July 26, 2006
Today, the Securities and Exchange Commission (“SEC”) voted unanimously to adopt new rules that will revise the disclosure requirements for executive and director compensation, related-party transactions, director independence and other corporate governance matters. The new rules will be effective for fiscal years ending on or after December 15, 2006, and therefore will apply to disclosures of 2006 compensation in companies’ 2007 proxy statements. The new rules applicable to disclosure of executive compensation arrangements on Form 8-K will become effective 60 days after the SEC issues the adopting release. We anticipate that the final rules and adopting release will be publicly available in the first part of August.
A summary of the new rules is set forth below. It is based on information provided at the SEC’s open meeting, and therefore may not reflect nuances that will appear in the forthcoming adopting release. We will provide further guidance on the new rules after the adopting release is issued.
Disclosure of Other Employees’ Compensation
The SEC did not adopt its proposal to require disclosure of the compensation paid to non-executive employees whose compensation exceeds that paid to any of the named executive officers. However, the SEC will propose and seek comment on an alternative provision under which companies that are “large accelerated filers” would be required to disclose the total compensation of up to three employees:
who are not executive officers but who have significant policy-making powers either within the company or within a significant subsidiary, principal business unit, division or function of the company; and
whose compensation exceeds that of any of the named executive officers listed in the Summary Compensation Table.
The SEC also will seek comment on whether these employees should be named in the proxy statement or identified only by job description.
Compensation Discussion & Analysis
The new rules delete the current requirement for a Board Compensation Committee Report on Executive Compensation and require instead a Compensation Discussion & Analysis (“CD&A”). SEC officials emphasized that the CD&A is intended to provide a dramatically different perspective on executive compensation compared to the existing Compensation Committee Report, as it will address the objectives, implementation and factors underlying each element of compensation paid to the named executive officers. The CD&A will be filed, rather than furnished, and thus subject to certification by a company’s principal executive officer and principal financial officer. In addition, SEC officials stated that they intend to review and comment on the CD&A to ensure that companies avoid “boilerplate” disclosures and to enforce the requirement that companies disclose any applicable performance criteria or formula used in determining the named executive officers’ compensation unless they can satisfy the burden of demonstrating that the information is both confidential and competitively sensitive.
In addition to the CD&A, companies will be required to furnish a compensation committee report that is similar to the existing audit committee report. This new report will be a brief statement on whether the compensation committee reviewed and discussed with management the CD&A and, based on that review and discussion, whether the committee recommended to the company’s board of directors that the CD&A be included in the company’s proxy statement and annual report on Form 10-K.
Determination of the Named Executive Officers
The “named executive officers” for whom compensation disclosure is required under the new rules will be the principal executive officer, the principal financial officer and the three other most highly compensated executive officers. The most highly compensated executives will be determined based on each executive’s “total compensation” number for the last fiscal year as required to be reported in the Summary Compensation Table (as discussed below) except that, in contrast to the proposed rules, amounts disclosed as earnings on deferred compensation and the actuarial increase in pension benefit accruals will not be counted. We understand that the final rules also will continue to include as “named executive officers” up to two additional executive officers who would have been “named executive officers” based on their “total compensation” (including perhaps severance payments) but for the fact that they were not executive officers at the end of the fiscal year.
Revised Compensation Tables
The new rules will require most companies to set forth six tables disclosing various aspects of the named executive officers’ compensation.
Summary Compensation Table
The Summary Compensation Table has been substantially revised from the current table, as reflected in the sample set forth at the end of this client alert. The table will include columns reporting dollar amounts for salary, bonus, stock awards, option awards, non-stock incentive plan compensation, the actuarial increase in pension plan accruals and above-market earnings on deferred compensation, and all other compensation, and will sum-up the foregoing amounts in a new “total compensation” column. The columns showing stock awards and option awards will be measured by grant date fair value and computed using the Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 123 (revised), Share-Based Payment (“FAS 123R”). The column disclosing all other compensation will include perquisites valued in the aggregate at $10,000 or more. In addition, the adopting release will contain further interpretive guidance regarding the determination of what is a perquisite.
