Copyright 2008, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Securities Regulation, March, 2008
The Canadian Securities Administrators (CSA) have re-published for comment proposed amendments to Form 51-102F6 Statement of Executive Compensation under National Instrument 51-102–Continuous Disclosure Obligations. These amendments contemplate significant changes to executive compensation disclosure.
The CSA initially published for comment proposed amendments on March 29, 2007 (the 2007 Proposal). The revised executive compensation disclosure proposal published on February 22, 2008 (the 2008 Proposal) reflects changes resulting from comments on the 2007 Proposal.
2008 Proposal Major Changes
The major changes in the 2008 Proposal from the 2007 Proposal are:
- Although not highlighted in the CSA notice accompanying the 2008 Proposal, a combination of changes results in a significant increase in the number of terminated executive officers for whom individual disclosure as Named Executive Officers (NEOs) will be required, in addition to the five officers for whom there is usually disclosure.
- The 2008 Proposal changes the test for excluding disclosure of target levels in the Compensation Discussion & Analysis for specific quantitative or qualitative performance factors to "seriously prejudice" the issuer's interests, from the existing test of "competitive harm", increasing required disclosure of such targets.
- The 2008 Proposal requires Summary Compensation Table disclosure of changes in compensatory pension elements, not changes in actuarial value as contemplated by the 2007 Proposal.
- The 2008 Proposal requires Summary Compensation Table disclosure of the grant date fair value of option and share awards, not the financial statement value as the 2007 Proposal contemplated.
- Under the 2008 Proposal, quantified disclosure of potential payments to NEOs is required for retirement, change of control, resignation and termination.
As discussed in a November 2006 Blakes Bulletin on Securities Law, New SEC Executive Compensation Disclosure Rules May Impact Canadian Public Companies, and in the CSA Notice relating to the 2007 Proposal, many Canadian issuers have already voluntarily adopted some of these changes in their proxy disclosure.
Additions To Named Executive Officers
In a significant change, the 2008 Proposal will result in an increase in the number of NEOs for whom individual disclosure is required by adding in many cases executive officers who have been terminated during the relevant fiscal year. This result occurs because of changes in the amounts used to determine the most highly paid executive officers.
As is currently the case, under the 2008 Proposal NEOs include (a) the CEO, (b) the CFO, (c) each of the issuer's three most highly-compensated executive officers (other than the CEO and CFO) serving as executive officers at the end of the most recently completed financial year and, in addition, (d) each individual who would be an NEO but for the fact that the individual was not an executive officer of the issuer at the end of the financial year. However, unlike the current requirements which base the determination of the most highly-compensated executive officers on salary and bonus only, the 2008 Proposal includes all compensation (other than compensatory pension amounts), including all severance and other termination benefits and payments, for this purpose. In many cases, this will have the effect of doubling or tripling the compensation of executives who have been terminated for the purposes of comparison to other officers. As well, in another change, the 2008 Proposal requires that the amounts for terminated executives be determined on the basis "as if" the executive was employed by the issuer at year end, implying that hypothetical annual salary and bonus amounts and all other forms of compensation, although not actually paid, granted or received, also be included in the calculation. The combined result of these proposed changes will be to require disclosure for individuals as NEOs who, but for their termination of employment, would not otherwise have been disclosed as NEOs, in addition to the disclosure for the other (generally five) NEOs.
Compensation Discussion & Analysis
As under the 2007 Proposal, the 2008 Proposal requires a Compensation Discussion & Analysis (CD&A). The 2008 Proposal has revised the 2007 Proposal such that the CD&A is to describe and explain all significant elements of compensation provided to NEOs for the most recent financial year. The current requirement for a Compensation Committee Report on Executive Compensation is eliminated. The following six items are to be described and explained in the CD&A:
(a) the objectives of the compensation program
(b) what the compensation program is designed to reward
(c) each element of compensation
(d) why the issuer chooses to pay each element
(e) how the issuer determines the amount, and, where applicable, the formula for each element
(f) how each element of compensation and the issuer's decisions regarding that element fit into the issuer's overall compensation objectives and affect decisions regarding other elements.
