United States: SEC Proposes Sweeping Compensation Disclosure Reform - Continued

The Grants of All Other Equity Awards Table is set forth below:

This new table would show all non-performance based equity compensation awards granted to a named executive officer in the last fiscal year which are not covered by the Grants of Performance Based Awards Table, and would include columns detailing, as applicable, the number of options or shares granted, the exercise or base price, the expiration date, the vesting date and the grant date. A footnote to the table would disclose any other material terms of any grant or award.

The amendments also would require a narrative description of any additional material factors necessary to an understanding of the quantitative disclosures in the Summary Compensation Table, the Grants of Performance-Based Awards Table and the Grants of All Other Equity Awards Table. This narrative disclosure is intended to give context to what appears in the tables and be more focused than the Compensation Discussion and Analysis. Examples of material factors that would, depending on the facts, be discussed in this section include the following:

• The material terms of a named executive officer’s employment arrangement;

• The repricing or material modification of any outstanding equity-based award;

• The material terms of any performance-based awards;

• The waiver or modification of any specified performance target; and

• The assumptions underlying any determination of an increase in the actuarial value of defined benefit and actuarial plans and the method of calculating earnings on deferred compensation plans.

In addition, the amendments would require a company to disclose the total compensation paid to up to three non-executive employees whose total compensation for the last fiscal year was greater than that of any of the named executive officers. The company also must provide a description of the job positions for each of these employees.

The amendments would require a new Outstanding Equity Awards at Fiscal Year-End Table in the form set forth below:

This new table would show, for each named executive officer, the total number of securities underlying exercisable and unexercisable options, SARs or similar instruments held, the in-the-money, amount of the awards, the number and market value of non-vested stock awards and the number and market or payout value of non-vested incentive plan award holdings as of the end of the last fiscal year. A footnote to the table must disclose the expiration date and vesting dates for each outstanding equity award.

The amendments also would require a new Option Exercises and Stock Vested Table in the form set forth below:

This new table is intended to show the value realized by each named executive officer from equity awards during the last fiscal year. Specifically, the table would display the total number of shares acquired by a named executive officer on exercise or vesting during the last fiscal year, the amounts realized upon exercise or vesting and the grant date fair value for the shares as previously reported in the Summary Compensation Table.

The amendments contemplate significant changes to the disclosure rules for:

• Defined benefit pension plan benefits;

• Non-qualified defined contribution pension plan benefits and other deferred compensation plan benefits; and

• Compensation arrangements triggered upon employment termination, a change in the named executive officer’s responsibilities or a change in control.

The amendments would require a new Retirement Plan Potential Annual Payments and Benefits Table in the form set forth below:

This new table would address both tax-qualified and non-tax-qualified plans. For the most common type of defined benefit plan (a plan under which benefits are calculated primarily by reference to final compensation or average final compensation), the existing rules only require a general table showing estimated annual benefits under the plan payable upon retirement for specified compensation levels and years of service. The amendments require plan-by-plan tabular disclosure of estimated annual retirement payments for each named executive officer followed by narrative disclosure of the material factors that are necessary to understand each plan, including:

• The material terms of the benefits under the plan;

• The amount of any lump sum that would be available as of the end of the last fiscal year and the valuation method and material assumptions used to calculate the lump sum amount;

• The specific elements of compensation included in the benefit formula;

• The reasons for each plan in the case of multiple plans; and

• Company policies regarding granting extra years of credited service under the plan.

In addition, the amendments require that benefit calculations reflect, and the disclosure identify by footnote, the named executive officer’s current form of benefit election (e.g., lump sum, single life annuity, etc.). Footnote disclosure also is required of any additional years of service that may have been credited to the named executive officer under a plan and the amount of any resulting benefit increase. If the named executive officer is not currently eligible to retire, the amendments require that the dollar amount of the named executive officer’s annual benefit be calculated based on his or her compensation for the prior fiscal year.

