SEC Overhauls Executive Compensation Disclosures

November 2006

On July 26, 2006, the Securities and Exchange Commission adopted substantial amendments to the rules governing the disclosure of compensation that SEC reporting companies (or "issuers") pay to their directors and to their principal executive officer, principal financial officer and three other most highly compensated executive officers (the "named executive officers"). The amended rules will be effective for the 2007 proxy season and will require significant changes to existing compensation disclosures. The following is a brief overview of the amendments.

Compensation Discussion & Analysis

Issuers must now begin their executive compensation disclosure with a narrative overview, called the "Compensation Discussion and Analysis" or CD&A, that describes the issuer's compensation objectives and policies for the named executive officers. The CD&A is intended to answer the following questions:

What are the objectives of the issuer's compensation programs?
What is the compensation program designed to reward and not reward?
What is each element of compensation?
Why does the issuer choose to pay each element of compensation?
How does the issuer determine the amount for each element of compensation?
How do the issuer's decisions regarding each element fit in to the issuer's overall compensation objectives and affect decisions regarding other elements?

The material information disclosed under the CD&A will depend upon each issuer's facts and circumstances, but the amended rules provide examples of information that may be disclosed, including the issuer's policies for allocating between long-term and short-term compensation and between cash and non-cash compensation, the specific aspects of corporate performance and individual performance that the issuer considers when setting compensation policies and making compensation decisions and how specific elements of compensation are tied to those aspects of performance and the role of executive officers in the compensation process. The CD&A should also explain how the issuer determines when to grant awards (including stock options), which would include disclosure of any program, plan or practice to either (i) select option grant dates for executive officers in coordination with the release of material non-public information or (ii) award options and set the exercise price based on the stock's price on a date other than the actual grant date.

Revised Compensation Tables

The executive compensation tables have been reorganized and streamlined in an effort to, in the SEC's words, "provide clearer and more logical picture of total compensation and its elements for named executive officers." The revised tables are organized into three broad categories:

current compensation for the last fiscal year and two preceding years, consisting of the summary compensation table and a table detailing grants of plan-based awards during the most recent fiscal year;
holdings of equity awards (including option awards and stock awards) as of the end of the most recent fiscal year, as well as recent realization on those awards, such as through vesting of restricted stock or the exercise of options; and
retirement and other post-employment benefits, including pension benefits, nonqualified deferred compensation and compensation payable in the event of termination of employment or a change in control.

The more significant changes to the existing disclosure format include:

the addition of a "Total" compensation column to the summary compensation table and other changes to illustrate the computation of "Total" compensation, such as disclosure of equity grants in dollar amounts (rather than number of shares) based on the total grant date fair value as determined under FAS 123R;
the addition of two new tables to supplement the summary compensation table: grants of performance-based awards and grants of all other equity awards;
replacing the existing pension plan table with two new tables: one for defined benefit pension plans and a second for nonqualified defined contribution and other deferred compensation plans; and
a requirement to disclose arrangements entitling any named executive officer to receive compensation upon resignation, severance, retirement, or a change in control in a narrative that describes the specific terms of each arrangement and quantifies the estimated payments and benefits that would be provided in each circumstance.

Disclosure of Perquisites

The amended rules reduce the threshold for disclosure of perquisites to $10,000 from current threshold, which is the lesser of $50,000 or 10 percent of total salary and bonus, and require footnote disclosure that identifies the particular nature of the benefit received. In addition, for the first time, the SEC provided guidance for determining what constitutes a perquisite. Specifically, an item should be considered a perquisite if it confers a direct or indirect benefit that has a personal aspect, even if it is provided for some business reason or for the convenience of the issuer, unless the benefit is generally available on a non-discriminatory basis to all employees. However, a benefit would not be a perquisite if it is "integrally and directly related" to a person's duties (an exception that the SEC believes should be narrowly construed). Finally, the fact that an issuer determines an expense to be "ordinary" or "necessary" for tax or other purposes is not conclusive for purposes of the amended rules.

Director Compensation

Director compensation for the last fiscal year is now required to be disclosed in a table with narrative disclosure, similar to the summary compensation table for executive compensation. Multiple directors may be grouped together in a single row of the table if all of the elements and amounts of their compensation are identical.

Disclosure of Related Party Transactions

The amendments also streamline and modernize the rules relating to disclosure of related party transactions. The amendments consolidate what were previously three separate disclosure rules covering transactions with management, certain business relationships and indebtedness into a single rule that requires disclosure of any transaction in which a "related person" (as defined) had or will have a direct or indirect material interest. The amendments increase the disclosure threshold for related party transactions from $60,000 to $120,000 and require narrative disclosure regarding the issuer's policies and procedures for the review, approval or ratification of related person transactions.

Conclusion

The amendments are extensive (the adopting release itself is 436 pages), and the process of understanding, analyzing and implementing the amended rules will require a significant amount of time and effort on the part of issuers and their counsel. Issuers need to begin the process now of compiling and quantifying compensation data, documenting their compensation programs and policies and understanding the details of the new compensation tables in order to be in compliance for the 2007 proxy season.

The Sherman & Howard Employee Benefits Team is ready to assist clients with this or related matters. Please visit our website at www.shermanhoward.com for more information.

