SEC Adopts Amendments to Executive Compensation and Related Person Transaction Disclosure Rules

By Edward P. Smith, Kevin C. Smith, Jessica Tsai, Andrew Hutchinson & Jennifer Kang

On August 11, 2006, the SEC issued a release regarding amendments to its rules requiring disclosure of executive and director compensation, related person transactions, director independence and other corporate governance matters, and security ownership of officers and directors adopted on July 26, 2006.¹ While the SEC added new rules requiring disclosure of option grant practices and made certain modifications based on the record number of comments received, the final rules were adopted substantially as proposed.² Certain modifications to the proposed rules are highlighted in italics below.

The amendments organize disclosure of executive compensation information into five broad categories:

• Option Disclosure;
• Compensation Discussion and Analysis ("CD&A");
• Summary Compensation Table for the last three fiscal years;
• Exercises and holdings of previously awarded equity interests; and
• Post-employment compensation.

The final rules will require new tabular and narrative disclosure regarding stock option grant practices that were not previously included in the proposed rules.

The new rules expand the tabular disclosures of option grants and are described in more detail below in the description of the revised and new tables under "Total Compensation to Named Executive Officers for the Last Three Fiscal Years."

• The Summary Compensation Table must include the fair market value of the option on the date of grant computed under FAS 123R.
• The new Grants of Plan-Based Awards Table must list the grant date of the option as determined under FAS 123R.
• If the exercise price of the option was below the closing market price of the stock on the date of grant, an additional column must be added to the table to disclose the closing market price of the stock on the grant date.
• If the grant date differs from the date that the compensation committee or board acted to grant the option, another additional column must be added to the table to disclose the date that the compensation committee or the board took action to grant the option.

In addition to tabular disclosure, companies will be required to provide a narrative disclosure in the new CD&A section of its practices related to the timing and pricing of stock option grants.

Disclosure is required of any program, plan or practice to select option grant dates for executive officers in coordination with the release by the company of material non-public information. Consistent with its views on principles-based di sclosure, the SEC believes that companies should consider their own facts and circumstances and should include all relevant material information when drafting the disclosure, including the following:

• If the company has such a program, plan or practice, whether the compensation committee or board may grant options at times when the committee or board is in possession of material non-public information; and
• How the compensation committee or board takes material non-public information into account when determining whether and in what amount to make grants to executives.

• Does a company have any program, plan or practice to time option grants to its executives in coordination with the release of material non-public information?
• How does any program, plan or practice to time option grants to executives fit in the context of the company’s program, plan or practice, if any, with regard to option grants to employees more generally?
• What was the role of the compensation committee or board in approving and administering such a program, plan or practice? How did the compensation committee or board take such information into account when determining whether and in what amount to make those grants? Did the compensation committee or board delegate any aspect of the actual administration of such a program, plan or practice to any other persons?
• What was the role of executive officers in the company’s practice of option timing?
• Does the company set the grant date of its stock option grants to new executives in coordination with the release of material non-public information?
• Does a company plan to time, or has it timed, its release of material non-public information for the purpose of affecting the value of executive compensation?

A new principles-based CD&A overview will replace the currently required performance graph and compensation committee report. The CD&A will be a comprehensive discussion of material information about the compensation objectives and policies for named executive officers and describe the material elements of compensation (both in-service and post-termination) to these executives. The CD&A will explain:

• the objectives of the compensation program;
• what the compensation program is designed to reward;
• each element of compensation and why the company chose to pay each element;
• how each element is determined, including any applicable formula; and
• how each element fits into overall compensation objectives.

The CD&A should focus on the material principles underlying executive compensation policies and decisions, without using boilerplate language or providing repetitive information. The new rules are principles-based with illustrative, non-exclusive examples of items that may constitute material information to be disclosed in the CD&A. The CD&A is intended to put into perspective for investors the numbers and narrative that are required to follow it, similar in concept to MD&A for financial disclosure.

Consistent with current rules, the CD&A will not require disclosure of any factors involving confidential commercial or business information, including target levels with respect to specific quantitative or qualitative performance-related factors, if such disclosure will have an adverse effect on the company. The standard to be applied will be the one used when companies request confidential treatment of information that otherwise is required to be disclosed in documents filed with the SEC. However, if the company uses target levels for specific quantitative or qualitative performance-related factors, or other factors or criteria that it does not disclose, the company must discuss how difficult it will be for the executive or how likely it will be for the company to achieve the undisclosed target levels or other factors. In addition, performance targets based on non-GAAP financial measures will not be subject to Regulation G and other related rules regarding use of non-GAAP measures, but the company must disclose how the measures are derived from the audited financial statements.

The CD&A will be "filed" (rather than "furnished") and will thus be a part of the disclosure subject to certification by a company’s principal executive officer and principal financial officer and securities law liability.