The Summary Compensation Table will “phase-in” over the next three years, so that in the first two years companies will not be required to recalculate or restate compensation for fiscal years that were covered in previously filed proxy statements. Thus, companies’ 2007 proxy statements generally will include only disclosures for the 2006 fiscal year.
Grants of Plan-Based Awards Table
The Summary Compensation Table will be accompanied by a Grants of Plan-Based Awards Table that provides additional detail regarding stock options and other equity awards (such as restricted stock or restricted stock units) granted during the fiscal year and amounts payable under other compensation plans (such as long-term incentive awards that are payable in cash or stock). In response to recent concerns about stock option grant practices, this table will require extensive disclosure on option grants, including: (1) the grant date FAS 123R fair value; (2) the grant date for accounting purposes; (3) the stock’s closing market price on the date of grant if greater than the option’s exercise price; and (4) the date on which the compensation committee (or the full board of directors) took action to grant the award if different than the grant date. If the exercise price is not the closing market price on the date of grant (for example, if the exercise price is the average of the high and low stock price on the grant date), companies will be required to provide a description of the methodology used in determining the option exercise price.
Outstanding Equity Awards at Fiscal-Year End Table
The Outstanding Equity Awards at Fiscal-Year End Table will present information on each outstanding equity award held by companies’ named executive officers at the end of the fiscal year, including the number of securities underlying both exercisable and unexercisable portions of each stock option as well as the exercise price and expiration date of each outstanding option. Unlike current disclosure requirements, this information will be presented on a grant-by-grant (instead of aggregate) basis, meaning that extensive space will be devoted to disclosure on executives who hold numerous awards.
Option Exercises and Stock Vested Table
The Option Exercises and Stock Vested Table will show amounts realized by companies’ named executive officers on options that were exercised or other stock awards that were earned during the last fiscal year. Companies will not, however, be required to disclose the FAS 123R grant date value of these awards.
Pension Benefits Table
The existing Pension Plan Table will be replaced with a new Pension Benefits Table, which will provide disclosure of the actuarial present value of each named executive officer’s accumulated benefit under each pension plan, assuming benefits are paid at normal retirement age based upon current levels of compensation. The value under each pension plan will be determined using the same assumptions used for financial statement purposes.
Nonqualified Deferred Compensation Table
The Nonqualified Deferred Compensation Table will disclose executive and company contributions under non-qualified defined contribution and other deferred compensation plans, as well as each named executive officer’s withdrawals, earnings and fiscal-year end balances in those plans. In contrast to the new Summary Compensation Table, which requires disclosure of only above-market or preferential earnings on non-qualified deferred compensation, all earnings on named executive officers’ deferred compensation will be disclosed in this table.
Termination and Change in Control Payments
The rules will require a narrative description of any arrangement that provides for payments or benefits in connection with a named executive officer’s termination of employment, a change in his or her responsibilities or a change in control of the company. In addition, companies will be required to quantify the amount (or estimate the range of amounts) that would have been payable to each named executive officer under each of the foregoing triggering events, assuming that the triggering event had occurred as of the end of the last fiscal year. Any benefits that are valued based on stock price likewise will be quantified based upon the stock’s price as of the end of the last fiscal year.
Stock Option Grant Practices
As noted above, in response to recent concerns about stock option grant practices, the rules and adopting release will contain extensive new disclosure requirements focusing on the timing of option grants in coordination with the release of material non-public information and the determination of exercise prices that differ from the stock price on the date of grant. In addition to the tabular disclosures addressed above, additional disclosure will be required in the CD&A regarding option grant practices, when applicable. With respect to both the timing of stock options and any programs under which option exercise prices are set at an amount below the closing market price of the stock on the grant date, SEC guidance will require companies to answer questions such as:
Does the company have a program or practice in place to time option grants to executive officers with the release of material non-public information (or to set exercise prices in coordination with such release)?
