On December 16, 2009, the U.S. Securities and Exchange Commission (SEC) adopted amendments to its proxy statement disclosure rules which will apply to proxy statements filed on or after February 28, 2010. The amendments impact the following areas: 

Compensation Disclosure

• A company must discuss its compensation policies or practices as they relate to risk management and risk-taking incentives that can affect the organization’s risk and management of it, if the risks arising from a company’s compensation policies and practices for employees are reasonably likely to have a material adverse effect on the organization;
• A company will have to report the aggregate grant date fair value of stock and option awards in the Summary Compensation Table (SC Table) and Director Compensation Table (DC Table); these values will be computed in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718, Compensation—Stock Compensation (FASB ASC Topic 718), rather than reflecting the expense recognized for financial statement purposes for the fiscal year; and
• Stock and option awards subject to performance conditions must be reported based on probable outcome of the performance conditions as of the grant date with a footnote indicating the maximum value based upon achieving the highest level of performance conditions.

Directors — A company will have to disclose:

• The qualifications of directors and nominees for director, and the reasons why each such person should serve as a director of the company;
• Any directorships held by each director and nominee at any time during the past five years at any public company or registered investment company;
• Consideration of diversity in the process by which candidates for director are considered for nomination by a company’s nominating committee;
• Additional legal actions involving a company’s executive officers, directors and nominees for director, lengthening the time during which such disclosure is required from five to ten years;
• A board’s leadership structure; and
• The board’s role in the oversight of risk.

Compensation Consultants

• A company will have to disclose the fees paid to compensation consultants and their affiliates under certain circumstances.

Shareholder Voting

• A company must disclose the vote results from a meeting of shareholders on Form 8-K generally within four business days of the meeting.

The SEC release in which these rules were adopted also included other proposed amendments to the rules governing the proxy solicitation process. The SEC has deferred consideration of those proposed amendments, pending its consideration of the proposal intended to facilitate shareholder director nominations in companies’ proxy materials.

Compensation Disclosure

Disclosure of the Company’s Compensation Policies and Practices as They Relate to the Company’s Risk Management

The rule expands compensation disclosures by requiring a company to address its compensation policies and practices for all employees, including non-executive officers, if the compensation policies and practices create risks that are reasonably likely to have a material adverse effect on the company. If this threshold is met, a company must discuss how these policies impact the company’s risks and its management of these risks.

This approach parallels the MD&A “reasonably likely” disclosure requirement, which requires risk-oriented disclosure of known trends and uncertainties that are material to the business.

If a company has compensation policies and practices for different groups that mitigate or balance incentives, these may be considered in deciding whether risks arising from the company’s compensation policies and practices for employees are reasonably likely to have a material adverse effect on the company as a whole.

A company does not have to make an affirmative statement that the risks arising from its compensation policies and practices are not reasonably likely to have a material adverse effect on the company.

Location of Disclosure. The CD&A provides a discussion and analysis of the compensation of the named executive officers and the information contained in the SC Table and other required tables. The new disclosure requirements cover all employees, not just the named executive officers.

As a consequence, these new disclosure requirements are not part of the CD&A.

Materiality. The final rule contains a non-exclusive list of situations where compensation programs might have the potential to raise material risks to companies; it then provides examples of the types of issues that would be appropriate for a company to address. Situations that potentially could trigger a disclosure about compensation policies and practices include:

• A business unit of the company that carries a significant portion of the company’s risk profile;
• A business unit with compensation structured significantly differently than other units within the company;
• A business unit that is significantly more profitable than others;
• A business unit where the compensation expense is a significant percentage of the unit’s revenues; and
• Programs that vary significantly from the overall risk and reward structure of the company, such as when bonuses are awarded upon accomplishment of a task, while the income and risk to the company from the task extend over a significantly longer period of time.

In addition to the above situations, a company must determine if there are other features of its compensation policies and practices that have the potential to incentivize its employees to create risks that are reasonably likely to have a material adverse effect on the company.

Sample Discussion Topics. The rules provide illustrative examples of the issues that would be appropriate for a company to address when the materiality threshold has been met. The examples are non-exclusive; the discussion of an example should be tailored to the facts and circumstances of the company. Examples of the issues that organizations may need to address regarding their compensation policies or practices include the following:

• The general design philosophy of the company’s compensation policies and practices for employees whose behavior would be most affected by the incentives, as such policies and practices relate to or affect risk-taking by those employees on behalf of the organization and the manner of their implementation;
• The risk assessment or incentive considerations, if any, in structuring compensation policies and practices or in awarding and paying compensation;
• How the policies and practices relate to the realization of risks resulting from the actions of employees in both the short-term and the long-term, such as clawbacks or imposing holding periods;
• How adjustments to compensation policies and practices are made to address changes in a company’s risk profile;
• Material adjustments that have been made to compensation policies and practices as a result of changes in the company’s risk profile; and
• The extent to which the company monitors its compensation policies and practices to determine whether its risk management objectives are being met with respect to incentivizing its employees.

