The Securities and Exchange Commission recently adopted final rules to require enhanced compensation and corporate governance disclosure for public company proxy statements and other SEC filings.  The final rules reflect changes that clarify, and in some instances broaden, the proposed rules issued on July 17, 2009.  The SEC designed these amendments to improve corporate disclosures and allow shareholders to make more informed voting and investment decisions.

This Update provides an executive summary of the final rules and a more detailed summary of the key components of the final rule changes, as well as practical guidance on actions public companies should take to prepare for the 2010 proxy season.

EFFECTIVE FOR MOST 2010 PROXY STATEMENTS

The enhanced disclosure rules apply to annual reports on Form 10-K and proxy statements filed on or after February 28, 2010 for companies with fiscal years ending on or after December 20, 2009. A company with a fiscal year that ends before December 20, 2009 does not have to comply with these new requirements for its annual report on Form 10-K and related proxy statement, even if it files one or both of them on or after February 28, 2010. The SEC released additional guidance that clarifies some transition issues.

  • Companies May Voluntarily Comply Early.  Companies may voluntarily comply with the Summary Compensation Table and Director Compensation Table amendments only if they also comply with all other Regulation S-K amendments that apply to the form being filed.  However, companies may voluntarily provide the other new disclosures without having to comply with all of the new requirements.
  • May Apply To Preliminary Proxy Statements Filed Before February 28, 2010.  If a company is required to file a preliminary proxy statement and expects to file its definitive proxy statement on or after February 28, 2010, then the preliminary proxy statement must comply with these new requirements even if filed before February 28, 2010.
  • Applies To Registration Statements Filed After Form 10-K.  A company with a fiscal year that ended before December 20, 2009 will not be required to comply with the Regulation S-K amendments until it files its 2010 annual report on Form 10-K for its fiscal year ending on or after December 20, 2009.  This means that any registration statement the company files under the Securities Act or Exchange Act before its 2010 annual report on Form 10-K is required to be filed would not be subject to the Regulation S-K amendments.
  • Applies To Initial Public Offerings Filed On Or After December 20, 2009.  If a company first files the registration statement for its initial public offering on or after December 20, 2009, the registration statement must comply with the Regulation S-K amendments for the SEC to declare it effective on or after February 28, 2010.
  • Accelerated Reporting Of Shareholder Voting Results On Form 8-K Effective For Meetings Held On Or After February 28, 2010.  The new Form 8-K Item 5.07 reporting requirement applies to any shareholder meeting that takes place on or after February 28, 2010.  If the shareholder meeting occurs before February 28, 2010, the new Item 5.07 Form 8-K requirement does not apply.

