PrintShare


Publications

SEC Adopts New Rules to Expand Proxy Disclosure for Compensation and Corporate Governance

Client Advisory

January 4, 2010

The SEC has adopted new rules to expand the disclosure in proxies for compensation and corporate governance and require prompt reporting of shareholders’ voting results on Form 8-K. These amendments are effective February 28, 2010. Therefore, proxy and information statements and Forms 10-K and 8-K, among others, filed after February 28, 2010, must comply the new rules. A copy of the adopting release is available at http://www.sec.gov/rules/final/2009/33-9089.pdf

The rule amendments will require reporting companies to provide disclosure covering:

  • If the risks from a company’s compensation policies are reasonably likely to have a material adverse effect on the company, how those compensation policies relate to the company’s risk management and risk-taking incentives;
  • The aggregate grant date fair value of stock awards and option awards granted in the fiscal year in the Summary Compensation Table and Director Compensation Table in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718, Compensation Stock Compensation (“FASB ASC Topic 718 ), rather than the dollar amount recognized for financial statement purposes for the current fiscal year;
  • The qualifications of directors and nominees for director;
  • All directorships held by each director and nominee during the past five years;
  • The consideration of diversity in the process by which candidates for director are considered for nomination;
  • An expanded list of legal actions involving a company’s executive officers, directors, and nominees for director, and covering a longer period of time, i.e., from five years to ten years;
  • A company’s board leadership structure and the board’s role in the oversight of risk;
  • The fees paid to compensation consultants and their affiliates under certain circumstances; and
  • The vote results from a meeting of shareholders to be reported on Form 8-K generally within four business days of the meeting.

A. Enhanced Compensation Disclosure

1.  The Company’s Compensation Policies and Practices Related to Risk Management

The new rule requires a company to disclose its compensation policies and practices for all employees, including non-executive officers, if the compensation policies and practices create risks that are reasonably likely to have a material adverse effect on the company.  If a company has compensation policies and practices for different groups that mitigate or balance incentives these could be considered in deciding whether risks arising from the Company’s compensation policies and practices for employees are reasonably likely to have a material adverse effect on the company as a whole. The new requirements are in a separate paragraph in Item 402 of Regulation S-K (and not part of the Compensation Discussion and Analysis).

The situations that would require disclosure will vary depending on the particular company and its compensation program. Nevertheless, the final rules contain a non-exclusive list of situations that potentially could trigger disclosure including, among others, compensation policies and practices:

  • At a business unit of the company that carries a significant part of the company’s risk profile;
  • At a business unit with compensation structured significantly differently than other units within the company;
  • At a business unit that is significantly more profitable than others within the company;
  • At a business unit where the compensation expense is a significant percentage of the unit’s revenues; and
  • 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.

This is a non-exclusive list of situations where compensation programs may have the potential to raise material risks to the company. There may be other features of a company’s compensation policies and practices that have the potential to incentivize its employees to create risks that are reasonably likely to have a material adverse effect on the company. However, disclosure under the amendments is only required if the compensation policies and practices create risks that are reasonably likely to have a material adverse effect on the company. Even in the situations listed above, a company may under appropriate circumstances conclude that its compensation policies and practices are not reasonably likely to have a material adverse effect on the company.

Taking a principles based approach, the final rules contain illustrative examples of the issues that a company should consider. The examples are non-exclusive and the application of an example should be tailored to the facts and circumstances of the company. If a company determines that disclosure is required, examples of the issues that companies may need to address regarding their compensation policies or practices include the following:

  • The general design philosophy of the company’s compensation policies and practices for employees whose behavior would be most affected by the incentives established by the policies and practices, how the policies and practices relate to or affect risk taking by those employees on behalf of the company, and the manner of their implementation;
  • The company’s risk assessment or incentive considerations, if any, in structuring its compensation policies and practices or in awarding and paying compensation;
  • How the company’s compensation policies and practices relate to the realization of risks resulting from the actions of employees in both the short term and the long term, such as through policies requiring claw backs or imposing holding periods;
  • The company’s policies regarding adjustments to its compensation policies and practices to address changes in its risk profile;
  • Material adjustments the company has made to its compensation policies and practices as a result of changes in its risk profile; and
  • The extent to which the company monitors its compensation policies and practices to determine whether its risk management objectives are being met for incentivizing its employees.

2.  Revisions to the Summary Compensation Table

The new rules require the reporting of stock awards and option awards in the Summary Compensation Table and Director Compensation Table of the aggregate grant date fair value of awards made during the year (regardless of the service period to which they relate) computed in accordance with FASB ASC Topic 718, rather than the dollar amount recognized for that year for financial statement reporting purposes.

The new rules contain special instructions for awards subject to performance conditions. The value of performance awards reported in the Summary Compensation Table, Grants of Plan-Based Awards Table and Director Compensation Table should be computed based upon the probable outcome of the performance conditions as of the grant date, excluding the effect of estimated forfeitures. The maximum value of the award assuming that the highest level of performance conditions is probable must be disclosed in a footnote.

