New 8-K Disclosures Include Some Comp. Agreements

According to securities experts, the SEC's instructions for the revised Form 8-K are such a travesty of plain English that companies may not realize the new rules capture some executive compensation agreements.

The recent amendments to Form 8-K, which were effective Aug. 23, expanded the number and type of events required to be reported. The amendments also shortened the filing deadline for most items to four business days, providing a limited safe harbor from certain liabilities.

What's "Material?"

One example likely to cause consternation among reporting companies lies in Item 1.01, which covers material non-ordinary course contracts.

At first glance, 1.01 appears to exclude compensation agreements because they occur in the ordinary course of business and are seldom material to the company.

Yet a closer reading reveals a cross-reference to Item 601(b)(10) of Regulation S-K (see excerpt, below), in which compensation contracts with named executive officers and directors are deemed material no matter how small the amount.

Some have accused the requirement as being overly confusing and oblique.

Kohl

"I'm not sure that it's the SEC sneaking it by, but I do think that companies have not focused on compensation arrangements as being material definitive agreements," says Robert Kohl, a partner at Katten Muchin Zavis Rosenman. "I think most companies have focused on supply agreements, purchase agreements, agreements made to effect joint ventures, things like that."

Named officers include the five highest-paid executives whose compensation appears in the proxy statement. Companies must disclose contracts with other executive officers unless they are "immaterial in amount or significance," but that qualification does not apply to directors and named executive officers, nor does it specify whether materiality applies to the company or the recipient.

"Companies [need to] evaluate it from multiple perspectives. They look at it from the company's standpoint as well as the shareholders' and the individual recipients' and make an overall determination," says Mark Borges, a principal at Mercer Human Resource Consulting.

Material Terms

Although Item 1.01 does not expand compensation disclosure beyond prior requirements, it moves up the date and gives the information greater prominence. "Instead of having that information at the end of the quarter or the end of the year where sometimes it might get lost in the larger context of the document," Borges says, "you now have a system that highlights these particular events."

Previously, companies filed compensation agreements as exhibits to a 10-Q or 10-K filing, but now they must describe the material terms in an 8-K filed within four business days of signing the contract.

Smith

The disclosure covers every aspect of executive compensation—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. "The company's basic pension plan, which covers all employees, would not be required to be disclosed pursuant to this rule," says Ed Smith, a partner at Chadbourne & Parke, "But any supplemental executive retirement plan which gives the executive benefits over and above what the basic retirement plan provides would be disclosable."

Executive pay disclosure does not end there. Under Item 5.02, issuers must describe the material terms of compensation agreements with newly appointed directors and principal officers. Although some named executive officers are also principal officers, the rule lists other officers whose compensation may not appear in the proxy.

For example, "Say it's the principal accounting officer," says Kohl at Katten Muchin Zavis Rosenman. "He may very well not be in the named five. Even if the amount in his contract does not meet the general materiality standard, you still have a disclosure obligation."

REGULATION S-K

Excerpt from Regulation S-K Item 601(b)(10)(iii), Material Contracts

(A) Any management contract or any compensatory plan, contract or arrangement, including but not limited to plans relating to options, warrants or rights, pension, retirement or deferred compensation or bonus, incentive or profit sharing (or if not set forth in any formal document, a written description thereof) in which any director or any of the named executive officers of the registrant, as defined by Item 402(a)(3) (§229.402(a)(3)), participates shall be deemed material and shall be filed; and any other management contract or any other compensatory plan, contract, or arrangement in which any other executive officer of the registrant participates shall be filed unless immaterial in amount or significance.

(B) Any compensatory plan, contract or arrangement adopted without the approval of security holders pursuant to which equity may be awarded, including, but not limited to, options, warrants or rights (or if not set forth in any formal document, a written description thereof), in which any employee (whether or not an executive officer of the registrant ) participates shall be filed unless immaterial in amount or significance. A consolidation or other acquisition transaction pursuant to which the registrant may make further grants or awards of its equity securities shall be considered a compensation plan of the registrant for purposes of the preceding sentence.

SOURCE: Regulation S-K §229.601. Item 601.

CMGI, the former Internet incubator-turned-technology solutions provider, applied the new rules in August when it replaced its CEO. "They filed an 8-K with the appointment and resignation information in there but they also included entry into a material agreement and walked through the new CEO's compensation package," says Chris Curtis, a vice president at Ashton Partners, a communications consultant.

Amendments, Specificity, Ad Hoc Awards, And More

Item 1.01 covers amendments to material contracts, too, which has raised fears that companies may have to disclose individual grants of options or restricted stock. "A grant by itself would not ordinarily need to be disclosed if it was made under a pre-existing plan which had already been disclosed," says Smith. Companies must still report individual grants on Form 4, but not on 8-K.

Kohl points out that broadly worded plans may not suffice. "If you have previously filed a plan that leaves the determination of the particular terms and conditions to the compensation committee and they vary considerably from officer to officer it seems like you may need to file an 8-K on each grant," he says, noting that companies can avoid the problem if they file a standard form of agreement for grants that includes more detail. "What seems to be the trigger is where nothing has previously been filed that treats that grant with enough specificity. I don't mean the number of shares; I mean things like the vesting period, the price, the forfeiture provisions," he says.

Some individual grants will not escape Form 8-K. An ad hoc award, which is not part of an existing compensation plan, prompts an 8-K because, Kohl says, "You won't have the exception that the plan was already filed."

The rules may capture grants under existing plans, too. "If the company makes a grant pursuant to an existing compensation plan and the terms deviate from the standard form of agreement used with that plan then you would probably have to disclose the award," says Borges from Mercer.

There is some leeway in terms of full disclosure of certain compensation agreements. For example, companies must describe the material terms of an executive compensation agreement on Form 8-K, but need only file the document itself with the next periodic report. That gives issuers an opportunity to apply for confidential treatment if the contract ties compensation to sensitive measures like earnings per share targets. "If the performance conditions are confidential or proprietary information to the company," says Smith, "They should be able to be omitted."

Ashton Partners' Curtis suggests companies should look beyond the letter of the new rules. "You've now got information that's being communicated to the public in an isolated fashion," he says, "You need to look at the context, you need to look at transparency, and you need to look at how people will react to this information, and what to do about that."

Curtis notes that CMGI's news release announcing the new CEO did not mention his compensation. "That information wasn't in the news release and didn't need to be, but they communicated the fact that this guy's on board, here's why he's on board, here's his track record, here's why we're excited to have him. It gives context to the 8-K that has all this information about how much money he's being paid."

Accelerated disclosure may also affect how compensation committees negotiate employment agreements. "They know the information is going to be disclosed up front, which could prompt a reaction from shareholders, or the media, or even regulators," says Borges, who sees the new 8-K rules as part of a broader initiative, "The SEC wants to ensure information is available to investors when it might be of use to them rather than of historical interest."