How does that program or practice fit into the context of the company’s program or practice, if any, with regard to option grants to employees generally?
What was the compensation committee’s role in approving and administering that program or practice?
What was the role of executive officers in the company’s program or practice?
Does the company plan to time, or has it timed, the release of material non-public information in order to affect the value of executive compensation?
Related-Party Transactions
The rules will make disclosure of related-party transactions more principles-based and increase the threshold for reporting such transactions from $60,000 to $120,000. Further, the rules will require disclosure of companies’ policies and procedures for reviewing and approving or ratifying related-party transactions.
Corporate Governance Disclosures
The new rules will consolidate and enhance disclosure requirements for director independence and other corporate governance matters. Disclosure will include: (1) standards applied by companies in assessing director independence; (2) whether each director and director nominee is independent; (3) descriptions of categories of transactions, relationships or arrangements not disclosed as related-party transactions but considered by the board of directors in determining director independence; (4) whether any members of the audit, nominating or compensation committees are not independent; and (5) extensive new disclosures on compensation committees’ procedures for determining executive and director compensation and the role of compensation consultants.
Other Requirements
Security Ownership of Directors and Officers: The rules will require disclosure of the number of shares owned by management that are subject to any pledge.
Director Compensation Table: As proposed, director compensation (including perquisites) for the last fiscal year must be disclosed in a new Director Compensation Table, which will mirror the format of the Summary Compensation Table described above.
Form 8-K: Under the new rules, disclosure requirements for executive compensation arrangements on Form 8-K will be revised to apply to employment arrangements and material amendments to those arrangements for named executive officers only.
Performance Graph: The SEC has retained the requirement for the stock performance graph, but moved it to appear in companies’ Form 10-K and annual report to stockholders.
Plain English: The rules will require companies to present most of this information in plain English, in order to provide clarity for the lay reader.
Planning for the New Rules
In preparing for the new rules, we recommend that companies:
Evaluate who their named executive officers are likely to be based upon the total compensation number (excluding deferred compensation earnings and the actuarial increase in pension plan accruals);
Prepare mockups of their executive and director compensation disclosure tables for compensation committee review;
Assess their disclosure controls and procedures for gathering the information that will be disclosed, with particular attention to determining which departments in the company are responsible for producing the necessary information and confirming that the information is calculated in the required manner;
Determine what elements of compensation each named executive officer receives, including details on the bases for and objectives of these elements of compensation and the factors affecting the amount of compensation (including potentially disclosable performance criteria), so that these can be described in the CD&A;
Review their procedures relating to option grants, and determine whether any changes in process are desirable;
Identify each benefit that is potentially payable to a named executive officer upon a change in control or termination of employment, the precise definitions of each triggering event, and the amounts (or an estimate of the range of amounts) payable under those benefits upon the occurrence of each triggering event;
Review and document their policies and procedures for approval or ratification of related-party transactions, and assess their procedures for identifying those transactions on a real-time basis; and
If relevant to the company, submit comments on the costs and possible competitive impact of the reproposed rule for disclosure of compensation to highly paid non-executives who have a significant policy-making or managerial role.
Summary Compensation Table
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Name
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Year |
Salary |
Bonus |
Stock |
Option |
Non- |
Change in |
All |
Total |
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PEO[1] |
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PFO[2] |
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A |
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B |
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C |
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Gibson, Dunn & Crutcher lawyers are available to assist clients in addressing any questions they may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or John F. Olson (202-955-8522, [email protected]), Ronald O. Mueller (202-955-8671, [email protected]), Brian J. Lane (202-887-3646, [email protected]), Amy L. Goodman (202-955-8653, [email protected]), Stephen Fackler (650-849-5385, [email protected]), James Moloney (949-451-4343, [email protected]), or Elizabeth Ising (202-955-8287, [email protected]).
© 2006 Gibson, Dunn & Crutcher LLP
The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.