On September 18, 2008, the Canadian securities regulators announced a new format for executive compensation disclosure. This new format comes into force December 31, 2008 and will apply to the description of 2008's executive compensation in next year's proxy material. The new format not only significantly impacts executive compensation disclosure, but also the internal process by which companies make compensation decisions. Companies should start planning for the new requirements now to ensure an orderly transition.
In 2006, the U.S. Securities and Exchange Commission adopted a new format for executive compensation disclosure. In 2007, the Canadian securities regulators followed with a similar proposal to revise executive compensation disclosure. Following industry comments on that 2007 proposal and on a revised proposal published in February of 2008, the Canadian securities regulators have now published final requirements which will come into force December 31, 2008. These new requirements will apply to the description of 2008's executive compensation in next year's proxy material.
Under the new requirements, all direct and indirect compensation provided to certain executive officers and directors for, or in connection with, the services they provided to the company or a subsidiary must be disclosed. In general, the disclosure must satisfy the stated objective of the new requirements, which is communicating to investors the compensation the company's board intended the company to pay, make payable, award, grant, give or otherwise provide certain executive officers and directors for the financial year. This disclosure is intended to provide insight into executive compensation as a key aspect of the overall stewardship and governance of the company and help investors understand how decisions about executive compensation are made.
Determination Of Named Executive Officers
Like the current requirements, the compensation of the company's CEO, CFO and the next three mostly highly compensated executive officers (or persons acting in a similar capacity) earning more than $150,000 (the "named executive officers") must be described under the proposed requirements. However, the next three mostly highly compensated executive officers (or persons acting in a similar capacity) are determined based on total compensation (excluding pension and change of control/termination payments), rather than just salary and bonus as is the case under the current requirements.
Compensation Discussion And Analysis
Companies will be required to prepare a narrative overview of the compensation provided to the named executive officers. This compensation discussion and analysis (CD&A) is similar in approach to a company's MD&A and replaces the current requirement for a report on executive compensation prepared by the compensation committee.
All significant elements of compensation awarded to, earned by, paid to, or payable to the named executive officers for the most recently completed financial year must be described and explained in the CD&A, including the following:
- the objectives of any compensation program or strategy;
- what the compensation program is designed to reward;
- each element of compensation;
- why the company chooses to pay each element;
- how the company determines the amount (or applicable formula) for each element; and
- how each element of compensation and the company's decisions about that element fit into the company's overall compensation objectives and affect decisions about other elements.
Benchmarks - The CD&A must describe any benchmarks used in determining compensation and explain the benchmark's components, including the companies used in the benchmark group and the selection criteria.
Targets - The CD&A must describe any performance goals or similar conditions that are based on objective, identifiable measures (such as share price or earnings per share). If performance goals or similar conditions are subjective, they may be described without providing specific measures. A company is not required to disclose performance goals or similar conditions in respect of specific quantitative or qualitative performance-related factors if a reasonable person would consider that their disclosure would "seriously prejudice" the company's interests. In such circumstances, the percentage of the executive's total compensation relating to the undisclosed performance goal or condition and how likely it would be for the company to achieve that goal or condition must be stated.
Performance Graph - The CD&A retains the current requirement of a performance graph comparing cumulative shareholder return over the past five years against at least one broad equity market index. The performance graph must now be accompanied by a discussion comparing the graph with the trend in the company's executive compensation over the same period.
Option Awards - In response to concerns regarding backdating of options, the CD&A must include a description of the process used to grant option-based awards to executives, including the role of the compensation committee and executives in setting or amending any equity incentive plan under which an option-based award is granted. The CD&A must also state if previous grants of option-based awards are taken into account when considering new grants.
Summary Compensation Table
Under the proposed requirements, the summary compensation table remains the primary means of describing compensation for the named executive officers. However, the items that must be reported in the table have changed from the current requirements. For each named executive officer the following items are to be reported in the table for the three recently completed financial years:
- dollar amount of share-based awards (based on grant date fair value of the award for that year, with any difference from accounting fair value explained in a note to the table);
- dollar amount of option-based awards (based on grant date fair value of the award for that year, with any difference from accounting fair value explained in a note to the table);
- non-equity annual incentive plan compensation (i.e. bonuses that relate to a single year);
- non-equity long-term incentive plan compensation (i.e. bonuses that relate to a period longer than one year);
- contribution plans;
- all other compensation, including perquisites (that in aggregate are worth $50,000 or more or are worth 10% or more of the executive's salary), post retirement benefits, tax gross-ups, termination or change of control payments or benefits, premiums for personal insurance policies, the cost of any securities issued at a discount, and all other amounts that cannot be properly reported in another column of the table; and
- total compensation.
A narrative description and explanation of the significant factors necessary to understand the table is also required. This narrative may include the significant terms of each executive's employment agreement, any repricings or significant changes to the terms of any share-based or option-based award program, and the significant terms of any award reported in the table (including a description of the formula or criterion applied in determining the amounts payable and vesting schedule).
Currency – All amounts are to be stated in the same currency as used in the company's financial statements.
Director Compensation - Compensation that an executive receives for acting as a director is to be included in the table.
Transition – In the first proxy season, the table will only need to report on compensation for the recently completed financial year. In the second proxy season, compensation for the two recently completed financial years are to be reported. In the third proxy season and thereafter, compensation for the three recently completed financial years are to be reported.