Pursuant to the final rules, a new Compensation Committee Report similar to the currently required Audit Committee Report will require a statement of whether the compensation committee has reviewed and discussed the CD&A with management and, based on this review and discussion, recommended that the CD&A be included in the company’s annual report on Form 10-K or proxy statement. The Compensation Committee Report will be furnished (rather than filed).

The currently required stock performance graph will be retained, but it will now be included under the disclosure item entitled "Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters" in annual reports to shareholders that accompany proxy statements relating to annual meetings at which directors are to be elected.

The Summary Compensation Table will continue to be the principal disclosure vehicle for executive compensation paid to named executive officers for the last three fiscal years, but with substantial revisions. Of particular note, the revised table will require disclosure of the named executive officers’ total compensation for each of the last three years, whether or not actually paid out.³

Companies will not be required to restate compensation disclosures in the Summary Compensation Table for previous fiscal years for which they were required to apply the rules currently in effect. Instead, the Summary Compensation Table disclosures required by the new rules will be required only for the most recent fiscal year for the first year of effectiveness, the two most recent fiscal years for the second year of effectiveness and the three most recent fiscal years thereafter. This will result in phased-in implementation of the disclosures over a three-year period.

Under current rules, the chief executive officer and the four other most highly compensated executive officers are considered named executive officers. Under the new rules, the named executive officers will consist of the principal executive officer, the principal financial officer and the three other most highly compensated executive officers. In addition, named executive officers will include:

• anyone who served as a principal executive officer or principal financial officer at any time during the last fiscal year; and
• up to two former executive officers for whom disclosure would have been required had they been executive officers at the end of the fiscal year.

The three most highly compensated executive officers (other than the principal executive officer and principal financial officer) will be determined based on total compensation for the last fiscal year, excluding earnings on nonqualified deferred compensation and changes in pension value. Under the current rules, this determination is based on salary and bonus only. The new rules will eliminate the ability to exclude an executive officer based on an unusually large cash compensation that is "non-recurring and unlikely to continue." However, companies will continue to be able to exclude an executive officer due to cash compensation relating to an overseas assignment attributed predominantly to such assignment.

The final rules include a new "total" column as the final column in the Summary Compensation Table. This column will aggregate the compensation described in each of the other columns in the table. As explained more fully below, the total column will include the dollar value of stock awards and option grants. This is a significant change from the current rules, which require disclosure only of the number of securities underlying the awards.

The current salary and bonus columns will be revised in a few respects. For example, all deferred compensation will be included in the salary, bonus or other columns, as appropriate (but will not need to be disclosed in a footnote, as originally proposed). Currently, disclosure of deferrals of salary and bonus is required only if the officer elects deferral. The new rules will cover deferrals made for any reason.

The current "restricted stock awards" column will be replaced with a new "stock awards" column. This column will show the dollar value of all stock-related awards deriving their value from the company’s equity securities or permitting settlement in such securities, other than awards that have option-like features. Awards of restricted stock, restricted stock units, phantom stock, phantom stock units, common stock equivalent units and similar instruments will be included in this column. Valuation will be based on the grant date fair value of the award, determined pursuant to FAS 123R for financial reporting purposes. The discussion of the relevant FAS 123R assumptions in the notes to the company’s financial statements or in its MD&A will have to be referenced and will be deemed part of the required disclosure.

Currently, companies may report stock awards that are subject to performance conditions as incentive plan awards. This will no longer be permitted as the new rules will require the grant date fair value of equity awards subject to performance-based conditions to be included in the stock awards column.

All earnings on outstanding stock awards paid or payable during the fiscal year will also be included in the stock awards column and quantified in a footnote, except with respect to awards which entitle the holder to receive dividends, if the dividends were already factored into the grant date fair value computed under FAS 123R. Currently, such earnings are reportable in the "other annual compensation" or "all other compensation" columns of the table and are disclosed only to the extent that such earnings are above-market or preferential.

Awards of options, stock appreciation rights and similar instruments with option-like features will be disclosed in a new "option awards" column in a manner similar to the stock awards described above. The column will disclose the grant date fair value of each award as determined pursuant to FAS 123R for financial reporting purposes, with a footnote referencing the discussion of the relevant FAS 123R assumptions similar to that described above for stock awards. Previously awarded options or freestanding stock appreciation rights repriced or otherwise materially modified during the last fiscal year will be required to be disclosed based on the incremental fair value of the award, as modified (rather than the total fair value, as originally proposed).

Similar to stock awards, all earnings paid or payable during the fiscal year in connection with outstanding option awards will need to be included in the column and also identified and quantified in a footnote, except with respect to awards which entitle the holder to receive dividends, if the dividends were already factored into the grant date fair value computed under FAS 123R.

