SEC Relents In Final Comp Rule; Clarity On Options, CD&A

Perhaps portending the amount of paperwork companies will face to comply with its new rules, the Securities and Exchange Commission issued its final text on the disclosure of executive and director pay last week—all 436 pages of it.

Along with the text, the SEC called for comment a revised proposal to require that companies disclose the compensation of three other highly paid, non-executive employees. Comments on that controversial provision—commonly known as the “Katie Couric rule”—are due 45 days after publication in the Federal Register. The rest of the compensation rule will take effect 60 days after publication in the Federal Register.

As Compliance Week has previously reported, companies will now need to make far more extensive and detailed disclosure, and can expect to spend considerably more time collecting all the details the SEC wants to see.

“Now that we know what the SEC is expecting in next year’s proxy statement, I think companies should be thinking about how their proxy disclosures will change and pulling together the new data that will now be required to be disclosed,” says Lisa Kunkle, a partner with the law firm Jones Day.

Smith

Among the most significant changes under the new rule: Companies must present a single, bottom-line number for total compensation to top executives, and most of the new disclosure will be required to be in plain English. “Compensation committees should be attentive to the fact that there will be much more detail required in next year’s proxy disclosure of the rationale for their decisions made this year,” says Edward Smith, a partner with Chadbourne & Parke. “There’s a lot of detail to review.”

Kunkle

Of particular interest are the rule’s provisions around estimating severance or change-in-control payments, Kunkle says. “While these estimates should be based on year-end stock price and salary levels, companies can at least see what will go into the calculations now.” In addition, she says perks have “garnered much attention recently, and companies should be re-examining what constitutes a perquisite and whether any additional items will need to be disclosed.”

And to quell the exploding scandal of backdated stock option grants, the final SEC rule obligates companies to present the details of their options-granting programs in the new Compensation Discussion and Analysis section to be required in annual reports.

Clarifying The Couric Rule

The SEC is also soliciting additional comment on a revamped version of its widely criticized proposal to disclose the total compensation and job description of as many as three highly compensated employees who are not executive officers or directors, but still earn more than the named executive officers. Under the revised approach, employees without responsibility for significant policy decisions within the company, or at some significant subsidiary business unit or function, would be excluded from the determination of who those three highly compensated employees are.

The SEC provided some specific examples in its request for comment. According to the release, “Responsibility for significant policy decisions could consist of, for example, the exercise of strategic, technical, editorial, creative, managerial, or similar responsibilities.” Employees who might be deemed to have responsibility for significant policy decisions could include the director of the news division of a major network; the principal creative leader of the entertainment function of a media conglomerate; or the head of a principal business unit developing a significant technological innovation, according to the Commission. Actors, professional athletes, top salesmen or similar well-paid employees without any responsibility for significant policy decisions would be exempt.

In particular, the SEC asked for comment on whether the proposal should be modified to apply only to large accelerated filers, which would disclose the total compensation for the most recent fiscal year and a description of the job position for each of their three most highly compensated non-executive employees whose total compensation is greater than any of the named executive officers.

Where Pressure Prevailed

The new compensation disclosures—the most substantial the SEC has made since 1992—generated more than 20,000 comments. While companies did not receive everything they wanted, the Commission did make several changes to its original proposal based on feedback it received, according to Julie Bell, a former staff attorney at the SEC and now with the law firm Hogan & Hartson.

THE RULE

The excerpt below is from the SEC final rule, "Executive Compensation and Related Person Disclosure," published Aug. 11, 2006:

The Securities and Exchange Commission is adopting amendments to the disclosure requirements for executive and director compensation, related person transactions, director independence and other corporate governance matters and security ownership of officers and directors. These amendments apply to disclosure in proxy and information statements, periodic reports, current reports and other filings under the Securities Exchange Act of 1934 and to registration statements under the Exchange Act and the Securities Act of 1933. We are also adopting a requirement that disclosure under the amended items generally be provided in plain English. The amendments are intended to make proxy and information statements, reports and registration statements easier to understand. They are also intended to provide investors with a clearer and more complete picture of the compensation earned by a company’s principal executive officer, principal financial officer and highest paid executive officers and members of its board of directors. In addition, they are intended to provide better information about key financial relationships among companies and their executive officers, directors, significant shareholders and their respective immediate family members. We also request additional comments regarding the proposal to require compensation disclosure for three additional highly compensated employees.

