Publications

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The Securities and Exchange Commission has proposed several new or amended rules aimed at modifying current executive compensation and corporate governance disclosures.

Stating that shareholders have increasingly focused on corporate accountability and expressed the desire for additional information that would enhance their ability to make informed voting and investment decisions, the SEC is proposing disclosure changes regarding overall compensation policies and their impact on risk taking, stock and option awards of executives and directors, director and nominee qualifications and legal proceedings, company leadership structure, the board's role in the risk management process and potential conflicts of interest of compensation consultants.

The SEC is also proposing requiring disclosure of shareholder voting results on Form 8-K rather than on Forms 10-Q and 10-K and revisions to certain proxy rules addressing the manner in which parties soliciting proxies communicate with shareholders.

The proposed amendments are set forth in a 137-page release entitled “Proxy Disclosure and Solicitation Enhancements.” You may read the release here. Comments on the proposal are due by September 15, 2009.

New Disclosures Regarding Material Risks in Overall Compensation Policies

The SEC is proposing to amend the current compensation disclosure and analysis (CD&A) requirements to require disclosure about how the company’s 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 proposed amendments would require a company to discuss and analyze its broader compensation policies and overall actual compensation practices for employees generally, including non-executive officers, if risks arising from those compensation policies or practices may have a material effect on the company.

Under the proposed amendments, the situations that would require disclosure will vary depending on the particular company and its compensation programs. The SEC indicated that situations potentially triggering discussion and analysis 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 is also proposing revising the Summary Compensation Table and Director Compensation Table disclosure to set forth the aggregate grant date fair value of stock and option awards computed in accordance with Statement of Financial Accounting Standard No. 123 (revised 2004), Share-Based Payment (SFAS 123R). The proposal would replace currently mandated disclosure of the dollar amount recognized for financial statement reporting purposes for the fiscal year in accordance with SFAS 123R – so the proposed amendment would result in disclosure of higher (non-cash) compensation amounts.

The SEC indicated that the current rule may be less informative of the amount of compensation a company decides to award during the year, and not adequately identify the executives that the company intends 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.

The SEC is proposing certain conforming amendments to the Grants of Plan-Based Awards Table, the Director Compensation Table, and Instruction 2 to the salary and bonus columns of the Summary Compensation Table.

New Disclosures Regarding Qualifications of Directors

The SEC is also proposing expanding disclosure requirements regarding the qualifications of directors and nominees. The proposal would require disclosure for each director and nominee that details the particular experience, qualifications, attributes or skills qualifying that person to serve as a director of the company as of the time that a filing containing such disclosure is made with the SEC, and as a member of any committee that the person serves on or is chosen to serve on (if known), in light of the company’s business and structure.

Currently, Item 401 of Regulation S-K requires 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 SEC’s proposed amendments would expand the information required about individual directors in Item 401 and supplement the current director qualification disclosures in Item 407. The SEC indicated that these proposals 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.

For example, information that may be disclosed includes information about:

• a director's or nominee’s risk assessment skills;
• a director's or nominee’s specific past experience that would be useful to the company;
• a director's or nominee’s particular area of expertise; and 
• why the director's or nominee’s service as a director would benefit the company.

In addition, the SEC is proposing to require disclosure of any directorships held by each director and nominee at any time during the past five years at public companies and to lengthen the time during which disclosure of legal proceedings is required from five to 10 years.

New Disclosures Regarding Company’s Leadership Structure

The SEC is proposing a new disclosure requirement, to appear in proxy and information statements, regarding a company’s leadership structure and why the company believes it is the best structure for it at the time of the filing. Companies also would 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 would 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.

Although the SEC has indicated that this proposal is not intended to influence a company’s decision regarding its board leadership structure, it seems likely that the proposal could have some influence on a company’s decision.

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

The SEC is proposing additional disclosure in proxy and information statements about the role of a company’s board of directors in the company’s risk management 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 market crisis, the SEC opined that it is important for investors to understand the board’s, or board committees’, role in this area.

Under this proposed amendment, disclosures may include:

• 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 whole or to a particular committee; and 
• whether and how the board, or board committee, monitors risk.

New Disclosures Regarding Compensation Consultants

The SEC is proposing 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 provide other services to the company. In addition, the proposed amendments would require a description of such other services.

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 disclosures are intended to enable investors to assess any incentives a compensation consultant may have in recommending executive compensation and to better assess the compensation decisions made by the board.

As proposed, if a compensation consultant or its affiliates played a role in determining or recommending the amount or form of executive or director compensation, and also provided additional services, then the company would be required to disclose the following:

• the nature and extent of all additional services provided to the company or its affiliates during the last fiscal year by the compensation consultant and any affiliates of the consultant;
• the aggregate fees paid for all additional services, and the aggregate fees paid for work related to determining or recommending the amount or form of executive and director compensation;
• whether the decision to engage the compensation consultant or its affiliates for non-executive compensation services was made, recommended, subject to screening, or reviewed by management; and
• whether the board of directors or the compensation committee has approved all of these services in addition to executive compensation services.

The proposed amendments would not apply to situations in which the compensation 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 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 is also proposing to transfer the requirement to disclose shareholder voting results from Forms 10-Q and 10-K to Form 8-K. Currently, Item 4 in Part II of Form 10-Q and Item 4 in Form 10-K require 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 SEC proposal would delete these current disclosure requirements and add a new Item 5.07 to Form 8-K requiring a company to file on Form 8-K the results of a shareholder vote within four business days after the end of the meeting at which the vote was held.