Where applicable, benchmarks are to be disclosed, explaining components and selection criteria and, where relevant, an explanation as to the formation of any peer group sample is required.
Targets based on objective, identifiable measures are to be disclosed where applicable. However, in a significant change, the 2008 Proposal, unlike both the 2007 Proposal and current requirements, does not allow the issuer to exclude specific target information that relates to specific quantitative or qualitative performance factors or criteria if it means disclosing confidential information that would result in competitive harm to the issuer. Rather, the issuer may exclude such target information only if disclosing it would "seriously prejudice the company's interests". The 2008 Proposal also provides that if a performance target level or other factor or criteria has been publicly disclosed, this exemption cannot be relied upon. In addition, under the 2008 Proposal, if this information is not disclosed, the issuer must disclose what percentage of the NEO's compensation is related to this undisclosed information and how difficult it could be for the NEO, or how likely it will be for the issuer, to achieve the undisclosed target levels or criteria.
The commentary in the 2008 Proposal, like the 2007 Proposal, provides examples of items that will usually be significant elements in the CD&A, such as the role of executive officers in determining executive compensation, identification of benchmarking in determining compensation or any element of compensation, and contractual and non-contractual arrangements, plans, process changes or other matters that might cause the disclosed amounts for the current year to be misleading as to expected future compensation levels.
As in the 2007 Proposal, the 2008 Proposal requires that the CD&A explain the process the issuer uses to grant options to executive officers including the role of the compensation committee and the executive officers in setting or amending any option program. This reflects the SEC requirements responding to the "option backdating" issue.
As in the 2007 Proposal, the 2008 Proposal requires that the currently-required performance graph showing the cumulative shareholder return over the five most recently completed fiscal years compared to the cumulative total return of at least one broad equity market index be contained in the CD&A. Unlike current requirements, the 2008 Proposal, as did the 2007 Proposal, requires that an explanation be provided as to how the trend shown by the graph compares to the trend in the issuer's compensation to executives over the same period. The 2008 Proposal contemplates that issuers may also include other relevant performance measures.
The 2008 Proposal does not change the 2007 Proposal in relation to management companies. If an issuer's executive officers are employed or retained by an external management company, the issuer is to disclose the amount paid by the issuer directly to persons employed or retained by the external management company who are acting as executive officers and directors of the issuer and the amount that the external management company paid to these persons that is attributable to the services they provided to the issuer directly or indirectly. The 2008 Proposal, as did the 2007 Proposal, provides that, if the external management company provides services to other companies, the issuer is to disclose the portion of the compensation paid to the officer or director that the management company attributes to services the external management company provided to the issuer or the entire compensation the external management company paid to the officer or director.
Summary Compensation Table
Subject to a transitional provision described below, the 2008 Proposal continues the requirement to disclose compensation for each NEO for the issuer's last three completed fiscal years.
Bonus and Non-Equity Compensation
The 2007 Proposal contemplated that certain amounts that currently are required to be disclosed as bonus would be disclosed in a new Non-Equity Compensation column of the Summary Compensation Table and the Bonus column would only include discretionary cash awards that were not based on any predetermined performance criteria that were communicated to an NEO. The 2008 Proposal, reflecting comments on the 2007 Proposal, eliminates this distinction between discretionary bonuses and non-equity incentives, and instead requires disclosure of all pay outs under non-equity incentive plans, split into two columns based on the length of the associated performance periods. One sub-column will disclose annual non-equity plan compensation, such as bonuses relating to a single financial year, and the second sub-column will disclose other non-equity incentive plan compensation relating to a longer period than one year.
Stock Options and Share Awards
As in the 2007 Proposal, under the 2008 Proposal the Summary Compensation Table will include columns for Share Awards (with the column name changed from Stock Awards) and Option Awards. (Share awards include restricted shares, restricted share units and deferred share units.) As under the 2007 Proposal, the Share Awards column will replace the current Shares or Units Subject to Resale Restrictions column. The 2007 Proposal contemplated that these Share Awards and Option Awards columns would disclose the dollar value of each share and option award as recognized for financial statement reporting purposes. Again, reflecting comments on the 2007 Proposal, and the current practices of many Canadian issuers, the 2008 Proposal requires disclosure of the grant date fair value of such compensation instead. The 2008 Proposal requires footnote disclosure as to whether the grant date fair value is different from the financial statement fair value, the amount of the difference and an explanation of the difference, and in addition, the methodology used to calculate the grant date fair value, including disclosure of the key assumptions and estimates used for each calculation and the reason why the company chose that methodology.