The amendments also would require a new Nonqualified Defined Contribution and Other Deferred Compensation Plans Table in the form set forth below:

This new table would show contributions, earnings, and balances under non-tax-qualified defined contribution and other deferred compensation plans for the named executive officers. While the existing rules require that company contributions and allocations to defined contribution plans be disclosed in the All Other Compensation column of the Summary Compensation Table, they do not require that compensation (such as base salary and bonus) deferred at the election of the executive be separately identified. In addition, only the above-market earnings on nonqualified deferred compensation must be shown under the existing rules; no disclosure is required of accumulating balances under these plans.

The amendments also would require a narrative description of the material factors that are necessary to understand what appears in the tables, including the measures of calculating interest or other plan earnings and the material terms of payouts, withdrawals and other distributions.

The amendments contemplate additional narrative disclosure of arrangements that compensate named executive officers on employment termination, a change in the named executive officer’s responsibilities (not required under the existing rules) or a change in control. Under the existing rules, arrangements with named executive officers (other than employment contracts) need not be disclosed if the amount involved is $100,000 or less. The amendments do not include this $100,000 exclusion. The narrative must describe:

• The specific payment and benefit triggers under the arrangements;

• The estimated payments and benefits that would be provided in each case;

• Any material conditions to the receipt of payments or benefits;

• The duration and waiver provisions of non-compete and similar agreements;

• Any tax gross-up payments;

• In the case of uncertain payments or benefits, reasonable estimates and material assumptions underlying those estimates; and

• Any other material features that are necessary to understand the arrangement.

The amendments incorporate the same thresholds for post-termination perquisites that apply to the disclosure of perquisites under the proposed Summary Compensation Table.

The amendments would require a new Director Compensation Table in the form set forth below:

This proposed Director Compensation Table is similar to the proposed Summary Compensation Table but requires disclosure only for the company’s last fiscal year. A footnote to the table must disclose the acquisition and vesting dates for the director’s outstanding equity awards at fiscal year end.

Items that would be shown in the All Other Compensation column of the proposed Director Compensation Table would include:

• Perquisites and personal benefits, unless the aggregate amount is less than $10,000;

• Earnings on nonqualified deferred compensation;

• Tax reimbursements;

• Annual company contributions or allocations to vested and unvested defined contribution and other deferred compensation plans;

• The compensation cost of any company security purchased from the company at a discount, unless the discount is generally available to all security holders or to all salaried employees of the company;

• The aggregate annual increase in actuarial value of the director’s benefits under all defined benefit and actuarial pension plans;

• Consulting fees;

• Awards under director legacy or charitable awards programs; and

• The dollar value of any life insurance premiums paid by the company (or on its behalf) for the director’s benefit.

The amendments also would require a narrative description of the material factors that are necessary to understand what appears in the table, such as a breakdown of the types of fees payable to the directors.

The amendments would expand the group of executives for which disclosure would be required under Item 5.02 of Form 8-K by adding all persons falling within the definition of named executive officer for the company’s previous fiscal year to the existing group of principal executive officer, president, principal financial officer, principal accounting officer, principal operating officer, or any person performing similar functions. Existing Item 5.02 of Form 8-K requires disclosure within four business days of the appointment or departure of directors and the specified officers and requires a brief description of the material terms of any employment agreement between the company and the officer.

In addition to expanding the scope of executives covered by Item 5.02’s existing disclosure requirements, the amendments would move to a new Form 8-K item (Item 5.02(e)) the current obligation to disclose in Item 1.01

of Form 8-K information regarding material employment compensation arrangements involving named executive officers.

New Item 5.02(e) would require disclosures regarding the principal executive officer, the principal financial officer and the named executive officers, expanding the disclosure items to include a brief description of any:

• New material compensatory plan, contract or arrangement (whether or not written) entered into with, or adopted with respect to, a covered person, or any new material grant or award is made thereunder; and

• Material amendment to any such compensatory plan, contract or arrangement (or any modification to a material grant or award).

