The 2007 proxy season was marked by significant new disclosure requirements for executive and director compensation, related party transactions, director independence and other governance matters that required companies to overhaul their proxy statements last year. While the 2008 proxy season may seem tame by comparison, new insight into these disclosures, as well as a few new rules and requirements, will have an impact on preparing for the annual meeting this year. Set forth below are the key items companies should consider now.
Annual Meeting Timetable
Large accelerated filers should review their annual meeting timetable and update it to reflect the model they will follow for delivery of proxy materials under the Securities and Exchange Commission’s new e-proxy rules. As discussed below under “E-Proxy Rules,” a determination to proceed with delivery under the “notice and access” model will mean that the company must meet new deadlines for completion of their proxy statement and annual report.
In addition, while companies may not need as much time or as many compensation committee meetings this year as compared to last to prepare their executive compensation disclosure, companies should determine the time and meetings that will be required and address any “lessons learned” from last year’s process. This means the appropriate disclosure team must coordinate early to identify responsibilities and deadlines.
The SEC adopted amendments to its proxy rules to require public companies and other soliciting persons to furnish proxy materials to shareholders using the Internet. All large accelerated filers except mutual funds must comply for solicitations commencing on or after January 1, 2008. All other companies and other soliciting persons, including mutual funds, must comply beginning January 1, 2009. For a discussion of the SEC’s mandatory e-proxy rules, see our Corporate Update dated June 27, 2007.
Under the new rules, all companies and other solicitors subject to the new rules must post a complete set of proxy materials on a website other than EDGAR and send a notice of availability to shareholders. The web-posted materials must be presented in a format “convenient for reading online” and for printing on paper, and the website must be maintained in a manner that does not infringe on the anonymity of a person accessing it. Companies must provide paper or e-mail copies, as specified by the shareholder, within three business days of a shareholder request.
Under the e-proxy rules, public companies have two choices for proxy delivery: "notice and access" or "full set delivery.” If a company determines to rely on the notice and access model for some or all shareholders, it must send the notice to shareholders and file it with the SEC at least 40 days before the shareholders’ meeting. However, a company using the full set delivery model for its proxy materials is not subject to this 40-day notice requirement.
Whether to e-proxy or not. In general, companies need to balance several factors in deciding whether to use the notice and access model for some or all shareholders. In particular, companies need to:
- Quantify all costs under both the full set delivery model and the new notice and access model;
- Assess their ability to meet the 40-day notice requirement and the related need for earlier completion of the annual report and proxy statement (note that intermediaries, such as Broadridge, will require that the materials are available even earlier);
- Assess their ability to meet the three-business-day requirement to fulfill requests for paper copies;
- Identify voting patterns and participation and identify any quorum or meeting proposal concerns, based on both historical and future conditions;
- Assess any shareholder preferences (this will probably vary depending on retail vs. institutional ownership); and
- Assess their ability to meet web-based requirements fundamental to the success of the notice and access model (such as their ability to meet system requirements and provide “web ready” documents that facilitate online use).
Executive and Director Compensation Disclosure
Executive compensation remains a “hot topic” for the 2008 proxy season. Companies will want to refine and improve their compensation disclosure as they approach the second year of compliance with the rules. The October 2007 SEC staff report on its review of the executive compensation disclosure of over 350 large public companies and the staff’s updated interpretive guidance under Item 402 of Regulation S-K should be reviewed carefully, and companies should confirm that their executive compensation disclosure conforms to this report and updated guidance.
Companies now will need to provide two years of annual compensation in the summary compensation table (SCT), and they should assess early how the comparative data will look. New “year over year” information may need to be explained or discussed. In addition, companies may have changes in their named executive officer (NEO) group from last year, and they should assess whether this will impact their 2008 proxy statement disclosure.
SEC staff review of executive compensation disclosure. Companies that received SEC staff comments on their 2007 compensation disclosure will need to revise their proxy statements as indicated in their responses to the SEC. In addition, all companies should review and update their Compensation Discussion & Analysis (CD&A) and related tables to address the SEC staff’s observations contained in the October 2007 report (available at http://sec.gov/divisions/corpfin/guidance/execcompdisclosure.htm).