Executive Summary Of The New Rules

  • New Analysis Of Risks Related To Compensation For All Employees.  Companies must discuss the company's policies and practices for compensating all employees (not just the named executive officers) as they relate to risk management practices and risk-taking incentives to the extent that risks arising from these policies and practices are reasonably likely to have a material adverse effect on the company.  The final rules differ from the proposed rules in two significant respects.  First, to focus disclosure on information that would be most relevant to investors, the final rules strengthen the materiality standard for disclosure from the proposed "may have a material effect on the company" to the more familiar standard used for MD&A purposes of "is reasonably likely to have a material adverse effect on the company."  Second, to maintain the focus of the CD&A on executive compensation and the information contained in the compensation tables, the new narrative disclosure is not a part of the CD&A as originally proposed, but will be a separate disclosure requirement.
  • Changed Reporting Of Stock Options And Stock Awards.  In a change that may affect which executive officers (other than the always included CEO and CFO) appear in the Summary Compensation Table, companies must disclose the value of stock options and stock awards granted during the year based on the aggregate grant date fair value of awards, rather than the current disclosure for all outstanding awards based on the value recognized during the year for financial statement reporting purposes.   The final rules reverse current guidance and the proposed rules by providing that companies must report performance awards at grant date fair value in the Summary Compensation Table, the Grants of Plan-Based Awards Table and the Director Compensation Table based on the probable outcome of the performance conditions on the date of grant (typically at target), rather than at maximum value (although companies must report the maximum value in a footnote to the Summary Compensation Table and the Director Compensation Table).  In an unusual departure from the strict formatting requirements of the compensation tables, the final rules permit, but do not require, companies to further enhance disclosure regarding stock options by adding a column to the Outstanding Equity Awards at Fiscal Year-End Table to report the fiscal year-end intrinsic value of outstanding stock options and stock appreciation rights.
  • Additional Disclosure About Compensation Consultants.  Companies must disclose fees paid to certain compensation consultants if the consultants provide other services to the company, in addition to providing advice to the board or the compensation committee on executive or director compensation.  Unlike the proposed rules, the final rules include a new $120,000 disclosure threshold and exclude fees paid solely for general survey information that is not customized for a particular company.
  • Enhanced Director, Nominee And Executive Officer Disclosure.  Companies must disclose director and nominee experience, qualifications, attributes or skills that led the company or other proponent to the conclusion, in light of the company's business and structure, that the person should serve as a director of the company.  The proposed rules would have required a similar disclosure for board committees, but the final rules do not require this added disclosure.  In addition, companies must disclose all public company board memberships held by a director or nominee at any time during the past five years, rather than only current board memberships.  The new rules also extend the "look-back" period for required disclosure of legal proceedings involving directors, nominees and executive officers from five to ten years.  In a departure from the proposed rules, the final rules expand the list of legal proceedings subject to the ten-year look-back period.  Lastly, the final rules impose another new requirement not included in the proposed rules, requiring companies to disclose whether, and if so how, the board or nominating committee considers diversity when nominating directors and, if there is a diversity policy, how the policy is implemented and an assessment of the policy's effectiveness.  The new rules do not define the term "diversity."
  • Board Leadership Structure Disclosure.  Companies must disclose the board's leadership structure, including whether the board has chosen to combine or separate the chairman and CEO positions, and why a specific leadership structure is appropriate for the company.  If the chairman and CEO positions are combined, companies must disclose whether the board has a lead independent director and what specific role the lead independent director plays.
  • Board Role In Risk Oversight Disclosure.  Companies must disclose the extent of the board's role in the risk oversight of the company, including a description of how the board administers its risk oversight function, and the effect this has on the board's leadership structure. The proposed rules had required disclosure of the board's role in risk management rather than risk oversight.
  • Accelerated Reporting Of Shareholder Voting Results On Form 8-K.  The final rules require companies to disclose shareholder voting results on a current report on Form 8-K, rather than on the quarterly report on Form 10-Q for the quarter in which the shareholder meeting was held (or annual report on Form 10-K if the meeting was held in the fourth quarter).  The final rules clarify that the Form 8-K must be filed within four business days of the date of the meeting.  If final voting results are not available to meet that deadline, a Form 8-K with preliminary results may be filed within four business days of the meeting, followed by a required amendment filed within four business days of the date on which final voting results are known.

NEW REQUIREMENTS FOR ENHANCED COMPENSATION DISCLOSURE

The SEC's final rules amend Items 401, 402 and 407 of Regulation S-K.

Companies Must Disclose The Relationship Between Risk Management And The Compensation Policies And Practices For All Employees.  The SEC's final rules amend Item 402 of Regulation S-K to require that a company discuss its policies and practices for compensating all employees, including non-executive officers, if the compensation policies and practices create risks that are reasonably likely to have a material adverse effect on the company.  This narrative disclosure will not appear in the CD&A, but will be separately disclosed under a new Item 402(s).  However, the SEC notes that, to the extent that risk considerations are a material aspect of a company's compensation policies or decisions for named executive officers, the company must discuss them in its CD&A.

  • Disclosure Standard Similar To MD&A.  In the adopting release, the SEC points out that the "reasonably likely" disclosure threshold is the same threshold used in the MD&A rules, and that the approach for risk disclosure in the new rules "would parallel the MD&A requirement, which requires risk-oriented disclosure of known trends and uncertainties that are material to the business."  The new rules also provide that, in assessing whether disclosure is required, a company could consider policies and practices that mitigate or balance incentives, such as clawback policies or stock ownership/holding requirements.   The SEC notes that, by focusing on risks that are reasonably likely to have a material adverse effect on the company, the new rules are intended to elicit disclosure that would be most relevant to investors and avoid voluminous disclosure of potentially insignificant and unnecessarily speculative information. The new Item 402(s) of Regulation S-K includes a nonexclusive list of situations that may trigger disclosure, such as different compensation policies and practices for different business units, and issues that companies may need to address related to the business units or employees discussed when disclosure is required.   Although all companies will have to perform some analysis of whether disclosure under the new rule is required, the SEC specifically notes that the new rule does not require a company to make an affirmative statement that it has determined that the risks arising from its compensation policies and practices are not reasonably likely to have a material adverse effect on the company.
  • Smaller Reporting Companies Exempt.  Smaller reporting companies are not required to provide the disclosure under new Item 402(s) of Regulation S-K.

