On July 10, 2009, the U.S. Securities and Exchange Commission (the “SEC”) released proposed amendments to its rules that would require expanded disclosure regarding executive compensation and corporate governance matters. The proposed amendments, which draw from similar requirements applicable to issuers participating in the Treasury’s Troubled Asset Relief Program, would require companies to provide additional disclosure with respect to:
- Overall compensation policies and the impact of such policies on corporate risk taking;
- Stock and option awards made to executive officers and directors;
- Director and board nominee qualifications and prior legal proceedings;
- Company leadership structure;
- The board’s role in the risk management process; and
- Potential conflicts of interests involving compensation consultants.
The proposed amendments would also require disclosure of shareholder voting results in a Form 8-K (as opposed to waiting for the next Form 10-Q or 10-K), and seek to clarify several interpretive issues under the SEC’s proxy rules that have arisen over the years in connection with proxy solicitations.
The SEC anticipates that these additional disclosure rules, if adopted, would be effective for proxy and information statements, annual reports and registration statements filed during the 2010 proxy season. The rule changes and their potential impact are discussed in greater detail below.
Executive and Director Compensation
Expanded Compensation Discussion and Analysis
The proposed amendments would require a company’s Compensation Discussion and Analysis (“CD&A”) to address how the company’s overall compensation for employees creates incentives that may impact the company’s risk and management of risk. This new disclosure requirement would compel companies to discuss and analyze their broader compensation policies and practices for all employees, and not just named executive officers, in the CD&A, but only if risks arising from such policies or practices could have a material effect on the company. Accordingly, under the proposed rules, companies would need to consider and, where appropriate, disclose the level of risk that non-executive employees may be inclined to take in order to satisfy the incentive-based elements of their compensation packages.
The SEC suggested that such enhanced CD&A disclosure regarding non-executive employee compensation may be appropriate in situations where:
- A particular business unit accounts for a significant portion of the company’s risk profile;
- The compensation of a particular business unit is structured significantly differently from that of other units;
- A particular business unit is significantly more profitable than other units;
- The compensation expense of a particular business unit represents a significant percentage of the company’s revenues; or
- Compensation policies or practices vary significantly from the company’s overall risk and reward structure, such as when the timing for performance-based bonuses or incentive awards occurs significantly before receipt of anticipated income or expiration of associated risk to the company.
Reflecting its concern for the nexus between compensation incentives and increased risk, the SEC also furnished several examples of the issues that a company may need to address in its CD&A regarding compensation policies or practices and potential material risks. These issues include:
- Compensation policy design and implementation factors for employees whose behavior would most likely be impacted by the incentives;
- The role of risk assessment in awarding or paying incentive compensation or otherwise structuring compensation policies;
- Whether and how compensation policies address potential risks, long- and short-term, of employee behavior, such as imposing claw backs or holding periods;
- Procedures for amending compensation policies to reflect changes in risk profile;
- Material changes made to compensation policies or practices to align with changes in risk profile; and
- The extent to which incentives in the compensation policies are monitored against compliance with risk management objectives.
This new disclosure will undoubtedly be uncharted territory for most companies, and crafting it may require extensive analysis and consideration by all participants in the disclosure process.
Revisions to Summary and Director Compensation Tables
The proposed amendments would revise the Summary Compensation Table and Director Compensation Table required by Item 402 of Regulation S-K to require disclosure of the aggregate grant date fair value of stock and option awards computed in accordance with FAS 123R. This disclosure would replace the current approach that is based on the dollar amount recognized for financial statement reporting purposes for the fiscal year. The effect of this change is that the full value of the award would be reported in the year that the award is made, even if the award vests over a number of years. In order to facilitate year-to-year comparison, the SEC is considering requiring recomputation of prior year disclosures, but without requiring the inclusion of different named executive officers for any recomputed year.
