The Canadian Securities Administrators (CSA) have at last released the final rule (the Rule) on executive compensation disclosure for reporting issuers. This Rule, found in Form 51-102F6 to National Instrument 51-102, results from a lengthy process of consideration of what disclosure of executive compensation should be required, in light of the US disclosure rules implemented a couple of years ago, as well as media and shareholder interest in the topic. The Rule is intended to result in clearer and more complete disclosure of precisely what was paid to Named Executive Officers (NEOs) ? and, more importantly, why NEOs were paid what they were paid and how compensation decisions were made.
The Rule places executive compensation clearly within the larger context of governance of the corporation. Disclosure of all of the compensation that a board intended to pay is seen as a means to provide investors with "insight into executive compensation as a key aspect of the overall stewardship and governance of the company." The securities regulators will be carefully reviewing disclosures made in 2009 and are expected to be vigilant to ensure their broad objectives are satisfied.
The Rule contains several significant changes from the current requirements, which will lead to considerable effort on the part of public company management and compensation committee members. The new disclosure requirements apply for financial years ending on December 31, 2008 and afterwards, so the proxy disclosures to be released in the spring of 2009 will be the first under the new rule. Importantly, issuers are not required to restate their disclosures for prior years or to include in their disclosure for 2008 compensation for prior years; the effect of this is that disclosures for 2008 are required to include only compensation for that year; disclosures for 2009 will include 2009 and 2008; and disclosures for 2010 will include 2010, 2009 and 2008.
If they haven’t already done so, company management and compensation committee members should begin to consider how the new requirements will change disclosures made to date. The rule is detailed and complex; likely the best way to prepare for its implementation is to prepare a draft of the new disclosure as soon as possible, then to compare this to current disclosure to identify where changes need to be made. Reviewing disclosures made by comparable companies under the US rule would be a good starting point, although there are significant differences in the applicable rules. The effort required to prepare disclosures in accordance with the Rule should not be underestimated; our experience with companies complying with the US rules has been that a lead time of six or more months may be required!
Major New Requirements
The major new requirements under the Rule are:
- Compensation discussion and analysis (CD&A) – this new narrative discussion is to describe all significant elements of compensation and the rationale for compensation awarded.
- The summary compensation table (SCT) is to include all compensation intended to be paid (including equity awards, based on their grant date fair values) and includes the new column "Total compensation." This column will likely be the most widely read part of the disclosures.
- Pension plan benefits – new tables are required, to give significantly enhanced disclosure of both defined benefit plans and defined contribution plans.
- Change of control and severance agreements – much more disclosure about these arrangements and their potential costs is required.
- More detailed director compensation disclosure.
Compensation Discussion and Analysis
Perhaps the biggest change from the current requirements will be the new narrative description of all significant parts of the executive compensation program. The CD&A section is to discuss and analyze the following elements:
- The objectives of the compensation program or strategy.
- What the compensation program is designed to reward.
- Each element of compensation.
- Why the company chooses to pay each element.
- How the amount paid under each element is determined.
- How each element of compensation, and the decisions made about that element, fit into overall compensation objectives and affect decisions about other elements.
As its name suggests, the CD&A is to provide a context for understanding the specific compensation disclosures in a manner similar to that provided by the Management Discussion and Analysis with regard to financial statement disclosures. The CD&A replaces the compensation committee report, but is intended to be more extensive, yet easy to understand; US examples have been criticized as being too long and complex.
Disclosures in the CD&A are to include several new items, including:
- A description of any new decisions or policies made after the end of the last fiscal year that could affect a reasonable person’s understanding of compensation paid during that year. While the compensation disclosure is still historical, under this requirement matters such as option repricings taken early in the next year would need to be disclosed (in the current market conditions, this requirement may result in disclosures that might not have been made under the current rule).
- Objective or quantitative or qualitative performance goals or metrics for compensation are to be disclosed, unless doing so would seriously prejudice the company’s interests. If particular performance metrics are not disclosed for this reason, disclosure will be required of what percentage of the Named Executive Officer’s total compensation relates to the undisclosed information and how difficult it would be for the NEO, or how likely it would be for the company to achieve the undisclosed goal. This disclosure requirement will need to be closely watched, since often performance metrics will key off important strategic drivers for a company, and could provide valuable information for analysts and competitors.