To facilitate year-to-year comparisons, the new Summary Compensation Table rules require companies providing Item 402 disclosure for a fiscal year ending on or after December 20, 2009, to present recomputed disclosure for each preceding fiscal year required to be included in the table, so that the stock awards and option awards columns present the applicable full grant date fair values, and the total compensation column is correspondingly recomputed. The stock awards and option awards columns amounts should be computed based on the individual award grant date fair values reported in the applicable year’s Grants of Plan-Based Awards Table, except that awards with performance conditions should be recomputed to report grant date fair value based on the probable outcome as of the grant date, consistent with FASB ASC Topic 718.

Additionally, if a person who would be a named executive officer for the most recent fiscal year, i.e., 2009, also was disclosed as a named executive officer for 2007, but not for 2008, the named executive officer's compensation for each of those three fiscal years must be reported pursuant to the amendments. However, companies need not include different named executive officers for any preceding fiscal year based on recomputing total compensation for those years pursuant to the amendments, or to amend a prior years' Item 402 disclosure in previously filed Forms 10-K or other filings.

B. Enhanced Director and Nominee Disclosure

Item 401 of Regulation S-K has been amended to expand other disclosure requirements for director and nominee qualifications, past directorships held by directors and nominees, and legal proceedings involving directors, nominees, and executive officers.

1.  Director Qualifications

The new rules require companies to disclose for each director and any nominee for director the particular experience, qualifications, attributes or skills that led the board to conclude that the person should serve as a director for the company when the disclosure is made in light of the company’s business and structure. The same disclosure would be required in the proxy soliciting materials for any nominee for director put forward by shareholders. This new disclosure will be required for all nominees and for all directors, including those not up for reelection in a particular year.  These new disclosures are in addition to the current requirements that companies describe the specific minimum qualifications and specific qualities or skills used by the nominating committee.

The final rules do not require disclosure of the specific experience, qualifications or skills that qualify a person to serve as a committee member. However, if an individual is chosen to be a director or a nominee to the board because of a particular qualification, attribute or experience related to service on a specific committee, such as the audit committee, then this should be disclosed under the new requirements as part of the individual’s qualifications to serve on the board.

The new rules do not specify the particular information that should be disclosed. Companies and shareholders have flexibility in determining the information about a director’s or nominee’s skills, qualifications or particular area of expertise that would benefit the company and that should be disclosed to shareholders. However, if particular skills, such as risk assessment or financial reporting expertise, were part of the specific experience, qualifications, attributes or skills that led the board or shareholder to conclude that the person should serve as a director, this should be disclosed.

2.  Other Directorships

The new rules require disclosure of any directorships held by each director and nominee at any time during the past five years with public companies and registered investment companies.

3.  Legal Proceedings

The new rules lengthen the time for which disclosure of legal proceedings involving directors, director nominees and executive officers is required from five to ten years. The new rules also expand the list of legal proceedings involving directors, executive officers, and nominees required to be disclosed under Item 401(f) of Regulation S-K.

These new legal proceedings include:

  • Any judicial or administrative proceedings resulting from involvement in mail or wire fraud or fraud in connection with any business entity;
  • Any judicial or administrative proceedings based on violations of federal or state securities, commodities, banking or insurance laws and regulations, or any settlement to such actions; and
  • Any disciplinary sanctions or orders imposed by a stock, commodities or derivatives exchange or other self-regulatory organization.

Settlement of private litigation need to be disclosed. 

4.  Diversity

The new rules amend Item 407(c) of Regulation S-K to require disclosure of whether, and if so how, a nominating committee considers diversity in identifying nominees for director. Additionally, if the nominating committee (or the board) has a policy for considering diversity in identifying director nominees, disclosure would be required of how this policy is implemented, as well as how the nominating committee (or the board) assesses the effectiveness of its policy. Diversity has not been defined in the rule and may be defined in various ways reflecting different perspectives that companies consider appropriate. For example, some companies may conceptualize diversity expansively to include differences of viewpoint, professional experience, education, skill and other individual qualities and attributes that contribute to board heterogeneity, while others may focus on diversity concepts such as race, gender and national origin.

The new disclosures under Item 401 would appear in proxy and information statements on Schedules 14A and 14C, annual reports on Form 10-K and registration statements on Form 10 under the Exchange Act, as well as in registration statements under the Securities Act.

C.  Board Leadership Structure

The new rules amend Item 407 of Regulation S-K and Item 7 of Schedule 14A to require disclosure of the company’s leadership structure and why the company believes its structure is the most appropriate structure for it.  Under the new rules, a company is required to disclose whether and why it has chosen to combine or separate the principal executive officer and board chairman positions.  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, the companies must 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. These amendments are not intended to influence a company’s decision for board leadership structure.