Effective Date: Will be effective 60 days after publication in the Federal Register [approximately Tues., Oct. 17, 2006].

Comment Date: Comments should be received on or before 45 days after publication in the Federal Register [approximately Monday, Oct. 2, 2006].

Compliance Dates: Companies must comply with these disclosure requirements in Forms 8-K for triggering events that occur on or after ... 60 days after publication in the Federal Register [approximately Tues., Oct. 17, 2006] and in Forms 10-K and 10-KSB for fiscal years ending on or after December 15, 2006. Companies other than registered investment companies must comply with these disclosure requirements in Securities Act registration statements and Exchange Act registration statements (including pre-effective and post-effective amendments), and in any proxy or information statements filed on or after December 15, 2006 that are required to include Item 402 and 404 disclosure for fiscal years ending on or after December 15, 2006. Registered investment companies must comply with these disclosure requirements in initial registration statements and post-effective amendments that are annual updates to effective registration statements on Forms N-1A, N-2 (except those filed by business development companies) and N-3, and in any new proxy or information statements, filed with the Commission on or after December 15, 2006.

Source

Final Rule Executive Summary (Executive Compensation and Related Person Disclosure, published by the SEC Aug. 11, 2006)

In an interview prior to the Aug. 11 release of the final text, Bell, who co-authored a study of the proposed rule and its comments, said the SEC seems to have heeded public comments in the calculation of aggregate total compensation in the summary compensation table, which is used to determine who a company’s named executive officers are.

The original proposed rule defined total compensation to include all earnings on deferred compensation plans and the annual increase in the actuarial value of pension plans. Commenters feared that including pension benefits might change the list of named executive officers from year to year, since a non-executive employee with a long tenure and large pension benefit might improperly end up on that list.

Bell

“The SEC obviously agreed with those comments,” Bell said. In the final rule, the value of accumulated pension benefits will still be presented, but in a separate column and not included in the total compensation column used to determine a company’s top named executive officers.

Another change Bell described as “somewhat surprising” was the reintroduction of the compensation committee report, albeit in shorter form. Under the proposed rules, the new CD&A was supposed to replace the committee report. In the final rules, however, the SEC added back a briefer version of the committee report which will include a statement that the committee reviewed and discussed the CD&A with management and recommended that it be put in the proxy.

“There were a lot of negative comments about the CD&A,” Bell said. Commenters were especially displeased that the CD&A will be “filed” rather than “furnished,” meaning its contents are subject to legal liability under federal securities laws, and subject to Section 302 certifications by the chief executive and financial officers under the Sarbanes-Oxley Act. Critics questioned having the CEO and CFO certify the disclosure since the compensation committee is tasked with setting the compensation of executive officers.

“The Commission tried to have their cake and eat it too,” Bell said. By having the CD&A filed, the SEC addressed its own concerns about companies only making boilerplate statements on compensation. By reintroducing the compensation committee report, it also addressed commenters’ worries about the CEO and CFO certifying the CD&A. Bell said the move “should give management comfort in making the certifications.”

The SEC also tweaked its proposal related to the narrative disclosure related to retirement plan and post-employment payments. Several commenters had suggested that the SEC provide guidance on the assumptions companies should use. “The SEC did exactly that,” Bell said. The SEC said companies can assume the triggering event took place on the last business day of company’s last fiscal year and that the price per share was the closing price on that day, which Bells says “gave companies more certainty.”

Related coverage and commentary, as well the SEC final rule, can be found in the box above, right.