On December 16, 2009, the Securities and Exchange Commission adopted final rules, effective February 28, 2010, intended to improve corporate governance disclosures and to clarify the SEC’s proxy rules. On December 22, 2009, the SEC published Compliance and Disclosure Interpretations (C&DIs) providing guidance as to transition dates for the new rules.
This advisory provides a summary of those changes, updated to reflect the transition interpretations, and our guidance on actions that companies should consider now in preparation for the new requirements.
The final rules require companies to disclose certain compensation policies and practices that could incentivize risk-taking in certain instances, as well as the board’s role in risk management. They also require additional disclosure relating to the board’s practices to encourage diversity, and its consideration of qualifications of directors, as well as expanded disclosure of legal proceedings involving directors. Finally, the final rules change the calculation for equity compensation in the Summary Compensation Table, require disclosure of fees paid to compensation consultants in certain circumstances, and require shareholder voting results to be disclosed on Form 8-K within four business days following the end of a shareholder meeting. A more detailed explanation of the final rules is set forth below.
Click here for the Final Rule Release No. 33-9089 and here for the transition C&DIs.
Compensation and Risk Management
New Item 402(s) of Regulation S-K requires proxy statement disclosure of a company’s compensation policies and practices applicable to all employees, including non-executive officers, as they relate to risk management practices and risk-taking incentives, but only if such risks are reasonably likely to have a material adverse effect on the company. The SEC has heightened the threshold for disclosure from “may” in the proposed rules to “reasonably likely” in the final rules. Given the relatively high standard for disclosure, few companies are likely to conclude that disclosure is necessary, but all companies should engage in a review and analysis. However, if a company does make such a determination, disclosure is required in a section separate from the Compensation Discussion and Analysis and could be together with other disclosures focusing on the compensation governance processes. The requirements for the disclosure are set forth in the release. Smaller reporting companies are not required to comply with this new disclosure requirement.
The SEC provided the following examples of situations to be considered where a company has compensation policies and procedures at business units that:
Calculation of Amount of Equity Compensation
Items 402(c) and 402(k) of Regulation S-K as amended require reporting of the aggregate grant date fair value of awards granted in the fiscal year in the Summary Compensation Table (SCT) and Director Compensation Table, respectively, rather than current disclosure of the dollar amount of stock-based compensation recognized in that year for financial statement reporting purposes. For awards that are subject to performance conditions, the tabular disclosure is based upon the probable outcome of the performance conditions as of the grant date (i.e., the target amounts). Additionally, a footnote indicating the grant date fair value, assuming that the highest level of performance conditions are achieved, is also required as part of the disclosure. For the named executive officers determined based on 2009 total compensation who are included in the Summary Compensation Table, the grant date fair value must also be presented in each prior year of the table, coupled with an updated total compensation value. The Summary Compensation Table and Director Compensation Table provisions applicable to smaller reporting companies, Items 402(n) and 402(r) of Regulation S-K, respectively, have been similarly amended to require reporting of the aggregate grant date fair value of awards.
Board of Directors—Enhanced Disclosure
Amended Item 401(e) of Regulation S-K requires disclosure in a proxy statement (or Form 10-K of companies which are not subject to the proxy statement rules) of information related to the board’s composition. This includes the specific experience, qualifications, attributes and skills that led to the board’s conclusion that each nominee, including incumbent directors, should serve or continue to serve on the board. While the SEC did not specify any particular skills that must be addressed in the disclosure, the SEC did state that, if risk assessment skills or financial reporting expertise were considered when assessing a candidate for the board, or if a specific skill or attribute was considered in connection with an anticipated appointment to a particular board committee, those skills should be disclosed. The placement of new disclosures should be determined on a case-by-case basis, taking into account the nature of the new disclosures, and how the company has structured its disclosures. However, the SEC decided to retain existing disclosure about the minimum qualifications that the nominating committee considers in the nomination process, and the new disclosure could be included together with the current disclosures. Depending on the nature of the disclosures, the new disclosure may be more suitably included together with the business background disclosure of directors and nominees.
Consistent with the current disclosure requirement regarding legal proceedings, the additional legal proceedings included in the new requirements will not need to be disclosed if the company determines that they are not material to an evaluation of the ability or integrity of the director or director nominee. Also, there is no disclosure required regarding civil lawsuits settled among private litigants. In most cases, we expect companies will include any new disclosures together with existing disclosure of legal proceedings, although in some cases it may be helpful or prudent to also address such matters with the discussion of a particular director’s qualifications.
Board of Directors—Risk Oversight and Structure
New Item 407(h) of Regulation S-K requires disclosure of the leadership structure of the board, including whether and why it has chosen to combine or separate the roles of principal executive officer and board chairman. Additionally, if a company combines the role of principal executive officer and board chairman, the company must disclose whether it has a lead independent director and what roles the lead director plays.
New Item 407(h) of Regulation S-K requires proxy statement disclosure describing the board’s role in risk oversight, including how the board administers its oversight function and how such administration operates in the context of the board leadership structure, including whether and how the responsibilities are allocated among different board committees. This disclosure includes:
We expect that companies will include the new disclosure together with existing disclosures about the governance practices of its board, and particularly together with any existing disclosure about the role of a lead independent director or similar function.
Amended Item 407(e)(3) of Regulation S-K requires disclosure in certain circumstances of fees paid to compensation consultants who advise both the board of directors and management.
A company must separately disclose a compensation consultant’s fees for executive compensation advice and other services if:
However, disclosure of a compensation consultant’s fees is not required if:
We expect that most companies will include the new disclosures together with existing disclosure on compensation committee activities.
Form 8-K Reporting of Shareholder Vote Results
New Item 5.07 of Form 8-K requires that shareholder meeting voting results be reported on Form 8-K rather than currently in Form 10-Q for the quarter in which the meeting occurred (or on Form 10-K in the case of a fourth quarter meeting). The company is required to file final voting results on Form 8-K within four business days following the end of the meeting. If final results are not available within four business days, then preliminary results are required to be reported, the final election results must be filed on an amended Form 8-K within four business days of certification.
The new rules are generally effective February 28, 2010. As provided in the SEC’s C&DIs, for a company with a fiscal year which ends on or after December 20, 2009, the company’s Form 10-K and the definitive proxy statement must comply with the new rules unless both are filed before February 28, 2010. Prior to February 28, 2010, a company may voluntarily comply with all or some of the new rules, except that if it elects to present grant date fair market value in the Summary Compensation Table and Director Compensation Table, it must comply with all other disclosure requirements under the new rules. All registration statements that are declared effective after February 28, 2010, must comply with the new rules unless the registration statement was first filed prior to December 20, 2009. Form 8-K reporting of voting results is required for annual shareholder meetings on or after February 28, 2010.
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