New Method For Reporting Value Of Stock Options And Stock Awards; May Change Named Executive Officer Group.  The SEC's new rules scuttle a highly criticized component of the equity compensation rules adopted in 2006 that required companies to report the value of all outstanding equity awards in the Summary Compensation Table and Director Compensation Table, based on the dollar amount recognized for financial statement reporting purposes during the year.  Under the revised Item 402 of Regulation S-K, companies must instead report amounts only for option awards and stock awards granted during the year, based on the aggregate grant date fair value of the awards computed in accordance with FASB ASC Topic 718 (formerly SFAS 123R).  This change will affect which executive officers (other than the always included CEO and CFO) will be "named executive officers" in the Summary Compensation Table, and may cause more variability from year to year in these designations to the extent executives receive larger than normal equity grants in a particular year.

  • Companies Must Recalculate Prior Year Amounts.  For transition to the new rules, companies with fiscal years ending on or after December 20, 2009 must recalculate under the new rules, and report in the Summary Compensation Table, the value of equity awards granted to the current year's named executive officers in all prior fiscal years required to be included in the table.

Other Changes To Compensation Disclosure Requirements.  The SEC's new rules clarify how companies should report the value of performance awards, and permit companies to add an intrinsic value column to the Outstanding Equity Awards at Fiscal Year-End Table.

  • Calculate Performance-Based Awards Based On Probable Outcome.  Instructions to the new rule clarify that the value of performance awards reported in the Summary Compensation Table, Grants of Plan-Based Awards Table and Director Compensation Table must be based on the probable outcome of the performance condition (typically the "target" award value) consistent with the grant date estimate of compensation costs to be recognized over the service period, excluding the effect of forfeitures. However, a footnote to the Summary Compensation Table and Director Compensation Table must disclose the maximum value of the award at the grant date, assuming achievement of the highest level of performance conditions.
  • Companies May Include Intrinsic Value Column In Outstanding Equity Awards At Fiscal Year-End Table.  In response to comments expressing frustration that the compensation tables no longer require disclosure of the intrinsic value of outstanding stock options, the SEC, which generally does not allow any alterations to the format of the compensation tables, took the unusual step of permitting, but not requiring, companies to add a column to the Outstanding Equity Awards at Fiscal Year-End Table to report the fiscal year-end intrinsic value of outstanding stock options and stock appreciation rights.

Companies May Need To Disclose Compensation Consultant Fees.  To help investors better assess the role of compensation consultants and potential conflicts of interest, the SEC's final rules amend Item 407 of Regulation S-K to require companies to disclose fees paid to certain compensation consultants who provide advice to the board or the compensation committee on executive or director compensation if the consultants also provide other services to the company.

  • Must Disclose Fees And Reasoning If Fees Exceed $120,000 For Other Services.  If a compensation consultant engaged by the board or compensation committee provides other services to the company (e.g. benefits administration or human resources consulting), in addition to its services related to determining or recommending the amount or form of executive or director compensation, and the fees for those additional services exceed $120,000 during the company's fiscal year, companies must report the following information:
    • the aggregate fees paid for (i) work related to determining or recommending the amount or form of executive and director compensation and (ii) the additional services;
    • whether management was involved in the decision to engage the compensation consultant for the non-executive compensation services; and
    • whether the board or the compensation committee approved the additional services.
  • If the board or compensation committee has not engaged its own compensation consultant but management or the company has, the company must disclose the aggregate fees paid to the consultant for advice on executive or director compensation and for the other services, if the consultant was engaged to provide advice on executive or director compensation and other services and it received more than $120,000 in fees for the other services during the company's fiscal year
  • Disclosure Not Required If Board And Management Have Their Own Consultants.  If both the board or the compensation committee and management have engaged different compensation consultants to provide advice on executive or director compensation, fee disclosure is not required, even if management's consultant provides additional services to the company.
  • Disclosure Not Required For Consulting Limited To Broad-Based Plans And General Survey Information. The new rules do not require fee disclosures where the consultant's only role is consulting on broad-based plans available generally to all salaried employees that do not discriminate in scope, terms or operation in favor of executive officers or directors (e.g., 401(k) plans or health insurance plans) or providing survey information that either is not customized for a particular company, or that is customized based on parameters that are not developed by the consultant.

