Publications

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The Securities and Exchange Commission has approved several new and amended rules aimed at modifying current executive compensation and corporate governance disclosures. The new and amended rules, approved on December 16, 2009, will become “effective” on February 28, 2010. We expect the SEC to issue clarifying guidance concerning the applicability of the effective date of the rules nest week.

Emphasizing a desire to increase shareholder visibility into executive compensation, corporate governance and company risk taking, thereby better enabling shareholders to hold executive officers and directors accountable for their decisions and performance, the SEC adopted disclosure changes regarding overall compensation policies and their impact on risk taking, stock and option awards of executives and directors, background and qualifications of directors and nominees, board diversity, legal proceedings involving a company’s directors, nominees, and executive officers, board leadership structure, the board’s role in the risk management process and potential conflicts of interest of compensation consultants.

The SEC also adopted a requirement that shareholder voting results be disclosed on Form 8-K within four business days of the meeting rather than on Forms 10-Q and 10-K.

The new and amended rules are set forth in Final Rule Release Nos. 33-9089 and 34-61175 entitled “Proxy Disclosure Enhancements.” You may read the final rule release here.

New Disclosures Regarding Compensation Policies and Practices Related to Risk Management

The SEC adopted new Item 402(s) of Regulation S-K, which requires that companies provide an analysis of how their overall compensation policies for employees create incentives that can affect the company’s risk and management of that risk, as well as the relationship between executive compensation policies and risks to the company. The amendments require a company to discuss and analyze its broader compensation policies and overall actual compensation practices for all employees generally, including non-executive officers, if risks arising from those compensation policies or practices are reasonably likely to have a material adverse effect on the company. Smaller reporting companies are exempted from complying with the requirements of new Item 402(s).

Under the new rule, the situations that would require disclosure will vary depending on the particular company and its compensation programs. The SEC indicated that situations potentially triggering disclosure could include, among others, compensation policies and practices:

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

New Tabular Disclosures Regarding Executive Compensation

The SEC also adopted revisions to the Summary Compensation Table and Director Compensation Table to require disclosure of the aggregate grant date fair value of stock and option awards computed in accordance with FASB ASC Topic 718. For awards subject to performance conditions, the value of such awards is to be calculated based on the probable outcome of the performance condition(s) on the grant date; a separate footnote disclosure will reflect the maximum award value based on the assumption that the satisfaction of the highest performance condition(s) is probable. The new rule replaces previously-mandated disclosure of the dollar amount recognized for financial statement reporting purposes for the fiscal year in accordance with FASB ASC Topic 718 – which resulted in the disclosure of higher (non-cash) compensation amounts.

The SEC indicated that the prior rule was sometimes less informative of the amount of compensation a company decides to award during the year, and did not adequately identify the executives that the company intended to compensate most highly, since the grant date fair value could differ from the amount reported for the full fiscal year, which could also have the potential to distort the identification of named executive officers. The SEC noted that if a company does not believe the grant date fair value reflects a named executive officer’s compensation, perhaps because the full grant date value for equity instruments may bear no relation whatsoever to value actually realized at a later date by the executive, it can provide appropriate explanatory narrative disclosure.

In order to facilitate a shareholder’s ability to compare a company’s year-to-year disclosures, the amended rule requires that each company with a fiscal year end of December 20, 2009 or later recompute its disclosures for all prior fiscal years to be included in the tables in accordance with these new disclosure requirements. However, companies will not be required to include different named executive officers for prior years solely as a result of these recomputed disclosures, or to amend prior years’ Item 402 disclosures.

New Disclosures Regarding Qualifications of Directors

The SEC adopted new rules requiring expanded disclosure regarding the qualifications of directors and nominees. The new rules require annual disclosure for each director and nominee that details the particular experience, qualifications, attributes or skills that led the board to conclude that such person was qualified to serve as a director of the company as of the time that a filing containing such disclosure is made with the SEC.

Under the current rules, Item 401 of Regulation S-K requires disclosure of brief biographical information about directors and nominees for the past five years, and Item 407 of Regulation S-K requires general disclosure about director qualification requirements at a company. The amendments expand the information required about individual directors in Item 401 and supplements the current director qualification disclosures in Item 407 by requiring that a company explain any differences in how its nominating committee evaluates nominees based on whether such nominee was recommended by a security holder.

The SEC indicated that these amendments are aimed at helping investors determine whether a particular director and the entire board composition is an appropriate choice for a given company as of the time that a filing containing this disclosure is made with the SEC, and will permit such investor to weigh a director or nominee against the standards established by the board.

