SEC Approves Final Rules to
Enhance Disclosures Regarding Risk, Compensation and Corporate Governance
On December 16, 2009, the Securities and Exchange Commission (SEC) approved amendments to rules which will impact proxy statements and related disclosures for companies which have a fiscal year ending after December 20, 2009. The amended rules are designed to enhance accountability and to help shareholders make more informed voting and investment decisions. The amended rules are effective February 28, 2010.[1]
Corporate Governance – Board Leadership Structure
New disclosure requirements now mandate disclosure of:
· the company's board leadership structure and why the company believes it is the most appropriate leadership structure;
· whether and why the company has chosen to combine or separate the chief executive officer and board chair positions;
· the rationale for the appointment of a lead director, if applicable, and a description of the role the lead director plays in the leadership of the company; and
· the board's role and involvement in risk oversight.[2]
The disclosure is designed to provide investors with insights about why the company has chosen a particular board leadership structure and how that structure assists in risk oversight. Such disclosures may address questions such as whether the persons who oversee risk report directly to the board as whole or to a committee and whether and how the board, or board committee, oversees risk.
Corporate Governance – Board Nominees and Incumbent Directors
Companies must also disclose additional information about directors' and director nominees' particular qualifications, including experience and particular skills to serve on the board.[3] Essentially, companies must include disclosure every year for each incumbent director and nominee focused on the specific "experience, qualifications, attributes or skills" that led the board to conclude that such person should serve (or continue to serve) as a director. The final rules do not require similar disclosure regarding board committee appointments (other than if the qualifications relate to a specific committee such as the audit committee). In addition, the new rules require companies to disclose, for each director and each nominee, other directorships held at public companies in the past five years (as opposed to only current directorships under the existing rules). Legal proceedings involving directors, director nominees, and executive officers also need to be disclosed if occurring in the past 10 years (as opposed to five years under the current rules). The final rules also expanded the types of legal proceedings that must be described. Companies must also now disclose if and to what extent diversity was considered in the director nomination process. In addition, if there is an existing policy with regard to the consideration of diversity in identifying director nominees, disclosure is required of how any such policy is being implemented and its effectiveness.
Risk Management/Compensation Disclosures
The new rules now require a company to discuss and analyze its
compensation policies and compensation practices from the perspective of risk
management if risks arising from those compensation policies are reasonably
likely to have a material adverse effect on the company. Not surprisingly, the SEC intends that the disclosures
will help investors determine whether the company has
established a system of incentives that can lead to excessive or inappropriate
risk taking.
The final rules added the
"reasonably likely" disclosure threshold similar to existing
Management's Discussion and Analysis (MD&A)
rules, added "adverse" to qualify material effect and removed the
required disclosure from the Compensation Discussion and Analysis (CD&A) section.
Also included in the final rules is a non-exclusive listing of scenarios
where compensation policies or programs could raise material risks as well as
examples of the types of issues that companies may consider addressing in their
disclosures.
Smaller reporting companies will
not, under the final rules, be required to provide this new disclosure even
though the new rule will not be a part of CD&A.[4]
The final rules also confirmed that
disclosing companies are not required to include an affirmative
statement that it has determined that the risks arising from its compensation
policies and practices are not reasonably likely to have a material adverse
effect on the company.
To address these new disclosure requirements, you should consider:
· how risk is monitored, whether or not tied to executive compensation philosophy or management;
· any unique business unit risks;
· the time horizon over which compensation may be earned;
· the existence and terms of effective compensation clawback or holding period provisions;
· the extent to which total compensation is tied to performance targets within the executive's actual or perceived control versus broader company performance metrics;
· the company's general risk profile when compared to its competitors;
· the company's specific risk profile and how its specific risk factors could impact decisions by managers who might seek short term financial gains; and
· any necessary adjustments to compensation policies and practices as a result of changes in the company's risk profile.
Summary Compensation Table
The revised Summary Compensation Table now requires disclosure of the aggregate grant date fair value of awards computed in accordance with FASB ASC Topic 718.[5] Previously, disclosure was required of the dollar amount recognized for financial statement reporting purposes for the fiscal year. For performance-based awards, the final rules provide for disclosure of compensation based on the probable outcome of the conditions as of the grant date rather than based on maximum performance as originally proposed (but with footnote disclosure of the maximum potential payout).
Disclosure of full grant date fair value permits, in the view of the SEC, investors to better evaluate the amount of equity compensation awarded. Also, because total compensation is the basis for determining which executives, in addition to the principal executive officer and principal financial officer, are the named executive officers whose compensation is reported, the full grant date fair value measure may better align the identification of named executive officers with company compensation decisions.
Disclosure of Shareholder Votes
The results of a shareholder vote must now be disclosed in a Form 8-K within four business days of the shareholder vote.[6] Previously, companies were required to disclose the results of a shareholder vote in the company's next Form 10-Q (or Form 10-K with respect to the fourth fiscal quarter).
Compensation Consultant Conflict of Interest
If a board of directors or compensation committee engages a compensation consultant which are paid more than $120,000 for non-executive compensation consultation services[7], the company must now describe:
· any role played by compensation consultants in determining or recommending the amount or form of executive and director compensation;
· the identity of compensation consultant;
· whether the compensation consultant was recommended by management, retained by management or directly by the board, compensation committee or any other person;
· in certain circumstances the amount of fees paid to the consultant; and
· the material elements of any instructions or directions given to the consultants with respect to the performance of their duties under the engagement. [8]
Similar disclosure is required even if the board or the compensation committee has not engaged its own consultant but the company has retained a consultant directly. A limited exception is provided for fees paid by the company to a consultant if the board (or the compensation committee) has retained its own consultant. Previously, companies were not required to disclose the fees paid to compensation consultants for executive compensation consulting or other services or to describe services that were not related to executive or director compensation.
Compensation consultants often provide additional services (e.g., benefits administration, human resources consulting and actuarial services) generating substantial fees which may create a conflict of interest. Additionally, services provided by such consultants to other companies where directors overlap can also raise conflict of interest issues.
For further information, or to discuss the implications of the new rules, please contact Joseph DeGroff, Stephen Hackman, Marc Sciscoe, Richard Thrapp
This publication is intended for general information
purposes only and does not and is not intended to constitute legal
advice. The reader must consult with legal counsel to determine how laws
or decisions discussed herein apply to the reader's specific circumstances.