Incentive Plan Awards
The proposed requirements establish two new tables to report on equity and non-equity incentive plan awards made to the named executive officers. A narrative description and explanation of the significant terms of all plan-based awards must accompany the tables. This narrative may include a description of any formulae or criteria to determine amounts payable, any conditions of the award (e.g. performance goals or similar conditions), estimated future payouts for non-equity incentive plan awards (e.g. performance goals or similar conditions and maximum amounts), and the closing market price on the grant date if the exercise price of the award is less than the market price.
Outstanding Share-Based Awards and Option-Based Awards Table – This table is to be completed for each named executive officer for all share-based and option-based awards outstanding at the end of the recently completed financial year. For each option-based award, the table reports the number of securities underlying the unexercised option, the exercise price, the expiry date and the in-the-money value of the unexercised option as of the end of the financial year. For each share-based award, the table reports the number of shares or units that have not vested and their market or payout value.
Value Vested or Earned During the Year Table - This table is to be completed for each named executive officer for all incentive plan awards vested or earned in the most recently completed financial year. The table shows the dollar value that would have been realized if options under the option-based award had been exercised on the vesting date, the dollar value realized upon vesting of share-based awards, and the total amount of any non-equity incentive plan compensation earned.
Pension Plan Benefits
The proposed requirements significantly increase the disclosure required for a named executive officer's pension plan benefits. This is in response to criticism that the current requirements only provide general information on benefit entitlements for specified compensation levels and years of service and do not disclose the particular circumstances and entitlements of each executive.
Two new tables for defined benefit plans and defined contribution plans will be required. A narrative description and explanation of the significant factors for each retirement plan in which an executive participates must accompany the tables. This narrative may include the significant terms and conditions of payments and benefits available under the plan (e.g. normal and early retirement payments, benefit formula, contribution formula, calculation of credited interest and eligibility standards), provisions for early retirement, the elements of compensation used in the benefit formula and policies on granting extra years of service (including explaining why the grant was appropriate).
Defined Benefit Plan Table - The defined benefit plans table will report, for each executive, the number of years of credited service, the annual benefits payable at year-end and at age 65, the accrued obligation at the start of the year, the compensatory and non-compensatory change in the accrued obligation for the year, and the accrued obligation at year-end.
Defined Contribution Plan Table - The defined contribution plans table will report, for each executive, the accumulated value at the start of the year, the compensatory and non-compensatory amounts received, and the accumulated value at the year end.
Deferred Compensation Plans – Under the proposed requirements, the significant terms of any deferred compensation plan for an executive must be described, including the type of compensation that can be deferred, any limitations on the deferral, the significant terms of payouts, withdrawals and other distributions, and the measures for calculating interest or other earnings (quantified where possible).
Termination And Change Of Control Benefits
Under the proposed requirements, a description of the employment contracts of the named executive officers will no longer be required. However, a detailed description of the terms of any contract or arrangement whereby payments are required to be made to a named executive officer upon retirement, resignation, termination (whether voluntary, involuntary or constructive), a change of control or a change in the executive's responsibilities will be required. The estimated incremental payments, payables and benefits that the executive would receive under that contract or arrangement must also be quantified (assuming the event that gave rise to the payment took place on the last business day of the recently completed financial year). If the payments and benefits are uncertain, an estimate of the payments and benefits must be provided and any significant assumptions underlying that estimate described.
The proposed requirements expand disclosure of director compensation. Compensation paid to directors must be described in a table that is similar to the summary compensation table for named executive officers (see "Summary Compensation Table" above), except that the directors' compensation table only covers a one year period as opposed to the three year period for named executive officers. Like the summary compensation table for named executive officers, the directors' compensation table must be accompanied by a description of any factors necessary to understand director compensation. All share-based awards, option-based awards and non-equity incentive plan compensation received by directors must also be described in the same format as required for the named executive officers (see "Incentive Plan Awards" above).
External Management Companies
If an external management company has an arrangement to provide the company's named executive officers or directors, any compensation paid by the company directly to those individuals and any compensation paid by the external management company to those individuals attributable to services provided to the company must be described. If the external management company provides executive management services to another company, the portion of the compensation paid to the individual acting as a named executive officer or director that the external management company attributes to services it provided to the company, or the total compensation the external management company paid to that individual, must be described.
Venture And Debt Only Companies
Under the proposed requirements, venture (i.e. companies not listed on the Toronto Stock Exchange or a major U.S. exchange) or debt-only companies will be required to describe more aspects of executive compensation than they are currently required to describe. Currently, those companies are exempt from certain requirements such as describing pension plan benefits and the compensation committee's report on executive compensation. Under the proposed requirements, venture and debt-only companies will be required to satisfy the same requirements as all other companies, except for preparing a performance graph.
U.S. Reporting Companies
U.S. reporting companies may prepare executive compensation disclosure that satisfies U.S. requirements (except U.S. reporting companies that are "foreign private issuers" that satisfy U.S. requirements by providing the more limited executive compensation disclosure permitted by the annual report on U.S. Form 20-F).
Trevor Scott is a solicitor at Farris and provides strategic and legal advice in diverse business areas. He has extensive experience in debt and equity financings for public and private companies, representing both issuers and investment banks. He also regularly advises on business acquisitions, divestments and take-over bids, including compliance issues with the Competition Act and assisting foreign investors with Investment Canada Act matters. Trevor also advises on corporate governance matters.
© 2008 Farris, Vaughan, Wills & Murphy LLP
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.