United States: Executive Compensation Disclosure Memo Series (Part 3 Of 6)

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Part 3 of 6 of the Executive Compensation Disclosure Memo Series summarizes the principal aspects of the Summary Compensation Table (the "SCT") and the Director Compensation Table, which are required in proxy statements (or 10-K’s for companies not subject to the proxy rules) filed during the upcoming proxy season.

The SEC views the SCT as the "principal disclosure vehicle for executive compensation." The SCT will reflect compensation awarded to, earned by, or paid to, each named executive officer ("NEO") for each of the last three fiscal years, with required disclosure being phased in over a three-year period. As a result, only fiscal 2006 compensation will need to be reported under the new rules in upcoming proxy statements and 10-Ks for December 31 fiscal year-end companies. Although voluntary compliance with the new disclosure rules for all three years is of course permitted, compensation from prior years can continue to be reported in the prior tabular format. The principal changes to the structure of the SCT include the following:

• a new column to report each NEO’s "total compensation;"

• a new column showing non-equity incentive plan compensation;

• presentation of the fair value of option grants rather than the number of shares;

• elimination of the division between annual and long-term compensation; and

• a new column for disclosure of annual increases in pension plan benefits and above-market earnings on nonqualified defined-contribution and other deferred compensation plan benefits.

Narrative disclosure will also accompany the table and provide material factors necessary to understand the information disclosed in the SCT. A sample of the new SCT is attached to this alert.

In an effort to offer shareholders a clearer picture of each NEO’s compensation package, the SEC added a new Total Compensation column to the SCT. This column represents the sum of the values set forth in the columns preceding the Total Compensation column of the SCT. Unlike the previous SCT, which provides for disclosure of certain amounts in terms of the number of underlying securities, the new SCT Total Compensation figure will disclose all NEO compensation in a dollar denominated figure. There are only three exceptions to this disclosure requirement:

• perks and personal benefits ("perks") with an aggregate value of less than $10,000;

• at-market earnings on nonqualified defined-contribution and other deferred compensation plan benefits; and

• the value of group life, health, hospitalization and medical reimbursement plan benefits (provided the plans are nondiscriminatory).

Although the Salary and Bonus columns are nothing new to the SCT, the SEC made several changes to these columns in the new executive compensation rules. First, the amount of salary, bonus or any other compensation that has been earned must be reported in the appropriate column, even if deferred until a future year. All forms of deferred compensation must be disclosed, not just deferred salary and bonuses, regardless of the reason for the deferral. Second, if an NEO’s salary and bonus cannot be calculated until after the date of the proxy statement, the company must disclose that in a footnote, indicating when the amount is expected to be determined, and file a Current Report on Form 8-K to report the amount when calculable.

Finally, certain compensation that would have been previously reported in the Bonus column will now be reported in the new Non-Equity Incentive Plan Compensation column. A performance bonus based on an outcome that was substantially uncertain when the performance target was set and communicated to the executive will now be reported in the Non-Equity Incentive Plan Compensation column. On the other hand, the Bonus column will include the non-performance-related bonuses, performance bonuses based on outcomes that were substantially certain when the target was established, and bonuses based on performance targets not communicated to the executive.

Three additional columns in the SCT cover plan-based awards: Stock Awards, Option Awards and Non- Equity Incentive Plan Compensation columns. Unlike prior requirements to disclose elements of stock and option compensation in numbers of shares rather than dollars, all compensation must now be disclosed in dollar amounts.

The reported value in the Stock Awards column is generally the fair value of the award on the grant date as determined under FAS 123R for financial reporting purposes. These awards include restricted stock, restricted stock units, phantom stock and phantom stock units, common stock equivalent units and other equity awards granted during the fiscal year that do not have "option-like features." The new rules also require a footnote referencing the disclosure of the relevant valuation assumptions in the notes to the company’s financial statements or in MD&A. Even if a stock award is subject to performance-based conditions, the award must be included in the Stock Awards column, which is different from the current rules that permit such awards to be reported as incentive plan awards.

The value of awards of options, stock appreciation rights and similar equity-based compensation instruments that have option-like features and are within the scope of FAS 123R must be disclosed in the Option Awards column. As with stock awards, the value is generally the fair value of the award on the grant date as determined under FAS 123R for financial reporting purposes. In addition, if the value of the present earnings on outstanding stock awards and option awards (such as dividends) were included in the calculation of the FAS 123R fair value of the award, such earnings are not required to be reported when actually paid. However, if the earnings were not included in the calculation of the FAS 123R fair value of the award when the award was granted, then the earnings must be disclosed in the All Other Compensation column when paid. Similar to the Stock Awards Column, a footnote referencing the disclosure of the relevant valuation assumptions must accompany the values provided in the Option Awards column.