A company should assess the information that is identified by the example in light of the organization’s particular situation. Generic or boilerplate disclosure that the incentives are designed to have a positive effect, or that compensation levels may not be sufficient to attract or retain employees with appropriate skills in order to enable the company to maintain or expand operations, should be avoided.

Smaller Reporting Companies. Smaller reporting companies will not be required to provide the new disclosure, even though the new rule will not be part of CD&A.

Suggested Actions

This might be the most difficult rule to implement. A company should review compensation policies and practices for both executive officers and employees with its compensation committee to determine if its compensation practices for employees are reasonably likely to have a material adverse effect on the organization. To assist in this process, steps should be taken to develop procedures to evaluate risks associated with the compensation policies. This may involve a significant amount of work on the part of a company even though the final disclosure itself may not be significant. Financial institutions that are Troubled Asset Relief Program (TARP) recipients are already required to analyze, at least semi-annually, employee compensation plans and the risks they pose to the recipient.

Revisions to the Summary Compensation and Director Compensation Tables

The SEC has amended Item 402 of Regulation S-K to revise the SC Table and DC Table to require disclosure of the aggregate grant date fair value of stock and option awards which will be computed in accordance with FASB ASC Topic 718. The revised disclosure would replace the previous disclosure which required that a company report the expense recognized for financial statement reporting purposes for the fiscal year.

This will also affect the calculation of total compensation, including for purposes of determining who is a named executive officer.

The grant date value of performance awards must be computed based upon the probable outcome of the performance condition as of the grant date. This amount must be consistent with the grant date estimate of compensation cost to be recognized over the service period, excluding the effect of forfeitures. The SC Table and DC Table must also include footnote disclosure of the maximum value assuming the highest level of performance conditions will be achieved.

Transition Rule. To facilitate year-to-year comparisons, the SC Table amendments will be implemented by requiring companies providing Item 402 disclosure for a fiscal year ending on or after December 20, 2009 to present recomputed disclosure for each preceding fiscal year required to be included in the table, so that the stock awards and option awards columns present the applicable full grant date fair values. The total compensation column must be recomputed too.

The stock awards and option awards columns amounts should be computed based on the individual award grant date fair values reported in the applicable year’s Grants of Plan-Based Awards Table, except that awards with performance conditions should be recomputed to report grant date fair value based on the probable outcome as of the grant date, consistent with FASB ASC Topic 718.

In addition, if a person who would be a named executive officer for the most recent fiscal year (2009) also was disclosed as a named executive officer for 2007, but not for 2008, the named executive officer’s compensation for each of those three fiscal years must be recomputed and reported.

Companies are not required to include different named executive officers for any preceding fiscal year based on recomputing total compensation for those years, or to amend prior years’ Item 402 disclosure in previously filed Forms 10-K or other filings.

Smaller Reporting Companies. A smaller reporting company, which is required to provide disclosure only for the two most recent fiscal years, may provide SC Table disclosure only for 2009 if the person was a named executive officer for 2009 but not for 2008.

Suggested Actions

A company should assess the grant date fair value reporting for equity awards by recalculating its compensation tables for the proxy statement based upon the aggregate fair value of stock and option awards on the grant date and recalculate performance awards. These results may differ from what was to be expected under the old rules. A company should also consider the impact of the recalculated 2007 and 2008 amounts.

Director and Nominee Disclosure

Director Qualifications. The final rules require companies to provide detailed disclosure every year for each director and any nominee for director of the particular experience, qualifications, attributes or skills that led the board to conclude that the person should serve as a director for the company.

This disclosure is required for all nominees and for all directors, including those not up for reelection.

The rules do not specify the particular information that should be disclosed by a company. A company will have some flexibility but must disclose information about a director’s or nominee’s skills, qualifications or particular areas of expertise that benefit the organization.

If an individual is (or was) chosen to be a director or a nominee to the board because of a particular qualification, attribute or experience related to service on a specific committee, such as the audit committee, then this should be disclosed under the new requirements as part of the person’s qualifications to serve on the board.

If particular skills, such as risk assessment or financial reporting expertise, were part of the director’s experience, qualifications, attributes or skills that led the board to conclude that the person should serve as a director, this should be disclosed.

Companies must still comply with the disclosure requirements in Item 407(c)(2)(v) of Regulation S-K regarding the specific minimum qualifications and specific qualities or skills used by the nominating committee to select directors.

