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The New SEC Compensation Reporting Rules

The SEC on August 11 issued the final rules for amendments to the disclosure requirements for executive and director compensation.  The adopting release is 436 pages in length.  The new rules are intended to make proxy statements easier to understand (“plain english”) with a clearer picture of executive compensation.  This memorandum summarizes the key elements of the new rules, highlighting changes from current reporting requirements.

Effective Dates and Transition

The new rules are effective for proxy statements filed after December 15, 2006 and 10-K’s filed for fiscal years ending after December 15, 2006.  Companies are not required to “restate” compensation disclosure for prior fiscal years.  For example, only the most recent fiscal year must be reflected in the new Summary Compensation Table, and information for years prior to the most recent fiscal year will not have to be presented at all.  Consequently, the transition to full reporting under the new rules in the proxy statement will take three years.

Compensation Disclosure and Analysis

The linchpin of the revised SEC rules is a new Compensation Discussion and Analysis report, pursuant to which management would explain in narrative form its compensation policies.

  • The Compensation Discussion and Analysis report would be deemed “filed” with the SEC, which means the disclosure would be subject to the liability requirements under securities laws (including the CEO and CFO certification provisions).
  • In a change from the proposed rules, the final rules require a separate compensation committee report, structured similarly to the current audit committee report.  The compensation committee would be required to state whether or not it reviewed management’s compensation discussion and analysis report and recommended its inclusion in the proxy statement.
  • The Compensation Discussion and Analysis must be principles-based.  The SEC wants to eliminate what they see as boilerplate disclosure in the current compensation committee reports. All elements of compensation must be described.
  • “Potentially appropriate disclosures” under the new Compensation Discussion and Analysis include (1) actions concerning executive compensation taken after fiscal year end, (2) company policies and decisions concerning recovery of awards following restatements, (3) available discretion concerning payment of incentives in the absence of attainment of performance goals, and (4) disclosure of how difficult or how likely the achievement of performance goals will be.  The new rules do not require the disclosure of specific performance targets if such disclosure would create a competitive disadvantage, but the SEC indicates it will review filings to determine if this standard has been met.

Summary Compensation Table

The SEC has amended the format of the Summary Compensation Table for executive officers.

  • The Summary Compensation Table (SCT) adds a new “total” column which totals the compensation reported in the other columns of the table.
  • The “total” column (reduced by amounts in the pension-deferred compensation column) is used to determine the executive officers who are subject to SCT reporting.  Currently, only the salary and bonus columns are used for this purpose.
  • The persons covered must include the CEO, CFO and the next three executive officers with the highest total compensation.  The SEC has requested further comment on whether up to three additional employees should be covered in the SCT if their total compensation exceeds any of the top five and they make significant policy-related decisions for the company, a division, a unit or a function.
  • The stock awards column and the option awards column must report a value based on amounts expensed during the year determined pursuant to FAS 123R.  Stock awards include restricted stock, restricted stock units, phantom stock, phantom stock units and common stock equivalent units (all of which do not have option-like features).  Option awards include options, stock appreciation rights and similar equity-based compensation instruments that have option-like features.
  • The non-equity incentive plan compensation column includes all incentive plan awards not included in the stock awards or option awards columns.
  • The SEC has eliminated prior distinctions between short-term incentive awards and long-term incentive awards.  The “bonus” column now includes incentives which are not pre-established and communicated to the executive and incentives the outcome of which was not substantially uncertain.  “Non-equity incentive plan compensation” refers to awards intended to serve as an incentive for performance to occur over a specified period (if the outcome with respect to the performance target is substantially uncertain at the time the performance target is established and the target is communicated to the executive).
  • Amounts are reportable in the non-equity incentive plan compensation column once the relevant performance conditions have been satisfied, even if the awards remain subject to forfeiture conditions (such as conditions requiring continued service or conditions that provide for forfeiture based on future company performance).
  • Amounts in the “all other compensation” column (a catch-all) must be separately identified and quantified in a footnote.  This column would include amounts paid in connection with employment termination or change of control, company contributions to defined contribution plans, life insurance premiums and tax gross-up payments.  In a change from the proposed rules, only above-market dividends or earnings on stock or option awards must be reported in this column (on the basis that the value of such items was implicitly included in the stock/option award valuation amounts).
  • Narrative disclosure is required to the extent necessary to an understanding of the information disclosed in the SCT and related Plan Grant Table (discussed below).  Depending on the context, the narrative could include the formula for determining grants, vesting schedules, performance-based conditions, and changes/acceleration of vesting or formula conditions.

Director Compensation Table

The new rules require director compensation to be set forth in a table.

  • A footnote to the Director Compensation Table must disclose aggregate amount of the equity awards for the director outstanding at fiscal year end.
  • The SEC provides some guidance for disclosure of non-standard plans.  For example, with respect to charitable award programs, the annual cost must be disclosed with footnote disclosure of the plan terms.


Perquisites and other personal benefits must be included in the “all other compensation” column in the SCT.  Disclosure of such amounts is required unless the aggregate amount is less than $10,000 (a reduction from the current $50,000 threshold).  Any perquisite which exceeds 10% of total perquisites must be identified and disclosed.

