This advisory discusses developments and trends that will affect the process of preparing the Form 10-K and annual meeting proxy statement in 2009 and subsequent years.

In 2009 public companies are not burdened by significant new disclosure rules or governance requirements, but rather the challenge of applying the substantially overhauled formal disclosure and governance regimes that the U.S. Securities and Exchange Commission (SEC) and the stock exchanges have adopted since the passage of the Sarbanes-Oxley Act to today’s extraordinary economic circumstances.  Investors in recent months have endured shocking blows to the value of their investments, and to confidence in the value of corporate disclosure and governance requirements and standards that many consider to be insufficient to their intended purposes. 

With the commencement of the Obama administration and the ongoing economic recession and financial system crisis, as well as stunning instances of apparent fraud and regulatory failure, significant new legislation and other federal regulation affecting the disclosure and governance practices of public companies is likely to be proposed in the coming months.  Although it is unlikely that most, if any, new requirements will be effective for the 2009 proxy season, at least for calendar year-end companies, public companies should take into consideration investor discontent and anger, expectations for increased transparency and the possibility of eventual substantial changes in requirements as they finalize disclosures for this year’s Form 10-K and proxy statement and prepare for their annual shareholder meetings.

Treasury Issues Additional Executive Compensation Rules Under TARP; TARP Reform Legislation Pending

On January 16, 2009, the U.S. Department of the Treasury issued interim final rules for reporting and recordkeeping requirements under the executive compensation standards of the Troubled Asset Relief Program’s (TARP’s) Capital Purchase Program (CPP) of the Emergency Economic Stabilization Act of 2008 (EESA). 

The new Treasury rules require the chief executive officer (CEO) to certify annually within 135 days after the financial institution’s fiscal year end that the financial institution and its compensation committee have complied with these executive compensation standards. 

In addition, the CEO of a participating company is required to certify that the compensation committee has reviewed the senior executives’ incentive compensation arrangements with the senior risk officers to ensure that these arrangements do not encourage senior executives to take unnecessary and excessive risks that could threaten the value of the financial institution.

Treasury originally published executive compensation standards for CPP in October 2008.  The rules generally apply to the CEO, chief financial officer and the next three most highly compensated executive officers.  These standards include the following:

  • Ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution
  • Requiring “clawback” of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate
  • Prohibiting the financial institution from making any golden parachute payment (based on the Internal Revenue Code provision) to a senior executive
  • Agreeing not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive

Although these rules currently apply only to companies participating in the CPP, these measures are expected to influence proposed regulation affecting all public companies.  On January 9, 2009, House Financial Services Committee Chairman Barney Frank (D-MA) introduced legislation to amend the TARP provisions of the EESA.  The legislation seeks to increase accountability and transparency and require Treasury to take steps on foreclosure mitigation.  In addition, for any new recipient of TARP funds (except certain small financial institutions), the proposed changes would apply the most stringent non-tax executive compensation restrictions from EESA to all participants in EESA programs.

In October 2008, in a speech urging better compliance with the SEC’s revised executive compensation disclosure rules adopted in 2006, John W. White, then the head of the SEC’s Division of Corporation Finance, advised public companies to consider the broader implications of the executive compensation requirements of the EESA programs:

… ask yourself this question:  Would it be prudent for compensation committees, when establishing targets and creating incentives, not only to discuss how hard or how easy it is to meet the incentives, but also to consider the particular risks an executive might be incentivized to take to meet the target—with risk, in this case, being viewed in the context of the enterprise as a whole?  I’ll let you think about what Congress might want.  We know what our rules require.  That is, to the extent that such considerations are or become a material part of a company’s compensation policies or decisions, a company would be required to discuss them as part of its CD&A. 

Click here for a copy of the White speech.

Accordingly, some non-financial services companies likely will address in their Compensation Disclosure and Analysis (CD&A) the relationship between their compensation programs and executive risk taking, although for most of these companies it is less likely that incentive compensation arrangements present enterprise-wide risk, so many are likely to wait and see how practice evolves and what additional regulation, if any, is proposed before adopting new disclosures in response to the EESA provisions.  In the meantime, all companies should consider whether incentive arrangements present risks as part of their enterprise risk assessment and management programs.  With regard to the influence on investor expectations of other EESA provisions, companies with clawback policies or agreements should disclose them in the CD&A, particularly if they are broader than the restrictions in EESA.  In addition, companies that have voluntarily limited payments on a change in control to amounts not in excess of the Internal Revenue Service’s (IRS’s) golden parachute limit might want to point out that consistency with the EESA restriction.