A new column will report the dollar value of all other amounts earned during the applicable fiscal year under non-equity based incentive plans. This column will be limited to awards where the relevant performance measure is not based on the price of the company’s equity securities or the award may not be settled with such securities. This will include performance-based compensation tied to measures such as return on assets, return on equity or performance of a business unit. Amounts will be included in this column in the year in which the relevant performance criteria are satisfied and the compensation is earned, whether or not the amounts were actually paid in that year. The new rules do not require disclosure of the grant date value of these non-stock awards in the Summary Compensation Table because there is no single required or accepted standard for measuring this value comparable to FAS 123R.

Similar to stock and option awards, all earnings paid or payable during the fiscal year on outstanding non-stock incentive compensation awards will need to be included in this column and also identified and quantified in a footnote.

The final rules separate this column from the All Other Compensation column under which this information was included in the rules as originally proposed. Above-market or preferential earnings, as the current rules require (rather than all earnings, as originally proposed), on deferred compensation that is not tax-qualified, including under non-tax qualified defined contribution retirement plans, must be disclosed under this column. The SEC notes that the full amount of earnings on nonqualified deferred compensation must be disclosed in the new Nonqualified Deferred Compensation Table. In addition, the aggregate increase in the actuarial value to the named executive officer of defined benefit and actuarial pension plans (including supplemental plans) accrued during the last fiscal year must be disclosed in the column. In computing the amount to be disclosed, the company should use the same assumptions it uses for financial reporting purposes under GAAP. Identification and quantification of the full amount of each element will be required in a footnote. Any negative amounts should be disclosed in a footnote, but not offset from the amount reported in the column.

This column will disclose the dollar amount of all compensation not required to be included in any other column (with the limited exception of perquisites and personal benefits if they total less than $10,000 for a named executive). Compensation required to be disclosed under this column specifically includes:

• the value of perquisites and other benefits, unless the aggregate amount of such compensation is less than $10,000 for any named executive. Under current rules, perquisites are disclosed unless they total the lesser of $50,000 or 10% of annual salary and bonus. The new rules provide that the aggregate incremental cost to the company is the proper measure for valuing perquisites and personal benefits and require footnote disclosure of the methodology for computing such cost;
• amounts paid or accrued in connection with any termination of employment or a change in control;
• annual company contributions or other allocations to vested and unvested defined contribution plans;
• the dollar value of any life insurance premiums paid by the company for the benefit of a named executive officer;
• tax gross-ups or other tax reimbursements with respect to any compensation, including perquisites and personal benefits;
• the company’s compensation cost (computed in accordance with FAS 123R) related to discounted security purchases, unless the discount is available generally to all security holders or all salaried employees; and
• the dollar value of any dividends or other earnings paid on stock or option awards if the dividends or earnings were not factored into the grant date fair value computed under FAS 123R.

Each item included in the all other compensation column with a value that exceeds $10,000 will need to be separately identified and quantified in a footnote, other than perquisites and other personal benefits. Unless the aggregate value of all perquisites and personal benefits is less than $10,000, any perquisite or other personal benefit must be identified by type and, if it is valued at the greater of $25,000 or 10% of total perquisites and other personal benefits, its value must be disclosed. Where perquisites are subject to identification, they must be described in a manner that identifies the particular nature of the benefit received. For example, it will not be sufficient to characterize generally as "travel and entertainment" different company-financed benefits, such as clothing, jewelry, artwork, theater tickets and housekeeping services. Currently, only perquisites that are 25% or more of total perquisites must be separately identified and quantified.

The SEC does not define perquisites or personal benefits in its rules.⁴ However, it has provided interpretive guidance (which is effective immediately) that among the factors to be considered in determining whether an item is a perquisite or personal benefit are:

• an item is not a perquisite or personal benefit if it is integrally and directly related to the performance of the executive’s duties; and
• otherwise, an item is a perquisite or personal benefit if it confers a direct or indirect benefit that has a personal aspect, without regard to whether it may be provided for some business reason or for the convenience of the company, unless it is generally available on a non-discriminatory basis to all employees.

Companies should initially evaluate the first prong of the analysis. If an item is integrally and directly related to the performance of the executive’s duties, it is not a perquisite and no further analysis is required. For example, a Blackberry or a laptop computer is integrally and directly related to the performance of an executive’s duties if the company believes it is an integral part of such executive’s duties to be accessible by e-mail to the executive’s colleagues and clients when out of the office.

However, the concept of a benefit that is "integrally and directly related" to job performance is a narrow one. It does not include items that facilitate job performance, such as use of company-provided aircraft, yachts, commuter transportation services, additional secretarial services devoted to personal matters or investment management services. Moreover, the fact that the company has determined that an expense is an "ordinary" or "necessary" business expense for tax or other purposes or that an expense is for the benefit or convenience of the company is not determinative of whether the expense is a perquisite or personal benefit for SEC disclosure purposes.

