Editorial: Debating The Materiality Of ‘Material Definitive Agreements’

I have no idea what is considered “material” anymore. Late last year, Compliance Week launched a database of “material definitive agreements” (see box at right), and I’ve been spending some of my free time searching through the nearly 6,000 contracts that have been filed since Aug. 23, 2004.

And, well, it’s surprising.

As you probably know, the SEC’s amended Form 8-K rules now require public companies to disclose an expanded number of items, and to do so in “real time”—usually four business days.

Two of those items, related to “material definitive agreements,” have created considerable confusion and discussion, particularly when it comes to the types of executive compensation agreements that must be disclosed. And it’s those agreements that are forcing me to rethink my understanding of “material.”

Last time I checked, “material information” meant data that might be relevant to an investor’s decision to buy, sell or hold a security. And the material definitive agreements to be disclosed are those that are “not made in the ordinary course of business.”

As we reported back in October, many executive compensation contracts fall into that category. “The disclosure covers every aspect of executive compensation,” we wrote: “stock options, warrants and rights as well as pension, retirement, deferred compensation, bonus, incentive or profit-sharing plans—unless the executive officer receives no greater benefit than other employees.”

And it certainly appears like those contracts are getting disclosed.

According to analysis conducted by Raisch Financial Information Services of Newton, Mass., of the nearly 6,000 material definitive agreements filed since Aug. 23 of last year, approximately 17 percent were related to compensation and employment.

But I wouldn’t exactly call them “material.”

On Jan. 10, for example, $228.7 million X-ray equipment maker Hologic disclosed that they had relocated their CEO to be closer to the company, and that they paid the relocation company about $82,000 to move him.

Like many of these agreements, they’re fascinating to read, but not necessarily educational or even “material.”

On Sept. 10, Continental Airlines disclosed that its senior vice president of marketing strategy and corporate development was leaving to “perform services for the government of the United States in Afghanistan.” The executive will be return to an SVP position when his leave of absence expires at the end of 2005.

Here’s my favorite:

Wynn Resorts—the brainchild of former Mirage Resorts Chairman Steve Wynn that is developing a luxury hotel casino in Las Vegas—disclosed in an 8-K on Dec. 9 that Steve and his wife had leased a villa suite at their resort. “The Audit Committee has determined that the rental for the first lease year will be $580,000.00,” the filing stated.

One might question the point of these disclosures, and in fact many experts acknowledge that there’s lot of gray area when it comes to disclosure of compensation-related agreements.

Keller

“This is an evolving area,” states Stanley Keller, a partner at Palmer & Dodge who recently chaired the ABA’s Committee on Federal Regulation of Securities. “There is a growing tendency to disclose perk arrangements,” he notes regarding the Wynn example, “at least where they are not routine as seems to be the case here.”

There are two primary reasons for this. First, the 8-K amendment includes a cross-reference to Item 601(b)(10) of Regulation S-K, in which compensation agreements with named executive officers and directors are deemed material no matter how small the amount.

Jacob

According to Valerie Jacob, a partner at Fried, Frank, Harris, Shriver & Jacobson in New York, the relevant item in Reg. S-K says an agreement is automatically material if it is a contract to which directors or officers are parties, except where immaterial in amount or significance. In the Wynn example, Jacob notes that “the company might conclude that it is immaterial since it was for $550,000, but since the contract is with the CEO, anything may be deemed material.” She adds that another section of Item 601 says a contract is automatically material if it is a management contract or a “compensatory plan, contract or arrangement” in which a director or named executive officer participates. “A company could easily conclude that this position would require the filing of the [Wynn] contract,” says Jacob.

And, of course, the second reason why more perks are getting disclosed is the threat of litigation or enforcement. Last September, GE was excoriated for failing to fully describe certain benefits it had agreed to provide former Chairman and CEO Jack Welch. And that wasn’t the first enforcement action taken against a company for failing to disclose retirement benefits; in 1997, the SEC found that W.R. Grace failed to fully disclose the substantial retirement benefits provided to its CEO, J. Peter Grace Jr.

The upshot here is that many companies are going out of their way to disclose even minor benefits on Form 8-K, lest regulators or litigators determine three years from now that shareholders should have known more about their executives’ housing arrangements.

But the downside to this trend, of course—besides the added expense and headache for public companies—is that it provides nothing but “noise” for the average shareholder.

Badami

Bryan Cave partner Heather Badami, for example, agrees that the Wynn Resorts filing may be an example of how interpretations of the new 8-K rules are resulting in over-disclosure and, potentially, investor confusion. According to Badami, the purpose of the material definitive agreements provision was to ensure investors could quickly understand how critical business commitments could affect investment decisions. “That Mr. and Mrs. Wynn have a nice place to live on the same terms as the other tenants does not seem to require such an alert to the public,” she says.

But whether those disclosures must be made, or not, is almost irrelevant.

The fact is, they are being made in abundance.

Raisch

“We’re seeing a wide variety of compensation-related disclosures in the 8-Ks right now,” says Raisch Financial Information Services CEO Robert Raisch. “Stock awards, trading plans, retention plans, savings plans, pension plans, severance letters, bonus programs, non-competes ... you name it.”

And that makes a database of material definitive agreements extremely valuable for companies and their advisors, who must now understand the types of filings being submitted by their peers and the market at large.

Which is why we launched our searchable database of material definitive agreements.

We are relentlessly focused on the disclosure, reporting and compliance requirements of our subscribers, and hope you find the service useful. You can always find the database in the left-hand navigation column of Compliance Week, or click here to try it out. And subscribers can always call our research department at (888) 519-9200 if they have questions or need assistance.