Directors, Director Nominees and Executive Officers
The proposed amendments would expand the disclosure requirements of Item 401 of Regulation S-K regarding the qualifications of all directors and director nominees. Specifically, the proposed amendments would require companies to disclose for each director or nominee for director, as of the time of the applicable filing, the specific experience, attributes or skills that, in light of the company’s business and structure, qualify the individual to serve on the board of directors (or any applicable board committee). This additional narrative disclosure may include, among other things, information about an individual’s risk assessment skills, particular area of expertise or past experience as well as an explanation as to why the individual’s service as a director would benefit the company. The expanded disclosure would apply to incumbent directors, to nominees for director who are selected by a company’s nominating committee, and to any nominees put forward by shareholders.
In addition, the proposed amendments would expand the required biographical information about directors and director nominees to include, in addition to disclosure of current directorships, disclosure of any public company directorships held during the past five years. They would also require disclosure of prior legal proceedings involving directors, director nominees or executive officers that occurred during the past ten years, as opposed to the current requirement of five years.
Company Leadership Structure
Under the proposed amendments, a company would be required to outline its leadership structure in its proxy and information statements and explain why it believes that structure is best for the company. A company would also be required to disclose whether and why it has elected to combine the positions of principal executive officer and chairman of the board, if they are combined, and to disclose whether and why it has appointed a lead independent director. If such a company has a lead independent director, it must disclose details about the specific role that person plays within the company’s leadership structure.
Risk Management Process
Pursuant to the proposed amendments, a company also would be required to include narrative disclosure regarding the board’s role with respect to the company’s risk management process, particularly with respect to credit risk, liquidity risk and operational risk matters. This disclosure would require discussion of how the company perceives the role of its board, as well as the relationship between the board and senior management, in managing the material risks associated with the company’s operations.
The proposed amendments would revise Item 407 of Regulation S-K to require a company to disclose certain additional information about the fees paid to compensation consultants and their affiliates when such consultants provide other non-executive compensation services – such as benefits administration, human resources consulting or actuarial services – to the company in addition to recommending certain executive compensation plans or policies. Specifically, in such a situation, the proposed amendments would require companies to disclose the following information:
- The nature and extent of all additional services provided by the compensation consultant or its affiliates to the company or its affiliates during the past fiscal year;
- The aggregate fees paid for all such additional services, as well as the aggregate fees paid to the consultant or its affiliates for work related to making determinations or recommendations regarding executive or director compensation;
- Whether the decision to engage the compensation consultant or its affiliates for the additional non-executive compensation services was made, recommended, monitored or approved by management; and
- Whether the company’s board of directors or compensation committee has approved all of the additional services in addition to the consultant’s executive compensation services.
In proposing this additional disclosure, the SEC noted that the provision of additional services by compensation consultants may create the appearance of a conflict of interest that may call into question the objectivity of the consultant’s executive pay recommendations.
Reporting of Shareholder Voting Results
Under the proposed amendments, a company’s obligation to disclose shareholder vote results would be transferred to Form 8-K from Forms 10-Q and 10-K. Instead of disclosing meeting results on the next Form 10-Q or 10-K to be filed, the results would be disclosed under new Item 5.07 of Form 8-K within four business days after the meeting at which the vote is taken. In situations where definitive results are not available within that period (such as a contested election of directors), a company would be required to file preliminary voting results on Form 8-K within four business days after preliminary results are determined, and then file an amended Form 8-K within four business days after the final voting results have been certified.
Proxy Solicitation Process
The proposed amendments would revise certain of the SEC’s proxy rules, including Rules 14a-2(b)(1), 14a-2(b)(1)(ix), 14a-4(d)(4), 14a-4(e) and 14a-12(a)(l)(i) under the Securities Exchange Act of 1934, as amended, to clarify certain interpretive issues that have arisen in recent years regarding the proxy solicitation process and granting of proxy authority. These revisions are highly technical in nature, and are not addressed in this Legal Alert.