- Performance targets. Companies must analyze carefully whether to disclose specific performance targets, both for the last completed fiscal year and for future periods. This requires an analysis of whether these targets are material to executive compensation policies and decisions (and therefore subject to disclosure) and, if so, whether disclosure would result in competitive harm to the company. If a company withholds targets on the basis of potential competitive harm, the company must be ready to support its determination and provide a meaningful assessment of the difficulty of achieving the targets. The SEC has suggested that vague statements such as “challenging but achievable” or “intended to encourage superior performance” are not enough.
- Analysis. Companies should review and revise the CD&A to improve disclosure on how and why their compensation committee arrives at specific executive compensation decisions and policies, with less emphasis on compensation program mechanics and decision-making procedures.
- Plain English. Companies should continue to improve on their use of “plain English.” The SEC staff recommends using more executive summaries and company-specific tables to make disclosures more accessible.
- NEO pay differences. Companies must identify material differences in compensation policies and decisions for each NEO in the CD&A. Only where these elements are similar for multiple executives may the company group executives together in the discussion.
Time frame. In addition to addressing compensation matters with respect to the last completed fiscal year, companies should consider the need to address pay practices for the current fiscal year as well as their historical pay practices. For example, material plan design changes made during the current fiscal year should be discussed, even if previously reported on Form 8-K. In addition, decisions relating to an executive’s compensation for the last completed fiscal year may have been affected by the executive’s performance in prior years.
- Benchmarks. Companies using benchmarks to set pay should disclose more fully any benchmarks and how they are used. Companies should explain in detail why the peer companies chosen are appropriate for their business and compensation. If a company exercises discretion when applying these benchmarks, it should provide detail regarding how that discretion has been exercised.
- Change in control arrangements. Companies should discuss more extensively the rationale for entering into agreements that provide change in control benefits and how these arrangements fit within overall pay practices and philosophy.
- Termination payments. If a company has not used tables to disclose change in control or other termination payments, it should consider doing so. With respect to tables disclosing change in control and termination payments, companies should include a “total” column for each NEO.
- Valuation assumptions. Companies should review their footnote disclosure regarding valuation assumptions for stock options and relevant vesting information for options and other stock-based compensation to make sure the disclosure is complete and complies with the SEC’s requirements.
CEO’s or consultant’s role. Companies should describe more fully the role that the CEO or a compensation consultant plays in decision making about pay, including the nature and scope of a consultant’s assignment and the material instructions that the company provides to the consultant.
SEC guidance. In August 2007, the SEC updated its interpretive guidance addressing S-K Item 402 available at http://sec.gov/divisions/corpfin/guidance/execcomp402interp.htm. When preparing the 2008 proxy statement, companies should review this guidance to see if it affects any of their 2007 disclosure. A few items worth noting include:
- Equity received in lieu of salary or bonus. Salary or bonus received in the form of equity should be disclosed in either the salary or bonus column, as applicable, of the SCT so long as the value of equity received is the same as the amount of salary or bonus forgone. The result would be different if the amount of salary or bonus foregone is less than the value of the equity-based compensation received instead, or if the agreement pursuant to which the NEO had the option to elect settlement in stock or equity-based compensation was within the scope of FAS 123R (e.g., the right to stock settlement is embedded in the terms of the award). (Question 4.03)
- Reimbursed perquisites. If a perquisite is “fully reimbursed” by the NEO, then it is not necessary to disclose it; however, the concept of full reimbursement is not limited to reimbursement of the “incremental” cost. (Question 4.07)
“Negative” compensation. The SEC limits the amount by which “negative” compensation can be reflected for forfeited equity awards to amounts previously reported in the SCT under the new rules. (Question 4.11)
- Dollar-denominated equity awards. Equity incentive plan awards denominated in dollars, but payable in stock, should be disclosed in the grants of plan-based awards table by including the dollar value and a footnote to explain that it will be paid out in stock in the form of whatever number of shares that amount translates into at the time of the payout. In this limited circumstance, and if all the awards in this column are structured in this manner, it is acceptable to change the captions for columns (f) through (h) to show “($)” instead of “(#).” (Question 5.01)
- Non-qualified deferred compensation earnings. For purposes of the non-qualified deferred compensation table, “earnings” include dividends, stock price appreciation (or depreciation) and any item other than contributions, withdrawals or distributions that increases or decreases the NEO’s account balance, since the purpose of the table is to show changes in the aggregate account balance at fiscal year end for each NEO. (Question 10.02)
