Copyright 2010, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Securities Regulation, December 2010
- Compensation Discussion & Analysis must address the risks associated with compensation policies and practices
- Mandatory disclosure of fees paid to compensation advisors
- CSA considering removing requirement to disclose defined contribution plan non-compensatory amounts
The Canadian Securities Administrators (CSA) have published for comment proposed amendments to Form 51-102F6 Statement of Executive Compensation under National Instrument 51-102 Continuous Disclosure Obligations. The current Form 51-102F6 came into force on December 31, 2008, after a lengthy process including two comment periods. The proposed amendments contemplate significant changes to executive compensation disclosure, with additional required disclosure relating to a number of matters such as risk management, officer and director hedging, performance goals, fees paid to compensation advisors, valuation of equity-based amounts, and the market value of vested share-based amounts.
The substantive proposed changes are:
- Disclosure in the Compensation Discussion & Analysis (CD&A) of whether the board of directors has considered the implications of the risks associated with the company's compensation policies and practices, including: (i) the nature and extent of the board's role in the risk oversight of compensation policies and practices; (ii) any practices used to identify and mitigate compensation policies and practices that could potentially encourage a named executive officer (NEO) or individual at a principal business unit or division to take inappropriate or excessive risks; and (iii) identified risks arising from the policies and practices that are reasonably likely to have a material adverse effect on the company.
- The Summary Compensation Table cannot be altered by adding columns.
- Removing the requirement to disclose noncompensatory amounts for defined contribution plans.
- Clearly stating if the company is relying on the "serious prejudice" exemption to exclude disclosure of specific performance goals.
- Disclosure of whether any NEO or director is permitted to purchase financial instruments that are designed to hedge or offset a decrease in the market value of equity securities granted as compensation or held, directly or indirectly, by the NEO or director.
- Providing a breakdown of all fees paid to compensation advisors for each service provided, similar to the disclosure currently required for audit-related, tax and other fees.
- Regardless of whether there are any differences between the valuation of equity-based awards disclosed in the Summary Compensation Table and the accounting fair value of such awards, companies will be required to disclose the methodology used to calculate grant date fair values of all equity-based awards, including key assumptions and estimates used for each calculation and why the company chose that methodology.
- Expanding the required disclosure of the process the company uses to grant option-based awards to all sharebased awards.
- New disclosure of the market value of vested sharebased awards in the Incentive Plan Awards table.
Risk Management Disclosure
Consistent with new rules adopted by the United States Securities and Exchange Commission amending compensation and corporate governance disclosure requirements for U.S. companies for the 2010 proxy season (2010 SEC Amendments), the Proposed Amendments broaden the scope of the CD&A requirements to require companies to disclose whether the board of directors considered the implications of the risks associated with the company's compensation policies and practices. If the company has completed such a risk analysis, the company will be required to disclose:
- the extent and nature of the board's role in the risk oversight of compensation policies and practices;
- any practices used to identify and mitigate compensation policies and practices that could potentially encourage an NEO or individual at a principal business unit or division to take inappropriate or excessive risks; and
- the identified risks arising from the policies and practices that are reasonably likely to have a material adverse effect on the company.
In addition, the Proposed Amendments add commentary which illustrates the following situations where an executive officer or a business unit of the company could potentially be encouraged to take inappropriate or excessive risks, such as compensation policies and practices:
- at a principal business unit of the company or a subsidiary of the company that are structured significantly differently than others within the company;
- for certain executive officers that are structured significantly differently than for other executive officers within the company;
- that do not include effective risk management and regulatory compliance as part of the performance metrics used in determining compensation;
- where the compensation expense to executive officers is a significant percentage of the company's revenues;
- that vary significantly from the overall compensation structure of the company;
- where incentive plan awards are awarded upon accomplishment of a task while the risk to the company from that task extends over a significantly longer period of time; and
- that contain performance goals or similar conditions that are heavily weighed to short-term rather than longterm objectives.
Summary Compensation Table Format
Relying on the existing subsection 1.3(2) of Form 51‑102F6, some issuers included additional columns in the Summary Compensation Table in order to provide additional executive compensation disclosure. The Proposed Amendments provide that the presentation of the Summary Compensation Table cannot be altered by adding columns, but that companies may chose to add another new table and other information, so long as the additional information does not detract from the prescribed form of the Summary Compensation Table. While the CSA have commented that this proposed change is a clarification, it is in fact a change to the current disclosure requirements as currently columns may be added to the Summary Compensation Table if certain conditions are met.
