On March 29, 2007, in response to investor demands for more meaningful and understandable disclosure of compensation paid to executive officers and directors, the Canadian Securities Administrators (CSA) published for comment a proposal to revise existing form requirements for disclosure of executive and director compensation by publicly traded issuers in Canada. The new disclosure requirements reflect in large measure changes which were adopted by the U.S. Securities and Exchange Commission (SEC) in August 2006.
Proposed new Form 51-102F6 Statement of Executive Compensation (the Proposed New Form) replaces the Report on Executive Compensation with a new Compensation Discussion and Analysis; makes several changes to the Summary Compensation Table, including the introduction of a “Total Compensation” column; requires enhanced disclosure of potential severance and termination entitlements and pension benefits and tabular presentation of director compensation information. The Proposed New Form also introduces several new definitions to the compensation lexicon and changes to the standards for disclosure of executive compensation.
Highlights of these changes are discussed below.
Click here for a chart comparing the requirements under the Proposed New Form with existing Canadian and U.S. executive compensation disclosure requirements.
The comment period ends on June 30, 2007, and the CSA intends to require issuers to comply with the new executive compensation disclosure requirements for financial years ending on or after December 31, 2007.
New Compensation Discussion and Analysis (CD&A)
One of the more significant aspects to the Proposed New Form is the inclusion of the CD&A. The CD&A is intended to provide context for the detailed compensation information contained in the form by providing a meaningful analysis of factors relevant to the issuer’s compensation decisions.
Although the CD&A replaces the current Report on Executive Compensation, the CD&A is not required to be a report of the issuer’s compensation committee. Moreover, the Proposed New Form does not include a provision corresponding to the requirement under the SEC's executive compensation disclosure rules to include a report of the compensation committee as to whether the compensation committee reviewed and discussed the CD&A with management and recommended the CD&A for disclosure.
The CD&A will require an issuer to disclose the material principles which underlie policies and procedures for the compensation of named executive officers (NEOs) including: (i) the objectives of the issuer's particular approach to compensation; (ii) what the issuer's particular compensation program is designed to reward; (iii) details as to each element of compensation an issuer has adopted; (iv) the reasons why the issuer has adopted each element of compensation; (v) how the issuer calculates the amount of each element of compensation; and (vi) how each compensation element and the issuer’s decisions respecting that element contribute to the issuer's overall compensation objectives and affect decisions regarding other elements. Unlike the current Report on Executive Compensation, the CD&A does not require special treatment for disclosure of the CEO's compensation.
The Proposed New Form retains the concept of a performance graph as part of the CD&A, but issuers will have more flexibility to change or supplement the chosen performance index. The Proposed New Form requires disclosure comparing the trend in the graph to the trend in the issuer’s compensation to executive officers over the same period. This is an odd proposal, not only because it is inconsistent with the approach taken by the SEC (which is of the view that the performance graph should not be presented as part of executive compensation disclosure), but also because it is unlikely to provide meaningful information for a variety of reasons, such as the fact that compensation may be linked in part to performance measures other than share price or may be dictated by competitive pressures, and the aggregate compensation payable to all executive officers will depend on the number of executive officers as well as their individual pay levels.
In a nod to recent scandals involving the backdating of stock option awards, the CD&A will require issuers to explain the process by which options are granted, including the role of the compensation committee and executive officers in setting or amending any option program.
The CD&A also would require issuers to disclose for the first time any provisions for the claw-back of awards based on results that are subsequently restated.
Changes to the Summary Compensation Table
As part of the CSA's objective to increase the scope and quality of an issuer's disclosure of executive compensation, the Proposed New Form will revise the Summary Compensation Table in two significant ways. First, the elements of the Summary Compensation Table, which include salary, bonus, stock awards, options awards, non-equity incentive plan compensation and the change in pension value, are all required to be disclosed in dollar amounts. This is a slight change from the current table which requires disclosure in dollar amounts for some but not all of the elements. For equity awards, the dollar amounts disclosed must represent the accounting expense recognized by the issuer for such awards as reported in the issuer’s financial statements. Second, the CD&A will amend the Summary Compensation Table to add two new columns. A “Change in Pension Value” column will report on the change in the present value of the NEOs defined benefit pensions over the course of the reporting period (including supplemental pensions). A "Total Compensation" column will represent the sum of all of the elements of the table.