Continuing Implementation of Revised Executive Compensation Disclosure Rules

The year 2009 is the final year of the three-year phase-in of the revised executive compensation disclosure rules adopted in 2006, and thus data for the past three years is required in the CD&A for the first time under the revised rules.  Consequently, with that and with compensation programs potentially changing, the following may occur:

  • New types of infrmation to include in the tables
  • New tables that the company did not have to include before
  • New narrative information in the CD&A or elsewhere, in particular if the presentation of three full years of information raises year-over-year comparative data questions that should be answered

In some cases, even in the tabular disclosure, an additional year of data can mean more than adding another row of information for the latest year.  For example, even if there are no new awards, information concerning outstanding awards may migrate within the tables as a result of passage of time or satisfaction of performance criteria.

In his speech in October 2008, the SEC’s White spoke to the Staff’s three primary areas of continuing concern (accordingly reflected in its comment letters) regarding the CD&A.  The key points made include the following.

Performance Targets:

If performance targets are a material element of a company’s compensation policies and decisions, they must be disclosed, unless the company concludes that disclosure would result in competitive harm, in which case disclosure regarding the degree of difficulty associated with achievement or non-achievement of the omitted performance objective is mandatory.  This disclosure should clearly address the criteria for determining undisclosed target levels, and it must directly establish the connection between the achievement of the performance objective and the characteristics of the incentive payment to which the goal applies.  Companies advancing a pay-for-performance philosophy should provide meaningful disclosure that describes the degree to which the performance goals or metrics were sufficiently challenging or appropriate in light of that compensation philosophy, and how achievement of the objectives actually rewarded performance. 

A new Staff Compliance and & Disclosure Interpretation (C&DI), No. 118.04, addresses how a company determines whether it may omit disclosure of performance target levels on the basis of competitive harm under Instruction 4 to Item 402(b).  The Staff recommends that a company availing itself of Instruction 4 should document the legal basis for excluding the disclosure contemporaneously with making the decision as the Staff consistently ask filers to provide it with the legal analysis setting forth the reasons why it believes competitive harm would ensue through disclosure.  The Staff expects companies to substantiate a legitimate position rather than merely provide generalized support for a casual determination that some sort of harm might result from disclosure.


Where a company benchmarks a material element of compensation, it must identify the companies that comprise the peer group used for this purpose.  The Staff expects disclosure concerning the basis for selecting the peer group, and the relationship between actual compensation and the data utilized in benchmarking or peer group studies.  The Staff believes that often the benchmarking methodologies used are not clear nor have companies adequately explained how they are utilizing the data collected from their analyses of peer group pay.  The Staff expects companies to disclose the extent to which companies set their compensation levels to remain competitive with a peer group.

Separately, the Staff has clarified what it expects for disclosure when a company may have looked at surveys that included data on dozens or hundreds of companies.  New C&DI 118.05 provides a general definition of benchmarking and states that benchmarking “generally entails using compensation data about other companies as a reference point on which—either wholly or in part—to base, justify or provide a framework for a compensation decision.  It would not include a situation in which a company reviews or considers a broad-based third-party survey for a more general purpose, such as to obtain a general understanding of current compensation practices.”


The Staff continues to express concern that the “how and the why” are missing from the CD&A in explaining the connection between the company’s philosophies and processes and the numbers the company presents in its tabular disclosure.  Many Staff comments request that companies discuss the material elements of compensation, how varying levels of compensation are determined, and why a company believes its practices and decisions fit within the overall compensation objectives and philosophy.  

Comment letters also ask companies to explain and place in context each of the specific factors considered when approving particular pieces of each named executive officers’ compensation package, analyze the reasons why the company believes that the amounts paid are appropriate in light of the various factors it considered in making specific compensation decisions, and describe why or how determinations with respect to one element affected other compensation decisions.  To the extent that a discussion of the comparison between actual results and the performance objectives used to establish compensation does not correspond with actual payouts because pay was influenced by an exercise of discretion, the Staff will request companies to provide appropriate qualitative disclosure of the reasons for the use of such discretion and how it affected actual pay. 

To the extent there is a relationship between payouts from different elements of compensation, the Staff asks companies to provide clear descriptions of the correlation between each element of compensation and how compensation decisions regarding one element affected levels of compensation derived from other elements.  The Staff seeks disclosure addressing the extent to which compensation committees are reviewing each element of compensation individually, or whether committees are engaging in a collective evaluation of all components of executive pay when establishing the various forms and levels of compensation.

One other new C&DI bearing on CD&A warrants mention.  Although most companies are aware that the role of any compensation consultants must be dislosed outside the CD&A in disclosure of governance matters under Regulation SK 407(e)(3), new C&DI No. 118.06 confirms that if a “compensation consultant plays a material role in the company’s compensation-setting practices and decisions,” then the company should discuss that in the CD&A.

