SEC Overhauls Executive Compensation Disclosures
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:
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:
The more significant changes to the existing disclosure format include:
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 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.
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.