These changes to the Summary Compensation Table are driven by a desire to provide investors, through the CD&A, with a clear understanding of exactly how an issuer’s executives are compensated in dollar terms. However, the calculation of the value of an equity award based on the accounting expense for the award can have the opposite result as it bears no relationship to the fair value of the equity award at the date of grant. Certain issuers in the U.S. have reported that their NEOs earned negative total compensation when the trading price of the issuer’s stock fell subsequent to the date of grant.
Enhanced Disclosure of Potential Severance and Termination Entitlements
In keeping with the theme of more precise quantitative disclosure of executive compensation, the Proposed New Form will require additional disclosure regarding termination and change of control benefits. Currently, issuers are required to disclose the terms and conditions (including dollar amounts) of employment contracts with NEOs and the terms of any arrangements where the NEO is the recipient of compensation in excess of $100,000 in connection with a change of control or the NEO’s resignation, retirement or other termination of employment. Although general disclosure of the terms of any employment contract will no longer be required, additional disclosure will be required for arrangements which provide compensation in the event of termination of an NEO, a change of control or a change in the NEO’s responsibilities.
The Proposed New Form will require issuers to describe the circumstances that trigger payments or other benefits, the estimated annual payments and benefits that an NEO would receive under the various circumstances and any conditions that apply to the receipt of such payments or benefits, such as compliance with non-competition, non-solicitation or confidentiality obligations. As part of this process, issuers will have to assume that the triggering event for the provision of these benefits occurred within the issuer's last completed financial year. Perquisites and other personal benefits will need to be identified and quantified in such disclosure unless the aggregate amount of such compensation is less than $50,000.
Enhanced Pension Benefits Disclosure
The Proposed New Form significantly increases required disclosure relating to NEOs’ pension benefits by highlighting the value of NEOs’ individual pension entitlements and the change in value year after year.
The current Pension Plan Table, which must be completed for defined benefit (DB) plans, includes a summary of pension amounts for different levels of service and remuneration, without any NEO specific information. Though non-binding, CSA Staff Notice 51-314 issued in January 2005 provided further guidance to issuers on enhanced disclosure of the value of pensions earned by individual NEOs.
As noted above, under the Proposed New Form, the change in the present value of NEOs’ DB pension over the reporting period (generally, based on financial reporting assumptions) will be reported on the Summary Compensation Table. Additionally, the new Retirement Plan Benefits Table requires an issuer to separately disclose the following information for each NEO in relation to each DB plan (including supplemental plans) in which the NEO participates: name of the plan, years of credited service, present value of accumulated benefits (again generally, based on financial reporting assumptions) and any payments to the NEO during the last fiscal year from the plans. There appears to be less discretion in the methodology for calculating such pension amounts under the Proposed New Form than under CSA Staff Notice 51-314. Issuers will also be required to provide a concise narrative description of any material factors necessary to understand the plans included in the Retirement Plan Benefits Table.
Contributions to vested and unvested defined contribution (DC) pension plans continue to be reported in the Summary Compensation Table. However, under the Proposed New Form issuers will also be required to provide a narrative description of the material terms of any DC pension plan in which a NEO participates.
Changes to Director Compensation Disclosure
The CSA proposes to increase transparency concerning director compensation through the addition in the Proposed New Form of two new tables: the Director Compensation Table and the Equity Grant Table. The Director Compensation Table is similar in form to the Summary Compensation Table as it requires quantified disclosure, for each director, relating to fees earned, stock awards, option awards, non-equity incentive plan compensation, changes in pension value and all other compensation. As with the Summary Compensation Table, these elements are totalled and reflected as an aggregate dollar figure representing the total compensation received by each director. The Equity Grant Table will require issuers to disclose, for each director, the grant date fair value of all stock awards and option awards.
Issuers will also be required to provide a narrative description of all of the factors necessary to understand a director's compensation as reflected in these new tables.
New Defined Terms
The Proposed New Form contains new terminology for non-salary compensation. Consistent with U.S. executive compensation disclosure rules, it is proposed that the term “bonus” will be limited to compensation that is not salary and which is not dependent on achieving performance measures within a specified period. This divergence from the conventional meaning of the term “bonus” may puzzle some as it is a common practice to set performance goals for the payment of bonus amounts. Under the Proposed New Form, performance based bonus amounts will be disclosed under the non-equity incentive plan column of the Summary Compensation Table rather than under the bonus column.