  • The SEC continues to believe that it is “not appropriate to define perquisites for personal benefits given the different forms of these items”.
  • The SEC provides some guidance.  An item is not a perquisite if it is integrally and directly related to the performance of the executive’s duties (which the SEC views as a “narrow” standard).  An item is a perquisite if it confers a direct or indirect benefit that has a personal aspect, without regard to whether it may be provided for some business reason or for the convenience of the company, unless it is generally available on a non-discriminatory basis to all employees.
  • Providing a benefit “for security purposes” does not affect its perquisite status.
  • Perquisites continue to be valued based on incremental cost.  The SEC specifically notes that the tax-based SIFL aircraft use standards are not appropriate for proxy reporting.  Footnote disclosure is required of the methodology followed in computing aggregate incremental costs.

Grants of Plan-Based Awards Table

The SEC has adopted a Plan Grant Table supplemental to the SCT, relating to grants of plan-based awards.

  • The table replaces the current long-term incentive plan awards table and would to some extent provide more information on compensation reported in the SCT.
  • The grants for each executive must be provided on a grant-by-grant basis.  Aggregation is not permitted.
  • A separate column is required if the exercise price of an option is other than the closing price on the grant date.
  • A separate column is required if the grant date of an option is other than the date on which the compensation committee approved the grant.
  • Supplemental disclosure is required (in the compensation discussion and analysis section) of any practices relating to the timing of option grants in coordination with the release of material nonpublic information.

Additional Equity Information

The SEC has adopted two new tables relating to option exercises and year-end equity.

  • Current rules require information with respect to outstanding options.  The new rules require tabular information on restricted stock and potential incentive plan payouts.
  • Current rules require disclosure of the value realized on the exercise of an option. The new rules require disclosure of the value realized on the vesting of restricted stock.
  • The information must be provided for each executive on an item-by-item basis.  Aggregation is not permitted.

Post-Employment Compensation

The SEC has made significant changes to the reporting of post-employment compensation.  The current pension plan table would be replaced with new tables for “pension benefits” and “non-qualified deferred compensation” information.

  • Disclosure is required of the assumptions underlying the valuation determinations for defined benefit plans.  Disclosure is also required of the material terms and conditions of benefits, including retirement benefit formulas and early retirement arrangements.
  • If credited years of service differ from actual years of service, the table must be footnoted quantifying the difference and any resulting benefit increase.
  • For deferred compensation amounts, the material terms of the arrangements must be described, including measures used to calculate interest and plan earnings.  All earnings (and not just above-market amounts) must be shown.  Footnote quantification should be made to the extent amounts shown were previously reported in the SCT.
  • In addition to the tables, the SEC has adopted significant revisions to requirements disclosing termination or change-in-control provisions.  The narrative disclosure must include (1) the specific circumstances that trigger the payment, (2) the estimated payments and benefits that would be provided in each termination circumstance, (3) how the benefit and payment levels are determined under each circumstance, and (4) any other material features necessary to understand the provisions.  The required disclosure must include the effect of tax gross-ups, making the calculations complex.

Form 8-K Compensation Reporting

The SEC amended Form 8-K with respect to compensation reporting in August 2004.  The amendments triggered a multitude of filings with respect to executive compensation under the “material agreement” standard of Form 8-K.

  • The SEC believes that 8-K compensation disclosure should be limited to that which is unquestionably or presumptively material.  The SEC has eliminated Section 1.01 of Form 8 K compensation reporting and now provides compensation reporting only under 5.02 of 8 K.
  • Reporting under 5.02 is limited to the CEO, CFO, CAO, COO or any person performing similar functions.  The new rules also apply the reporting to persons who were named in the prior year’s proxy statement.  The required disclosures include a description of any material new compensation plans or grant/awards for such persons.

Beneficial Ownership Disclosure

The SEC has amended the beneficial ownership disclosure in the proxy statement by adding a requirement for footnote disclosure of the number of shares pledged as security by the named executive officers and directors.

Related Party  Transactions Disclosure

The SEC has made significant revisions to the related party transaction disclosure rules.  The new rule provides for principles-based disclosure.  The thresholds of the current rules (relating to certain percentages of a company’s revenues) have been deleted.

  • Disclosure is required of any transaction in which the company was a participant if the amount involved exceeds $120,000 and any director, executive officer or 5% stockholder  (or any immediate family member of such persons) would have a “direct or indirect material interest”.
  • A person does not have an “indirect material interest” if the interest arises only from such person’s position as a director of another entity or from such person’s ownership of less than 10% of the equity of such other entity.
  • The new rules require disclosure of the policies and procedures established by the company’s board of directors regarding reportable related party transactions, including policies and procedures for the review, approval or ratification of the transactions.

Corporate Governance Disclosure

The SEC has consolidated its various disclosure requirements regarding director independence and related corporate governance requirements under a single disclosure item.  Most of the required disclosure tracks that under current rules, with the following exceptions:

  • Disclosure is required of any transactions, relationships or arrangements not disclosed pursuant to required “related party disclosure” that were considered by the board of directors in determining a director’s independence.
  • Independence determinations must be made for any person who served as a director during the prior fiscal year, even if such person is no longer a director.
  • Specific compensation committee disclosure is required concerning compensation consultants, including their identification, whether the consultants are hired directly by the compensation committee, and the nature of their assignment.