Committee Memberships. The final rules do not require disclosure of the specific experience, qualifications or skills that qualify a person to serve as a committee member.

Directorships with Public Companies or Investment Companies. Currently, the rules require disclosure of any existing director positions held by each director and nominee in any company with a class of securities registered pursuant to Section 12 of the Exchange Act, or subject to the requirements of Section 15(d) of that act, or any organization registered as an investment company under the Investment Company Act.

This disclosure has been expanded to include service on boards of those companies for the past five years (even if the director or nominee no longer serves on that board).

Legal Proceedings. The current rules require disclosure about director and executive officer involvement in certain legal proceedings. The amendments: (i) lengthen the time during which disclosure of legal proceedings involving directors, director nominees and executive officers is required from 5 to 10 years; and (ii) expand the list of legal proceedings involving directors, executive officers and nominees. These new legal proceedings include:

• Any judicial or administrative proceedings resulting from involvement in mail or wire fraud or fraud in connection with any business entity;
• Any judicial or administrative proceedings based on violations of federal or state securities, commodities, banking or insurance laws and regulations, or any settlement to such actions; and
• Any disciplinary sanctions or orders imposed by a stock, commodities or derivatives exchange or other self-regulatory organization.

Disclosure of a settlement of a civil proceeding among private parties is not required.

As with the current rules, the additional legal proceedings will not need to be disclosed if they are not material to an evaluation of the ability or integrity of the director or director nominee.

Diversity. Item 407(c) of Regulation S-K has been amended to require disclosure of whether, and if so how, a nominating committee considers diversity in identifying nominees for director. In addition, if the nominating committee (or the board) has a policy with regard to the consideration of diversity when identifying director nominees, disclosure is required of how this policy is implemented, as well as how the nominating committee (or the board) assesses the effectiveness of its policy.

Diversity is not defined in this rule, so a company will have to disclose its definition. The SEC noted that some companies may conceptualize diversity expansively to include differences of viewpoint, professional experience, education, skill and other individual qualities and attributes that contribute to board heterogeneity, while others may focus on diversity concepts such as race, gender and national origin. A company may define diversity in ways that it considers appropriate.

Suggested Actions

A company should begin revising existing D&O questionnaires in order to collect additional information about directors’ qualifications, skills and experiences, as well as additional biographical data, including information about past directorships. It should also begin revising director and executive questionnaires to capture information regarding past legal proceedings.

A company needs to decide whether the board or the nominating committee will make decisions regarding the directors’ and nominees’ qualifications which are to be discussed in the proxy statement and then develop a process and schedule appropriate time for the individuals’ experience, qualifications, attributes or skills to be formally evaluated and for the appropriate disclosures to be developed. The nominating committee is probably best suited to make these determinations. This information can be included with each director’s biography or in a separate narrative discussion.

If the company has not already done so, it should determine whether the nominating committee should adopt a diversity policy for directors. If a company has a policy, it should evaluate the effectiveness and implementation of such policy.

Board Leadership Structure 

A new disclosure requirement has been added to require disclosure of the company’s leadership structure and why the company believes it is the most appropriate structure for the organization at the time of the filing.

The amendments will require companies to provide shareholders with disclosure of, and the reasons for, the leadership structure of a company’s board concerning the principal executive officer, the board chairman position and, where applicable, the lead independent director position.

Under the amendments, a company is required to disclose whether and why it has chosen to combine or separate the principal executive officer and board chairman positions, and why it believes that this is the most appropriate board leadership structure for the organization. 

If a company has combined the role of principal executive officer and board chairman, it will have to disclose whether it has a lead independent director designated to chair meetings of the independent directors. The amendments also require disclosure of whether and why the company has a lead independent director, as well as the specific role such person plays in the leadership of the organization.

Suggested Actions

A company should evaluate its current leadership structure to determine if the structure is appropriate for the organization and develop a discussion of this leadership structure.

Board Role in Risk Management

A company must disclose the board’s role in the oversight of risk, including how the board administers its risk oversight function, such as through the whole board, or through a separate risk committee or the audit committee. If more than one committee oversees this function, the company must disclose how these committees interact when performing this task. A company may have to discuss whether the individuals who supervise the day-to-day risk management responsibilities report directly to the board as a whole or to a board committee, or how the board or committee otherwise receives information from such persons.

Suggested Actions

The board’s role in risk assessment and oversight should be reviewed and consideration should be given to whether it or its committees have the appropriate structure and processes in place to oversee major risks. Risk management procedures should be supplemented as necessary.

Disclosure Regarding Compensation Consultants

The amendments require disclosure about the fees paid to compensation consultants and their affiliates when they: (i) played a role in determining or recommending the amount or form of executive and director compensation, and (ii) provided additional services to the company.