In addition, the SEC adopted amendments requiring the disclosure of any directorships held by each director and nominee at any time during the past five years at public companies and registered investment companies (whether or not the director currently serves on such board), and to lengthen the time during which disclosure of certain legal proceedings (other than private litigation) is required from five to 10 years. The expanded list of legal proceedings to be disclosed under these new amendments includes:

• 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 or regulations, or any settlement of such actions; and
• any disciplinary sanctions or orders imposed by a stock, commodities or derivatives exchange or other self-regulatory organization.

New Disclosures Regarding Board Diversity

The SEC adopted an amendment to Item 407(c) of Regulation S-K that requires the disclosure of whether a company’s nominating committee considers diversity in identifying director nominees, and if diversity is considered, in what way. Additionally, if the board or nominating committee has a policy regarding the consideration of diversity, the amended rule will require that companies disclose the implementation and assessment of the effectiveness of such diversity policy. The SEC did not define “diversity” in the new rules, instead noting that each company should be permitted to define diversity in the manner it considers appropriate.

New Disclosures Regarding Board Leadership Structure

The SEC adopted a new disclosure requirement, to appear in proxy and information statements, regarding a board’s leadership structure and why the company believes it is the best structure for it at the time of the filing. Companies will be required to disclose whether and why they have chosen to combine or separate the principal executive officer and board chair positions. For companies with a combined principal executive officer and board chairman who have a lead independent director designated to chair meetings of independent directors, disclosure will be required as to whether and why the company has a lead independent director and the specific role the lead independent director plays in the leadership of the company.

New Disclosures Regarding Role of Board in Company’s Risk Oversight Process

The SEC adopted rules requiring additional disclosure in proxy and information statements about the role of a company’s board of directors in the company’s risk oversight process. Noting that companies face a variety of risks, including credit risk, liquidity risk and operational risk, and that risk and the adequacy of risk oversight played a role in the recent financial crisis, the SEC opined that it is important for investors to understand the board’s, or board committees’, role in this area.

Under the new rules, disclosures may include, where relevant:

• how the board implements and manages its risk management function, such as through the board as a whole or through a particular committee;
• whether the persons who oversee risk management report directly to the board as a whole or to a particular committee; and
• whether and how the board, or board committee, monitors risk.

New Disclosures Regarding Compensation Consultants

The SEC adopted new disclosures regarding the fees paid to compensation consultants and their affiliates when they play any role in determining or recommending the amount or form of executive and director compensation, if they also provided other services to the company for fees that exceed $120,000 for such other services during the company’s fiscal year. In addition, the new rules require disclosure of whether the decision to retain such consultant or its affiliates to provide such non-executive compensation consulting services was made by management, and whether the board or the compensation committee approved the non-executive compensation consulting services. The disclosure of executive compensation consulting services and other services provided to management will not be required if the board has retained its own (different) consultant.

Many compensation consultants or their affiliates provide a broad range of additional services, such as benefits administration, human resources consulting and actuarial services, which can generate significant fees. Expressing concern that such additional services may create actual or apparent conflicts of interest that call into question the objectivity of the consultants’ executive pay recommendations, the SEC indicated that these new disclosure requirements are intended to enable investors to assess any incentives a compensation consultant may have in recommending director and executive compensation and to better assess the compensation decisions made by the board.

The amendments do not apply to situations in which the compensation consultant’s only role in recommending the amount or form of executive and director compensation is in connection with consulting on broad-based plans that do not discriminate in favor of executive officers or directors of the company, such as 401(k) plans or health insurance plans.

Reporting of Voting Results on Form 8-K

The SEC also adopted a requirement to disclose shareholder voting results on Form 8-K, as opposed to Forms 10-Q and 10-K. Previously, Item 4 in Part II of Form 10-Q and Item 4 in Form 10-K required the disclosure of vote results on any matter that was submitted to a vote of shareholders during the fiscal quarter covered either by the Form 10-Q or, with respect to the fourth fiscal quarter, by the Form 10-K. The amendment eliminates the requirement to disclose voting results in the Form 10-Q and Form 10-K and adds a new Item 5.07 to Form 8-K that requires a company to file a Form 8-K to report the results of a shareholder vote within four business days after the end of the meeting at which the vote was held. To the extent the final voting results are unknown at the time the Form 8-K is required to be filed, Item 5.07 of Form 8-K requires that companies file preliminary voting results within four business days after the end of the meeting, and later amend such Form 8-K filing to disclose final results within four business days after such final results become available.