On August 11, 2006, the Securities and Exchange Commission (the “SEC”) adopted extensive amendments to its disclosure requirements for executive and director compensation that will apply to the upcoming proxy season (first quarter 2007 for 12/31 fiscal year-end companies). As a result, companies and their directors – especially compensation committee members – need to understand the implications of these new requirements now and consider how they will affect executive compensation disclosures.
Companies will also need to consider the potential impact of the new rules on the design of administrative practices under their compensation plans and programs.
Principles-Based Disclosure
As described by SEC Chairman Christopher Cox, these new rules are not designed to judge or limit the amount that companies and their compensation committees can pay to their executives. The new rules are designed, however, to require that all elements of compensation be fully disclosed in a manner that is clear, concise and understandable to shareholders.
The new executive compensation rules require disclosure of all forms of compensation awarded to, earned by, or paid to the named executive officers and directors of the company, resulting in the presentation of a single dollar figure that represents total compensation. Under the prior disclosure rules, many companies elected not to report certain transactions as the rules did not explicitly call for their disclosure. The new rules reverse this paradigm; compensation must be disclosed unless the rules specifically permit exclusion. These new disclosures may result in significantly larger amounts being reported this year, as companies are required to report the total value of option holdings, the projected cash payouts possible under change-incontrol arrangements, and the accrued benefit earned during the year related to SERPs. It is crucial that shareholders (and directors) are presented with a clear message as to the company’s compensation philosophy, policy and practice.
Start Assembling Information
While compensation reportable in upcoming proxy statements under these new rules has already been, to a large extent, determined, companies and compensation committees can still make a difference, both in how effectively they comply with the new rules and in the appeal of the "story" they are able to tell in their disclosure. As a result, the new disclosure requirements should provide a framework for compensation planning for fiscal 2007 as well as disclosure regarding past compensation that will appear in the upcoming proxy statement.
Generally, to prepare for the new disclosure requirements, companies will need to collect a large amount of data – much of it for the first time. More specifically, companies should now begin to organize and revise their disclosure controls and procedures to assure that the decisions made by the compensation committee and the factors, materials and analytical tools utilized by this committee are recorded and documented. The use of these tools, such as compensation consultants, wealth accumulation analyses, internal pay equity studies and especially tally sheets, will be necessary to assemble, collect and verify all the required information on a timely basis regarding both compensation and related-person transactions. Compensation committees should also have access to tax and accounting advisors, since the tax and accounting effects of the compensation committee’s decisions may also need to be disclosed.
Additionally, the compensation committee will need to have a clear understanding of how the company’s compensation policy operates and how all elements of compensation work together to compensate and motivate the executive officers. As the end of the year approaches, there is still time to modify the philosophy, policies and processes that will need to be reflected in the coming proxy statement to reflect best practices.
Actions To Consider Now
- Board review of executive officer list
- Begin assembling compensation information for executive officers
- Arrange for compensation committee meetings at the end of this year and the 1st quarter of next year
- Be sure that your advisors (including attorneys, accountants, actuaries for retirement plans and compensation consultants) are ready to assist you with the new disclosure obligations
- all individuals serving as the Company’s principal executive officer at any time during the year, regardless of total compensation;
- all individuals serving as the Company’s principal financial officer at any time during the year, regardless of total compensation;
- the Company’s three most highly compensated executive officers, other than the principal executive and financial officer, who earned at least $100,000 in total compensation; and
- up to two other executive officers who left during the year whose compensation (including severance) was higher than the lowest total compensation reported for another named executive officer, (i.e., who would have been included but for the fact of their departure during the year).
Executive Officers
As under the past rules, compensation must be disclosed for the company’s named executive officers. The new rules have tweaked the determination of the named executive officers. Moreover, as a best practice, it is appropriate for the board to conduct an annual review of the company’s executive officers to ensure that subtle responsibility changes over time haven’t changed the roster of executive officers. The new rules generally require disclosure of the compensation of the following individuals (the "named executive officers"):
The definition of executive officer was not changed. An executive officer includes the president, any vice president in charge of principal business unit, division or function (such as sales, administration or finance), or any other officer who performs policy making functions for the company. The SEC also repeated its position that executive officers of subsidiaries should be deemed executive officers of the company if they perform policy making functions for the company.
We recommend that the Company’s board of directors review the slate of executive officers of the Company at each year end to confirm that the list of individuals with "policy making functions" hasn’t changed, and if it has, to modify the list of executive officers. Remember, new executive officers may have obligations to file beneficial ownership reports (i.e., Forms 3 and 4) with the SEC.
Small Business Reporting Companies
Small business companies will only need to report the compensation of all individuals who served as a principal executive officer at any time during the year, regardless of total compensation, and their two most highly compensated executive officers, other than the principal executive officer, who earned at least $100,000 in total compensation.
Drafting the Disclosure
Once the company and its compensation committee are satisfied with the philosophy, policies and processes utilized in determining its executive compensation, they will need to begin drafting the required disclosure, which will be presented in the proxy statement or 10-K. To assist in this undertaking, Powell Goldstein is preparing a series of six brief memos covering the following elements of the new executive compensation requirements:
1. Overview of Disclosure Memo Series;
2. Compensation Discussion and Analysis;
3. Summary Executive Officer and Director Compensation Tables;
4. Supplemental Compensation Tables;
5. Related Party Transactions and Beneficial Ownership Table; and
6. Corporate Governance Disclosures.
As you begin to implement many of these items in preparation for the 2007 proxy season, please feel free to contact your regular Powell Goldstein contact for advice and assistance.
To read Part 2 of 6 please click here
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.