- The performance graph that is required under the existing rule is maintained, but is now to be accompanied by a discussion of how the trend in the company’s share price over a five-year period compares to the trend in compensation paid to NEOs over this same period. Given recent volatility in stock markets, these comparisons will doubtless produce interesting reading.
Summary Compensation Table
While the objective of the entire Rule is to capture all compensation paid or payable to NEOs, the Summary Compensation Table (SCT) is to be the clearest outline of that compensation. The table is to include the following elements of compensation:
- Dollar amounts of equity awards (shares and options), calculated on their grant date fair values.
- Dollar amounts of non-equity awards, including short-term and long-term incentive plans.
- Pension value, including the compensatory amounts for both defined benefit and defined contribution plans.
- All other compensation, which will include perquisites (those valued at more than $50,000 or 10% of total salary), post-retirement benefits, tax gross-ups, insurance premiums, and payments resulting from termination or change of control agreements.
The SCT is to be accompanied by a narrative description of any significant factors necessary to understand the information in the table.
The disclosure of the value of equity award grants is to be calculated based on the fair value of the award at the grant date; this requirement resulted from extensive commentary, particularly in light of the US experience. Under the US disclosure requirements, equity award grants are disclosed in the SCT at their financial statement values, which are usually the financial year-end values. The Rule requires disclosure of the compensation that the board of directors intended to pay at the date of grant, not any change resulting from stock market movements after that date. Any changes between the grant date and financial year-end values are to be stated and explained in a footnote to the SCT.
Pension Plan Benefits
Current pension benefit disclosures have been criticized as being too general and inadequately disclosing either the cost to a company of pension benefits, or the actual benefits to the NEOs. To address these matters, the Rule requires disclosure of significantly more information on pension plan entitlements and costs to the company, through two new tables, one for defined benefit plans and one for defined contribution plans. The disclosure in both tables is to show the required information for each NEO. The disclosure of defined benefit plan benefits is to show the number of years of credited service, the annual benefits payable at year-end and at age 65, the accrued obligation at the start of the year, the changes to that obligation due to both compensatory and non-compensatory factors, and the accrued obligation at the end of the year. In the case of defined contribution plans, the disclosure must show the accumulated value at the start of the year, the compensatory and non-compensatory values, and the accumulated value at the end of the year.
Termination and Change in Control Benefits
Each agreement, plan or other arrangement under which payments may be made to NEOs as a result of any termination of employment or change in control is to be described and explained. In addition, the payments that may be made under these arrangements are to be quantified, on the assumption that the triggering event for the payment occurred on the last business day of the last financial year. Equity-based components of these payments are to be valued using the closing market price of the company’s securities on that date. If the triggering event actually occurred earlier in the year, amounts paid or payable would be included in the SCT.
Directors are not free from the enhanced disclosure under the Rule. A new director compensation table is to be included, which is to disclose the compensation paid to each director. This table is to show fees paid, equity-based awards (shares and options), non-equity incentive payments, pension value and any other compensation. As with the SCT, this table leads to the final column, showing the total compensation paid.
Consistency with US Disclosure Requirements
The Rule is consistent with the US executive compensation disclosure requirements in many ways. Those Canadian public companies that are "SEC issuers" under Canadian securities laws may satisfy the Rule by filing their US disclosures. The Rule is not, however, identical to the US requirements, including in the following respects:
- Under the Rule, equity grants are to be reflected on the SCT at their value as at the date of grant, and not at the value as noted in the company’s financial statements, as is the case under the US rules. As discussed above, this is intended to disclose to investors the value of this component of total compensation that the directors had in mind on the date of the compensation decision. Differences between this value and the financial statement value are to be noted and commented upon in a footnote to the SCT.
- The performance graph, with its accompanying comparison of trends in executive compensation with share price trends, is not required under the US rules.
The new Rule will require a wholesale review of executive compensation disclosures by Canadian public companies. The major points noted above are but a fraction of the changes in the disclosure requirements and issuers are urged to begin reviewing the impact of the Rule on their disclosures as soon as possible.