The Securities and Exchange Commission adopted new and revised disclosure rules to require enhanced proxy disclosures about risk, compensation, and corporate governance that will be effective for the upcoming proxy season.1 Because preparations for proxy disclosures are underway and companies will need to update their officer and director questionnaires to reflect these changes, the final rule was posted on December 16, 2009, the same day that the Commission adopted the rules.
In particular, changes to proxy disclosures relate to: (i) compensation policies and practices that are reasonably likely to increase a company’s risk exposure, (ii) revisions to the summary compensation table disclosure of equity awards, (iii) qualifications of directors and nominees, (iv) board leadership structure and role in risk oversight, and, (v) conflicts of interests of compensation consultants.
The new rules also require companies to file a Form 8-K within four business days after the end of a meeting at which a vote is held to describe the results of shareholder votes.
The Commission deferred consideration of proposed amendments to rules governing the proxy solicitation process pending its consideration of its proxy access proposal.
New Disclosure About Compensation Incentives for Risk Taking
Notably the Commission scaled back its original proposal to require disclosure of the relationship of compensation to risk for all employees by including a significantly higher disclosure threshold. As adopted, the revisions will require a discussion of risks arising from a company’s compensation policies and practices for all employees only if such policies and practices are “reasonably likely” to have a material “adverse” effect on the company. The proposed rules would have required disclosure if risks arising from compensation policies “may have” a “material effect” on the company. The Commission noted that companies are familiar with the “reasonably likely” threshold because it is used in Management’s Discussion and Analysis rules which require risk-oriented disclosure of known trends and uncertainties that are material to the business. By focusing on material “adverse” effects, disclosure would be required only if it would have a material adverse financial impact on the company.
If a company determines that the threshold for disclosure is met and disclosure is required, it will need to discuss compensation policies or practices for all employees, including non-executive officers, as they relate to risk management and risk-taking incentives that can affect the company’s risk and management of that risk. As adopted, the required disclosures would not appear in the Compensation Discussion and Analysis (CD&A), as originally proposed, in order to maintain the focus of the CD&A discussion on the compensation of named executive officers. Smaller reporting companies would not be required to provide the new disclosure even though the new rule will not be part of CD&A.
The new disclosure rules incorporate a principlesbased approach. To assist a company in determining whether its compensation programs are reasonably likely to raise material risks, the final rule contains, as proposed, a non-exclusive illustrative list of situations where compensation programs may have the potential to raise material risks, and examples of the types of issues that would be appropriate for a company to address. Included among the list of situations that potentially could trigger disclosure include compensation policies and practices at a business unit of a company (i) that carries a significant portion of the company’s risk profile, (ii) that is structured significantly differently than other units within a company, (iii) that is significantly more profitable than others within the company, or (iv) where the compensation expense is a significant percentage of the unit’s revenues. Disclosure may also be appropriate for company policies and practices that vary significantly from the overall risk and reward structure of the company, such as when bonuses are awarded upon accomplishment of a task, while the income and risk to the company from the task extend over a significantly longer period of time.
Revisions to the Summary Compensation Table
In order to provide investors with a better understanding of the value of stock and option awards granted to company executives and directors, the revisions will require disclosure of the aggregate grant date fair value of awards2 rather than the current disclosure of the dollar amount recognized in the fiscal year for financial statement reporting purposes. The revisions will apply to companies with a fiscal year on or after December 20, 2009. These changes will affect disclosure of stock and option awards in the Summary Compensation Table and the Director Compensation Table and will require companies to present recomputed disclosure for each preceding fiscal year required to be included in the table so that the stock and option awards columns present the full grant date fair values and the total compensation column is correspondingly recomputed. If a person who would be a named executive officer for 2009 also was disclosed as a named executive officer for 2007, but not for 2008, then the named executive officer’s compensation for each of those three fiscal years must be reported. However, companies would not be required to include different named executive officers for any preceding fiscal year based on recomputing total compensation for those years or to amend prior years disclosure in previously filed Forms 10-K or other filings.
Noting that performance awards of equity compensation generally are designed to incentivize attainment of target performance and set a higher maximum performance level as a “cap” on attainable compensation, the final rules require disclosure of performance awards based on the probable outcome of the performance condition(s) as of the grant date rather than the maximum value assuming the highest level of performance. This amount will be consistent with the grant date estimate of compensation cost to be recognized over the service period, excluding the effect of forfeitures. However, in order to permit investors to understand an award’s potential maximum value, companies will be required to provide footnote disclosure of the maximum value of the performance awards by assuming the highest level of performance conditions is probable.
Enhanced Director and Nominee Disclosure
The rules will require new disclosure for each director and nominee for director about the particular experience, qualifications, attributes or skills that qualify that person to serve as a director of the company. However, the rules do not specify the particular information about such experience, qualifications, attributes or skills that should be disclosed. The new disclosure will be required to be made annually for all nominees and for all directors, including those not up for reelection in a particular year. In a change from the proposed rules, the final rules do not require disclosure of the specific experience, qualifications, attributes or skills that qualify a person to serve as a committee member.
As adopted, the rules will require new disclosure of whether diversity is a factor in considering candidates for nominations to the board, and if so, how diversity policies are implemented and how the company assesses the effectiveness of its diversity policies. The rules do not define diversity but rather leave it up to each company to define diversity as broadly or as narrowly as the company may choose; for example, by defining it in terms of backgrounds, viewpoints, education, race, gender, national origin or other factors.
