Ten steps for implimenting the SEC's new compensation disclosure rules
In light of pressure from institutional investors and a string of enforcement actions by the staff of the SEC over incomplete executive compensation disclosures, the SEC adopted amendments to its rules governing the disclosure of executive and director compensation. The main goals of the new rules are to make executive compensation disclosure more understandable and to provide investors with a clearer and more complete picture of the compensation paid to the executives and directors of public companies. The rules are also intended to require more complete qualitative information regarding the manner and context in which compensation is awarded and earned.
Because of the complexity of the new rules and the number of changes made to the previous executive compensation disclosure system, public companies, executives and compensation committees should start taking the following steps to prepare for the implementation of these new rules.
Identify the most highly compensated officers: The group of individuals for which compensation is required to be disclosed in the summary compensation table in the proxy statement has changed. Tabular compensation disclosure is required for each individual who held the positions of chief executive officer or chief financial officer at any time during the most recent fiscal year, as well asfor the three other most highly compensated executive officers with more than $100,000 of total compensation, less the sum of abovemarket or preferential earnings on non-qualified deferred compensation and the increase in pension values during that fiscal year. These changes will require companies to keep track of compensation for a larger group of individuals in anticipation of changes to the group of named executive officers.
The SEC decided not to adopt at this time the controversial ‘Katie Couric’ provision that would have required disclosure of up to three employees (without specifically naming them) who were not executive officers during the prior fiscal year, if their total compensation exceeded that of any of the named executive officers.
Instead, the SEC resubmitted for comment a provision that would require disclosure of total compensation for up to three non-executive officer employees whose total compensation exceeded that of any of the named executive officers, except that employees having no responsibility for significant policy decisions would be excluded. The SEC also asked for comment on restricting the rule to large accelerated filers.
Evaluate the effects on equity-based awards and changes in existing awards: The summary compensation table must include the full aggregate FAS 123R grant date fair value of all stock awards, stock options, stock appreciation rights and other similar equity-based compensation. The previous table required disclosure of long-term compensation, including the number of securities underlying options and stock appreciation rights and the value of restricted stock awards using the market value of the stock at the date of grant. Companies and compensation committees may want to consider these disclosure changes when creating, amending or terminating equity- based awards and deferred compensation arrangements.
Consider quantitative disclosure and post-employment benefits in drafting new compensation arrangements: Companies must provide increased tabular and narrative disclosures regarding postemployment compensation. The new tabular information covers retirement plan and nonqualified deferred compensation to named executive officers, and the narrative disclosures require companies to disclose and analyze specific post-termination payment arrangements with named executive officers.
Companies and their compensation committees should be mindful of these disclosure obligations in preparing and negotiating postemployment provisions in employment, change-in-control, compensation award and other similar agreements.
Prepare for the new compensation tables and compensation discussion and analysis section: The new rules require a substantially greater number of compensation tables and a more thorough analysis of the material factors that underlie a company’s compensation policies. This compensation discussion and analysis (CD&A) section requires, at a minimum, the objectives of the company’s compensation programs, what the compensation program is designed to reward and not reward, why the company chooses to pay each element of compensation, how the company determines the amount for each element and how each compensation element fits into the company’s overall compensation objectives and affects decisions regarding other elements.
Thus, companies and compensation committees should begin to adjust their data-gathering systems to reflect the information that is required by the new rules. Compensation committees should adjust, if necessary, their determination processes and judgments regarding reviewing and setting executive compensation so that the required analysis can be prepared.
