On December 16, 2009, the Securities and Exchange Commission (the “SEC”) approved amendments to the rules governing executive compensation and corporate governance disclosures in proxy statements and other documents filed with the SEC. The new rules will become effective on February 28, 2010, as discussed below. The SEC’s press release is available on its website here and the final rules are available here.

Compensation-Related Amendments

Compensation Policies

In response to significant concerns regarding the interplay of executive compensation incentives and corporate risk profiles, the SEC amended Item 402 of Regulation S-K to require companies to discuss their compensation policies and practices for all employees, including non-executive officers, if such policies and practices create risks that are “reasonably likely to have a material adverse effect on the company.” The disclosure is specifically limited to “adverse” effects; companies are not required to discuss compensation policies that mitigate business risks. This additional disclosure must appear in a section separate from the CD&A because it relates to non-executive level employees.

For guidance, this new rule includes several examples of situations that might trigger the new disclosure, such as:

  • a business unit that carries a significant portion of a company’s risk profile;
  • a business unit that is significantly more profitable than others within the company; a business unit where the compensation expense is a significant percentage of the unit’s revenues;
  • a business unit whose risk and reward structure varies significantly from that of the overall company; and
  • where a company provides a bonus based on the accomplishment of a task and the income and risk associated with that task extend over a significant period of time.

The SEC has also provided examples of potential issues to discuss in this new section, including:

  • the general philosophy of the compensation policy;
  • how the policy addresses long-term and short-term risks;
  • how the policy would be changed to address changes in a company’s risk profile; and
  • how the company monitors its policies to determine if its objectives are being met.

Smaller reporting companies will not be required to provide this new disclosure, and a company need not make an affirmative statement regarding risk taking policies if it has determined that the risks arising from its compensation policies and practices are not reasonably likely to have a material adverse effect on the company.

Equity Grant Reporting

Item 402 was also amended to require companies to disclose in the Summary Compensation Table and Director Compensation Table the full grant date fair value of awards made during the fiscal year in question, rather than the dollar amount recognized for financial statement reporting purposes as the current rule requires. The SEC believes fair value on the date of grant is more meaningful to investors and better reflects a compensation committee’s decision-making process with respect to stock and option awards. For performance-based awards, companies must compute the value based on the “probable outcome of the performance condition(s) as of the grant date,” with the maximum possible value of the award being disclosed in a footnote to the Summary Compensation Table and Director Compensation Table.

For companies providing disclosure for fiscal years ending after December 20, 2009, each of the preceding fiscal years in the table must be re-calculated using the new standard. However, it is not necessary to change the list of individuals who were named executive officers in preceding years. The proposal to eliminate the full grant date fair value of each equity award from the Grants of Plan-Based Awards Table was not adopted in the final rule.

Governance-Related Disclosures

Director Qualifications and Background

The SEC also amended Item 401 of Regulation S-K to require expanded disclosure regarding the qualifications of directors and nominees. For each director and nominee, the final rules require companies to disclose the particular experience, qualifications, attributes or skills that led the board to conclude that the person should serve as a director. The new disclosure is required for all directors and nominees, not just those directors up for reelection. The rules do not require disclosure of the qualities that qualify a person to serve as a committee member.

In addition, companies now must list the public company directorships held by each director and nominee at any time during the past five years, instead of just current directorships. They must also include information on legal proceedings involving directors, nominees and executive officers occurring during the past ten years, instead of the current five-year disclosure period. The rule also expanded the types of legal proceedings that must be disclosed to include:

proceedings resulting from mail, wire or business fraud; proceedings based on violations of state or federal securities, commodities, banking or insurance laws (or settlements thereto, not including settlements to civil actions among private parties); and disciplinary sanctions or orders imposed by a stock, commodities or derivatives exchange or other self-regulatory organization.

Board Diversity

Item 407(c) of Regulation S-K was amended to require disclosure of whether, and if so how, a nominating committee considers diversity in identifying nominees for director. If such a policy exists, companies must disclose how the policy is implemented and how the board (or committee) assesses the effectiveness of its policy. The SEC declined to define “diversity” in this amendment, but suggested that the term could include differences of viewpoint, professional experience, education and skills, as well as consideration of race, gender and national origin.

Governance Structure

The SEC amended Item 407 of Regulation S-K and Schedule 14A to require disclosure of whether and why a company has chosen to combine or separate the principal executive officer and board chairman positions, and the reasons why it believes that this board leadership structure is the most appropriate structure for the company at the time of filing. If these positions are combined, and a lead independent director is designated to chair meetings of the independent directors, the amendments require disclosure of why this leadership structure was chosen, as well as the specific role the lead independent director plays in the company’s leadership structure. The SEC hopes this rule will make a company’s corporate governance more transparent, but does not intend for it to influence a company’s decision regarding its leadership structure.

Risk Oversight

The final rule also requires companies to describe the board’s role in the oversight of risk and how this role affects the leadership structure of the company. The SEC stated that this rule is focused on risk oversight, not risk management, with particular focus on how the board administers this function, be it through a committee or with the involvement of the entire board.