The SEC expressed concern that a delay between the end of an annual or special meeting and when the voting results of the meeting are disclosed in a Form 10-Q or 10-K may make the disclosure less useful to investors and the markets. However, the SEC also recognized that in certain situations, such as contested elections, companies may not have definitive vote results within four business days after the meeting. Accordingly, the proposal includes an instruction that if the matter voted upon at the meeting relates to a contested election of directors and the voting results are not definitively determined at the end of the meeting, companies would disclose preliminary voting results on Form 8-K within four business days after the preliminary voting results are determined and file an amendment to the Form 8-K within four business days after the final voting results are certified.

Revisions to Proxy Solicitation Process

The SEC is also proposing revisions to rules governing the proxy solicitation process to clarify various interpretive issues that have arisen. The SEC indicated that, if the proposed amendments are adopted, it anticipates that compliance with the amendments would begin in the 2010 proxy season.

Rule 14a-2(b)(1). Rule 14a-2(b)(1) under the Securities Exchange Act of 1934, as amended (the Exchange Act), exempts from the generally applicable disclosure, filing and most other requirements of the proxy rules solicitations by shareholders or other non-management parties who are not seeking proxy authority and do not have a substantial interest in the subject matter of the solicitation. However, this exemption is unavailable to, among others, a person who furnishes or otherwise requests, or acts on behalf of a person who furnishes or requests, a “form of revocation,” or a person who, because of a substantial interest in the subject matter of the solicitation, is likely to receive certain “benefits” from a successful solicitation.

The SEC is proposing to clarify that an unmarked copy of management’s proxy card that is requested to be returned directly to management is not a “form of revocation” under Rule 14a-2(b)(1) so that a person who furnishes such a duplicate proxy card is not disqualified from relying on the exemption. This proposal, which is contrary to the holding of Mony Group, Inc. v. Highfields Capital Mgmt. L.P., 368 F.3d 138 (2d. Cir., 2004), would aid efforts by persons not seeking proxy authority to facilitate voting by shareholders sharing their views on matters submitted for shareholder approval, such as in a “just vote no” campaign, without having to incur the costs and efforts of conducting a fully-regulated proxy solicitation.

The SEC is also proposing to clarify that a person need not be a security holder of the class of securities being solicited and that the “benefit” need not be related to or derived from any security holdings in the class being solicited for Rule 14a-2(b)(1)(ix) to disqualify the person from relying on the exemption.

Rule 14a-4(d)(4). Rule 14a-4(d)(1) under the Exchange Act requires that, in order to solicit authority to vote for the election of a person to office, the person must be a bona fide nominee who consents to being named in the soliciting person’s proxy statement and to serving if elected. Rule 14a-4(d)(4) provides an exception to the bona fide nominee requirement that permits a person to solicit support for nominees who, if elected, would constitute a minority of the board of directors (commonly referred to as a short slate), to round out its short slate of nominees up to the total number of director positions then subject to election by seeking authority to vote for nominees named in the registrant’s proxy statement.

The SEC is proposing to allow a person soliciting in support of nominees who, if elected, would constitute a minority of the board to seek authority to vote for another soliciting person’s nominees in addition to or instead of the issuer’s nominees to round out its short slate.

The proposed exception would be available only when non-management parties are not acting together. Such parties would be required to represent in their proxy statement that they have not agreed and will not agree to act, directly or indirectly, as a group or otherwise engage in any activities that would be deemed to cause the formation of a group as determined under Section 13(d)(3) of the Exchange Act and in Regulation 13D-G promulgated thereunder with the other non-management person. In addition, a non-management soliciting person that seeks to round out its short slate with any nominee named in another non-management person’s proxy statement would also be required by the proposed rule to represent in its proxy statement that it is not a participant in the other non-management person’s solicitation.

Rule 14a-4(e). Rule 14a-4(e) under the Exchange Act requires a proxy statement or form of proxy to provide that the shares represented by the proxy be voted “subject to reasonable specified conditions.” Expressing concern that the recipient of a proxy could seek to exercise a degree of discretion that would be inconsistent with Rule 14a-4(c)’s limits on when a proxy can confer discretionary authority, the SEC is proposing that the “reasonable specified conditions” under which the shares represented by a proxy will not be voted under Rule 14a-4(e) must be “objectively determinable.”

Rule 14a-12. Rule 14a-12 under the Exchange Act permits a solicitation to be made before furnishing security holders with a proxy statement meeting the requirements of Rule 14a-3(a) if, among other requirements, each written communication that is part of the solicitation contains specified participant information. Rule 14a-12(a)(1)(i) requires such information to include the identity of the participants in the solicitation and a description of their direct or indirect interests or a legend advising security holders where they can obtain that information. The SEC is proposing to clarify that the required participant information must be filed under cover of Schedule 14A in a proxy statement or other soliciting materials no later than the time the first soliciting communication is made.

SEC Seems Poised for Additional Action

The SEC indicated that it is continuing to explore other ways to improve proxy disclosures. In addition to requesting comments on the proposals summarized above, the SEC generally requested comments on whether there are other initiatives it should consider in order to improve the disclosure in proxy statements, particularly with regard to executive compensation disclosure. The SEC also requested comments on numerous specific compensation and governance matters.

Given the SEC’s recent adoption of new proxy and executive compensation rules, as well as pending legislation on these topics, the SEC seems poised for further action. We will continue carefully monitoring relevant developments to help public companies plan for their potential impact.