NEW REQUIREMENTS FOR ENHANCED DIRECTOR, NOMINEE AND EXECUTIVE OFFICER DISCLOSURE

The new rules amend Item 401(f) of Regulation S-K to expand the disclosure requirements regarding the qualifications of directors and nominees, past directorships held by directors and nominees, and legal proceedings involving directors, nominees and executive officers. The SEC designed this new requirement to assist investors in determining whether and why a director or nominee is a good fit for the company, and to allow companies flexibility in disclosing material background information on the directors and nominees.  The final rules also amend Item 407(c) of Regulation S-K to require disclosure of whether, and if so how, a nominating committee considers diversity when identifying nominees. 

Companies Must Disclose Director And Nominee Qualifications.  The final rules require companies to disclose a director's or nominee's specific experience, qualifications or skills that qualify that person to serve as a director, which could include:

  • any specific past experience that would be useful to the company;
  • the director's or nominee's particular area of expertise; and
  • why the director's or nominee's service as director would benefit the company.

This expanded disclosure applies to all directors and nominees, including incumbent directors, director nominees who are selected by a company's nominating committee and any nominees put forward by other proponents.

Must Disclose Past Directorships.  The new rules require companies to disclose all public company directorships held by each director and nominee at any time during the past five years (companies had to disclose only current director positions under the prior rules).  The SEC intends this additional disclosure to allow investors to better evaluate the relevance of a director's or nominee's past board memberships or professional or financial relationships that might pose a potential conflict of interest.

Must Disclose Additional Information Regarding Legal Proceedings.  To provide investors with more extensive information regarding an individual's competence and character, the SEC extended the look-back period for the disclosure of the involvement of directors, nominees and executive officers in legal proceedings from five years to ten years. 

The SEC also expanded the list of covered legal proceedings to include:

  • proceedings resulting from involvement in mail or wire fraud or fraud in connection with a business entity;
  • proceedings based on violations of federal or state securities, commodities, banking or insurance laws and regulations, or any settlement of these types of actions; and
  • any disciplinary sanctions or orders imposed by stock, commodities or derivatives exchange or other self-regulatory organization.

Companies are not required to report legal proceedings if that information is not material to the evaluation of a director nominee, and they are not required to disclose settlements of civil suits among private parties.

Must Disclose Information About Diversity Policy.  If a company's nominating committee (or board) has a policy with respect to the consideration of diversity when identifying nominees, the company must disclose how this policy is implemented, as well as how the nominating committee (or board) assesses the effectiveness of its policy.  The final rules, however, do not define diversity, which means that companies can develop and disclose their own standards.

NEW REQUIREMENTS FOR BOARD GOVERNANCE DISCLOSURE

The SEC's final rules add a new section to Item 407 of Regulation S-K to impose two additional disclosure requirements.

Must Disclose Board Leadership Structure.  The final rules require a company to disclose its board leadership structure and explain why it believes its structure is appropriate given the company's specific characteristics or circumstances at the time of filing.  In particular, a company must disclose:

  • whether and why the company has chosen to combine or separate the board chairman and CEO positions;
  • if the board chairman and CEO positions are combined, whether and why the company has a lead independent director as well as the specific role the lead independent director plays in the company's leadership; and
  • why the company believes its structure is the most appropriate for the company at the time of the filing.

Must Disclose Board's Role In The Risk Oversight Process.  The SEC's final rules require additional disclosures about the extent of the board's role in the risk oversight of the company, such as how the board administers its oversight function, and the effect that this has on the board's leadership structure.  The disclosure requirement is designed to provide information about how the company perceives the role of its board and the relationship between the board and senior management in managing the company's material risks.  Specifically, the disclosure requirement gives companies the flexibility to describe how the board administers its risk oversight function, such as through the whole board or through a separate risk committee or audit committee.  The adopting release notes that companies may also want to address whether the individuals who supervise the day-to-day risk management responsibilities report directly to the board as a whole or to a board committee or how the board or committee otherwise receives information from these individuals.

AMENDED FORM 8-K REQUIRES ACCELERATED REPORTING OF SHAREHOLDER VOTING RESULTS

The SEC added a new item to Form 8-K to require a company to disclose the results of a shareholder vote within four business days after the date on which the vote occurs.  In situations such as contested elections where a company may not have definitive results within four days after the meeting date, the company must report the preliminary voting results on Form 8-K within four business after the preliminary voting results are determined.  Once the company certifies the final voting results, the company must then file an amended report on Form 8-K within four business days to disclose those final results.  This final rule eliminates the current requirement to report shareholder voting results on the Form 10-Q for the quarter during which the shareholder meeting is held (or Form 10-K for the fourth quarter).

Top Ten Practical Tips For The 2010 Proxy Season

Companies should take the following actions now to implement the new rules for their 2010 proxy statement.