Pension Value Increase
The 2007 Proposal contemplated a new column in the Summary Compensation Table for Pension Value, which would disclose the increase in the actuarial present value of each NEO's accumulated benefit under all defined benefit and actuarial pension plans, as under the SEC requirements. Again, reflecting comments on the 2007 Proposal, and the current practices of many Canadian issuers, the 2008 Proposal proposes including in this column, for both defined benefit and defined contribution plans, service costs and other compensatory amounts, and not including non-compensatory factors. As under the 2007 Proposal, this amount is included in the amount disclosed in the Total Compensation column as noted below, but will not be included for the purposes of determining NEOs.
All Other Compensation
The "All Other Compensation" column in the Summary Compensation Table has been retained. Under the 2008 Proposal, as under the 2007 Proposal, perquisites and personal benefits will be included in this column, as will items such as tax grossup amounts, termination payments, compensation costs for security purchases and dividends and other earnings paid on share or option awards.
Perquisites and Benefits
The 2008 Proposal changes in one respect the threshold for disclosing perquisites and other personal benefits. Under current requirements, perquisites and personal benefits need not be disclosed unless the aggregate amount of these is greater than the lesser of $50,000 and 10% of the total annual salary and bonus of the NEO (the SEC lowered the threshold for this purpose to $10,000). However, under the 2008 Proposal, the test to be used for the purposes of determining whether the amount of perquisites and personal benefits will be required to be disclosed will be whether the aggregate amount is greater than the lower of 10% of salary only and $50,000. The 2008 Proposal, as did the 2007 Proposal, bases the determination as to whether something is a perquisite on the new definition in the SEC rules, a change from current requirements. Issuers are to consider whether an item is intrinsically and directly related to an executive's duties and, where it is not so intrinsically and directly related to such duties, in the sense of it being necessary for a person to do his job, issuers must consider whether the executive receives a personal benefit from the item that is not generally available to all employees. If something confers a personal benefit and is not intrinsically and directly related to the job, under the 2008 Proposal the item is a perquisite, even if it also has a business purpose or is beneficial to the issuer. As well, the amounts are to be valued on the basis of the incremental cost to the issuer.
As in the 2007 Proposal, the 2008 Proposal includes a new column in the Summary Compensation Table showing Total Compensation for the fiscal year, which will be the total of the amounts shown in all the other Summary Compensation Table columns.
The 2008 Proposal, as did the 2007 Proposal, provides that if an NEO is also a director, compensation received for services as a director is to be included in the Summary Compensation Table, with a footnote explaining which amounts relate to that role.
The 2008 Proposal, similar to the 2007 Proposal, requires narrative disclosure of any significant factors necessary to understand the information disclosed in the Summary Compensation Table.
Grants of Equity Awards
As the 2008 Proposal requires fair value grant date disclosure for option and share awards, the 2007 Proposal for tabular disclosure for each NEO of the grant date aggregate fair value of share awards and option awards made in the most recent fiscal year was eliminated. However, the 2008 Proposal requires Share Awards and Option Awards column footnote disclosure as to the differences between the grant date fair value and the financial statements fair value, the methodology used to calculate the grant date fair value, including key assumptions and estimates, and the reason for such choice.
Equity-Based And Non-Equity Based Awards
As did the 2007 Proposal, the 2008 Proposal requires tabular disclosure of information on outstanding equity-based awards, both option and share awards, for each NEO. This will include, for options, the number of securities underlying options, exercise prices, expiration dates, and the value of unexercised in-the-money options and, for share awards, the number and market or payout value of shares or units that have not vested as at the most recently completed financial year (assuming achievement of threshold performance goals, except where performance for the most recent year exceeded that threshold in which case the disclosure is to be based on that measure).