Option acceleration or termination. In the termination payments table, acceleration of options must be valued and disclosed and cannot be treated as generally available to all employees on a nondiscriminatory basis, unless the amounts of options are equal for all employees. (Question 11.02)
- Director equity awards. Footnote disclosure required in the director compensation table for the full grant date fair value of equity awards relates only to awards granted during the last completed fiscal year. (Question 12.03)
- Director aggregate equity awards. Footnote disclosure required in the director compensation table of the aggregate number of stock awards and the aggregate number of option awards outstanding at fiscal year end includes only unexercised options (whether or not exercisable) and unvested stock awards and units. (Question 12.04)
Charitable matching programs. A charitable matching program available to all employees must be included in the director compensation table. (Question 12.05)
- Gross-up calculations. In calculating potential payments upon termination or change in control, a company may not substitute January 1 of the current fiscal year for the last business day of the company’s last completed fiscal year, in order to reduce the excise tax “gross up” amounts calculated under Section 280G of the Internal Revenue Code. (General Guidance, Section 11.01)
Additional SEC Guidance on Regulation S-K Items
The SEC also issued additional interpretive guidance as to various Regulation S-K Items that affect disclosure in the proxy statement as follows:
- Regulation S-K Item 201. In March 2007, the SEC staff updated its guidance regarding Item 201(d) (securities authorized for issuance under equity compensation plans), clarifying how various types of equity awards should be reflected in the table called for by this item. The staff also provided guidance regarding Item 201(e) (performance graph), clarifying, among other things, the proper presentation of a self-constructed peer or market capitalization index, that the initial price following an IPO must be the closing price on the first trading day, and that the performance graph must be located in the annual report to shareholders required by Rule 14a-3 or Rule 14c-3 under the Securities Exchange Act of 1934 (although it may be reproduced in the proxy statement).
- Regulation S-K Item 403. In March 2007, the SEC staff updated its guidance regarding disclosure of security ownership of certain beneficial owners and management to clarify, among other things, that shares subject to a “negative pledge” fall within the requirement to indicate by footnote if shares are pledged by the holder and may also fall within Item 403(c)’s requirement to disclose “any arrangement . . . including any pledge . . . which may at a subsequent date result in a change in control of the registrant” in certain circumstances.
- Regulation S-K Item 404. In March 2007 and August 2007, the SEC staff updated its guidance regarding disclosure of transactions with related persons and clarified, among other things, the appropriate disclosure of various transactions involving the family members of directors and executive officers.
- Regulation S-K Item 407. In March 2007, the SEC staff updated its guidance regarding disclosure of various matters of corporate governance, including disclosures concerning director independence and board committees, and clarifying that the disclosure can not be made by incorporation to information posted on a company’s website.
The updated SEC staff guidance and interpretations are available at: http://sec.gov/divisions/corpfin/cfguidance.shtml.
Compliance with Sarbanes-Oxley Section 404 for Smaller Companies. A non-accelerated filer filing its Form 10-K for a fiscal year ending on or after December 15, 2007 will be required to include for the first time a report by management assessing the effectiveness of the company's internal control over financial reporting (ICFR) as required by Section 404 of the Sarbanes-Oxley Act and Rules 13a–15(c) and 15d–15(c) under the Securities Exchange Act of 1934. These companies also will need to revise their CEO and CFO certifications to include all the language required once management’s report has been included. These filers will not, however, be required to file an auditor’s attestation of management’s report until the Form 10-K filed for a fiscal year ending on or after December 15, 2008. See SEC Release No. 33-8760 available at: http://sec.gov/rules/final/2006/33-8760.pdf.
SEC Section 404 Interpretive Guidance and Rule Amendments. In June 2007, the SEC issued interpretive guidance and rule amendments regarding management's report on ICFR. The SEC's interpretive and rulemaking initiatives:
- provide guidance regarding management's evaluation and report on ICFR using a top-down, risk-based approach;
- clarify that an evaluation that complies with the guidance will satisfy the requirements, but confirm there are numerous ways for management to evaluate the effectiveness of the company's ICFR;
- revise the SEC's rules to clarify that a company's auditor is required to express a single opinion directly on the effectiveness of ICFR in its attestation report but is not required to submit a separate opinion on management's process for evaluating ICFR, which was previously required; and
- define the term "material weakness."
See SEC Release Nos. 33-8810 and 33-8809, available at: http://sec.gov/rules/interp/2007/33-8810.pdf and http://sec.gov/rules/final/2007/33-8809.pdf. Companies should also review the SEC staff’s FAQs regarding management’s internal control report and related certifications updated in September 2007 and available at: http://sec.gov/info/accountants/controlfaq.htm.
