As companies head into this year’s annual meeting season and get down to business preparing their annual reports on Form 10-K, executive compensation is once again the critical issue they’ll need to focus on.
While there aren’t a slew of new disclosure rules to contend with this year, observers say the stakes are higher, since the Securities and Exchange Commission has made clear that it wants more detailed, forthcoming, and informative disclosure about executive pay in this year’s proxy statements. The SEC overhauled its compensation disclosure rules in 2006, and 2007 was the first time companies had to abide by them. In speeches, guidance and comment letters, the Commission has repeatedly stated that last year’s efforts were not sufficient.
“Executive compensation disclosure is the hot topic,” says Heather Badami of the law firm Bryan Cave.
Badami
Badami recommends that companies carefully examine SEC comments on the first round of proxy disclosures as they draft this year’s proxy materials. Even companies that didn’t get staff comment letters need to be responsive to those comments in their disclosures, she says. (Some 350 large companies did get comments late last year, and the SEC published its overall findings for the benefit of others.)
“Companies should be putting as much energy into [their compensation disclosures] as they did last year,” she says. “It’s even more important to focus on it this year because the SEC has spoken. There’s no excuse not to get this right.”
Betsy Hinck of the law firm Dorsey & Whitney agrees that companies’ executive compensation disclosure “is a pretty high-stakes game.” The SEC, institutional investors, and shareholder activists all “expect to see companies do a better job this year,” she says.
Hinck encourages companies to view the proxy statement “as a strategic document” rather than required technical compliance and as a means to communicate with shareholders on issues like executive pay. “It’s about the strategic decisions, like how the company is going to reach out to shareholders, how it’s going to present its compensation story, and whether to go electronic or stick with paper [proxy materials].”
Hinck
Hinck says the primary focus for most companies will be improving their Compensation Discussion & Analysis based on the SEC’s call to explain more of “the why” behind their compensation decisions, “and how to present that information more clearly.”
In particular, companies that did not disclose performance targets last year must wrestle with whether they can continue to take that approach, Hinck says. The SEC has made crystal clear its view that a company must have very good reason to keep such information private.
Badami reminds companies to consider the entirety of their disclosure. “There might be additional disclosures they have to think about because their Summary Compensation Table will include more than one year of data for the first time,” which may lead to a discussion of the differences from last year, she says.
Other issues companies should especially heed:
Interpretive Guidance
Last August the SEC’s Division of Corporation Finance updated its interpretations related to Items 402 and 404 of Regulation S-K, which address executive compensation and related-party transactions. The updates included guidance on when a company can report a negative number for stock option expense in the summary compensation table because of forfeitures. Hinck says companies should review the guidance “to make sure they didn’t get any of those hazier areas wrong.”
E-Proxy
This marks the first year large accelerated filers (those with a public float of $700 million or more) must comply with the so-called e-proxy rule, which requires them to post their proxy materials online and provide notice to shareholders of their availability. While all large filers must post their materials online, they can opt to use the rule’s “notice and access” model, continue to deliver paper proxy materials to all shareholders, or try some mixture of the two.
For companies that have decided to stick solely with paper for all shareholders, Hinck says, “It’s pretty much business as usual.” They may, however, need to add a few sentences to their proxies to indicate that their proxy materials are available online—and they should make sure those materials, as posted, comply with SEC requirements.
“They need to be in a format that’s easily readable over the Internet, and they can’t interfere with the privacy of those who are accessing them or voting,” she says.
“Most companies can save some work by filing their annual report on Form 10-K and incorporating by reference into the registration statement amendment on Form S-1.”
— Heather Badami,
Partner,
Bryan Cave
Issuers that plan to use the notice-and-access model must be sure they can meet a requirement that their proxy materials be posted online and filed with the SEC 40 days before their annual meeting date. Hinck says companies should factor in an extra five days so intermediary proxy assistance firms such as Broadridge have time to prepare. That may preclude some companies with early meetings from using the notice-and-access model this year.
Smaller Reporting Companies
Rule amendments that eliminate the SEC’s current SB forms and system take effect at the start of February. Hinck notes that companies that qualify under the old “small business issuer” definition—annual revenues of less than $25 million and a public float of $25 million or less—will have the choice of filing their next annual report for a fiscal year ending on or after Dec. 15, 2007, using either old Form 10-KSB under the old rules or on Form 10-K using the new simplified disclosure requirements in Regulation S-K for “smaller reporting companies.”
Companies newly qualifying as “smaller reporting companies”—those with a public float of less than $75 million as of the last business day of their most recently completed second fiscal quarter, or, for companies with no public float, annual revenues of less than $50 million during the most recent completed fiscal year of audited financials—can choose on an item-by-item basis whether to use the new simplified Regulation S-K requirements when filing their next periodic report due after Feb. 4.
Badami says the real benefit to using a revised Form 10-K this year is for companies that have effective or pending SB-2 resale registration statements on file. When Form SB-2 is eliminated Feb. 4, an annual report filing by those companies will require them to update the registration statement on another form, typically Form S-1, she says.
“Most companies that aren’t penny stock companies can save some work by filing their annual report on Form 10-K and incorporating by reference into the registration statement amendment on Form S-1,” she says. “It looks like companies that file on Form 10-KSB won’t be able to incorporate by reference into Form S-1.”
Hinck also has a drafting tip for non-accelerated filers complying with Sarbanes-Oxley Section 404 for the first time. Since the SEC revised its rules in June 2007 to clarify that a company’s auditor is required to express a single opinion directly on the effectiveness of internal controls over financial reporting, companies should ensure that they revise the language in the Reg S-K Item 308 disclosure of Form 10-K regarding the auditor’s attestation report; they should remove a reference to “management’s assessment of” in the statement that the independent auditor has issued an attestation report on the company’s internal controls.
And Badami reminds companies listed on Nasdaq or the American Stock Exchange to update their directors and officers questionnaire to reflect changes to the exchanges’ definitions of director independence. Those rules were amended last year to increase the compensation threshold from $60,000 to $100,000 to match the New York Stock Exchange’s definition.
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