These disclosures would be required whether or not the duty to provide a disclosure pursuant to Item 5.02 arises in connection with a triggering event (i.e., an appointment or departure).

New Item 5.02(e) also would require, as a result of such a triggering event, a brief description of any:

• Material plan, contract or arrangement to which a covered officer or director is a party or in which he or she participates that is entered into or materially amended in connection the triggering event; and

• Grant or award to any covered person (or any modification to a grant or award), under a plan, contract or arrangement in connection with any triggering event.

A company need not file a Form 8-K for grants or awards or modifications to grants or awards if they are consistent with the terms of previously disclosed plans or arrangements and they are disclosed the next time the company is required to provide new disclosure under Item 402 of Regulation S-K.

New Item 5.02(e) also would require companies to disclose salary and bonus information for the covered employees for the last fiscal year that was not available when Item 402 of Regulation S-K disclosure for the fiscal year was originally made.

The SEC has proposed that new Item 5.02(e) would enjoy the safe harbor regarding Section 10(b) and Rule 10b-5 in the event that a company fails to timely file reports required by such item. The safe harbor applies until the filing due date of the company’s quarterly or annual report for the period in question.

In addition, the SEC has proposed that the Form S-3 eligibility requirements be amended so that a company would not lose its eligibility to use Form S-3 registration statements if it failed to timely file reports required by new Item 5.02(e).

Existing Item 404 of Regulation S-K requires disclosure regarding related party transactions. Currently, the disclosure standards rely in part on instructions that serve to delineate what transactions are reportable or excludable. The SEC has proposed to make this disclosure requirement more principles-based. The amendments address disclosure requirements in four areas:

• Related person transactions (including indebtedness);

• The company’s policies and procedures for the review, approval or ratification of related person transactions;

• Transactions with promoters of a company; and

• Corporate governance disclosure requirements (including disclosure regarding the independence of directors).

The proposed amendments to Item 404(a) would retain the principles for disclosure of related person transactions that are specified in existing Item 404(a). Importantly, however, the proposed revision of Item 404(a) would delete the long-standing instructions that serve as bright line standards to delineate which transactions are reportable or excludable from disclosure. In addition, under the amendments, Item 404(c) also would be deleted so that indebtedness involving a related person would be disclosable only if the transaction constituted a related party transaction requiring disclosure under revised Item 404(a).

Under proposed Item 404(a), a company must disclose any transaction since the beginning of the company’s last fiscal year or any currently proposed transaction:

• In which the company was or is to be a participant;

• In which the amount involved exceeds $120,000; and

• In which any related person had, or will have, a direct or indirect material interest.

The amendments retain the "materiality" standard for disclosure currently embodied in Item 404(a); disclosure would be based on whether the related person had, or will have, a direct or indirect material interest in the transaction. The materiality of any interest would continue to be determined based upon a determination of the significance of the information to investors in light of all the circumstances and the significance of the interest to the person having the interest. The relationship of the related persons to the transaction, and with each other, and the amount involved in the transaction would be among the factors to be considered in determining materiality.

The proposed amendments would eliminate existing Instructions 1, 7 and 9 to Item 404(a).

The proposed amendments also would modify the current rules by:

• Requiring disclosure if a company is a "participant" in a transaction, rather than if it is a "party" to the transaction;

• Increasing the $60,000 threshold for disclosure to $120,000;

• Including a defined term for "transaction" that covers a series of similar transactions; and

• Including a single defined term for "related persons."

As is currently the case, disclosure would be required for three years in applicable filings under the Securities Act.

The proposed amendments would eliminate the existing distinction between indebtedness and other types of related person transactions by integrating Item 404(c) into Item 404(a).

The effect of this integration would be to require disclosure of:

• Indebtedness transactions with regard to all related persons covered by the related person transaction disclosure requirement, including significant shareholders; and

• All material indirect interests in indebtedness transactions of related persons, including significant shareholders and immediate family members.