If an item is not integrally and directly related to the performance of the executive’s duties, the second prong of the analysis must be applied. For example, a company’s provision of helicopter service for an executive to commute to work from home is not integrally and directly related to job performance (although it would benefit the company by getting the executive to work faster), clearly bestows a benefit that has a personal aspect and is not generally available to all employees on a non-discriminatory basis. Business purpose or convenience does not affect the characterization of an item as a perquisite or personal benefit where it is not integrally and directly related to the performance by the executive of his or her job.

A company may reasonably conclude that an item is generally available to all employees on a non-discriminatory basis if it is available to those employees to whom it lawfully may be provided. For this purpose, a company may recognize jurisdictionally based legal restrictions (such as for foreign employees) or the employees’ "accredited investor" status. In contrast, merely providing a benefit consistent with its availability to employees in the same job category or at the same pay scale does not establish that it is generally available on a non-discriminatory basis to all employees.

• Applying the concepts outlined by the SEC, examples of disclosable perquisites or personal benefits include:
• club memberships not used exclusively for business entertainment purposes;
• personal financial or tax advice;
• personal travel using company vehicles;
• personal travel otherwise financed by the company;
• personal use of other company property, housing and other living expenses (including relocation assistance and payments to stay at one’s personal residence);
• security provided at a personal residence or during personal travel;
• commuting expenses (whether or not for the company’s convenience or benefit); and
• discounts on the company’s products or services not generally available to employees on a non-discriminatory basis.

Examples of items that are not perquisites or personal benefits include:

• travel to and from business meetings;
• other business travel;
• business entertainment;
• security during business travel; and
• itemized expense accounts the use of which is limited to business purposes.

Beyond these examples, the SEC believes companies and their advisors must decide whether particular arrangements require disclosure as perquisites or personal benefits.

A new supplemental table will follow the Summary Compensation Table, combining the Grants of Performance-Based Awards and Grants of All Other Equity Awards Tables which were originally proposed. Disclosure in this table will complement Summary Compensation Table disclosure of grant date fair value of stock awards and option awards by disclosing the number of shares of stock or units comprising or underlying the award. This supplemental table will show the terms of grants made during the current year, including estimated future payouts for both equity incentive plans and non-equity incentive plans, with separate disclosure for each grant. If the exercise price differs from the closing market price on the grant date, an additional column showing its closing price will be required. If the exercise price differs from the closing market price, the methodology for determining the exercise or base price will require footnote or narrative disclosure. If the grant date differs from the date of the compensation committee, another additional column showing the date of the action will be required. See Exhibit B hereto for the form of this new table. Because the Summary Compensation Table will disclose the grant date fair value of equity awards, the current Options/SAR Grants in Last Fiscal Year table will be eliminated.

As proposed, the rules would have permitted aggregation of option grants with the same exercise or base price. The SEC did not adopt such rules as proposed, based on its belief that grant-by-grant disclosure is the most appropriate approach, particularly given its particular disclosure concerns regarding option grant practices of companies. For incentive plan awards, threshold, target and maximum payout information should be provided, but if the award provides only for a single estimated payout, that amount should be reported as the target.

Narrative disclosure will follow the Summary Compensation Table and the supplemental table, focused on the quantitative disclosures in the tables. This disclosure will describe any additional material factors necessary to understand the information disclosed in the tables, and may include descriptions of:

• material terms of named executive officers’ employment agreements;
• any option repricings or other material modifications of outstanding options or other stock-based awards (such as extensions of exercise periods, changes of vesting or forfeiture conditions and changes or eliminations of performance criteria)⁵;
• award terms relating to data provided in the Grants of Plan-Based Awards table, such as the formula or criteria to be applied in determining the amounts payable, the vesting schedules and other material conditions (other than any factor or condition that includes confidential commercial or business information, disclosure of which will adversely affect the company’s competitive position);
• material waivers or modifications of any specified performance targets, goals or conditions; and
• an explanation of the amount of salary and bonus in proportion to total compensation.

The SEC also re-proposed for comment a modified version of its proposed requirement to disclose compensation of up to three employees who are not executive officers. The revised proposal would require disclosure of the total compensation (excluding earnings on nonqualified deferred compensation and changes in pension value) and job positions of each of a company’s three most highly compensated employees, whether or not they were executive officers during the last completed fiscal year, whose compensation for that fiscal year was greater than that of any of the named executive officers included in the tables, except that employees having no responsibility for significant policy decisions within the company, a significant subsidiary, or a principal business unit, division or function would be excluded. The SEC suggests that these responsibilities could consist of "the exercise of strategic, technical, editorial, creative, managerial or similar responsibilities." The SEC clarified that this formulation would not pick up investment professionals such as traders or portfolio managers simply as a result of performing the duties associated with those positions, absent other broader duties within a firm. The SEC also requests comment on whether the requirement should extend only to "large accelerated filers."