In addition to website posting requirements for proxy materials, discussed above, companies also should review whether they are complying with a few prior website posting requirements from last year that they may have missed. In particular:
- Charters. Companies are not required to deliver board committee charters to shareholders if those charters are made available by a website link; but, companies must reference the website link in the proxy statement.
- Director independence. Under Regulation S-K Item 407, where a company adopts its own definition for “independence” of directors, it must disclose the website link where the definition may be found or append the definition to the proxy statement every three years.
Following three years of campaigning by shareholder activists, over 60% of S&P 500 corporations have now adopted some form of majority-voting requirement for election of directors. States are also beginning to amend their corporation statutes to make it easier for corporations to opt out of the plurality-voting default rule and adopt majority voting or at least adopt a policy requiring directors to submit resignations if they do not receive a majority of votes cast in their favor.
Companies that have not received a shareholder proposal and are not otherwise under pressure from activists to adopt a majority-election measure may wish to continue to study the matter this year. This is especially true given uncertainties in the areas of “shareholder-access” and discretionary voting of street-name shares in director elections (each of which is discussed below) as well as the lack of practical experience with the new e-proxy rules. As companies watch and wait to see how these developments play out, boards must be kept thoroughly advised on the majority-election options and their relation to these other developments.
Once approached by activists, however, a company may be better off working with the proponent and adopting a measure preemptively rather than permitting the proposal, especially a binding bylaw proposal, to go to a vote. By acting preemptively, a company will retain more control over the process and the actual provision adopted. A bylaw proposal, once approved by shareholders, may be impossible to change without another shareholder vote.
For a more complete discussion of majority voting and related developments, see the Corporate Update dated October 25, 2007, "Majority Election of Directors: Where Are We Today?".
SEC’s Alternative “Shareholder Access” Proposals
In July 2007, the SEC proposed two alternative amendments to Rule 14a-8 under the Securities Exchange Act of 1934, which governs the ability of companies to exclude shareholder proposals from company proxy materials. One proposal would amend Rule 14a-8 to enable shareholders to include director nomination bylaw proposals in the company’s proxy materials, so long as the proposal was binding on the company if approved, the proponent has held more than 5% of the company’s securities for at least one year, and the shareholder proponent has filed a Schedule 13G disclosing all required information. The other proposal would reaffirm the staff’s position allowing the exclusion of shareholder proposals regarding director nomination bylaw provisions under Rule 14a-8 in order to address the issues raised by the Second Circuit in AFSCME v. AIG, 462 F.3d 121 (2d Cir. 2006).
According to SEC Chairman Cox, any effort to fundamentally alter shareholder access to a company’s proxy statement will need to be re-proposed by the SEC before any action can be taken. However, Chairman Cox continues to reiterate his vow to have “a clear, unambiguous rule in place in time for the  proxy season.” This has led to speculation that the SEC may adopt the proposal reaffirming pre-AFSCME v. AIG law as a temporary measure for the 2008 proxy season. Whether Chairman Cox will expend the political capital needed to do so in the face of the departure of Commissioner Campos, the announced departure of Commissioner Nazareth and strong democratic Congressional opposition, is difficult to predict.
Proposals to Amend NYSE Rule 452 Regarding Broker Discretionary Voting in Director Elections
In a development that could have a significant impact on public company director elections, the New York Stock Exchange has proposed an amendment to NYSE Rule 452, which governs broker voting of shares held in street-name absent instruction from beneficial owners. This rule applies to all brokers (and thus, its impact is not limited to NYSE-listed companies). The proposed amendment would make corporate director elections non-routine, so brokers would no longer be able to vote without instruction. Thus, vote “no” or “withhold” campaigns would no longer be “diluted” by a block (often 20-25% of votes cast) of broker discretionary votes in favor of management’s slate.
While the proposed amendment was originally slated to take effect on January 1, 2008, the NYSE has notified listed companies that the SEC will consider approval of the Rule 452 amendment “as part of a broad range of issues relating to shareholder communications and proxy access.” Thus, although the proposed amendment to NYSE Rule 452 is still very much on the table, it will not be in effect for the 2008 proxy season. Nonetheless, companies should continue to assess the extent to which broker voting is a factor in their director elections.
