The SEC has adopted final rules related to proxy disclosure enhancements. In particular, the new rules require disclosures in proxy and information statements about:
- The relationship of a company's compensation policies and practices to risk management.
- The background and qualifications of directors and nominees.
- Legal actions involving a company's executive officers, directors and nominees.
- The consideration of diversity in the process by which candidates for director are considered for nomination.
- Board leadership structure and the board's role in risk oversight.
- Stock and option awards to company executives and directors.
- Potential conflicts of interests of compensation consultants.
The new rules, which will be effective February 28, 2010, also require quicker reporting of shareholder voting results.
Details on the Final Rules
The SEC's approved rules will affect the following areas:
Require Disclosure of a Company's Compensation Policies and Practices as They Relate to the Company's Risk Management
The SEC approved a rule that would help investors determine whether a company has incentivized excessive or inappropriate risk-taking by employees. Among other things, it would require a narrative disclosure about the company's compensation policies and practices for all employees, not just executive officers, if the compensation policies and practices create risks that are reasonably likely to have a material adverse effect on the company. The final rules no longer require this disclosure in the Compensation Discussion and Analysis section, which generally applies to compensation practices only as they relate to named executive officers. Instead, the new disclosures regarding all employees will be made under a new Item 402(s) of Regulation S-K. Smaller reporting companies will not be required to provide the new disclosure.
In an important change from the earlier reporting release, the final rule addresses concerns some commentators raised that the proposal did not allow companies to consider compensating or offsetting steps or controls designed to limit risks of certain compensation arrangements. If a company has compensation policies and practices for different groups that mitigate or balance incentives, these could be considered in deciding whether risks arising from the company’s compensation policies and practices for employees are reasonably likely to have a material adverse effect on the company as a whole.
Enhance Information About Directors and Nominees
The SEC approved new rules to improve information about directors and nominees for director. The new requirements include, for each director and director nominee, disclosure of:
- The particular experience, qualifications, attributes or skills that led the company's board to conclude that the person should serve as a director of the company. This new disclosure is required for all nominees and for all directors, including those not up for reelection. The final rules do not require disclosure of the specific experience, qualifications or skills that qualify a person to serve as a committee member. However, if an individual was chosen to be a director because of a particular qualification related to service on a specific committee, then disclosure is required as part of the individual’s qualification to serve on the board.
- Any directorships at public companies and registered investment companies that each director and director nominee held at any time during the past five years.
- Legal proceedings, such as SEC securities fraud enforcement actions against the director or nominee, going back 10 years instead of the current 5 years, as well as an expanded list of legal proceedings covered by the rule.
Disclose How Diversity Is Considered in the Director Nomination Process
The SEC approved a rule that would require disclosure of whether, and if so how, a nominating committee considers diversity in identifying nominees for director.
If the nominating committee or the board has a policy with regard to the consideration of diversity in identifying director nominees, the final rules require disclosure of how this policy is implemented and how the nominating committee or the board assesses the effectiveness of its policy.
The SEC recognizes some companies may conceptualize diversity expansively to include differences of viewpoint, professional experience, education, skill and other individual qualities and attributes that contribute to board heterogeneity, while others may focus on diversity concepts such as race, gender and national origin.The SEC believes that for purposes of this disclosure requirement, companies should be allowed to define diversity in ways that they consider appropriate. As a result, the final rules do not define diversity.
Provide Information About Board Leadership Structure and the Board's Role in Risk Oversight
The SEC approved rules relating to board leadership structure and the board's role in risk oversight. The rules require disclosure about:
- A company's board leadership structure, including whether the company has combined or separated the chief executive officer and board chair position, and why the company believes its structure is the most appropriate for the company at the time of the filing.
- In certain circumstances, whether and why a company has a lead independent director and the specific role of such director.
- The extent of the board's role in the risk oversight of the company. Companies face a variety of risks, including credit risk, liquidity risk and operational risk. This disclosure requirement gives companies the flexibility to describe how the board administers its risk oversight function, such as through the whole board, or through a separate risk committee or the audit committee, for example. Where relevant, companies may want to address whether the individuals who supervise the day-to-day risk management responsibilities report directly to the board as a whole or to a board committee or how the board or committee otherwise receives information from such individuals.