	Contact Us Services Attorneys News and Events Publications About the Firm Inclusiveness Careers Blog In the Media Events and Registration Press Releases Speaking Engagements Articles Client Advisories Subscriptions History Offices Pro Bono Interlaw Contact Us Culture Legal Opportunities Support Staff Publications Client Advisories Home > Publications > Client Advisories > View SEC Overhauls Executive Compensation Disclosures November 2006 On July 26, 2006, the Securities and Exchange Commission adopted substantial amendments to the rules governing the disclosure of compensation that SEC reporting companies (or "issuers") pay to their directors and to their principal executive officer, principal financial officer and three other most highly compensated executive officers (the "named executive officers"). The amended rules will be effective for the 2007 proxy season and will require significant changes to existing compensation disclosures. The following is a brief overview of the amendments. Compensation Discussion & Analysis Issuers must now begin their executive compensation disclosure with a narrative overview, called the "Compensation Discussion and Analysis" or CD&A, that describes the issuer's compensation objectives and policies for the named executive officers. The CD&A is intended to answer the following questions: What are the objectives of the issuer's compensation programs? What is the compensation program designed to reward and not reward? What is each element of compensation? Why does the issuer choose to pay each element of compensation? How does the issuer determine the amount for each element of compensation? How do the issuer's decisions regarding each element fit in to the issuer's overall compensation objectives and affect decisions regarding other elements? The material information disclosed under the CD&A will depend upon each issuer's facts and circumstances, but the amended rules provide examples of information that may be disclosed, including the issuer's policies for allocating between long-term and short-term compensation and between cash and non-cash compensation, the specific aspects of corporate performance and individual performance that the issuer considers when setting compensation policies and making compensation decisions and how specific elements of compensation are tied to those aspects of performance and the role of executive officers in the compensation process. The CD&A should also explain how the issuer determines when to grant awards (including stock options), which would include disclosure of any program, plan or practice to either (i) select option grant dates for executive officers in coordination with the release of material non-public information or (ii) award options and set the exercise price based on the stock's price on a date other than the actual grant date. Revised Compensation Tables The executive compensation tables have been reorganized and streamlined in an effort to, in the SEC's words, "provide clearer and more logical picture of total compensation and its elements for named executive officers." The revised tables are organized into three broad categories: current compensation for the last fiscal year and two preceding years, consisting of the summary compensation table and a table detailing grants of plan-based awards during the most recent fiscal year; holdings of equity awards (including option awards and stock awards) as of the end of the most recent fiscal year, as well as recent realization on those awards, such as through vesting of restricted stock or the exercise of options; and retirement and other post-employment benefits, including pension benefits, nonqualified deferred compensation and compensation payable in the event of termination of employment or a change in control. The more significant changes to the existing disclosure format include: the addition of a "Total" compensation column to the summary compensation table and other changes to illustrate the computation of "Total" compensation, such as disclosure of equity grants in dollar amounts (rather than number of shares) based on the total grant date fair value as determined under FAS 123R; the addition of two new tables to supplement the summary compensation table: grants of performance-based awards and grants of all other equity awards; replacing the existing pension plan table with two new tables: one for defined benefit pension plans and a second for nonqualified defined contribution and other deferred compensation plans; and a requirement to disclose arrangements entitling any named executive officer to receive compensation upon resignation, severance, retirement, or a change in control in a narrative that describes the specific terms of each arrangement and quantifies the estimated payments and benefits that would be provided in each circumstance. Disclosure of Perquisites The amended rules reduce the threshold for disclosure of perquisites to $10,000 from current threshold, which is the lesser of $50,000 or 10 percent of total salary and bonus, and require footnote disclosure that identifies the particular nature of the benefit received. In addition, for the first time, the SEC provided guidance for determining what constitutes a perquisite. Specifically, an item should be considered a perquisite if it confers a direct or indirect benefit that has a personal aspect, even if it is provided for some business reason or for the convenience of the issuer, unless the benefit is generally available on a non-discriminatory basis to all employees. However, a benefit would not be a perquisite if it is "integrally and directly related" to a person's duties (an exception that the SEC believes should be narrowly construed). Finally, the fact that an issuer determines an expense to be "ordinary" or "necessary" for tax or other purposes is not conclusive for purposes of the amended rules. Director Compensation Director compensation for the last fiscal year is now required to be disclosed in a table with narrative disclosure, similar to the summary compensation table for executive compensation. Multiple directors may be grouped together in a single row of the table if all of the elements and amounts of their compensation are identical. Disclosure of Related Party Transactions The amendments also streamline and modernize the rules relating to disclosure of related party transactions. The amendments consolidate what were previously three separate disclosure rules covering transactions with management, certain business relationships and indebtedness into a single rule that requires disclosure of any transaction in which a "related person" (as defined) had or will have a direct or indirect material interest. The amendments increase the disclosure threshold for related party transactions from $60,000 to $120,000 and require narrative disclosure regarding the issuer's policies and procedures for the review, approval or ratification of related person transactions. Conclusion The amendments are extensive (the adopting release itself is 436 pages), and the process of understanding, analyzing and implementing the amended rules will require a significant amount of time and effort on the part of issuers and their counsel. Issuers need to begin the process now of compiling and quantifying compensation data, documenting their compensation programs and policies and understanding the details of the new compensation tables in order to be in compliance for the 2007 proxy season. The Sherman & Howard Employee Benefits Team is ready to assist clients with this or related matters. Please visit our website at www.shermanhoward.com for more information. Copyright 2000-2013 Sherman & Howard L.L.C. 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