensation

    Noting the increasing complexity of director compensation packages, the SEC proposes a Director Compensation Table similar to the proposed Summary Compensation Table, except that it would only cover the last completed fiscal year. The director table would include a total column and be accompanied by narrative disclosure describing material factors helpful in understanding the table.

    IV. Other Items

    The proposal also includes changes to Form 8-K relating to executive compensation matters and revised disclosure rules regarding related party transactions and director independence.

    Conclusion

    The proposal seeks to balance investors' right to know information necessary for the functioning of efficient capital markets against overly-burdensome and economically punitive disclosure requirements. Additionally, the proposal intentionally avoids addressing what executive compensation should be, but rather aspires to set forth a disclosure regime that improves the quality and quantity of information in the marketplace.