,
John O. Newell ,
Ettore A. Santucci P.C. ,
Marian A. Tse 
and
Samantha M. Kirby
On December 16, 2009, the Securities and Exchange Commission ("SEC") adopted rules requiring companies to make additional disclosures in proxy statements about (i) their board of directors and executive officers, including director and director nominee qualifications, legal actions involving directors, director nominees or executive officers, board leadership structure and risk oversight; (ii) compensation policies and practices that relate to risk management practices and risk-taking incentives; and (iii) potential conflicts of interest of compensation consultants that advise companies and their boards of directors. In addition, the new rules change how companies must report awards of stock and options in the Summary Compensation Table and Director Compensation Table and when companies must report voting results from stockholder meetings.
The rules are effective for filings made on or after February 28, 2010. The text of the SEC release is available on the SEC's website here. The additional disclosures will be required in companies' proxy statements and certain other filings for which disclosure regarding corporate governance, directors and executive officers and compensation is required, which may include Form 10-K annual reports and registration statements under the Securities Exchange Act of 1934 and registration statements under the Securities Act of 1933 and Investment Company Act of 1940.
Board Of Directors And Executive Officers
The rules require companies to make additional disclosures about their board of directors and executive officers, including:
- Director Qualifications. For each director and director nominee, a discussion of the specific experience, qualifications, attributes and skills that led to the board's conclusion that the person should serve as a director in light of the company's business and structure. If material, this disclosure is required to cover more than the past five years, including information about the person's particular areas of expertise or other relevant qualifications.
- "Bad Boy" Disclosures. An expanded list of legal proceedings involving a director, director nominee or executive officer that must be disclosed, which includes (i) orders, judgments, decrees or findings relating to alleged violations of securities or commodities laws, laws respecting financial institutions or insurance companies or laws prohibiting fraud and (ii) sanctions or orders of any self-regulatory organization, such as the stock exchanges, or other similar organizations. In addition, the look-back period for disclosing these legal proceedings, as well as the other "bad boy" legal proceedings previously required to be disclosed, has been increased from five years to 10 years.
- Other Directorships. Any other public company or registered investment company directorships held by directors and director nominees during the past five years, as opposed to just current directorships, which are required to be disclosed by existing rules.
- Leadership Structure. The leadership structure of the board of directors, including whether the same person serves as both chief executive officer and chairman of the board and, if so, whether the company has a lead independent director and the specific role the lead independent director plays in the leadership of the board. The disclosure must indicate why the company has determined that its leadership structure is appropriate given the specific characteristics or circumstances of the company.
- Risk Oversight. The board's role in the oversight of risk, such as how the board administers its oversight function, and the effect that this has on the board's leadership structure.
- Diversity. Whether, and if so how, the nominating committee or the board considers diversity in identifying nominees for director. If the nominating committee or the board has a policy with regard to the consideration of diversity in identifying director nominees, the company must describe how this policy is implemented as well as how it assesses the effectiveness of its policy.
Action Items:
- Update directors' biographical information to include the expanded discussion required by the new rules regarding each director's specific experience, qualifications, attributes and skills that led to the board's conclusion that the person should serve as a director in light of the company's business and structure and any other additional disclosure required by the new rules. Circulate the updated disclosure concerning directors' and nominees' experience, qualifications, attributes and skills for internal review.
- Update director and officer questionnaires to gather additional information about director and nominee qualifications, legal actions and other public company or registered investment company directorships. Our 2009 Year-End Toolkit will contain questionnaires that have been updated to gather this additional information.
- Consider whether any changes to the board leadership structure, such as the appointment of an independent chairman or lead independent director, are desired in light of the new disclosure requirements. Update the description of the board's leadership and risk oversight and related matters and circulate for internal review.
- Consider adopting a formal policy addressing the consideration of diversity in identifying director nominees. Note that the new rules do not define diversity, citing a wide range of factors that companies may wish to consider, including differences in viewpoint, professional experience, education, skill, race, gender and national origin.
Compensation Policies And Practices Relating To Risk Management
Under the new rules, if risks arising from a company's compensation policies and practices for its employees are reasonably likely to have a material adverse effect on the company, then the company is required to include a discussion of these compensation policies and practices as they relate to risk management practices and risk-taking incentives. The SEC has indicated that situations that may trigger disclosure include, among others, compensation policies and practices:
- At a business unit that carries a significant portion of the company's risk profile;
- At a business unit with compensation structured significantly differently than other units within the company;
- At a business unit that is significantly more profitable than others within the company;
- At a business unit where the compensation expense is a significant percentage of the unit's revenues; and
- That vary significantly from the overall risk and reward structure of the company, such as when bonuses are awarded upon accomplishment of a task, while the income and risk to the company from the task extend over a significantly longer period of time.
If a company determines that disclosure is required, the SEC has provided the following examples of issues that the company may need to address for the business units or employees:
- General design philosophy of compensation policies and practices for employees whose behavior is most affected by the incentives established by the policies and practices, and the manner of their implementation;
- Risk assessment or incentive considerations, if any, in structuring compensation policies and practices or in awarding and paying compensation;
- How compensation policies and practices relate to the realization of risks resulting from the actions of employees in both the short term and the long term, including policies requiring claw backs or imposing holding periods;
- Policies regarding adjustments to compensation policies and practices to address changes in risk profile, and material adjustments made as a result of any such changes; and
- Monitoring of compensation policies and practices to determine whether its risk management objectives are being met with respect to incentivizing its employees.