RiskMetrics’ Updated Corporate Governance Voting Guidelines

RiskMetrics Group ISS Governance Services recently released updates to its corporate governance policies that guide its voting recommendations to institutional shareholders on matters submitted by companies for shareholder approval at annual shareholder meetings, including an expanded list of “poor pay practices” that will influence ISS’s voting recommendations with respect to the re-election of compensation committee members (and, potentially, other board members).  These updates are discussed in a separate McDermott Will & Emery On the Subject entitled “Responding to RiskMetrics’ Updated Corporate Governance Voting Guidelines for the 2009 Proxy Season,” available at

Stock Exchange Governance Rule Changes

In the fall of 2008, the NYSE and NASDAQ director independence requirements were modestly amended, which should be reflected in the 2009 director and officer questionnaires.

NYSE Changes

The NYSE increased from $100,000 to $120,000 the amount of direct compensation that a director or members of a director’s immediate family may receive from a listed company in a 12-month period within the prior three years and still be considered an independent director.  This amendment conforms the NYSE rules with the threshold amount for disclosure in proxy statements and Form 10-K under the SEC’s Regulation S-K.  The NYSE also amended its rules to provide that a director may still be considered independent if the director has an immediate family member currently working for the company’s auditor, as long as the immediate family member is not a partner of the company’s auditor or is not personally involved (and has not been personally involved for the past three years) in the company’s audit.  In each case the company’s board of directors still needs to affirmatively determine that any relationship with such a director is not material.

NASDAQ Amendment

For the same reason as the similar NYSE change, NASDAQ rules were amended to provide that a director is not independent if the director or an immediate family member accepted any compensation from the listed company in excess of $120,000 (previously $100,000) during any period of 12 consecutive months within the three years preceding the determination of independence (excluding compensation for board or board committee service, compensation paid to an immediate family member as a non-executive employee, benefits paid under a tax-qualified retirement plan and non-discretionary compensation).  

Possible Passage of Proposed Amendment to NYSE Rule 452

With the changes in Washington, D.C., including a new SEC chairman, it is anticipated that in 2009 the SEC might approve the NYSE’s long-pending proposal to amend its broker voting rule (Rule 452) to deny brokers the right to use their own discretion to vote uninstructed shares in connection with the annual election of directors.  Even if this amendment is approved, however, it does appear unlikely that such a change would be effective for meetings held in the winter or early spring of 2009.  As brokers have traditionally voted their uninstructed shares for management’s slate of directors, this amendment to Rule 452 would likely increase the percentage impact of withheld votes and more frequently trigger the provisions of majority voting policies or bylaw provisions adopted by many companies in recent years.  Some brokerage firms, however, have voluntarily applied proportional voting to uninstructed shares in accordance with the voting on instructed shares, which in general will mitigate the potential impact of an amendment to Rule 452.

New SEC Staff Legal Bulletin on Shareholder Proposals

In November 2008, the SEC Staff issued Staff Legal Bulletin No. 14D regarding Rule 14a-8 under the Securities Exchange Act of 1934, the shareholder proposal rule.  The bulletin provides a new SEC e-mail address ([email protected]) to send Rule 14a-8 no-action requests and related correspondence, requires that proposal proponents send copies of correspondence to the company, and establishes procedures for the company and the proponent to provide additional correspondence to the SEC's Division of Corporation Finance and to each other.  The bulletin also discusses the treatment of proposals that recommend, request or require a board of directors to unilaterally amend the company’s articles or certificate of incorporation, and the circumstances under which a company must send a notice of defect if the company’s records indicate that the proponent has not owned the minimum amount of securities for the required period of time as set forth in Rule 14a-8(b).  Staff Legal Bulletin No. 14D is available here.


In 2009, for the first time all public companies subject to the SEC’s proxy requirements must comply with its electronic proxy rules (referred to as e-proxy).  The e-proxy rules require that a company’s proxy materials (i.e., the proxy statement, a proxy card, the “glossy” annual report to shareholders and any other soliciting materials) be posted in a reader-friendly format on an internet website (other than the SEC’s website).  The website must not contain any technology, such as cookies, that would compromise the anonymity of shareholders.  The e-proxy rules also permit, but do not require, a company to deliver a Notice of Internet Availability of Proxy Materials (a Proxy Notice) in lieu of mailing the materials to shareholders (referred to as Notice and Access), but hard copies of the proxy materials must be delivered to any shareholder who requests them.  