D.  Board Role in Risk Oversight

The new rules amend Item 407 of Regulation S-K to require companies to describe the board’s role in oversight of risk. This disclosure requirement gives companies the 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 the effect this has on the board’s leadership structure. Where relevant, companies may want to address whether the individuals who supervise the day-to-day risk management responsibilities report directly to the board as a whole or to a board committee or how the board or committee otherwise receives information from those individuals.

E.  Compensation Consultants

The new rules amend Item 407 of Regulation S-K to require disclosure about the fees paid to compensation consultants and their affiliates when they played a role in determining or recommending the amount or form of executive and director compensation, and they also provided additional services to the company.  Under the current rule companies must describe the role of the compensation consultant in determining or recommending the amount or form of executive and director compensation.

If the board or compensation committee has engaged its own consultant to provide advice or recommendations on the amount or form of executive and director compensation and the consultant or its affiliates provide other non-executive compensation consulting services to the company that exceed $120,000 during the company’s fiscal year, then the following disclosure is required:

  • the aggregate fees for determining or recommending the amount or form of executive and director compensation and the aggregate fees for the non-executive compensation consulting services;
  • whether the decision to engage the compensation consultant or its affiliates for non-executive compensation consulting services was made or recommended by management; and
  • whether the board or compensation committee has approved these non-executive compensation consulting services provided by the compensation consultant or its affiliate.

If the board or compensation committee has not engaged its own consultant, but management has engaged a compensation consultant (including its affiliates) to provide executive compensation consulting services and non-executive compensation consulting services to the company, and the fees for the non-executive compensation consulting services exceed $120,000 during the company’s fiscal year, then the company is required to disclose the aggregate fees paid for advising on the amount and form of executive and director compensation and for all additional services.

If the board or compensation committee and management has each engaged its own consultant, fee and related disclosure for consultants that work with management (whether for only executive compensation consulting services, or for both executive compensation consulting and other non-executive compensation consulting services), is not required.

Also excepted from the disclosure requirement are services involving only broad-based non-discriminatory plans or providing information, such as surveys that are not customized for the company, or are customized based on parameters that are not developed by the consultant.

F.  Reporting of Voting Results on Form 8-K

New Item 5.07 to Form 8-K requires companies to disclose on Form 8-K the results of a shareholder vote and to file the Form 8-K within four business days after the end of the meeting at which the vote was held. This eliminates the requirement to disclose shareholder voting results on Forms 10-Q and 10-K. 

The new instruction to Form 8-K states that companies are required to file preliminary voting results within four business days after the end of the shareholders’ meeting, and then file an amended report on Form 8-K within four business days after the final voting results are known. However, if a company obtains the definitive voting results before the preliminary voting results must be reported and decides to report its definitive results on Form 8-K, it will not be required to file the preliminary voting results.

G.  Transition: Effective Dates

The SEC published guidance in the form of Compliance and Disclosure Interpretations (“C&DIs”) concerning the effective dates of the amendments to the compensation-related disclosure requirements in Items 402 and 407 of Regulation S-K. These C&DIs may be found at http://www.sec.gov/divisions/corpfin/guidance/pdetinterm.htm

The final amendments generally become effective on February 28, 2010, and the revisions to the rules on disclosure of equity compensation are further limited to fiscal years ending on or after December 20, 2009.

  • Interaction Between Effective Dates. Both effective dates must be considered in determining whether compliance with the new rules is required. For example, an issuer need not comply with the new disclosure rules if its Form 10-K and definitive proxy statement are filed before February 28, 2010, even if the issuer’s fiscal year ended on or after December 20, 2009. Similarly, to the extent the issuer’s fiscal year ended before December 20, 2009, the new rules need not be complied with even if the filing for the year is made after February 28, 2010.
  • Preliminary Filings. The filing date of an issuer’s definitive proxy statement is the relevant date for determining whether compliance with the new rules is required. Consequently, if a preliminary proxy statement is filed before February 28, 2010, if an issuer with a fiscal year ending on or after December 20, 2009, expects to file its definitive proxy statement on or after February 28, 2010, the new rules must be complied with in both the preliminary proxy statement and the definitive proxy statement.
  • New Registrants Filing on or After December 20, 2009. If a new registrant first files its registration statement on or after December 20, 2009, the registration statement must comply with the new rule if it is to be declared effective on or after February 28, 2010.
  • Voluntary compliance. The SEC endorsed voluntary compliance with the new rules even if compliance is not required for a particular issuer.   However, if the issuer complies voluntarily with the revised equity award disclosure rules, it must also comply with the rest of Regulation S-K as amended by the final amendments. Issuers may choose to comply selectively with the other parts of the new rules, provided they do not comply with the new equity award disclosure rules.


Questions regarding this advisory should be addressed to Guy P. Lander (212-238-8619, lander@clm.com).



Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. © 2017 Carter Ledyard & Milburn LLP.
© Copyright 2010

Related practice areas:


© Copyright 2017 Carter Ledyard & Milburn LLP