RiskMetrics (ISS) 2007 Post Season Report and 2008 Voting Policies
The last proxy season can serve as a useful guide when analyzing what to expect this proxy season. Companies will want to review the “2007 Postseason Report” issued by RiskMetrics (formerly know as ISS) for some of the 2007 proxy season trends. This report (available at http://www.riskmetrics.com/pdf/2007PostSeasonReportFINAL.pdf) reveals that:
- As of September 15, 2007, a total of 656 shareholder proposals had been put before shareholders, up from 581 for the same period in 2006.
- Overall, 306 proposals were withdrawn by shareholders as of September 15, 2007 (up from 189 for the same period in 2006), suggesting that companies are more willing to engage with shareholders on issues such as majority voting.
- A total of 107 shareholder proposals received a majority or more of shareholder support in 2007, down from 116 proposals in 2006 but up from just 85 proposals in 2005.
- As of June 30, 2007, 41 proposals that requested an annual advisory vote on compensation (or “say on pay”) were voted on and averaged about 42 percent support.
- According to the report, seven of those proposals received a majority of votes cast.
- As of September 15, 2007, the SEC’s staff had issued 155 no-action letter responses in 2007 allowing the exclusion of a shareholder proposal, up from 129 in 2006.
In addition, RiskMetrics published its own evaluation of executive compensation disclosures from the 2007 proxy season, available at: http://www.riskmetrics.com/pdf/ExecComp BestPractices.pdf. This report reflects many of the same themes as in the SEC staff’s report for improving executive compensation disclosure.
Finally, while RiskMetrics’ 2008 voting policies have not yet been published, RiskMetrics has revealed some of its proposed policy updates on important corporate governance issues (see http://www.riskmetrics.com/pdf/ISS_Governance_Services_Policy_Comment_2008.pdf). These include policy updates on “aggressive accounting practices,” cumulative voting, independent chairs, “poor pay practices” and say on pay, stock option overhang and product safety. Companies should familiarize themselves with these policy proposals as they get ready for the proxy season.
Exchange Listing Standards
While no significant changes to the listing standards of the NYSE, AMEX and Nasdaq have occurred or been proposed since last proxy season, companies should confirm that they are in compliance with the following rules:
- DRS eligibility. Each of the exchanges require listed companies to be eligible to participate in the Direct Registration System (DRS) effective January 1, 2008. DRS allows a shareholder to be registered directly on the books of the transfer agent without the need of a physical certificate to evidence the security ownership. Under this system, the shareholder receives a statement of ownership and periodic account statements. DRS is different than “book-entry” or “street name” ownership in that no share certificate of any kind is issued to DTC or in the street name of a shareholder's broker to represent the shares. Companies should review their bylaws to make sure that they do not currently provide that all shares will be represented by certificates. See http://sec.gov/rules/sro/nyse/2006/34-54289.pdf (NYSE), http://sec.gov/rules/sro/nasdaq/2006/34-54288.pdf (Nasdaq) and http://sec.gov/rules/sro/amex/2006/34-54290.pdf (AMEX).
- Nasdaq’s “electronic disclosure submission system.” Nasdaq rules require listed companies to provide notice of material news to MarketWatch prior to release of the information to the public. On September 4, 2007, Nasdaq began requiring companies to use an "electronic disclosure submission system" to alert its MarketWatch of material news. Prior to this change, issuers could provide material news notifications electronically, via fax or telephone. Repeated failure by a Nasdaq-listed company to notify Nasdaq using the electronic disclosure submission system prior to the distribution of material disclosure to the public will result in a violation of Nasdaq’s listing requirements. See SEC Release No. 34-55856 available at:
- Pending NYSE proposals to amend corporate governance listing standards. The SEC has still not published for comment the NYSE proposals filed with it in November 2005 to revise NYSE corporate governance listing standards. While the NYSE proposals regarding director independence disclosure essentially have been superseded by the SEC’s 2006 amendments to Item 407 of Regulation S-K, other rule changes remain a genuine possibility. NYSE listed companies should “stay tuned” for NYSE rulemaking in 2008 that will address requirements such as meetings of non-management directors, participation by directors in the audit committees of multiple companies and reporting promptly any waivers of a code of ethics for an executive or director. As a reminder, companies also should use the NYSE’s Annual Written Affirmation as a guide to ensure compliance with NYSE standards and should prepare Exhibit G to the Annual Written Affirmation while preparing the Form 10-K and proxy statement to ensure that all required disclosure has been provided. These forms are available at: http://www.nyse.com/regulation/listed/1101074752859.html.