The Non-Equity Incentive Plan Compensation column is used to report any award where the relevant performance measure is not based on the price of the company’s equity securities. Also, as discussed above, the outcome with respect to the performance measure must be substantially uncertain when it is established and communicated to the NEO (otherwise it is a "bonus"). Unlike the disclosure of other amounts in the SCT, disclosure of non-equity incentive plan awards is required to be made only in the year in which the award is earned and not the year granted, regardless of when payment is made.

Finally, narrative disclosure accompanying the SCT must describe any material information necessary to understand the information set forth in the table. This narrative should provide a specific context to the quantitative disclosure in the SCT, explaining, for example:

• the relationship between amounts disclosed and any employment agreements;

• the material terms of awards reported, such as performance conditions, vesting conditions and the formula or criteria used to determine the amount payable;

• where applicable, whether dividends or dividend equivalents accrue on stock awards and the applicable dividend rate; and

• any performance-based conditions and any other material conditions applicable to the award. The SEC will permit non-disclosure of performance targets that would result in competitive harm to the company if disclosed, but will likely require strong and specific support for non-disclosure.

The new executive compensation rules continue to differentiate between small business issuers and other issuers. The SEC requires small business issuers to provide the following:

• the Summary Compensation Table (for only the last two fiscal years);

• the Director Compensation Table; and

• related narrative disclosure.

Also, NEOs will include only the principal executive officer and the two other most highly paid executives.

The All Other Compensation column includes any other element of compensation unless it is reportable in another column of the SCT or there is a specific instruction indicating that the particular element of compensation is not reportable in the SCT. Examples of compensation to be included in this column are:

• perks valued in the aggregate at $10,000 or more;

• all tax gross-ups or other amounts reimbursed during the fiscal year for the payment of tax gross-ups on perks;

• the amount paid or that becomes due to any NEO in connection with any termination of employment or change in control of the company;

• company contributions or other allocations to taxqualified and non-tax qualified defined contribution plans (whether or not vested);

• the dollar value of any insurance premiums paid by, or on behalf of, the company during the fiscal year with respect to life insurance for the benefit of any NEO; and

• the dollar value of dividends or other earnings paid in stock or option awards, when those amounts were not factored into the grant date FAS 123R fair value required to be reported in the stock or option awards.

Amounts not reportable in this column include:

• the value realized upon exercise of options or vesting of restricted stock;

• dividends and dividend equivalent payments on stock awards and options, unless the value of those dividends was not taken into account when determining the grant date fair value of the stock awards and options; and

• benefits paid pursuant to defined benefit pension plans unless the payment is accelerated due to a change in control.

Footnotes to the All Other Compensation column are required to identify and quantify any item reported in this column whose value exceeds $10,000, other than perks (which are discussed below).

The SEC has been increasingly focused on the current disclosure of perks for several years. There are three important points about the thresholds used to determine when disclosure of perks is required.

• Perks are only included in the total dollar figure in the All Other Compensation column if the perks have a total value of $10,000 or more.

• If the $10,000 threshold is met, all perks must be identified in a footnote.

• In the footnote, the amount of an individual perk must be disclosed if the aggregate incremental cost of the perk to the company is the greater of $25,000 or 10% of the total perks received by the NEO.

Although the SEC does not provide a definition of a perk, the following guiding principles should help determine whether an item is a perk:

• An item is not a perk if "it is integrally and directly related to the performance of the executive’s duties," or the item is necessary to do the job, such as an office, secretarial support or a reserved parking space.

• An item is a perk if "it confers a direct or indirect benefit that has a personal aspect, without regard to whether it may be provided for some business reason or for the convenience of the company," and it is generally unavailable to all employees.

• Determine whether existing processes are adequate to track total compensation and implement the necessary "repairs"

• Prepare compensation spreadsheets for all possible NEOs

• Understand the impact of the FAS 123R value disclosure of equity awards and how the full value is reported in the SCT

• Drill down with respect to all other elements of NEO and director compensation

• Determine whether each item of value provided to NEOs and directors constitutes a perk Financial Institutions

In a major change from the prior disclosure rules, director compensation must be quantified in a tabular format similar to the SCT. However, the Director Compensation Table is limited to the past fiscal year, and no supplemental tables are required for director compensation. A narrative description must accompany any facts necessary to provide shareholders a material understanding of the tables, such as a breakdown of directors’ fees. Fees paid in stock and in cash must be reported separately, and companies must report in a footnote the aggregate number of stock awards and stock options outstanding for each director at year end. Finally, in the All Other Compensation column, companies must disclose any additional director compensation not reported in the other columns, generally under the same instructions provided for the SCT.

As you begin to implement many of these items in preparation for the 2007 proxy season and need additional advice or assistance, please feel free to contact your regular Powell Goldstein contact.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.