Compensation Consultants

The SEC also amended Item 407 of Regulation S-K to require additional information about compensation consultants’ fees and conflicts of interest. Under the new rule, if the board or company management (i) engages a compensation consultant to advise on executive and director compensation, and (ii) that consultant (or its affiliates) also provides consulting services other than executive compensation consulting services, and (iii) the fees paid for those “other” services exceed $120,000 during the company’s fiscal year, additional disclosure is required. However, if the board and company management each engage their own compensation consultants, then the additional disclosure is not required with respect to the consultant engaged by company management, regardless of whether that consultant provides “other” services. In addition, the additional disclosure is not required if the consultant’s role is limited to consultation on broad-based non-discriminatory plans (such as 401(k) or health plans) or the provision of information, such as surveys, that are not customized for the company based on parameters developed by the consultant.

Under the new rules, companies must disclose: (i) the aggregate fees paid for services provided to either the board or the company with regard to determining or recommending the amount or form of executive and director compensation, (ii) the aggregate fees paid for any “other” consulting services, and (iii) whether the decision to engage the compensation consultant (or its affiliates) for the “other” services was made or recommended by management, and whether the board approved such “other” services. Disclosure of the nature and extent of the “other” services is not required.

Other Matters

Annual Meeting Voting Results

The SEC also adopted amendments to ensure that the results of shareholder votes are announced publicly on a more timely basis. The amendments remove such reporting requirements from Form 10-K and Form 10-Q and add a new disclosure requirement in Form 8-K. Effective as of February 28, 2010, reporting companies will be required to file a Form 8-K disclosing voting results within four business days after the meeting at which a shareholder vote was held. If final voting results are not available, a company must report preliminary results on Form 8-K within four business days, and disclose final results on an amendment to the Form 8-K within four business days after the final voting results are known.

Proxy Solicitation Amendments The SEC deferred consideration of the various proposed rules regarding the proxy solicitation process pending consideration of current proposals intended to facilitate shareholder director nominations in companies’ proxy materials. The SEC recently re-opened the comment period on a limited basis with respect to those proposed shareholder director nomination rules. The re-opened comment period will end on January 19, 2010.

Effective Date

The new rules will become effective on February 28, 2010. Guidance recently released by the SEC provides the following clarifications:

  • If an issuer’s fiscal year ends on or after December 20, 2009, its Form 10-K and proxy statement must comply with these new rules if these documents are filed on or after February 28, 2010.
  • If such an issuer is required to file a preliminary proxy statement and expects its definitive proxy statement to be filed on or after February 28, 2010, then the preliminary proxy statement must also comply with the new rules. If such an issuer files its Form 10-K for 2009 before February 28, 2010 and its proxy statement on or after February 28, 2010, only the proxy statement must comply with the new rules.
  • If an issuer’s fiscal year ends before December 20, 2009, its Form 10-K and proxy statement for 2009 need not comply with the new rules, even if they are filed on or after February 28, 2010.

Issuers who are not required to comply with new rules may do so on a voluntary basis, but if an issuer chooses to comply with the amendments to the Summary Compensation Table and Director Compensation Table, it must also comply with all of the other Regulation S-K amendments adopted on December 16, 2009. For issuers with a fiscal year ending before December 20, 2009, only registration statements filed after the issuer’s fiscal year 2010 Form 10-K must comply with the new amendments. If a new registrant files its initial registration statement on or after December 20, 2009, it must comply with the new amendments.

The amendment requiring that companies report voting results on a Form 8-K is effective for any shareholder meeting that takes place on or after February 28, 2010.

Next Steps

These new rules will require companies to begin preparing their proxy statements earlier than usual as some of the new disclosure, particularly the qualifications of the directors and nominees, will require much greater input from the board of directors and board committees. We suggest that companies take the following steps to prepare themselves for the new disclosure in this next proxy season:

  • revise director and officer questionnaires to collect information regarding directorships held by directors and nominees at public companies and registered investment companies during the last five years, as well as other information regarding director and nominee qualifications;
  • revise director and officer questionnaires to collect information regarding the expanded list of legal proceedings within the last ten years;
  • conduct an assessment (including through discussions with your compensation committee, where appropriate) of the risks your company faces and what material adverse effects compensation policies may have on these risks;
  • determine whether the new rules regarding compensation consultant disclosure will apply to your company and, if so, gather information on the services provided by such consultant and its affiliates;
  • determine whether the new rules regarding grant date value reporting of equity awards will affect the company’s list of named executive officers;
  • review the reasons for combining (or separating, if applicable) the roles of chairman of the board and principal executive officer;
  • meet with your nominating committee regarding director qualifications and diversity considerations and, if appropriate, institute a new process for assessment of directors and analysis of potential nominees;
  • begin redrafting biographical information for directors to add disclosure on the experience, skills and qualifications of each director; and
  • allow board members additional time for review of the draft proxy statement.