The 2007 Proposal also required a second table showing for each NEO the value realized during the last fiscal year on exercise of options, and the value realized on vesting of share awards. The 2008 Proposal retains this table and adds an additional column to disclose non-equity incentive pay-outs for the year.
Similar to the 2007 Proposal, the 2008 Proposal requires issuers to explain in narrative form the significant terms of all planbased awards, both equity and non-equity, such as the number of securities underlying each award, general descriptions of formulae or criteria used to determine amounts payable, exercise prices and expiry dates, performance-based or other significant conditions, and information concerning non-equity incentive plan awards, including estimated future payouts.
These two tables replicate much of the information that is contained in the current Aggregated Option Exercises During the Most Recently Completed Financial Year and Financial Year End Option Values Table, with additional similar information now being required for other share awards.
In this regard, the 2008 Proposal requirements relating to these two tables diverge from the SEC's approach, as the SEC's requirements include greater tabular disclosure with respect to the grant of each outstanding equity award at fiscal year end, and option exercises and stock vested in the last fiscal year.
Retirement Plan Benefits
The 2008 Proposal for retirement plan benefit disclosure has been changed significantly from the 2007 Proposal, and accordingly differs from the SEC rules. The CSA indicated that the 2008 Proposal relating to retirement benefit plan disclosure reflects emerging practices in Canada. The format of the defined benefit retirement plan table has been changed to provide a continuity schedule for accrued obligations to date. The table requires disclosure of the number of years of credited service, annual benefits payable, as at both year end and age 65, accrued obligations at the start of the year, compensatory changes to the accrued obligation, non-compensatory changes to the accrued obligation and the accrued obligation at year end.
In another significant change, from both the current requirements and the 2007 Proposal, the 2008 Proposal requires disclosure for defined contribution plans similar to that proposed for defined benefit plans.
Narrative disclosure is also required for each NEO retirement plan of significant factors necessary to understand the tabular information, such as the significant terms and conditions of payment and early retirement provisions.
Termination And Change Of Control Benefits
The 2007 Proposal would have required issuers to provide disclosure for each contract, plan or arrangement (written or unwritten) providing for payments to an NEO at, following or in connection with termination, or a change of control of the issuer and to provide a quantification of estimated payments and benefits that an NEO will receive under all termination scenarios, assuming that the triggering event takes place on the last business day of the issuer's last completed financial year. Again, responding to comments on the 2007 Proposal, the 2008 Proposal requires such disclosure for four termination scenarios, being retirement, resignation, termination (including constructive termination) and change of control. The 2008 Proposal also provides that disclosure is only required for estimated incremental payments and benefits. The commentary in the 2008 Proposal clarifies that common law or civil law requirements may be excluded. As under the 2007 Proposal, disclosure will be required as to, among other things, the circumstances that trigger payouts or the provision of benefits and any significant conditions or obligations (such as a non-compete) that apply.
As under the 2007 Proposal, the 2008 Proposal provides for a new table disclosing, for each director, the amount of each form of their compensation and their total compensation, similar to the Summary Compensation Table for NEOs. Currently, narrative disclosure of the directors' compensation arrangements is required. However, disclosure is not to be included for a director who is also an NEO if compensation for those services as director is reflected in the Summary Compensation Table and elsewhere pursuant to the requirements. Disclosure of factors necessary to understand the director compensation disclosed in the table will also be required, which reflects current requirements to disclose standard compensation arrangements, such as those relating to retainer, committee, chairman and attendance fees.
Location Of Disclosure And Certification
The 2008 Proposal, like the 2007 Proposal, proposes that executive compensation disclosure remain in the management information circular. Unlike the SEC requirements, the CSA are not proposing that executive compensation disclosure be subject to the certification requirements.
The 2008 Proposal, like the 2007 Proposal and current requirements, provides that SEC issuers may satisfy these requirements by providing the information required by Item 402 of Regulation S-K.
Effective Date And Transition
The CSA propose that the new requirements apply to companies with financial years ending on or after December 31, 2008. The 2008 Proposal provides that, as a transitional matter, an issuer may provide disclosure for less than three financial years in the Summary Compensation Table until December 31, 2010.
Request For Comments
The CSA has requested comments on the 2008 Proposal by April 22, 2008.
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.