Disclosure of material indirect interests of these related persons in transactions involving the company would continue to be required by Item 404(a). In addition, certain ordinary course loans by financial institutions would be subject to an exception contained in an instruction to Item 404(a).

The proposed amendments include definitions of certain terms, including: "transaction," "related person" and "amount involved."

Under the amendments:

• "transaction" would include, but not be limited to, any financial transaction, arrangement or relationship or any series of similar transactions, arrangements or relationships (including indebtedness and guarantees of indebtedness);

• "related person" would mean any (1) director or executive officer of the company and his or her immediate family members; (2) any nominee for director and the immediate family members of any nominee for director (with respect to disclosure provided in a proxy or information statement involving the election of directors); and (3) any 5% security holder (known to the company) or any immediate family member of any such person. In addition, the term "immediate family member" of a related person would be expanded from the existing definition (essentially children, parents, spouses, siblings, and in-laws) to expressly include stepchildren, stepparents and any person (other than a tenant or employee) sharing the household of a related person; and

• "amount involved" would mean the dollar value of the transaction, or series of similar transactions and would include: (1) for leases or similar transactions, the aggregate amount of all periodic payments or installments due on or after the beginning of the company’s last fiscal year, including any required or optional payments due during or at the conclusion of the lease; and (2) in the case of indebtedness, the largest aggregate principal amount of all indebtedness outstanding at any time since the beginning of the company’s last fiscal year and all amounts of interest payable on it during the last fiscal year.

The effect of these definitions would be to clarify and broaden what constitutes a related party transaction requiring disclosure.

For example, one consequence of the new "related person" definition would be the express requirement to disclose any transaction involving the company and a person (other than a significant shareholder or family member of such shareholder) that occurred during the last fiscal year, so long as the person was a "related person" during any part of that year. Current Item 404(a) does not state that disclosure is required under such circumstances, although many practitioners have interpreted Item 404(a) as requiring disclosure for a transaction with a "related person" if the requisite relationship existed at the time of the transaction, even if the person was no longer a related person at the end of the company’s most recent fiscal year.

Notably, the proposed amendments to Item 404(a) also clarify that disclosure is not required for transactions with persons who have been or who will become significant shareholders (or their family members), but were not so at the time of the transaction. However, disclosure would be required regarding a transaction that begins before a significant shareholder achieves such status and continues (for example, through the on-going receipt of payments) on or after the person becomes a significant shareholder.

The proposed amendments to Item 404(a) also specify the disclosure requirements for related person transactions. The description of the transaction must include:

• The person’s relationship to the company;

• The person’s interest in the transaction with the company, including the related person’s position or relationship with, or ownership in, a firm, corporation or other entity that is a party to or has an interest in the transaction; and the dollar value of the amount involved in the transaction and of the related person’s interest in the transaction; and

• Any other information regarding the transaction or the related person in the context of the transaction that is material to investors.

Existing required disclosure of amounts possibly owed to the company under Section 16(b) of the Exchange Act (i.e., short-swing profit liability) would be eliminated.

Finally, the amendments except certain categories of transactions from the related party disclosure rules, either because the disclosure is made under other disclosure rules or because the transactions are outside of the materiality principles articulated in the amendments.

The excepted categories of transactions include:

• Disclosure of certain compensation arrangements as follows:

• Compensation to an executive officer if: (1) the compensation is reported under Item 402 of Regulation S-K; or (2) the executive officer is not an immediate family member of a related person and the compensation would have been reported under Item 402 as compensation earned for services to the company if the executive officer was a named executive officer, and such compensation had been approved by the compensation committee (or a group of independent directors performing a similar function); and
• Compensation to a director (or nominee for director) if the compensation is reported under proposed Item 402(l).

• Certain situations involving indebtedness, including:

• Amounts due from the related person for purchases of goods and services subject to usual trade terms, ordinary business travel and expense payments, and other transactions in the ordinary course of business; and
• Indebtedness in which the lender is a bank, savings and loan association or broker-dealer extending credit (and the loans are not otherwise required to be disclosed as non-accrual, past due, restructured or potential problems).

