SEC Adopts New Disclosure Rules Concerning Executive Compensation
By: THOMAS F. STEICHEN, RUILIN LI, & SCOTT DORFMAN, Summer Associate
November 2006
On July 26, 2006, the Securities and Exchange Commission (“SEC”) adopted broad changes to its existing rules regarding disclosure of executive and director compensation. This first major overhaul in 14 years is designed to provide investors with easily understood compensation information. The rule changes will affect disclosure in annual reports, registration statements, proxy statements, and Form 8-K reporting.
Annual reports on Form 10-K and Form 10-KSB for fiscal years ending on or after December 15, 2006 must comply with the new rules. They apply to proxy statements filed after December 15, 2006, if such statements include certain disclosures for fiscal years ending on or after December 15, 2006. The new disclosures will also be required in any registration statement filed on or after December 15, 2006, to the extent that it relates to executive compensation disclosures in fiscal years ending on or after December 15, 2006. Form 8-K compliance is now required for triggering events that occur after November 7, 2006. The following are key provisions of the changes:
Named Executive Officers
The principal executive officer, principal financial officer, and the three other highest-paid executive officers are considered “named executive officers” (NEOs) under the new rules; however, for small business issuers, the NEOs are the principal executive officer and the two other highest-paid executive officers. Compensation disclosure for these positions is required under the rules. A determination of the three/two highest-paid executive officers will be based on annual “total compensation.”
Compensation Discussion and Analysis
The centerpiece of the SEC’s new rules is its Compensation Discussion and Analysis (“CD&A”), which refines the required tabular disclosure and provides for greater narrative disclosure. The SEC labels this section the “principles-based overview explaining the policies and decisions related to NEO compensation in one place.” It is not required for small business issuers.
Compensation Committee Report
In addition to the CD&A, the SEC requires companies, other than small business issuers, to furnish a compensation committee report. The report should now include a statement of whether the committee has discussed and reviewed the CD&A section with management, and recommended that it be included in the annual report on Form 10-K and proxy statement. Analysts suggest that the report state that the committee considers the company’s executive compensation to be reasonable. Since the report is required to be “furnished” rather than “filed,” it is likely subject to less stringent liability under securities laws.
Tabular Disclosure
The rules contain new or revised tables both to disclose executive compensation and to provide tabular and narrative disclosure of all compensation paid to or earned by a director. The director compensation table will be similar to a summary compensation table, except that the former should provide information for the last completed fiscal year only. The following is a general description of these tables:
Summary Compensation Table
Following the CD&A, compensation disclosure must be presented in a summary compensation table, which should disclose compensation for each NEO over the last three years (two years for small business issuers). According to the SEC, the columns should include the following, in addition to salary and bonus information:
- A dollar value for all equity-based awards shown in separate columns for stock and stock options;
- The amount of compensation under non-equity incentive plans (new column);
- The annual change in the actuarial present value of accumulated pension benefits, as well as preferential earnings on nonqualified deferred compensation (new column);
- The amount of all other compensation, including perquisites of more than $10,000. This is revised from the previous threshold of $50,000; and
- A new total compensation column, which is the sum of the other columns.
It is important to note that companies need not restate on the summary table compensation for previous fiscal years previously reported under the old rules.
Other Required Disclosures
The SEC is requiring a new “grants of plan-based awards table” to supplement the summary compensation table. Required disclosure includes the: (i) grant date fair value; (ii) Financial Accounting and Standards Board Statement No. 123(R) grant date; (iii) closing market price on the grant date (if greater than the exercise price); (iv) date the compensation committee or board voted to grant the award (if different from grant date); and (v) description of the methodology used to determine the exercise price.
A company must disclose information regarding the decision-making process or methodology used in determining grant dates in the narrative disclosure portion of the “grants of plan-based awards table” or in the CD&A. The SEC requires guidance on the following questions:
- Does the company have any program or plan to coordinate option grants with the release of material non-public information?
- How does any program, plan, or practice to time option grants to executives relate to the company’s practice with other employees?
- What was the role of the compensation committee and executive officers in approving and administering the program?
- Does the company plan to time, or has it in the past timed, its release of material non-public information for the purpose of affecting executive compensation value?
The SEC is requiring companies (other than small business issuers) to include two new disclosure tables on outstanding equity interests to accompany the summary compensation table, including the outstanding equity awards at fiscal-year end, and option exercises and stock vested. The new rules require disclosure on retirement and post-employment plans in the form of pension benefits and nonqualified deferred compensation tables. They also modify the related-person-transaction-disclosure requirement, and increase the required-disclosure threshold from $60,000 to $120,000. Finally, the rules update requirements regarding director independence to reflect current listing standards.
Form 8-K
The new rules modify Form 8-K reporting by consolidating all employment and compensation arrangement disclosure under one item heading: 5.02. They also require disclosure of certain employment arrangements and material amendments for NEOs.