Two new tables form the basis for the next category of the executive compensation disclosure. These new tables will replace the currently required Fiscal Year-End Option/SAR Value table and Aggregated Option/SAR Exercise table, and highlight holdings of previously awarded equity at fiscal year end and amounts realized during the last fiscal year on previously awarded equity.

The first table will disclose information regarding outstanding awards under stock option or stock appreciation right plans, restricted stock plans, incentive plans and similar plans and the market-based values of the awards as of the company’s fiscal year-end. This table will require disclosure on an individual grant basis (rather than an aggregate basis, as originally proposed) of:

• the number of securities underlying unexercised instruments that are exercisable;
• the number of securities underlying unexercised instruments that are unexercisable;
• the exercise or base price; and
• the expiration date

of unexercised options, stock appreciation rights and similar instruments held at fiscal year end. In addition, an additional column for reporting the number of securities underlying unexercised unearned options amended under equity incentive plans has been added. The table will also require disclosure of:

• the number of shares of unvested stock and equity incentive plan awards; and
• the market value of shares of unvested stock and equity incentive plan awards

under restricted, stock, incentive and other similar plans held at fiscal year end. The final rules do not include the proposed requirement to disclose whether an option with an expiration date after the fiscal year end but before the date of disclosure had been exercised or expired. See Exhibit C hereto for the form of this new table.

The second table will disclose the amounts received upon the exercise of options and similar instruments and the vesting of restricted stock, restricted stock units and similar instruments during the last fiscal year. Amounts realized on transfer for value of equity-based awards must be disclosed in this table. The final rules eliminated the proposed requirement to disclose the grant date fair value of awards previously disclosed in prior years’ Summary Compensation Tables. See Exhibit D hereto for the form of this new table.

The new rules will substantially revise the required disclosure of post-employment compensation for named executive officers. The new rules will replace the existing pension plan table and related disclosure with a new table detailing defined benefit pension plans and enhanced narrative disclosure. A new table and further disclosure regarding nonqualified defined contribution plans and other deferred compensation will also be included. Finally, more detailed disclosure will be required for compensation arrangements triggered upon termination of employment or changes in control.

The new Pension Benefits Table will require disclosure of the actuarial present value (rather than the estimated annual retirement benefit, as originally proposed) of each named executive officer’s accumulated benefit under each tax-qualified defined benefit plan, supplemental employee retirement plan and cash balance plan, computed using the same assumptions (except for the normal retirement age) used for financial reporting purposes under GAAP. Note that amounts payable under nonqualified deferred contribution plans will be covered by the separate table discussed below.

If the named executive is not yet eligible to retire, the amount will be calculated based on the normal retirement age as defined in the plan, or if not so defined, the earliest time at which a participant may retire under the plan without any benefit reduction due to age. The estimates should be based on current compensation, and as such, future levels of compensation need not be estimated for purposes of the calculation. If the credited years of service for a named executive under any plan differ from his or her actual years of service, a footnote specifying the difference and the resulting benefit increase will be required. Further, if the named executive left during the year, the amount of annual benefits to which the executive is entitled will need to be disclosed. See Exhibit E hereto for the form of this new table.

A narrative description of any material factors necessary to understand each plan disclosed in the table will also be required. This could include:

• the material terms and conditions of benefits payable under the plan;
• if any named executive is currently eligible for early retirement under any plan, the name of such executive and the plan and a description of the plan’s early retirement payment and benefit formula and eligibility standards;
• the specific elements of compensation, such as salary and various forms of bonus, included in applying the benefit formula, identifying each such element;
• company policies on granting extra years of credited service; and
• reasons for multiple plans.

A second new table will require disclosure of contributions, earnings and balances under nonqualified defined contribution and other deferred compensation plans. In an attempt to avoid "double counting" of compensation, a footnote to the table will specify the amount of contributions and earnings reported in the table that are also reported in the Summary Compensation Table for the year and the extent to which amounts reported in the aggregate balance column of the table were previously reported in Summary Compensation Tables for prior years. See Exhibit F hereto for the form of this new table.

A narrative description of material factors necessary to understand this table will also be required, which could include:

• types of compensation permitted to be deferred and limitations on deferral rights;
• measures of calculating interest or other plan earnings; and
• material terms with respect to payouts, withdrawals and other distributions.

