In July 2006, new rules were adopted by the United States Securities Exchange Commission ("S.E.C.") regarding the disclosure of executive compensation.1 These new rules came into effect on November 7, 2006, and will apply to the 2007 reporting year. When this process commenced at the beginning of 2006, spokespersons for Canadian regulatory authorities indicated that they would be addressing the changes being made by the S.E.C., and considering whether similar changes should be adopted in Canada. On March 29th of this year, the Canadian Securities Administrators ("CSA") published for comment proposed amendments to existing regulations which address disclosure requirements regarding executive compensation. This proposed regulation was published after this article was prepared. For various reasons, it is likely that ultimately the Ontario Securities Commission ("O.S.C.") and other Canadian regulatory authorities will adopt substantially equivalent regulations to these new S.E.C. rules in respect to executive compensation disclosure. We will not know what the nature of the new Canadian rules will be until after the comment period in respect to the March 29 release closes on June 30, 2007, and a final version of the new proposed regulation is issued for comment and implementation. The target date for the new executive compensation disclosure rules in Canada is the first quarter of 2008.
The new S.E.C. disclosure rules are generally consistent with policies currently issued by Canadian regulatory authorities in respect to disclosure of executive compensation. Also, given the apparent importance for the S.E.C. of these new disclosure rules, and given the importance of multi-jurisdictional status for Canadian securities issuers and the Canadian securities industry, adoption of similar changes to executive compensation disclosure rules in Canada, is more likely than not.
This article addresses some of the changes that the S.E.C. has recently adopted relating to disclosure requirements for executive compensation, and their implications if similar provisions are adopted by Canadian regulators. The first change in the new S.E.C. disclosure rules is the requirement for new disclosures in a compensation discussion and analysis ("CD&A") report. The CD&A report provides a general overview of the compensation plan of specified senior executives of companies to which the regulation applies. The new rules require an explanation in plain language of all the material elements of the company’s compensation program for certain of its designated senior officers. Also, this analysis must provide a discussion and analysis of the material factors, which drive the compensation policies and decisions made by the companies. Included in the CD&A must be an explanation of any contract a company has with its senior executives that include provisions related to termination of employment or change in control, and the basis for selecting the events which trigger the payments under those provisions.
In addition, these new rules also require a compensation committee report that is similar to the currently required audit committee report. Amongst other things, the compensation committee report must confirm that the compensation committee has reviewed the CD&A report. The Compensation Committee report must confirm that the compensation discussion and analysis has been discussed with management of the company and that the Compensation Committee recommended to the Board that the CD&A report be included in the company’s reporting filings, including form 10-K and proxy statement. Accordingly, the company and its certifying officers could have liability for the contents if it is inaccurate or misleading though omission.
As part of these new disclosure rules, there will have to be an expanded disclosure of potential post- employment payments and agreements. Some of these would accompany the narrative to the summary tables required by the regulations, and others would be included in the CD&A report. It appears that under the new rules, in the narrative section describing potential post-employment payments, there will need to be a robust analysis and description of the reasons for these provisions and the underlying principles for having them in place. These new reporting and disclosure requirements, if adopted by Canadian regulators, would require that the process undertaken by Boards and Compensation Committees in entering into a employment agreements with its executives in the future, be closely coordinated between inhouse legal counsel, the Compensation Committee of the Board of Directors, human resources departments, as well as any compensation consultants or lawyers retained to provide opinions.
The implications of these new disclosure requirements, if similar ones were adopted by Canadian regulatory authorities, are two-fold. The first is that when decisions are made with respect to the appropriate notice period contained in executive employment agreements in the event of dismissal without just cause, a Board and its Compensation Committee should carefully document that they have considered all material information that was available at the time. In addition, there should be a record made of the rationale and basis for approving such agreements. This documentation would be helpful, if not essential, for the purposes of preparing a CD&A report in the event it become applicable to Canadian companies. Similar considerations would also apply to change of control agreements.
A second implication of these new disclosure requirements, should they be adopted by Canadian regulators, is that the description and analysis of the change of control agreements and severance provisions in executive employment agreements published in the CD&A report, would set out as a matter of record through filing, the basis and grounds for a Board and its Compensation Committee’s exercise of their business judgment in approving these agreements. If the reasonableness of such contracts were challenged, the Board and it’s Compensation Committee would be restricted to the grounds set out the CD&A disclosure, in its defence of the proper exercise of business judgment. Adding new grounds as a rationale for the approval by a Board of any agreements that might be challenged, could raise issues as to whether full and complete disclosure as required by the new disclosure rules was in fact made.
It is clear that the adoption of such executive compensation disclosure rules by Canadian regulators would put a significant onus on companies to ensure that their compensation policies are in line with industry standards and defensible from the perspective of shareholders. We will continue to monitor these legislative developments in light of the CSA’s proposed amendments. It is anticipated that such developments will be canvassed in an upcoming edition of the L&E News, along with advice to boards of directors regarding the implementation of executive compensation in this new legislative environment.
1 Securities Act release No. 33-8732 and 34-54302.
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