Keep track of perquisites and other compensation: Disclosure is required in the ‘all other compensation’ column of the summary compensation table of all compensation not properly reportable in the other columns. Reporting is required for the specific terms of compensation, including perquisites and other personal benefits totaling $10,000 or more given with footnote disclosure that identifies and quantifies such benefits in excess of $10,000, including the value of any perquisite valued at the greater of $25,000 or 10 percent of all perquisites. So what is a perk, you may ask? The new rules include the SEC’s guidance on what constitutes a perquisite. Generally, any item of compensation that is ‘integrally and directly related to the performance of the executive’s duties’ would not be considered a perk. Even so, compensation related to the executive’s duties that confers a direct or indirect personal benefit will be considered a perquisite, unless it is generally available to employees on a non-discriminatory basis. Also, compensation committees should keep in mind that an analysis of the types of and reasons for granting perquisites to named executive offi- cers may be required in the CD&A.
Draft the proxy statement in ‘plain English’: Compensation disclosures in the proxy statement must be written in ‘clear, concise and understandable’ language, commonly known as ‘plain English.’ Generally, plain English focuses on creating shorter and simpler sentences, using active rather than passive voice, decreasing the emphasis on industry jargon and defined terms and breaking up long paragraphs into bulleted lists and shorter paragraphs.
Because the annual meeting proxy statements of many companies have not typically been written in plain English, it might be helpful to begin thinking now about converting the compensation sections, as well as the entire proxy statement, into plain English format. Companies should allow extra time in the proxy statement drafting schedule in 2007 to focus on issues of plain English.
Establish and review policies and procedures related to the approval of related party transactions: The rules require proxy statement disclosure of the policies and procedures related to the approval of related party transactions. The rules also expand the group of family members that are deemed to be ‘related parties’ and increase the dollar threshold of reportable transactions to $120,000 from the current $60,000.
For any company that does not already have such policies regarding related party transactions in place, either on a standalone basis or as part of its audit committee charter, the board of directors should consider adopting such policies before the next proxy statement to avoid having to justify why there is no such policy or procedure. To prepare for the 2007 proxy season, personnel charged with monitoring related party transactions should amend questionnaires and similar disclosure tools accordingly.
Obtain compensation committee approval of executive compensation:
Another significant change to the related party disclosures is the elimination of the rule that permits the omission in the compensation section of related party transactions disclosed in the related party transaction section of the proxy statement. Under the new rules, disclosure of compensation of executives is not generally required under the related party transaction section so long as the compensation is approved by the compensation committee or other committee of independent directors or is reported in the compensation section (for named executive officers). Thus, to avoid unnecessary or duplicative disclosure of compensation arrangements under the related party transaction section, it will be necessary for a company’s compensation committee to approve the compensation to all executive officers regardless of whether they are a named executive officer.
Monitor director compensation and independence:
Director compensation is now required to be provided in tabular form. The required information is similar to that provided for executive officers in the summary compensation table. As a result, director compensation information should also be tracked throughout the year so it can be accurately reported in the proxy statement.
Furthermore, each company should take this opportunity to reconsider the independence of each director. The new rules require disclosing the factors considered in making such a determination, even if the company has relied on a stock exchange categorical standard in arriving at an assessment that the director is in fact independent.
Begin to adopt and implement changes to the compensation approval process:
The SEC amended the required compensation committee disclosures to include additional information regarding the constitution and operation of the compensation committee, including the committee’s scope of authority; the extent to which, and to whom, the committee may delegate such authority; any role of executive officers in determining or recommending the amount or form of executive and director compensation; and disclosures regarding the use of compensation consultants to determine or recommend the amount or form of executive and director compensation. In light of these increased disclosures, compensation committees may want to analyze their structure and internal operations – including their reliance on executive officers and compensation consultants – in advance of potential required proxy disclosures for next year.
With the increasing focus on a more holistic approach to compensation standards and guidelines, the compensation committee should use the time before the next proxy season to assess how it reviews the substance of executive compensation packages, as well as the tools it uses to do so, and make changes where necessary or desirable. As sunlight is added to the executive compensation process, the compensation committee’s processes will undoubtedly be evaluated to determine if they need to be changed or improved.
Jane Storero is a partner at the Blank Rome LLP anfd Jeffrey Taylor is an associate.