Serious Prejudice Exemption
The "serious prejudice" exemption from the requirement to disclose specific performance goals or similar conditions as part of the CD&A requirements is available if the disclosure would "seriously prejudice the interests of the company". The CSA are concerned that it is difficult to recognize when the company is relying on this exemption. The Proposed Amendments require the company to explicitly state that it is relying on the serious prejudice exemption and explain why disclosing the relevant performance goals or similar conditions would seriously prejudice the company's interests.
The Proposed Amendments provide that, for this purpose, a company's interests are not considered to be seriously prejudiced by disclosing performance goals or similar conditions if those goals or conditions are based on broad corporate-level financial performance metrics such as earnings per share, revenue growth, and earnings before interest, taxes, depreciation and amortization (EBITDA), and that companies do not qualify for this exemption if they have publicly disclosed the performance goals or similar conditions.
Executive Officer and Director Hedging
The Proposed Amendments contemplate broadening the CD&A requirements to require disclosure of whether any NEO or director is permitted to purchase financial instruments (such as prepaid variable forward contracts, equity swaps, collars, or units of exchange funds) that are designed to hedge or offset a decrease in the market value of equity securities granted as compensation or held, directly or indirectly, by the NEO or director.
While this information is generally available on the System for Electronic Disclosure by Insiders (SEDI), the CSA commented that investors will benefit from including this additional disclosure in CD&A.
New Compensation Committee Disclosure
The Proposed Amendments contain a new section 2.4 of Form 51-102F6 which provides more detailed and additional new requirements for compensation committee disclosure, which overlap to a certain extent with the current requirements contained in Form 58-101F1 Corporate Governance Disclosure. If the company has established a compensation committee, the Proposed Amendments require the company to:
- disclose the name of each committee member and whether or not the committee is composed entirely of independent directors;
- disclose whether or not one or more of the committee members has any direct experience that is relevant to his or her responsibilities in executive compensation;
- describe the skills and experience that enable the committee to make decisions on the suitability of the company's compensation policies and practices that are consistent with a reasonable assessment of the company's risk profile; and
- describe the responsibilities, powers and operation of the committee.
Consequential amendments proposed to be made to Form 58-101F1 will allow companies to incorporate by reference in that form the proposed disclosure under the amended Form 51-102F6.
Disclosure of Fees Paid to Compensation Advisors
Consistent with the 2010 SEC Amendments, the Proposed Amendments expand the required disclosure regarding compensation advisors retained by the company, including a description of the advisor's mandate and any other work performed for the company, by including a requirement to provide a breakdown of all fees paid to compensation advisors for each service provided. The amendment proposed is consistent with the disclosure currently required in National Instrument 52-110 Audit Committees for auditors for audit-related, tax and other fees.
Additional Commentary Regarding CD&A Disclosure
The Proposed Amendments require the CD&A to provide additional disclosure by specifying that the following additional examples will be significant elements of disclosure concerning compensation:
- whether the board of directors can exercise discretion, either to award compensation absent attainment of the relevant performance goal or similar condition or to reduce or increase the size of any award or payout, including if they exercised discretion and whether it applied to one or more NEOs; and
- whether the company will be making any significant changes to its compensation policies and practices in the next financial year.
Disclosure of Valuation of Equity-Based Awards
Currently companies are only required to disclose the methodology used to calculate grant date fair values of equity-based awards, including key assumptions and estimates used for each calculation, if the methodology used in the Summary Compensation Table is different from that used for financial reporting purposes. The Proposed Amendments require all companies, regardless of whether there are any differences between the method used for purposes of the Summary Compensation Table and for financial reporting, to disclose the methodology used to calculate grant date fair values of equity-based awards, including key assumptions and estimates used for each calculation, and why the company chose that methodology. In other words, it is proposed that companies which disclose the financial reporting values in the Summary Compensation Table must also disclose key assumptions and estimates as are disclosed by companies which use different values for the Summary Compensation Table and for financial reporting purposes.