The new rules significantly modify SEC compensation-related disclosures for termination or change in control provisions. For all arrangements (whether written or unwritten) that provide for payments in connection with the resignation, severance, retirement or other termination of a named executive officer, a change in such officer’s responsibilities or a change in control of the company, the new rules will require disclosure, among other things, of:

• the specific circumstances that trigger payments or the provision of other benefits (including perquisites and health care benefits) under the arrangements;
• how the appropriate payment and benefit levels are determined under the various circumstances that would trigger payments or provision of benefits;
• any material conditions or obligations applicable to the receipt of payments or benefits, such as non-compete, non-solicitation, non-disparagement or confidentiality agreements, and provisions regarding waiver or breach of these agreements;
• the duration of any non-compete or similar agreements; and
• tax gross-up payments.

Quantitative disclosure should be calculated assuming that the triggering event took place on the last business day of the company’s last fiscal year and the price per share was the closing market price on that date. Where uncertainties as to the payment of benefits or the amounts payable exist, a company will need to make reasonable estimates and disclose any material assumptions underlying its estimates. Such estimates will be considered forward-looking information falling within the safe harbor for disclosure of such information.

Director compensation disclosure requirements will also be significantly revised by the new rules. The SEC adopted a new director compensation table similar to the Summary Compensation Table for named executive officers, but which only includes information for the last fiscal year. Like the Summary Compensation Table, the director compensation table includes as its last column a "total" column that aggregates the total value of each form of compensation contained in the columns that precede it. The other columns include:

• fees earned or paid in cash;
• stock awards;
• option awards;
• non-equity incentive plan compensation;
• change in pension value and nonqualified deferred compensation earnings (now separated from the "all other compensation" column); and
• all other compensation.

The "all other compensation" column will include, among other things:

• perquisites and personal benefits if the aggregate amount is $10,000 or more for any director;
• tax reimbursements;
• the company’s compensation cost (determined in accordance with FAS 123R) related to discounted security purchases, unless the discount is available generally to all security holders or all salaried employees;
• annual company contributions or other allocations to vested and unvested defined contribution and other deferred compensation plans;
• consulting fees;
• awards under director legacy or charitable awards programs;
• the value of any life insurance premiums paid by the company for the director’s benefit; and
• the dollar value of any dividends or other earnings paid on stock or option awards if the dividends or earnings were not factored into the grant date fair value computed under FAS 123R.

If all the elements and amounts of compensation are identical for all directors, the new rules will permit grouping all directors in a single row. The new rules will also require footnote disclosure of the aggregate number of outstanding equity awards held by directors at fiscal year end. See Exhibit G hereto for the form of this new table.

The final rules were adopted substantially as proposed and eliminate employment compensation arrangements from Item 1.01 of Form 8-K (entry into material agreements) and cover material compensation arrangements for executive officers and directors under a modified and broader Item 5.02 (which currently covers appointments and departures of principal officers and elections and departures of directors).

Specifically, the SEC adopted the following changes to Item 5.02 of Form 8-K:

• adding a new instruction to Item 5.02 that clarifies the "named executive officers" to be persons for whom disclosure was required in the most recent filing with the SEC that required disclosure under Regulation S-K Item 4.02(c);
• requiring disclosure of information regarding the departure of all named executive officers, in addition to the officers currently specified in Item 5.02 (i.e., the principal executive officer, president, principal financial officer, principal accounting officer, principal operating officer and anyone performing similar functions);
• requiring a brief description of any material plan, contract or arrangement to which a covered officer or director is a party or in which he or she participates that is entered into or materially amended in connection with any of the triggering events specified in Item 5.02 (i.e., appointment or departure) or any grant or award to such covered person in connection with any such event;
• for the principal executive officer, the principal financial officer and each named executive officer, requiring a brief description of any material new compensatory plan, contract or arrangement, or material grant or award thereunder, or any material amendment to a compensation plan, contract or arrangement (or any material modification to a grant or award thereunder), whether or not such occurrence is in connection with an appointment or departure. However, grants and awards or modifications thereto will not need to be disclosed if they are consistent with the terms of previously disclosed plans or arrangements and are disclosed the next time the company is required to provide new disclosure under Regulation S-K Item 402;
• adding a requirement for disclosure of salary and bonus for the most recent fiscal year that was not available at the latest practicable date in connection with a disclosure made under Regulation S-K Item 402. This disclosure requires a new total compensation recalculation to reflect the new salary or bonus information; and
• revising Instruction 2 to new Item 5.02(e) so that:

• prior references to "original terms" is changed or eliminated and replaced by the phrase "previously disclosed terms," in order to minimize ambiguity; and
• no distinction is made between awards granted under cash or equity-based plans.

Item 5.02 requires only a brief description of the specified matters and is not intended to require an updating of all the Regulation S-K Item 402 disclosure.

In addition to the amendments to Items 1.01 and 5.02, General Information D of Form 8-K has been revised, as proposed, to permit companies in most cases to omit the Item 1.01 heading so long as all of the substantive disclosure required by Item 1.01 is included elsewhere in the Form 8-K.