Companies that choose to use Notice and Access must deliver a Proxy Notice to shareholders at least 40 calendar days before the annual meeting date and posting proxy materials on a website.  The 40-day requirement effectively means that proxy materials must be finalized some 45 to 50 days prior to the meeting date, not including additional time needed to clear any preliminary proxy materials required to be filed with the SEC.  The SEC Staff has indicated in public comments a willingness to relax the 40-day requirement, although no change to the rule has been formally proposed.  The Proxy Notice must be limited to the information set forth in the SEC rules and cannot be accompanied by a proxy card.  Companies can use both Notice and Access for certain shareholders, and a traditional mailing of the proxy materials without a Proxy Notice for other shareholders (referred to as Full Set Delivery).  

It is unclear whether or not the use of Notice and Access satisfies U.S. Department of Labor standards applicable to delivery of proxy materials to employees participating in 401(k) and other employee benefit plans.  Consequently many companies continue to use Full Set Delivery (including through electronic delivery under prior SEC guidance, which was unaffected by e-proxy) to furnish materials to those participants.         

Public companies should evaluate with their advisers and service providers, (e.g., counsel, transfer agent, proxy solicitors and Broadridge Financial Services or other intermediary) whether savings in printing and postage costs can be realized using Notice and Access, with consideration of first-year adoption costs and additional service fees.  Companies should also consider the prospective impact of the use of Notice and Access on voting rates and quorum requirements, with consideration given to a company’s shareholder profile and the specific matters to be presented for a vote at the meeting.

Management’s Discussion and Analysis, and Risk Factors

There have been no changes to the SEC’s rules or formal guidance regarding management’s discussion and analysis (MD&A) since 2008, but the SEC Staff has used speeches and its comment letters on periodic filings to emphasize fairly predictable issues of greatest concern given the current challenging economic environment, including with respect to revenues, liquidity and capital resources, and “known trends and uncertainties” that might have a material impact on the company’s finances (even if not company-specific).  The SEC has issued several significant interpretative releases with respect to MD&A the past 20 years and given the extraordinary challenges facing all businesses, individuals responsible for MD&A disclosure should re-familiarize themselves with this guidance and review their MD&A disclosure controls and procedures.  Click here for suggested MD&A drafting procedures.  In addition, in 2008, the SEC Staff issued two “Dear CFO” letters to certain chief financial officers regarding the discussion of fair value accounting in MD&A.  Samples of these letters are available here.

Material changes to the MD&A, in particular with respect to trends and uncertainties disclosure, will likely result in a corresponding need to make changes to the company’s risk factor disclosure and cautionary language regarding forward-looking statements included in the Form 10-K under the Private Securities Litigation Reform Act of 1995.

Smaller Reporting Companies – Internal Control over Financial Reporting

In June 2008, the SEC approved a further additional one-year extension of the Sarbanes-Oxley Act Section 404(b) auditor attestation requirement of a company’s internal control over financial reporting (ICFR) for non-accelerated filers (those with less than $75 million in market capitalization) pending completion of Public Company Accoutning Oversight Board’s (PCAOB’s) issuance of final staff guidance on auditing ICFR of smaller public companies, and a ongoing SEC review of whether its guidance to management on evaluating ICFR and the PCAOB’s Auditing Standard No. 5 regarding ICFR are having the intended effect of facilitating more cost-effective ICFR evaluations and audits for smaller reporting companies.  If no further extensions are granted, non-accelerated filers must comply with the auditor attestation requirements in their annual reports filed for fiscal years ending on or after December 15, 2009.  

XBRL Adopted

On December 18, 2008, the SEC voted to require public companies and mutual funds to use interactive data for financial information, using the XBRL (eXtensible Business Reporting Language) format.  With interactive data, all of the facts in a financial statement are labeled with unique computer-readable “tags,” which function like bar codes to make financial information more searchable on the internet and more readable by spreadsheets and other software. 

For public companies, interactive data financial reporting will occur on a phased-in schedule beginning in 2009.  The largest companies that file using U.S. generally accepted accounting principles (U.S. GAAP) with a public float above $5 billion will be required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2009.  This will cover approximately 500 companies.  The remaining companies that file using U.S. GAAP will be required to file with interactive data on a phased-in schedule over the next two years.  Companies reporting in International Financial Reporting Standards issued by the International Accounting Standards Board will be required to provide their interactive data reports starting with fiscal years ending on or after June 15, 2011.  Companies will be able to adopt interactive data earlier than their required start date.  All U.S. public companies will be required to have filed interactive data financial information by December 2011.  Further communication on this matter will be forthcoming after the SEC’s adopting release becomes available.