SEC Adopts New Executive Compensation Disclosure Rules

On July 26, 2006, the Securities and Exchange Commission approved extensive and comprehensive amendments to the disclosure requirements for executive and director compensation.  Significant revisions were also adopted to Current Reports on Form 8-K and disclosure regarding related party transactions and security ownership of officers and directors.  The SEC intends the revisions to make executive compensation disclosure and relationships in proxy statements more complete and easier to understand.  The final rules (Release No. 34-54302) are available at http://www.sec.gov/rules/final/2006/33-8732.pdf.  The amendments will be in effect for next year’s proxy season.  The amended disclosure will generally be required to be provided in plain English.  Major additions and changes are summarized below.

CD&A
The amendments require enhanced narrative disclose of a company’s compensation policies and its objectives of executive compensation programs in a new section entitled “Compensation Discussion and Analysis” (CD&A).  CD&A is a “principles-based” overview that seeks to address the objectives and implementation of executive compensation programs focusing on the most important factors underlying the company’s compensation policies and decisions.  A company’s CD&A should avoid boilerplate disclosure, instead identifying a disclosure concept and providing several illustrative examples.  CD&A is “filed” and not “furnished,” making it subject to certification by the principal executive and principal financial officers.

Compensation Committee Report
The compensation committee report was eliminated in its current format and replaced with a report with requirements similar to the requirements of the audit committee report.  The new compensation committee report requires the committee to state whether it has reviewed and discussed CD&A with management and, based on this review, recommended that it be included in the company’s annual report and proxy statement.

Summary Compensation Table
The amendments also make comprehensive changes to the Summary Compensation table.  Most significantly, a new column captioned “Total Compensation” requires disclosure of the total value of an executive’s compensation by adding all amounts disclosed in the other columns in the table.  The new summary table also includes the following new columns:

• the dollar value for all equity based awards measured at fair value on the grant date computed pursuant to the Financial Accounting Standards Board’s Financial Accounting Statement 123(R);
• the amount of compensation under non-equity incentive plans and a column reporting the annual change in the actuarial present value of accumulated pension benefits and above-market or preferential earnings on nonqualified deferred compensation so that these amounts can be deducted from total compensation for purposes of determining named executive officers;
• the aggregate amount of all other compensation not reported in the table, including perquisites.  The threshold for disclosing perquisites was reduced to an aggregate of $10,000.  Previously, the rule allowed perquisites and other personal benefits totaling the lesser of $50,000 or 10% or the officer’s annual salary and bonus to be omitted.  The SEC intends to issue additional guidance for determining what is a perquisite. 

The new tabular disclosure will be phased in over the next three fiscal years, with three years of new disclosure required in proxy statements by 2009.

New Option Disclosure
The new rule also addresses option timing and backdating issues which have been the focus of recent SEC inquiries and investigations.  First, as discussed above, disclosure in the Summary Compensation table includes the grant date fair value, the FAS 123(R) grant date, the closing market price on the grant date if greater than the exercise price and the date the award was approved by the compensation committee or full board of directors.  If the exercise price of an option grant is not the grant date market closing price per share, companies must explain their methodology for determining the exercise price.  In addition, companies must disclose in their CD&A enhanced narrative discussion regarding their option grant plan or practices, such as reasons for selection of a particular grant date and methods used to select terms of an award.  A separate table including disclosure of equity awards, the “Grants of Plan-Based Awards” table, discussed below, also requires disclosure of the grant date determined pursuant to FAS 123(R).

Other Reorganized Executive Compensation Tables
The new rule also reorganizes and streamlines other tabular compensation disclosure by requiring the following:

• the “Grants of Plan-Based Awards” table supplements the summary compensation table by showing the terms of grants made during the current fiscal year, including estimated future payouts for equity incentive plans and non-equity incentive plans;
• the “Outstanding Equity Awards at Fiscal Year-End” table discloses all information regarding outstanding equity awards held by a named executive officer;  
•  the “Option Exercises and Stock Vested” table discloses amounts received by named executive officers of equity compensation during the past year;
•  the “Pension Benefits” table discloses the estimated retirement benefits payable at normal retirement age and, if available, early retirement under each defined benefit plan; and 
• the “Nonqualified Deferred Compensation” table discloses information, including year- end balance, executive contributions and all earnings and withdrawals for the most recent year, under a company’s nonqualified deferred compensation plans.  Additional disclosure regarding payments and benefits payable upon termination or change in control agreements is also required, including a quantification for each named executive officer of any potential payments and benefits assuming the triggering event occurred on the last day of the fiscal year of the report and the price per share is based on the closing market price on the last day of the fiscal year.

Narrative disclosure following the tables will provide a description of potential factors necessary to an understanding of the tables.

New Director Compensation Table
Companies are required to include a new “Director Compensation” table similar to the Summary Compensation table.  Disclosure is limited to the preceding fiscal year instead of the preceding three fiscal years as required by the Summary Compensation table.  Accompanying narrative must include the company’s option grant practices for directors.

Retention of Performance Graph
As proposed, the stock performance graph would have been eliminated.  The final rule, however, retained the performance graph, moving it to the annual report to shareholders instead of the proxy statement.

Amendments to Form 8-K
Form 8-K was amended to contain all disclosure related to employment agreements in one item.  Only compensation arrangements with named executive officers are required to be disclosed.

Amendments to Related Party Transaction Disclosure and Director Independence
The new rule also revises related party transaction disclosure.  The threshold for disclosing transactions was increased to $120,000 from $60,000.  Companies are required to disclose their policies and procedures relating to the review, approval and ratification of related party transactions.  The distinction between indebtedness and other types of related party transactions and certain requirements for disclosure of specific types of director relationships was eliminated.  Further, the amendments require a narrative explanation of the independence status of directors under a company’s director independence policies consistent with current exchange listing standards.

Security Ownership of Officers and Directors
The amendments also require companies to disclose the number of shares pledged by management and the inclusion of directors’ qualifying shares in the total amount of securities owned.

Officers and Employees for which Compensation Disclosure is Required
The final rule defines “named executive officers” as:

• the principal executive officer;
• the principal financial officer; and
• the three other most highly-compensated executive officers.

A proposed, the compensation disclosure would have been required for up to three non-executive employees whose total compensation was more than the total compensation paid to any of the company’s named executive officers.  This so-called “Katie Couric” clause was stricken from the final rule and re-proposed to cover up to three additional employees who have policy-making responsibilities at either the parent level or a significant subsidiary of a principal business unit, division or function.  The re-proposed rule excludes professional athletes, portfolio managers, news broadcasters, commissioned sales people and others that would have been included in the definition as originally proposed.  The re-proposed rule also only requires additional disclosure for large accelerated filers (in excess of $700 million in market capitalization).

Small Business Issuers
The amendments require only the following tables for small business issuers:

• the Summary Compensation table, which requires disclosure for the prior two, instead of three, fiscal years;
• the Outstanding Equity Awards at Fiscal Year-End table; and
• the Director Compensation table.

In addition, the amendments for small business issuers provide that:

• compensation disclosure is required only for the principal executive officer and two other most highly compensated officers;
• CD&A and the related compensation committee report are not required;
• the disclosure threshold for related party transactions is $120,000 or 1% of the small business issuer’s total assets at year-end for the last three fiscal years.

For further information regarding the executive compensation disclosure amendments or other securities issues, please contact one of our securities attorneys.