SEC Votes to Propose Sweeping Changes to Compensation Disclosure Rules

By Ettore A. Santucci, Marian A. Tse, Scott A. Webster, John R. LeClaire and Antonio G. Gomes

On January 17, 2006, the Securities and Exchange Commission voted to propose the first comprehensive revision of the rules relating to the disclosure of executive compensation by public companies since 1992. The proposed rules would amend disclosure requirements for executive and director compensation, related party transactions, director independence and other corporate governance matters, as well as security ownership of officers and directors. The proposed rules would affect disclosure in proxy statements, annual reports and registration statements. The proposals would also require most of this disclosure to be provided in "plain English." In addition, the proposals would clarify the current reporting requirements of Form 8-K regarding compensation arrangements.

At the time this article was prepared, the SEC release containing the proposed rules was not yet available. We will publish more detailed information concerning the SEC’s proposed rules after the full text of the proposed rules become available. We expect the proposed rules to be the subject of extensive comment. Given that the SEC has proposed a 60-day public comment period, we believe that, when adopted, the final rules will likely be effective for the 2007 proxy season.

The SEC’s proposals would combine the current tabular disclosure presentation with narrative disclosure designed to provide a more complete disclosure of compensation paid to a company’s top executive officers and directors.

• A new "Compensation Discussion and Analysis" (CD&A) section would replace the current compensation committee report and performance graph and be required to address the objectives of the company’s executive compensation program, the elements of executive compensation, the most important factors that directors weighed in determining specific compensation types and amounts, and how the directors’ determinations further the company’s objectives.

• The new CD&A disclosure would be deemed to be "filed" with the SEC, subjecting the company to a higher level of securities law liability as compared to the currently "furnished" compensation committee report.

• The SEC’s proposals would also change which executive officers (the socalled "named executive officers") are covered by the compensation disclosure rules.

• The CFO will now be required to be included as a named executive officer in all instances.
• Up to three other employees who are not executive officers (identified by job function, not by name) will now be required to be included as named executive officers if any such individual’s compensation is in excess of the compensation paid to any of the company’s most highly paid executive officers.
• Determination of who is named as a named executive officer would be based on total compensation, rather than based on just salary and bonus as currently required.

• A reorganized Summary Compensation Table would present three-year compensation data.

• A new column would sum up all other columns and disclose one number – a single bottom line figure – for total annual compensation.

• A dollar value will be shown for all stock-based awards measured at grant date fair value (e.g., Black-Scholes value) computed pursuant to Statement of Financial Accounting Standards No. 123(R), Share- Based Payment.

• The "all other compensation" column would require disclosure of all other compensation not reported in other columns, including:
• perquisites if they exceed $10,000 in the aggregate;
• the increase in the actuarial value of non-qualified pension plans (e.g., SERPs) accrued during the year; and

• all earnings on non-qualified deferred compensation.

• The SEC’s proposal would also provide interpretive guidance for determining what is a perquisite.

• Proposed disclosure regarding stock-based compensation would include:

• two supplemental tables reporting grants of performance-based awards and grants of all other equity awards;
• an Outstanding Equity Awards at Fiscal Year-End Table, which would show outstanding awards representing potential amounts that may be received in the future; and
• an Option Exercises and Stock Vested Table, which would show amounts actually realized on equity compensation during the last year.

• The SEC’s proposal would also provide for enhanced disclosure concerning retirement plans and post-employment compensation and benefits.

• A new Retirement Plan Potential Annual Payments and Benefits Table would disclose annual benefits payable to each named executive officer.
• A Nonqualified Defined Contribution and Other Deferred Compensation Plans Table would disclose year-end balances, executive contributions, company contributions, earnings and withdrawals for the year.
• The proposal would require disclosure and quantification of payments and benefits (including perquisites) payable to executive officers upon termination of employment or a change in control.

• A Director Compensation Table, similar to the Summary Compensation Table, and related narrative would disclose director compensation for the last year.

• The current requirement for the presentation of a 5-year stock performance graph would be eliminated under the proposed rules.

The SEC’s proposals would revise the current disclosure requirements concerning related party transactions. The proposals would:

• require disclosure regarding policies and procedures for approving related party transactions;

• expand the categories of related persons; and

• increase the threshold for disclosure from $60,000 to $120,000. The SEC also committed that the requirements for the disclosure of related party transactions would be made more principles-based.

The SEC also proposed to consolidate existing corporate governance disclosure requirements into one new item under Regulations S-K and S-B. The new streamlined disclosure would require:

• disclosure of whether each director and director nominee is independent;

• a description of any relationships not otherwise disclosed that were considered when determining whether each director and director nominee is independent;

• disclosure of any audit, nominating and compensation committee members who are not independent; and

• a narrative description of the procedures used by compensation committees for determining executive and director compensation.

The SEC’s proposals would also require disclosure of the number of shares pledged by management.

Form 8-K The proposals would modify the disclosure requirements of Form 8-K to capture some employment arrangements and material amendments thereto only for named executive officers. The proposals would also consolidate all Form 8-K disclosure regarding employment arrangements under a single item.

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