Disclosure required if the board’s compensation consultant provides additional services to the company. Disclosure would be required if: (i) the board has engaged a compensation consultant to advise the board as to executive and director compensation; and (ii) such consultant or its affiliates provides other non-executive compensation consulting services to the company with a value in excess of $120,000 for a fiscal year.

If the $120,000 threshold is satisfied, the final rule requires disclosure of the aggregate fees paid for services provided to either the board or the company with regard to determining or recommending the amount or form of executive and director compensation, and the aggregate fees paid for any non-executive compensation consulting services provided by the compensation consultant or its affiliates.

A company would also have to disclose whether the decision to engage the compensation consultant or its affiliates for the non-executive compensation consulting services was made, or recommended by, management, and whether the board approved such other services.

Disclosure required if the board does not have a compensation consultant, but the company receives executive compensation and on-executive compensation services from its consultant. Disclosure is required even if the board has not engaged a compensation consultant, when management or the company receives executive compensation consulting services and other non-executive compensation consulting services from a consultant or its affiliates, and the fees for the non-executive compensation consulting services provided by that consultant or its affiliates exceed $120,000 for the fiscal year.

Disclosure not required if the board and management have different compensation consultants, even if management’s consultant provides additional services to the company. In some instances, the board may engage a compensation consultant to advise it on executive or director compensation, and management may engage a separate consultant to provide executive compensation consulting services and one or more additional non-executive compensation consulting services.

Disclosure is not required if the board has retained its own consultant that reports to the board. The exception would be available without regard to whether management’s consultant participates in board meetings.

Where the board’s compensation consultant provides additional non-executive compensation consulting services to the company, the rule would require fee and other related disclosures if the $120,000 fee threshold is satisfied.

Disclosure required only if fees for additional services exceed $120,000 during the company’s last completed fiscal year. The final rule has a disclosure threshold. Under the rule, if the board has engaged a compensation consultant to provide executive and director compensation consulting services to the board or if it has not retained a consultant but there is a firm providing executive compensation consulting services, fee disclosure is required if the consultant or its affiliates also provides other non-executive compensation consulting services to the company, and the fees for the other services exceed $120,000 for the fiscal year.

Disclosure of nature and extent of additional services not required. Disclosure of the nature and extent of additional services provided by the compensation consultant and its affiliates to the company need not be provided. Nevertheless, a company may include a description of any additional non-executive compensation consulting services provided by the compensation consultant and its affiliates.

Exceptions to the disclosure requirement for consulting on broad-based plans and provision of survey information. Where the compensation consultant’s only role in recommending the amount or form of executive or director compensation is in connection with consulting on broad-based plans that do not discriminate in favor of executive officers or directors of the company, disclosure need not be made. This includes situations where the compensation consultant’s services are limited to providing information, such as surveys, that either is not customized for a particular company, or that is customized based on parameters that are not developed by the compensation consultant.

The exception is not available if the compensation consultant provides advice or recommendations in connection with the information provided in the survey.

 

Suggested Actions

A company should identify and quantify any services that the compensation consultants perform for the company or the compensation committee. Consideration should also be given to the hiring by the compensation committee of an independent consultant. A company or its compensation committee should also consider whether to adopt a policy that limits or prohibits the committee consultant from providing non-executive compensation consulting services.

Reporting of Voting Results on Form 8-K.

The requirement to disclose shareholder vote results has been transferred from Forms 10-Q and 10-K to Form 8-K. New Item 5.07 to Form 8-K requires companies to disclose the results of a shareholder vote within four business days after the end of the meeting at which the vote was held.

The instruction to Form 8-K states that companies are required to file the preliminary voting results within four business days after the end of the shareholders’ meeting and then file an amended report on Form 8-K within four business days after the final voting results are known. If a company obtains the definitive voting results before the preliminary voting results must be reported and decides to report its definitive results on Form 8-K, it will not be required to file the preliminary voting results. To the extent that companies are concerned that the disclosure of preliminary voting results could be confusing to investors, they may include additional disclosure that helps to put the preliminary voting disclosure in a proper context.

For further information, please contact Timothy Sullivan, Michael D. Morehead or your regular Hinshaw attorney.

Tax Advice Disclosure: To ensure compliance with the Internal Revenue Service regulations governing the issuance of advice on Federal tax issues, we advise you that any tax advice in this communication (and any attachments) is not written with the intent that it be used, and cannot be used, to avoid penalties that may be imposed under the Internal Revenue Code.

This alert has been prepared by Hinshaw & Culbertson LLP to provide information on recent legal developments of interest to our readers. It is not intended to provide legal advice for a specific situation or to create an attorney-client relationship.