In addition to new disclosure requirements, the rules revise current disclosure of directorships held by directors and nominees in public companies and registered investment companies to include the past five years instead of the existing requirement to disclose only current director positions. In another revision, the rules extend from five years to ten years the reporting period for legal proceedings involving directors, executive officers, and persons nominated to become directors that are material to an evaluation of the ability or integrity of any director, director nominee or executive officer. While the types of legal proceedings that are required to be disclosed have been expanded by the revised rules, settlements of private civil litigation will be excepted from disclosure.
New Disclosure About Board Leadership Structure
New disclosure will also be required about a company’s board leadership structure. Companies will be required to disclose whether and why they have chosen to combine or separate the principal executive officer and board chair positions and the reasons why the company believes that this board leadership structure is the most appropriate structure for the company at the time of the filing. Where the role of principal executive officer and board chairman are combined, and a lead independent director is designated to chair meetings of the independent directors, companies will be required to disclose whether and why the company has a lead independent director, as well as the specific role the lead independent director plays in the leadership of the company.
New Disclosure About the Board’s Role in the Oversight of Risk Management
New disclosure about the board’s role in the oversight of a company’s risk will require a discussion about persons who oversee risks such as credit risk, liquidity risk and operational risk, and the relationship between the board and senior management in managing the material risks facing the company. The disclosure requirement allows companies 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 and whether the individuals who supervise the day-to-day risk management responsibilities report directly to the board as a whole, to a committee, such as the audit committee, or to one of the other standing committees of the board.
New Disclosure Regarding Compensation Consultants
Currently, disclosure regarding compensation consultants focuses on a description of the role of the compensation consultant in determining or recommending the amount or form of executive and director compensation. Under the new rules, the fees paid to compensation consultants will be required under certain circumstances. The new rule addresses conflict of interest concerns about whether executive pay recommendations may have been influenced by compensation consultants who are paid significant fees for other services beyond executive compensation services.
In changes from the proposing release, the final rules include a threshold of $120,000 in additional services below which disclosure will not be required and an exception for fee disclosure of management’s consultant when the board engages its own consultant that is different from the compensation consultant retained by management. Under the new rules, if the board, compensation committee or other persons performing the equivalent functions (collectively, the “board”) has engaged its own compensation consultant to provide advice or recommendations on the amount or form of executive or director compensation, and the board’s consultant or its affiliates provide other non-executive compensation consulting services of more than $120,000 during the last fiscal year, then fee and related disclosure will be required. If the board has not engaged its own consultant, but management or the company receives executive compensation and non-executive compensation services from a consultant, disclosures will be required if the fees for the non-executive compensation consulting fees exceed the $120,000 threshold. Disclosure of management’s consultant fees will not be required if the board has its own compensation consultant and management engages a separate consultant to provide executive compensation consulting services, even if management’s consultant provides additional services to the company. However, in this situation where management and the board have their own consultants and the board’s consultant provides additional non-executive compensation consulting services, fee and related disclosures for the board’s consultant would be required. The Commission reasoned that in situations where a board has retained its own compensation consultant, and the company or management has a different consultant, there is less potential for conflicts of interests involving compensation consultants engaged by management and fee disclosure for services provided by management’s consultant would be less relevant because the board is able to rely on its own compensation consultant’s advice.
If disclosure is required, such disclosure will consist of the aggregate fees paid for all additional services and the aggregate fees paid for work related to determining or recommending executive and director compensation. In a change from the proposed rules, disclosure of the nature and extent of additional services is not required.
In addition, where the board has engaged its own compensation consultant and disclosure is required, companies will also be required to disclose whether the decision to engage the compensation consultant or its affiliates for non-executive compensation services was made or recommended by management and whether the board approved these non-executive compensation consulting services. No disclosure would be required where the compensation consultant’s services involve only consulting on broad-based plans that do not discriminate in favor of executive officers or directors of the company, such as 401(k) plans or health insurance plans or where the consulting services consist of providing the board with peer surveys, such as those that provide general information regarding the forms and amounts of compensation typically paid to executive officers and directors within a particular industry, that are not customized for a particular company or are customized based on parameters that are not developed by the consultant.
New Reporting of Voting Results on Form 8-K
The rules will require companies to report the results of shareholder votes in a Form 8-K to be filed within four business days after the end of the meeting at which a vote was held by adding a new Item 5.07 to Form 8-K. This replaces the current system where voting results are disclosed in a Form 10-Q or 10-K, which could be a few months from the actual vote on such important matters as investment or divestments, changes in shareholder rights and capital changes as well as director elections. As adopted the rules will clarify that this information need be provided only when a meeting of shareholders is involved. The disclosure will consist of the quantitative results of each matter voted on at the meeting and a brief description of each matter. In situations such as contested elections, where companies may not have definitive vote results within four business days after the meeting, companies will be required to disclose on Form 8-K the preliminary voting results within four business days after the preliminary voting results are determined, and file an amended report on Form 8-K within four business days after the final voting results are known.
In view of the short amount of time within which companies have to incorporate these changes into their proxy statements or annual reports, companies should take action as soon as possible to:
- Revise Officer and Director Questionnaires or send out supplemental questionnaires
- Provide each Director as early as possible with their own biographical descriptions
- Involve the nominating committee early in the process to allow them to consider qualifications of nominees