Require Quicker Reporting of Voting Results
The SEC approved amendments to Form 8-K that would require companies to disclose the results of a shareholder vote within four business days after the end of the meeting at which the vote was held. This replaces the requirement to disclose voting results in Forms 10-K and 10-Q, which often are filed months after the relevant meeting.
Revise the Summary Compensation Table
The SEC approved revisions to the reporting of stock and option awards in the Summary Compensation Table and the Director Compensation Table to better reflect the compensation committee’s decisions with regard to these awards.
The amended rule requires companies to report the value of options when they are awarded to executives (the aggregate grant date fair value), instead of the current requirement to report the annual accounting charge.
A special instruction addresses performance-based awards to address concerns that the new rule might discourage use of these awards. Specifically, the value of performance awards reported in the Summary Compensation Table, Grants of Plan-Based Awards Table and Director Compensation Table are required to be computed based upon the probable outcome of the performance condition(s) as of the grant date. To provide investors additional information about an award’s potential maximum value subject to changes in performance outcome, the rules require footnote disclosure of the maximum value assuming the highest level of performance conditions is probable in the Summary Compensation Table and Director Compensation Table.
To facilitate year-to-year comparisons, the SEC is implementing the Summary Compensation Table amendments by requiring companies providing the disclosure for a fiscal year ending on or after December 20, 2009, to present recomputed disclosure for each preceding fiscal year required to be included in the table, so that the stock awards and option awards columns present the applicable full grant date fair values, and the total compensation column is correspondingly recomputed. However, companies are not required to include different named executive officers for any preceding fiscal year based on recomputing total compensation for those years pursuant to the amendments, or to amend prior years’ disclosures in previously filed Forms 10-K or other filings.
Enhance Disclosure About Compensation Consultants
The SEC approved rules requiring disclosure about the fees paid to compensation consultants and their affiliates in certain circumstances. The final rules can be summarized generally as follows:
- If the board or compensation committee has engaged its own consultant to provide advice or recommendations on the amount or form of executive and director compensation and the board's consultant or its affiliates provide other non-executive compensation consulting services to the company, fee and related disclosure is required, unless the fees for the non-executive compensation consulting services do not exceed $120,000 during the company’s fiscal year. Disclosure is also required of whether the decision to engage the compensation consultant or its affiliates for non-executive compensation consulting services was made or recommended by management, and whether the board has approved these non-executive compensation consulting services provided by the compensation consultant or its affiliate.
- If the board has not engaged its own consultant, fee disclosures are required if there is a consultant (including its affiliates) providing executive compensation consulting services and non-executive compensation consulting services to the company, unless the fees for the non-executive compensation consulting services do not exceed $120,000 during the company’s fiscal year.
- Fee and related disclosure for consultants that work with management (whether for only executive compensation consulting services, or for both executive compensation consulting and other non-executive compensation consulting services) is not required if the board has its own consultant.
- Services involving only broad-based, non-discriminatory plans or the provision of information, such as surveys, that are not customized for the company or are customized based on parameters that are not developed by the consultant, are not treated as executive compensation consulting services for purposes of the compensation consultant disclosure rules.
Steps Companies Should Take Now
In response to the SEC's approved rules, we recommend companies consider taking the following steps:
- Consider whether compensation policies and practices create risks that are reasonably likely to have a material adverse effect on the company. If not, document the basis for the decision. The SEC may raise this point in a comment letter, and after-the-fact justifications may not be convincing.
- Gather information to draft disclosures about the experience, qualifications, attributes or skills that led the company’s board to conclude that a person should serve as a director for the company.
- Update officer and director questionnaires regarding directorships at public companies and registered investment companies during the last five years and gather information for expanded disclosures regarding legal proceedings.
- Determine how a nominating company considers diversity in identifying nominees, define diversity and identify any related policies and how the board assesses the effectiveness of any such policy.
- Identify and describe how the board administers its risk oversight function.
- Gather information to report the value of stock options at grant date fair value or, for performance awards, the probable outcome at the grant date. Recompute prior fiscal years’ awards included in the Summary Compensation Table.
- Determine whether disclosure will be required for fees paid to compensation consultants and gather necessary information.