The SEC also extended the current safe harbors regarding Section 10(b) and Rule 10b-5 liability and Form S-3 eligibility for failures to timely file reports required by certain items of Form 8-K, including Item 1.01, if the company includes the relevant information in its next following quarterly or annual report, to Item 5.02(e) disclosures on Form 8-K.

The new rules require footnote disclosure to management’s beneficial ownership table that will require disclosure of the number of shares pledged as security by named executive officers, directors, director nominees and directors and executive officers as a group. According to the SEC, pledged shares may be subject to material risks or contingencies that do not apply to other shares beneficially owned by these persons. Because of the potential to influence management’s performance and decisions, the SEC believes that the existence of pledges by these persons could be material to shareholders.

The new rules will not apply to shares owned by greater than 5% shareholders who are not named executives, directors or director nominees, other than pledges that may result in a change of control, which are currently required to be disclosed. In addition, the SEC will require disclosure of beneficial ownership of directors’ qualifying shares, which is currently not required.

The new rules streamline the current disclosure requirements for related person transactions and make them more principles-based.

The basic framework for disclosure of related person transactions currently contained in Item 404(a) of Regulation S-K is retained. However, it no longer includes some of the instructions that help in making bright line determinations as to whether transactions are reportable or excludable. Instead, revised Item 404(a), relying more heavily on a materiality analysis, consists of a general statement of the principles for disclosure, followed by certain specific disclosure requirements and instructions. Current Regulation S-K Item 404(c), which addresses indebtedness, has been folded into Item 404(a). Consolidation of Items 404(a) and 404(c) results in disclosure of indebtedness transactions with regard to all related persons, including significant shareholders—a group which does not currently fall under Item 404(c).

Specifically, revised Item 404(a) requires disclosure regarding:

• any "transaction" since the beginning of the last fiscal year (or a currently proposed transaction);
• in which the company was or is to be a "participant;"
• in which the amount involved exceeds $120,000 (as opposed to $60,000 as is currently required); and
• in which any "related person" had, or will have, a direct or indirect material interest.

The term "transaction" is defined broadly to include any financial transaction, arrangement or relationship (including any indebtedness or guarantee of indebtedness) or any series of similar transactions, arrangements or relationships.

The term "related person" means:

• any director, director nominee (for proxy or information statements relating to the election of the nominee) or executive officer, or immediate family member of any such person, who held such position at any time during the specified disclosure period (regardless of whether the transaction occurred while he or she held such position); and
• any person beneficially owning more than 5% of any class of the company’s voting securities, or an immediate family member of any such person, at the same time the transaction in which the person held such interest occurred.

The term "immediate family member" is defined broadly to include any child, stepchild, parent, stepparent, spouse, sibling, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-in-law, and any person (other than a tenant or employee) sharing the household of any director, nominee for director, executive officer, or significant shareholder of the company.

In addition, the new rules call for disclosure if a company is a "participant" in a transaction, rather than if it is a "party" to the transaction, because the SEC believes that "participant" would more accurately address transactions benefiting the company, though not technically as a contractual party.

The $60,000 threshold for disclosure is raised to $120,000 to adjust for inflation since the rules’ original adoption and is not intended to be a bright line materiality standard. Like the current rule, a materiality analysis is required for transactions above the threshold to determine if the related person has a direct or indirect material interest. The materiality of any interest will continue to be determined on the basis of the significance of the information to investors in light of all the circumstances, including the relationship of the related persons to the transaction.

As a result of the consolidation of Items 404(a) and 404(c), the new rules now call for disclosure if there is a direct or indirect material interest in indebtedness transactions that exceed $120,000. In response to comments, the SEC excluded the disclosure of indebtedness transactions of significant shareholders (or their immediate family members) that would otherwise have been required as a result of integrating Items 404(a) and 404(c). The new rules also eliminate the disclosure required under Item 404(c) regarding amounts possibly owed to the company under Section 16(b) of the Exchange Act.

Although primarily a principles-based rule, the final rules provide that certain specified transactions will be exempt from related person disclosure requirements, including:

• Director and executive officer compensation reported pursuant to Regulation S-K Item 402;
• Compensation to an executive officer who is not an immediate family member of another related person if such compensation will have been reported under Regulation S-K Item 402 if the executive officer was a named executive officer;
• Indebtedness due from any related person for purchases of goods and services subject to usual trade terms, for ordinary business travel and expense payments and for other transactions in the ordinary course of business;
• Transactions in which the related person’s interest arises only from the person’s position as a director of another entity party to the transaction or from the ownership by such person (and all other related persons) of less than a 10% equity interest in a non-partnership entity party to the transaction, or from both such position and ownership;
• Transactions in which the related person’s interest arises only from the person’s position as a limited partner (but not general partner) in a partnership in which the related person (and all other related persons) have less than a 10% interest in that partnership;
• Transactions where the rates or charges involved are determined by competitive bids, or the transaction involves the rendering of services as a common or contract carrier, or public utility, at rates or charges fixed in conformity with law or governmental authority;
• Transactions involving services as a bank depositary of funds, transfer agent, registrar, trustee under a trust indenture, or similar services; and
• Transactions where a related person receives pro rata dividends or returns on the ownership of equity securities.