  • Start Now!  Update Annual Reporting T&R Schedule.  Make sure you assemble the right team to gather and process the relevant information needed to comply with the SEC's new disclosure requirements.   Update time and responsibility schedules for the 2010 proxy season to build in sufficient additional time to gather and process additional information related to the enhanced disclosure requirements.
  • Circulate Updated D&O Questionnaire.  Circulate a revised director and officer questionnaire that covers the additional disclosure requirements.  Determine how to gather and present information on specific director experience, qualifications and skills.
  • Assess Risk Management.  Review compensation policies and practices for all employees to assess whether they create risks to the company that would require disclosure, and discuss with the compensation committee the nature of the information that would need to be analyzed and disclosed. Companies may need to put in place new risk assessment procedures.  In addition, companies may want to consider implementing "clawback" or "stock ownership/holding" policies to mitigate risk relating to compensation policies and practices.
  • Update Summary Compensation Table.  Create the Summary Compensation Table for all executive officers that includes the aggregate grant date fair value of option awards and stock awards granted during the fiscal year to determine which executive officers are most likely to constitute the three most highly compensated executive officers, other than the CEO and CFO.  For these named executive officers, recalculate the grant date fair value of equity awards for the prior fiscal years that will be included in the table.  Review the draft Summary Compensation Table with the compensation committee and highlight the impact that the timing of equity grants and large one-time grants may have on named executive officer status.
  • Assess Compensation Consultant Fees And Services.  Assess the services provided by compensation consultants and the fees paid for these services to determine the nature of the information that will need to be disclosed.
  • Assess Board Leadership Structure.  Discuss with the board or the governance committee the new required disclosure rules regarding the rationale for the company's leadership structure.
  • Assess Board Role In Risk Oversight.  Discuss with management, the board and any appropriate committees the new required disclosure rules regarding the board's role in the risk oversight function.
  • Make Sure Compensation Disclosure Complies With Current SEC Guidance.  The SEC Staff has publicly stated that as they review compensation disclosure going forward they will be asking companies to amend their reviewed filings as part of the comment process, rather than requesting that companies make the requested changes only in future filings.  In addition, recent SEC guidance and expert analysis highlight that companies continue to need to focus the CD&A more on analysis, explaining why companies made their compensation decisions (rather than what they decided or describing their process for making compensation decisions).  The SEC Staff remains concerned that companies are failing to disclose in the CD&A information regarding specific performance targets or, if they properly omitted this information because it would cause competitive harm, the degree of difficulty and likelihood of achieving those targets.  Also, if companies benchmark their executive compensation to peer group companies, they must also disclose how the compensation they paid compared to the executive compensation of the benchmarked companies.
  • Include "Routine" Item For Annual Shareholders Meeting. The recent amendment of NYSE Rule 452 to eliminate discretionary broker voting in the election of directors, which generally applies to all shareholder meetings held on or after January 1, 2010, may make it more difficult to achieve a quorum.  To address this issue, companies should consider including at least one meeting agenda item that qualifies as "routine"—such as the ratification of accountants. See our July 27, 2009 Update. (http://www.perkinscoie.com/news/pubs_detail.aspx?publication=2242&op=updates)
  • Consider Impact Of 2010 Riskmetrics (ISS) Proxy Voting Guidelines.  The Riskmetrics 2010 Update announced a new consolidated executive compensation evaluation policy that includes new "pay-for-performance" standards and risk management evaluation.  Under the new "pay-for-performance" standards, Riskmetrics will consider the historical alignment of the CEO's total direct compensation and total shareholder return over a period of at least five years, with a focus on the most recent three years.  Riskmetrics will also evaluate problematic pay practices to consider whether incentive practices may motivate inappropriate risk-taking by executives and assess the extent to which techniques such as clawback policies or stock ownership/holding requirements may mitigate this risk.  Riskmetrics may apply these, depending on the pay issue, to ballot items regarding election of directors (primarily compensation committee members), advisory votes on compensation (management say-on-pay proposals) and equity plan proposals. 

ADDITIONAL INFORMATION 

You can find a copy of the full text of the SEC's final rule release at http://www.sec.gov/rules/final/2009/33-9089.pdf.  You can find a copy of the SEC's compliance and disclosure interpretations regarding proxy disclosure enhancements transition guidance at http://www.sec.gov/divisions/corpfin/guidance/pdetinterp.htm.  You can find discussions of other recent cases, laws, regulations and rule proposals of interest to public companies on our website. (http://www.perkinscoie.com/resources/updates.cfm?group=83)

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.