Important Note: smaller reporting companies will not be subject to these new rules.
Action Items:
- Evaluate compensation policies and practices at all levels within the company to determine whether there are risks arising from these compensation policies and practices that are reasonably likely to have a material adverse effect on the company. Companies should specifically consider different compensation policies and practices that apply to different groups of employees. To the extent that all employees are subject to substantially similar policies and practices, this discussion may be consolidated. To the extent that companies have significantly different compensation structures for certain groups of employees, such as compensation that is heavily weighted towards transaction-based incentives, a separate discussion of such compensation structures may be required. Each public company will have a different risk profile, and as a result there is no "one-size-fits all" approach. Both quantitative and qualitative analysis of compensation policies and procedures may, and likely will, be appropriate.
Potential Conflicts of Interest of Compensation Consultants
The rules also require disclosure of the fees paid to compensation consultants in the following circumstances:
- Compensation Consultant Engaged By Compensation Committee. If a compensation consultant is engaged by the compensation committee to provide advice or recommendations on the amount or form of executive and director compensation and the compensation consultant or its affiliates also provided additional services to the company or its affiliates in an amount in excess of $120,000 during the company's last fiscal year, then the company must disclose (i) the aggregate fees for determining or recommending the amount or form of executive and director compensation and (ii) the aggregate fees for such additional services. In addition, the company must disclose whether the decision to engage the consultant for the other services was made or recommended by management and whether the compensation committee or the board approved such other services.
- Compensation Consultant Engaged By Management. If the compensation committee has not engaged a compensation consultant, but management has engaged a compensation consultant to provide advice or recommendations on the amount or form of executive and director compensation and the compensation consultant or its affiliates also provided additional services to the company in an amount in excess of $120,000 during the company's last fiscal year, then the company must disclose (i) the aggregate fees for determining or recommending the amount or form of executive and director compensation and (ii) the aggregate fees for such additional services. Note: For companies where the compensation committee and management have separate compensation consultants, no disclosure requirement is triggered for services provided by management's compensation consultant, regardless of whether those services relate to executive or director compensation or other matters.
Action Items:
- Review the use of compensation consultants by the compensation committee and/or management of the company, and determine whether any disclosure will be required.
- Consider using separate consultants for executive and director compensation and for all other matters.
Summary Compensation Table And Director Compensation Table Changes
Under the new rules, in the Summary Compensation Table and Director Compensation Table, companies must disclose the aggregate grant date fair value of stock and option awards in the year in which the grant was made. Previously, companies were required to report the amount recognized during the year for accounting purposes for all stock and option awards, regardless of when they were granted. This will be a significant change in how total compensation will be calculated for directors and named executive officers. For example, if a company granted one of its named executive officers an equity award on December 31, 2009 with a grant date fair value of $500,000 that vested over five years, under the new rules, the company would be required to report the entire $500,000 as 2009 compensation. Under the old rules, the grant date fair value would have been incorporated into the executive's compensation over five years (approximately $100,000 per year).
For equity awards that are subject to performance conditions, the value that is to be reported is to be based on the probable outcome of such conditions, which should be consistent with the estimate of the aggregate compensation cost to be recognized under applicable accounting rules, excluding the effect of estimated forfeitures. However, companies must also disclose in footnotes to the tables the value of the award at the grant date assuming that the highest level of performance conditions will be achieved.
In adopting the new rule, the SEC specifically considered whether the grant date fair value for stock and option awards should be included for the year in which the grant occurred for accounting purposes or the year to which the grant related. The SEC concluded that the amount should be included for the year in which the grant date occurred, stating that "because it appears that multiple subjective factors, which could vary significantly from company to company, influence equity awards granted after fiscal year end, we are concerned that changing the approach to reporting [away from the requirement to report awards in the year granted] could result in inconsistencies that would erode comparability."
This rule change is also significant because it influences the total compensation number that is used to determine which executive officers are "named executive officers" whose compensation information must be disclosed in the proxy statement. Under SEC rules, "named executive officers" generally includes the CEO and CFO as well as the three other most highly compensated executive officers based on their total compensation as reported in the Summary Compensation Table. As a result, if an executive officer who would not ordinarily be a named executive officer receives a large one-time grant in a particular year, that executive officer could become a named executive officer for that year. In the adopting release, the SEC specifically acknowledged this consequence and indicated that in such situations the company can consider including compensation disclosure for the executive officer who ordinarily would have been a named executive officer to supplement the required disclosures.
Under the new rules, data for prior years, if included in the table, must be recalculated in accordance with the new rules.
Action Items:
- Assess how this change will impact the identity of the company's "named executive officers," and consider whether it will be appropriate to include supplemental compensation disclosure for executives who, but for large grants of stock, would be "named executive officers."
- Consider how this change will impact the company's reported total compensation for its named executive officers and directors, in particular in connection with the reporting year for year-end grants which may be made just prior to the end of the current year or in the beginning of the new year.
Early Disclosure Of Stockholder Votes On Form 8-K
The rules create a new Item 5.07 of Form 8-K pursuant to which companies are required to disclose the results of stockholder votes within four business days of a stockholder meeting or written consent in lieu of a stockholder meeting. In the event that final voting results are not available, companies must file preliminary voting results within four business days of the vote, and file the final voting results within four business days after they become available. This item replaces the previous Form 10-Q and Form 10-K requirement to report these voting results for stockholder meetings or consents that occurred during the quarterly period to which the report related (or the fourth quarter for Form 10-Ks).
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