As with the current rules, disclosure will continue to be required for three years in registration statements filed under the Securities Act or the Exchange Act.

The final rules contain a new disclosure requirement calling for a description in the proxy statement or other applicable form of the company’s policies and procedures for review or approval of reportable related person transactions and the material features of the policies and procedures. The new rules also require disclosure of any reportable related person transaction where the company’s policies and procedures did not require review or approval or where the policies and procedures were not followed.

The new rules expand existing disclosure requirements regarding director independence and compensation committee matters and cover these and other corporate governance disclosures under a new Item 407 of Regulation S-K.

The following disclosures are required with respect to director independence:

• identification of the company’s independent directors (and, in proxy or information statements, director nominees) based on the independence definitions of the listing standards applicable to the company or, if the company is not listed, the listing standards of any national securities exchange or national securities association specified by the company;
• identification of any non-independent members of the compensation, nominating or audit committees;
• if the company is a listed issuer whose securities are listed on a national securities exchange or in an inter-dealer quotation system which has requirements that a majority of the board of directors be independent or that board committee members be independent, and also has exemptions to those requirements upon which the company relied, the company must disclose the exemption relied upon and explain the basis for its conclusion that such exemption is applicable;
• for each director or director nominee identified as independent, a description, by specific category or type, of any transactions, relationships or arrangements, on a director by director basis, not disclosed pursuant to paragraph (a) of Item 404 that were considered by the board of directors of the company in determining that the applicable independence standards were met; and
• if a company has adopted definitions for determining independence of its directors and board committee members, whether those definitions are posted on its website (if not so posted, the company will be required to include the definitions as an appendix to its proxy statement periodically).

In addition, the audit committee charter will no longer be required to be included in proxy statements delivered to security holders if it is posted on the company’s website.

The new rules require enhanced disclosures regarding compensation committees similar to the disclosure currently required for audit and nominating committees, such as:

• the scope of authority of the compensation committee;
• the extent to which the compensation committee may delegate authority to other persons;
• whether the compensation committee has a charter, and, if so, the company’s website address at which the charter is available (or if it is not posted, requiring the charter to be attached to the company’s proxy statement periodically);
• any role of executive officers in determining or recommending the amount or form of executive and director compensation; and
• any role of compensation consultants in determining or recommending the amount or form of executive and director compensation, and information related to the involvement of such consultants.

The new rules also consolidate into new Regulation S-K Item 407 other existing corporate governance disclosure requirements, such as disclosures regarding board meetings, nominating committees, audit committees, audit committee financial experts, compensation committee interlocks and shareholder communications, with minimal modifications.

Under current rules, a foreign private issuer complies with the SEC’s executive and director compensation disclosure rules if it provides the information required by Form 20-F, with more detailed information provided if otherwise made publicly available. Form 20-F permits foreign private issuers to present summarized data regarding compensation and benefits. Information is required to be presented on an individual basis only if required in the issuer’s home country or is otherwise publicly disclosed by the issuer. The SEC did not change these rules as they relate to executive and director compensation disclosures.

Under current rules, a foreign private issuer complies with the SEC’s related person transaction disclosure rules if it provides the information required by Form 20-F. Form 20-F sets forth a principles-based disclosure standard for transactions and loans involving the issuer and a variety of related parties. The SEC will retain this approach as it relates to third-party transactions, but will require additional disclosure if such information is made publicly available or required to be disclosed by the issuer’s home jurisdiction or a market on which its securities are listed or traded.

Finally, the SEC will eliminate the requirement that foreign private issuers file as an exhibit to Form 20-F any management contracts or compensatory plans unless the contracts or plans are required to be publicly filed in the issuer’s home country or are publicly disclosed by the issuer.

The SEC’s proposed rules will require all disclosures related to executive and director compensation, related person transactions, director independence and other corporate governance matters to be written in plain English.

• For Forms 8-K, compliance will be required for triggering events that occur 60 days or more after publication of the final rules in the Federal Register.
• For Forms 10-K, compliance will be required for fiscal years ending on or after December 15, 2006.
• For proxy and information statements and Securities Act registration statements, compliance will be required for filings made on or after December 15, 2006 that are required to include executive compensation and related person transaction disclosure for fiscal years ending on or after December 15, 2006.

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