On July 10, 2009, the SEC proposed changes to its executive compensation and governance disclosure requirements that would expand the disclosures companies are required to make regarding:
The proposing release also would change the framework for disclosure of stock and option awards, require earlier disclosure of shareholder voting results, and clarify certain proxy solicitation rules. The SEC intends the proposed rule changes, if adopted, to be effective for the 2010 proxy season.
Compensation Discussion and Analysis of Risk
The proposed rule changes would require the Compensation Discussion and Analysis (CD&A) section of proxy statements to address compensation policies and practices as they relate to risk management practices and risk-taking incentives. Discussion would be required about compensation policies and practices for employees generally — not, as in the rest of the CD&A, for only the named executive officers — to the extent that risks arising from such policies and practices may have a material effect on the company. In preparing this discussion, companies would need to consider the level of risk that employees might be encouraged to take to meet their incentive-compensation targets or conditions. The CD&A would retain its current requirement to discuss, to the extent material, exposure to downside performance risk and cost-benefit analysis with respect to the compensation of named executive officers. Consistent with the principles-based approach of the rest of the CD&A, the proposed rules include the following illustrative list of generally applicable compensation policies and practices that might warrant discussion if the effects of such items are material:
The proposing release also provided the following examples of the types of issues that may be appropriate for discussion and analysis:
The proposing release emphasizes (1) that companies should evaluate whether discussion of these issues is appropriate in light of their importance to investors based on the individual company’s circumstances, and (2) that the level of detail should vary depending on the particular facts of the company or business unit involved. The release seeks comment on a number of issues, including whether the discussion should be mandatory only for certain sizes of companies or certain industries and whether discussion of all of the examples of issues should be required.
Compensation Table Disclosures for Equity Awards to Eliminate GAAP Expense Framework
Since its adoption in 2006, the SEC’s current framework for reporting stock and option awards in the Summary Compensation Table (showing the dollar amount recognized during the year for financial reporting purposes rather than the aggregate grant date fair value of awards) has been criticized by investors, practitioners, and commentators as potentially misleading and confusing to investors. For example, reporting the expense can result in a negative compensation number in years in which equity awards are forfeited, and using the expense to determine the most highly-paid executives for purposes of inclusion in the Summary Compensation Table can result in significant variation from year to year for reasons unrelated to companies’ compensation decisions. The SEC has received a number of comments opposing the current framework, and many companies have responded to its perceived weaknesses by providing “alternative” Summary Compensation Tables using the aggregate grant date fair value. The proposing release would unwind the current framework and require companies to report stock and option awards in the Summary Compensation Table and Director Compensation Table using their aggregate grant date fair value instead of the companies’ expense recognized for financial reporting purposes.
In a related change, companies also would no longer be required to report the amount of salary and bonus foregone at the election of an executive in the Summary Compensation Table. Instead, non-cash awards received upon such an election by the executive would be reported in the Summary Compensation Table in the form elected. Additionally, the requirement to report the full grant date value of each individual equity award in the Grants of Plan-Based Awards Table and corresponding footnote disclosure to the Director Compensation Table would be eliminated to avoid redundancy.
More Detailed Director and Nominee Disclosures
The proposed rule changes would expand required disclosures regarding directors and director nominees. Companies would be required to disclose the particular experience, qualifications, attributes, and skills of each director and nominee, when considered in light of the company’s business and structure, that qualify such director or nominee to serve as a director of the company and as a member of any committee on which such director or nominee will serve. The expanded disclosure requirements would apply to incumbent directors, nominees selected by the company, and to any nominees put forward by other proponents. Companies also would be required to disclose any public company directorships held by each director and nominee at any time during the past five years rather than current directorships only. Additionally, the time during which disclosure is required of certain bankruptcy-, criminal-, or securities-related legal proceedings would be lengthened from five to 10 years.
New Disclosures Regarding Company Leadership Structure
Under the proposed rule changes, companies would be required to disclose their leadership structure and justify it, providing an explanation for why they believe such structure is the best for them at the time of the disclosure. Companies would be required to disclose whether and why they have combined or separated the principal executive officer and board chair positions. Companies also would be required to disclose (1) whether they have a lead independent director, (2) if they do, (a) the reasons for having a lead independent director and (b) the specific role that the lead independent director has in the leadership of the company. In addition, companies would be required to disclose the board’s involvement in the risk management process (for example, whether the company’s risk management function is implemented and managed by the entire board or through a committee and whether the persons overseeing risk management report to the board or a committee).
Conflicts of Interest Involving Compensation Consultants
Companies would be required to disclose additional information concerning compensation consultants and their affiliates, if the consultants or affiliates (1) play any role in determining or recommending the amount or form of executive and director compensation and (2) also provide other services to the company. Under such circumstances, companies would be required to disclose:
The new compensation consultant disclosures would not be required if the consultant’s only role in recommending the amount or form of executive or director compensation is in connection with consulting on broad-based plans that do not discriminate in favor of officers or directors such as 401(k) plans or health insurance plans.
Form 8-K Disclosure of Shareholder Voting Results
Currently, companies are required to report the results of shareholder votes in the periodic report for the period in which the vote was taken. Consequently, results of shareholder votes may not be disclosed until some time after the vote is taken. For example, for a calendar year company, the results of a shareholder vote that takes place in October would generally not be required to be announced until the company files its annual report on Form 10-K in March of the following year. Under the proposed rules, companies would be required to report the results of shareholder votes on a current report on Form 8-K within four business days after the end of the meeting at which the vote was taken. If the vote relates to a contested election of directors and the voting results are not definitively determined at the end of the meeting, companies would be required to disclose the preliminary voting results on Form 8-K within four business days after the preliminary results are determined and then file an amended report on Form 8-K within four business days after final results are certified.
Proposed Rules for Management Investment Companies
The proposed rules would similarly expand disclosures for directors and director nominees, leadership structure and risk management for management investment companies such as mutual funds registered under the Investment Company Act of 1940.
Proxy Solicitation Process Clarifications
The SEC included in the proposed rules a number of technical clarifications and refinements relating to the proxy solicitation process and voting, stating that it intends the changes to provide greater certainty to soliciting parties, help shareholders receive timely and complete information, and facilitate shareholder voting. Specifically, the rules would provide as follows:
The SEC has requested comment on a number of issues in connection with the proposed rules. Comments must be submitted by September 15, 2009. As the SEC anticipates that the proposed rule amendments would be effective for the 2010 proxy season, companies may wish to begin the process now of gathering the additional information necessary to comply with the expanded disclosure requirements.
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Joshua A. Agen
Stephen J. Byrnes, Jr.
Linda Y. Kelso
Carolyn T. Long
James M. Reeves