A public company preparing, or beginning to prepare, the proxy statement for its 2013 annual shareholders’ meeting should be aware (or be reminded) of a new disclosure requirement adopted by the Securities and Exchange Commission last June. As part of its rulemaking under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC adopted a new Item of Regulation S-K, Item 407(e)(3)(iv) (.PDF), that requires disclosure regarding a compensation consultant whose work has raised any conflict of interest.

The new disclosure requirement supplements an existing disclosure requirement stated in Item 407(e)(3)(iii) of Regulation S-K. That Item has required a public company to disclose in its annual proxy statement the role of compensation consultants in determining or recommending the amount or form of executive and director compensation.  The disclosure must be made regarding any compensation consultant, whether engaged by the compensation committee, by the board of directors, or by management; but it need not be made regarding a consultant who only gives advice or recommendations on broad-based plans or provides non-customized data or information.  In brief, the disclosure should:

  • Identify each such compensation consultant.
  • State whether the consultant was engaged directly by the compensation committee or any other person (such as management).
  • Describe the nature and scope of the assignment of the consultant.
  • Describe the material instructions or directions given to the consultant.

The disclosure must also include, in certain situations, the fees paid to the compensation consultant.

The disclosure requirement of new Item 407(e)(3)(iv) applies only to a compensation consultant who is the subject of disclosure under Item 407(e)(3)(iii)  and whose work has raised any conflict of interest.  The disclosure should include:

  • The nature of the conflict.
  • How the conflict is being addressed.

The disclosure is required only regarding a compensation consultant’s actual conflict of interest, not any potential conflict of interest or any appearance of a conflict of interest.  According to the instruction to the new Item, a company should consider at least the “independence factors” set forth in the SEC's Rule 10C-1 in determining the existence of a consultant's conflict of interest.

The six factors set forth in Rule 10C-1, which was adopted by the SEC under the Dodd-Frank Act with the new Item, are:

  • The other services provided to the company by the person that employs the compensation consultant.
  • The amount of fees received from the company by the person that employs the compensation consultant, as a percentage of the total revenue of the person that employs the consultant.
  • The policies and procedures of the person that employs the compensation consultant that are designed to prevent conflicts of interest.
  • Any business or personal relationship of the compensation consultant with a member of the compensation committee.
  • Any stock of the company owned by the compensation consultant.
  • Any business or personal relationship of the compensation consultant or the person employing the consultant with an executive officer of the company.

These independence factors are stated in Rule 10C-1 primarily for direction to the national securities exchanges for their listing standards regarding independence of compensation committee members and advisers, which are not yet effective.  The SEC determined, however, that they would provide a suitable framework for identifying conflicts of interest of compensation consultants as well.

The new disclosure requirement will apply to all public companies (other than registered investment companies) that are subject to the SEC’s proxy rules.  There is no exception for smaller reporting companies, for controlled companies, or for companies that do not have equity securities listed on a securities exchange.

OUR TAKE:  To ensure compliance with the new disclosure requirement, a public company may wish to do the following in preparing the proxy statement for its 2013 annual meeting:

  • Ensure that the board of directors and its compensation committee are aware of the new disclosure Item.
  • Consider the six factors described above regarding each compensation consultant already engaged and any consultant proposed to be engaged.
  • Discuss with each compensation consultant already engaged, and any consultant proposed to be engaged, the relevant factors described above, whether any conflict of interest exists, how any existing conflict is being or will be addressed by the consultant, and the appropriate disclosure of any existing conflict.
  • Modify the D&O questionnaire to include questions regarding the new conflict-of-interest disclosure.