“Non-equity incentive plan”, a new term, is defined as a plan, other than an equity incentive plan, providing compensation that depends on achieving certain performance goals within a specified period. The term “equity incentive plan” is defined as a plan which provides compensation that not only falls within Section 3870 of the CICA Handbook but also depends on achieving certain performance goals within a specified period. Equity incentive compensation is divided into option awards ( options, stock appreciation rights and awards with “option-like features”), and stock awards (stock, restricted stock or restricted stock units, phantom stock, phantom stock units and similar instruments that are not option awards). An option award or stock award is an equity incentive plan award if it depends on achieving performance goals within a specified period.
New guidance has been provided as to what benefits received by an NEO are “perquisites”. Perquisites are items which (i) are not integrally and directly related to the performance of the NEO’s duties, (ii) provide a direct or indirect benefit to the NEO that has a personal aspect, and (iii) are not available on a non-discriminatory basis to all employees.
Changes to Standards for Disclosure
In recent years, many issuers have enhanced their executive compensation disclosure in response to investor demands for better disclosure. The Proposed New Form will make mandatory certain disclosure which is currently provided by some issuers on a voluntary basis and will limit the flexibility of issuers to make changes to the prescribed format for disclosure. Under the Proposed New Form:
- Required information must be disclosed in accordance with the form, whereas Item 1.2 of the current form merely states that the disclosure should be prepared in the prescribed format.
- It will be necessary to report compensation deferred at the election of the NEO in the column in which it would appear prior to such deferral. Currently, if the NEO can elect to receive non-cash compensation in lieu of salary or bonus, the amount elected may instead be reported in the appropriate non-cash compensation column.
- Amounts must be reported in the same currency used by the issuer in its financial statements.
- Actions relating to executive compensation that were taken after the company’s last fiscal year end must be disclosed in the CD&A. Currently, executive compensation disclosure is focussed on compensation earned in the prior fiscal year, although many issuers have supplemented this with details concerning awards or compensation changes implemented after the fiscal year end but prior to the effective date of the management information circular..
- Issuers must indicate how disclosed performance targets based on non-GAAP financial measures are derived from the GAAP numbers. Such disclosure is currently encouraged by CSA staff pursuant to CSA Staff Notice 52-306, but is not mandatory.
Under the Proposed New Form, issuers listed on the TSX Venture Exchange (Venture Issuers) will become subject to the same executive compensation disclosure requirements required of other Canadian issuers, with one exception, thereby substantially increasing the level of disclosure required by Venture Issuers. Venture Issuers will not, however, be required to provide a performance graph.
Venture Issuers are currently exempt from several executive compensation disclosure requirements, including the requirements to provide disclosure with respect to option and SAR repricings, defined benefit or actuarial plans, the composition of the Venture Issuer's compensation committee, the report on executive compensation and the performance graph. Moreover, Venture Issuers which do not send proxy circulars are exempt from providing executive compensation disclosure.
The CSA’s proposal to apply virtually all of the requirements of the Proposed New Form with equal force to Venture Issuers is a departure from the SEC’s approach which provides exemptions to small business issuers.
Canadian Issuers Reporting in the U.S.
Issuers who comply, even voluntarily, with U.S. executive compensation requirements applicable to U.S. domestic issuers will continue to be exempt from complying with the requirements of Form 51-102F6.
What Should Issuers Be Doing?
The CSA intends to require issuers to comply with a new form for executive compensation disclosure for financial years ending on or after December 31, 2007. If the final version of the form resembles the Proposed New Form, issuers will need to make substantial changes to the manner in which they gather and disclose executive compensation information compared to prior years. To prepare for these changes, issuers should:
- build additional lead time for the preparation of executive compensation disclosure in their timetables for next year’s proxy circular;
- review existing executive compensation disclosure practices in light of the manner in which these would be disclosed under the Proposed New Form;
- consider preparing a mock-up of their executive compensation disclosure using the Proposed New Form and the information most recently disclosed, to help identify any changes needed to disclosure controls and procedures, including identifying any new types of information likely to be required to meet the requirements of the Proposed New Form; and review with the Compensation Committee changes to executive compensation practices and executive compensation disclosure practices arising as a result of the Proposed New Form.