Pension Plan Benefits Disclosure – Proposed Amendments
Under the current Form 51-102F6, companies are required to disclose in the Defined Contribution Plans (DC Plans) table the non-compensatory amount, including employee contributions and regular investment earnings on employer and employee contributions, for DC Plans. In the Proposed Amendments, the CSA have stated that they are contemplating the relative benefit of retaining this column in the DC Plans table as currently required. The CSA are requesting comment from market participants on whether there is value in requiring disclosure of non-compensatory amounts for DC Plans. The CSA have stated that, depending on the comments received, the final amendments to Form 51-102F6 may include an amendment removing this requirement.
Intended to Pay versus Paid
Currently Section 1.1 of Form 51-102 F6 provides that the objective of required disclosure is to "communicate the compensation the board of directors intended the company to pay". This reference to "intended" has resulted in confusion and ambiguity in applying the requirements of Form 51-102F6 by requiring disclosure of intended amounts as opposed to actual amounts. For instance, a compensation committee may establish a bonus program under which it expects certain amounts may be paid to the executive for an expected performance, but the actual results of the bonus program may result in a lower or higher bonus being paid for the year. The Proposed Amendments remove this reference to the board's intention, and state that the objective is to communicate actual amounts paid or payable, and add an additional objective to communicate the decision-making process relating to compensation. Consistent changes have also been proposed to the Summary Compensation Table requirements.
Expanded Disclosure of Share-Based Awards
Form 51-102F6 currently requires disclosure of the process the company uses to grant option-based awards, including the role of the compensation committee and executive officers in setting or amending any equity incentive plan under which an optionbased award is granted and whether previous grants are taken into account when considering new grants. The Proposed Amendments extend these disclosure requirements to all share-based awards.
Mandatory Disclosure of Market Value of Vested Share Based Awards
The Proposed Amendments require a column be added to the Incentive Plan Awards table which will disclose, for each NEO, the aggregate market value or payout value of vested share-based awards that have not yet been paid-out or distributed. While many share-based award plans provide for payout or distribution of awards upon vesting, some plans, most notably deferred share unit plans, do not. For share-based awards which do not provide for immediate payout upon vesting, this proposed requirement would result in an element of double counting, as the same vested awards may appear in multiple years' executive compensation disclosure.
No Proposal to Disclose Amounts Realized Upon Exercise of Equity Awards
The CSA also commented on an amendment that they are not proposing, confirming that they do not intend to reintroduce a requirement to disclose the aggregate dollar value realized upon the exercise of options, stock appreciation rights or other equity-based compensation awards. For financial years ending prior to December 31, 2008, companies were required to disclose the aggregate dollar value realized upon the exercise of options or stock appreciation rights. Upon the adoption of the new Form 51-102F6 in 2008, this requirement was replaced by a requirement to disclose specific information about equity-based and non-equity awards in two new tables. The first such table requires companies to disclose information about all outstanding sharebased and option-based awards. The purpose of this table is to give readers information about the position of outstanding equity-based awards (both in and out-ofthe- money). The second such table shows any amounts an NEO realized during the most recently completed financial year from the vesting of equity-based awards assuming the equity-based award had been exercised on the vesting date. The CSA believe that this information provides readers with a clear picture of what has happened to an award after it was disclosed in the SCT. The CSA also noted that the information to calculate gains on the exercise or sale of equity-based awards is available on SEDI and can be calculated for individual NEOs. In light of this, the CSA determined that they do not intend to reintroduce a requirement to disclose the aggregate dollar value realized upon the exercise of options, stock appreciation rights or other equity-based compensation awards.
No Proposal to Disclose Comparisons of CEO Compensation to Median Compensation
The 2010 SEC Amendments included a controversial requirement for public companies to disclose:
- the median annual total compensation for the employees (except the CEO);
- the annual total compensation of the CEO; and
- the ratio of the CEO's compensation to the median.
The requirement to disclose the "median compensation" of all employees has attracted criticism on numerous grounds, including: difficulty in determining the annual compensation across large work forces, perverse incentives to reduce lower-paid position headcount (for example by outsourcing), issues relating to treatment of employees of non-wholly owned subsidiaries and foreign subsidiaries, and treatment of part-time employees. Given the numerous issues relating to this requirement, and the consequent administrative burdens, companies will note with relief that the CSA have not included any equivalent requirements in the Proposed Amendments.
EFFECTIVE DATE AND TRANSITION
The CSA propose that the new requirements apply to companies with financial years ending on or after October 31, 2011.
REQUEST FOR COMMENTS
The CSA have requested comments on the Proposed Amendments by February 17, 2011.
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