Executive Compensation Disclosure Memo Series (Part 5 of 6)

To read Part 4 of 6 please click here

Part 5 of 6 of the Executive Compensation Disclosure Memo Series summarizes the newly adopted rules with respect to the (i) disclosure of related person transactions and (ii) revised requirements for information to be reported in the beneficial ownership table.

As amended, Item 404 of Regulation S-K streamlines related person disclosure requirements, making it much less prescriptive and more principles-based. As amended, the new Item 404 has been restructured as follows:

• Item 404(a) contains a general disclosure requirement for related-person transactions, including those involving indebtedness;

• Item 404(b) requires disclosure regarding the company’s policies and procedures for the review, approval or ratification of related-person transactions; and

• Item 404(c) requires disclosure regarding promoters and certain control persons of a company.

Item 404(a) contains a general statement of the principle for disclosure followed by specific disclosure requirements and instructions related to coverage, scope, methodology and other matters. The requirements for disclosure of indebtedness have been consolidated into this item.

The broad disclosure principle contained in Item 404(a) requires disclosure of any transaction since the beginning of the last fiscal year or any currently proposed transaction:

• in which the company was or is to be a participant;

• in which the amount involved exceeds $120,000; and

• in which any related person had or will have a direct or indirect material interest (see below for a discussion of who is considered a "related person" under new Item 404).

It is worth noting that the $120,000 threshold referred to above simply acts as a floor for purposes of determining whether a transaction needs to be disclosed. Transactions exceeding the prescribed threshold may not require disclosure if, upon consideration, such transactions are determined not to be material to the person involved. Nevertheless, historically, most companies have been reluctant to omit disclosure of transactions that exceed the threshold without substantial support for the proposition that the related person’s interest was not material. As a practical matter, we think that this practice will continue.

The principles-based approach set forth above requires disclosure of transactions in which a company is a "participant" as opposed to a "party." The change makes it clear that disclosure will be required even if the company is not technically a party to the arrangement or transaction, but nevertheless benefits or otherwise participates in the transaction. Also, even though the new principles-based approach does not expressly mention transactions between related persons and subsidiaries, companies still must include subsidiaries in making materiality determinations in all circumstances.

Under revised Item 404, the term "related person" means any person (or his or her immediate family members) who, at any time during the period specified, was:

• a director or executive officer of the registrant;

• a nominee for director or any of such nominee’s immediate family members (this applies to disclosure in a proxy or information statement relating to the election of directors); or

• a security holder known to the registrant to beneficially own more than 5% of any class of the registrant’s voting securities or any of such holder’s immediate family members.

Once a material transaction has been identified, a company will need to describe the transaction, including:

• the related person’s name and relationship to the company;

• the related person’s interest in the transaction;

• the approximate dollar value of the amount involved in the transaction and of the related person’s interest in the transaction (without regard to profit or loss); and

• any other information regarding the transaction or the related person that in light of all the circumstances would be material to investors.

There is an exception to Item 404(a) for any bank services as a depositary of funds or any loan with a bank subsidiary so long as that loan is not classified as non accrual, past due, restructured or as a potential problem, and the loan:

• was made in the ordinary course of business;

• was made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with persons not related to the lender; and

• did not involve any more than the normal risk of collectibility or present other unfavorable features.

Under revised Item 404(b) a company will be required to disclose its policies and procedures for the review, approval or ratification of related person transactions. Specifically, a company will be required to describe its policies and procedures for the review, approval or ratification of Item 404(a) transactions.

Such description should discuss the material features of the policies and procedures that are necessary for an understanding of them, including:

• the types of transactions covered;

• the standards to be applied;

• the persons responsible for applying the policies and procedures; and

• whether the policies and procedures are in writing and, if not, how they are evidenced.

Any Item 404(a) policies and procedures that are not required to be approved must be identified and if the policies and procedures have not been followed, this must be disclosed.

ACTIONS TO TAKE NOW

• adopt or amend a related party transaction policy to be able to say that the policies and procedures are in writing;

• update directors' and officers' questionnaires to reflect the new related party disclosure rules and reporting requirements in connection with the beneficial ownership table;

• consider whether to send questionnaires to 5% shareholders for the purpose of identifying their immediate family members;

• consider whether revised standards affect satisfaction of director independence requirements for purposes of Rules 16b-3 and 162m.

SMALL BUSINESS REPORTING COMPANIES The new related party and beneficial ownership rules discussed herein equally apply to small business issuers, except for the requirements of Item 404(b).

Item 403 of Regulation S-K, which requires reporting of beneficial ownership of equity securities by directors, named executive officers and 5% shareholders, has been amended. The amendment requires footnote disclosure of the number of shares pledged as security by the individuals whose information is reported in the table.

As you begin to implement many of these items in preparation for the 2007 proxy season and need additional advice or assistance, please feel free to contact your regular Powell Goldstein contact.

This Client Alert is prepared by the Financial Institutions Practice Group of Powell Goldstein LLP as a client service. The information discussed is general in nature and may not apply to your specific situation. Legal advice should be sought before taking action based on the information discussed.