New Help on Reg S-K; Proxy Access; CD&As

The Securities and Exchange Commission’s Division of Corporation Finance has issued new interpretations related to Items 402 and 404 of Regulation S-K, which address executive compensation and related-party transactions.

The new interpretations “shed light on some important nuances,” says Stephen Quinlivan, a shareholder in the law firm Leonard, Street and Deinard.

While many of the interpretations focus on issues that may only benefit a small number of companies, Quinlivan says others “will be broadly applicable to most public companies.”

Among other things, the new interpretations clarify the operation of Internal Revenue Code Section 280G in required calculations of potential payments upon termination and change in control—figures some companies have said are difficult to calculate because of their hypothetical nature.

Quinlivan

Specifically, Quinlivan notes, the guidance states where the last day of the last completed fiscal year for a calendar year-end company isn’t Dec. 31, the company may calculate the tax gross-up on the assumption that a change-in-control occurred Dec. 31, rather than the last business day of its last completed fiscal year, using the company stock price as of the last business day of its last completed fiscal year.

Quinlivan says the interpretations also give helpful guidance regarding when a company can report a negative number for stock option expense in the summary compensation table “because of forfeitures or achievement of a performance based condition is no longer probable.”

“The SEC takes the rational view that only previously expensed portions of awards that were previously reported in the summary compensation table may be reversed,” he says. “You can never reverse the portion of an award before effectiveness of the new rules or before the time a person became a named executive officer.” However, he says, how much can be reversed when a person was a named executive officer in some years but not others remains an open question.

The staff also gives useful guidance with respect to M&A transactions. For instance, following a merger, generally the surviving company need not report compensation paid by predecessor companies that “disappear” during the merger, Quinlivan notes. Likewise, he says, a parent corporation need not report compensation paid to an employee of a subsidiary prior to the time the subsidiary became a subsidiary. But, he warns, different results may apply in amalgamations and combinations.

Quinlivan also notes what he calls a “curious interpretation” related to perquisites: The interpretations say an executive officer who has a meal at a country club hasn’t made full reimbursement unless the cost of the meal and a proportional amount of the dues paid by the company club are reimbursed.

Under the rules, the disclosure of all perks, including those with no aggregate incremental cost, is required if perks exceed $10,000 in the aggregate, Quinlivan says. However, if an executive officer fully reimburses the company for a perk, it isn’t considered a perk and doesn’t need to be separately identified.

CII Questions SEC on Proxy Access Meltdown

What if the Securities and Exchange Commission fails to adopt a final rule on shareholder access to the proxy in time for the next proxy season? That’s a question being asked by the Council of Institutional Investors, which has raised concerns about what it says appear to be conflicting views on the issue.

The question could be rendered moot if the SEC does adopt a final rule in time for the proxy season, as it has repeatedly promised to do. The Commission is currently soliciting feedback on two opposing rule proposals related to proxy access. Comments on the controversial measures are due Oct. 2.

Cox

Meanwhile, in an Aug. 8 letter to SEC Chairman Christopher Cox, CII General Counsel Jeff Mahoney asked the agency to clarify its position regarding shareholder resolutions on proxy access in the absence of a final rule.

Campos

As previously reported by Compliance Week, the SEC at a July 25 open meeting voted to publish two proposals for comment. One, favored by Republican Cox and Democratic commissioners Annette Nazareth and Roel Campos, would allow certain shareholders to include their nominations for corporate directors in the proxy statement. The other, favored by Republican commissioners Paul Atkins and Kathleen Casey, would prohibit it.

Historically, the SEC has interpreted Rule 14a-8 of the Securities Exchange Act as allowing companies to keep shareholder nominations to the board out of the proxy. That policy unraveled last fall, when an appellate court ruled that Rule 14a-8 does allow such shareholder access. Since then, the SEC has stopped issuing the no-action letters that let companies block shareholder nominations.

In his letter, Mahoney wrote: “It was our understanding that … the SEC staff indicated that they would maintain the status quo and would not resume issuing no-action letters permitting the exclusion of shareowner resolutions on proxy statement access for board nominations unless a final rule is adopted which makes exclusions of such resolutions permissible,” Mahoney wrote.

Atkins

The letter goes on to say CII was “surprised and concerned” by remarks made Aug. 2 by Commissioner Paul S. Atkins before the Federal Reserve Bank of Chicago, which Mahoney says “ appear to be in direct conflict with statements made by the SEC staff” at the July 25 meeting.

During that July 25 meeting, in response to a question raised by Campos, Corporation Finance Director John White said that if the staff received a no-action request related to excluding a bylaw proposal that would put a shareholder access process in place before the Commission adopted a final rule, “We would be analyzing it and approaching it the same way we did last season.”

The letter cites this passage from Atkins’ speech: “We specifically adopted a current interpretation of the director election exclusion that is consistent with the SEC’s long-standing interpretation … This interpretation, which now governs our administration of that provision, will provide the necessary clarity and uniformity for both investors and companies alike until an amendment is adopted in the future.”

As of late last week, Mahoney said he hadn’t received a response from the SEC. A spokesman for the Commission declined to comment, saying that the SEC “doesn’t discuss correspondence,” referring to the staff comments made at the meeting.

More Hints on CD&A Review

SEC officials are giving a few more details about their ongoing review of filings companies made earlier this year under the new rules for disclosure of executive compensation.

In remarks before a committee of the American Bar Association last week, John White, head of the SEC’s Division of Corporation Finance, said his staff is waiting to send out any comment letters about the proxy disclosures so all comments can be as consistent as possible. But, he added, those comments should be ready shortly.

The SEC is also preparing a more comprehensive report on the Compensation Discussion & Analysis portion of the proxy disclosures, based on a review of CD&As submitted earlier this year. White was less specific about when that report will be ready for public consumption, but promised it would be released in time for the 2008 proxy season.

White emphasized that, in its reviews, the staff is looking for analysis, particularly on the different components of compensation and on change-of-control and termination payments.

White

The staff is also looking closely at whether descriptions of pay-for-performance targets are adequate. “We’re seeing a lot of really vague disclosure in this area about ‘individual performance goals and targets’ without further discussion,” White noted.

A company is allowed to withhold performance formulas for competitive reasons, but it must clearly justify why disclosing the formula would be harmful—and SEC staffers are paying particularly close attention to that, White said. If the targets were properly withheld, he said, the staff would look at whether the alternative disclosure about the difficulty of achieving them was adequate.

The staff also expects to issue many comments seeking more disclosure where benchmarking is used or seeking clarification on who makes compensation decisions, including the role of the CEO and others in decision making.

In addition, the staff will continue to post interpretations on the Division of Corporation Finance Web site. “I can’t tell at this point whether we will need some rule change cleanups or not,” White said. “What I can say is that we are not working on any rulemaking currently; the timing just doesn’t work for next proxy season. We would need to propose and adopt rules by December, so modifying the rules is a project for next summer, if needed.”