In the case of indebtedness in which the lender is a bank, savings and loan association or broker-dealer, the only required disclosure will be a statement, if correct, that the loans (1) were made in the ordinary course of business; (2) were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with persons not related to the bank; and (3) did not involve more than the normal risk of collectibility or present other unfavorable features.

Finally, the amendments contain a new instruction that indicates that a person who has a position or relationship with a firm, corporation or other entity that engages in a transaction with the company will not be deemed to have an indirect "material" interest within the meaning of revised Item 404(a) if:

• The interest arises only (1) from the person’s position as a director of another corporation or organization that is a party to the transaction; (2) from the direct or indirect ownership by the person and all other related persons, in the aggregate, of less than a 10% equity interest in another person (other than a partnership) which is a party to the transaction; or (3) from both such position and ownership; or

• The interest arises only from the person’s position as a limited partner in a partnership in which the person and all other related persons have an interest of less than 10% and the person is not a general partner of, and does not have another position in, the partnership.

The amendments would require a company to describe the company's policies and procedures for the review, approval or ratification of transactions with related persons that would be reportable under Item 404(a). The description would include the material features of these policies and procedures, including:

• The types of transactions that are covered by the policies and procedures and the standards to be applied pursuant to the policies and procedures;

• The persons or groups of persons on the board of directors or otherwise who are responsible for applying the policies and procedures; and

• Whether the policies and procedures are in writing and, if not, how such policies and procedures are evidenced.

The amendments also would require the company to identify any related party transactions where the company’s policies and procedures did not require review, approval or ratification or where the policies and procedures were not followed.

The amendments would require disclosure in Securities Act registration statements regarding promoters and transactions with those promoters if the company had a promoter at any time during the last five fiscal years. The disclosure would include:

• The names of the promoters;

• The nature and amount of anything of value received by each promoter from the company and the nature and amount of any consideration received by the company; and

• Additional information regarding any assets acquired by the company from a promoter.

Although the amended disclosure requirements are consistent with existing requirements regarding promoters, this disclosure is not currently required if the company was organized more than five years ago. The amendments also would require the same disclosure that is required for promoters for any person who acquired control, or is part of a group that acquired control, of a company that is a shell company.

The amendments would consolidate in new Regulation S-K Item 407 the disclosure requirements regarding director independence and related corporate governance disclosure requirements and update director independence disclosure to reflect existing SEC requirements and listing standards.

Under the amendments, a company must identify the independent directors of the company (and, in proxy or information statements, nominees for director) under the definition for determining board independence applicable to its directors. The amendments also would require disclosure of any members of the compensation, nominating and audit committees that the company had not identified as independent under the definition of independence for that board committee applicable to it.

If the company is not listed, the amendments would require disclosure of those directors and director nominees that the company identifies as independent (and committee members not identified as independent) using a consistent definition for independence for directors (and for committee members) of a national securities exchange or a national securities association, as specified by the company.

The amendments would require a company that has adopted definitions of independence for directors and committee members to disclose whether those definitions are posted on the company’s Web site. Alternatively, a company could include the definitions as an appendix to the company’s proxy materials at least once every three years or if the policies have been materially amended since the beginning of the company’s last fiscal year.

For each director or director nominee identified as independent, the company must describe any transactions, relationships or arrangements not disclosed under Item 404(a) that were considered by the board of directors in determining that the applicable independence standards were met.

This independence disclosure would be required for any person who served as a director of the company during any part of the year for which disclosure must be provided, even if the person no longer serves or, if the information is in a proxy statement, if the director’s term of office will not continue after the meeting.

The amendments also would revise the existing rules regarding the audit committee and nominating committee disclosure to eliminate duplicative committee member independence disclosure and to update the required audit committee charter disclosure requirement for consistency with the nominating committee charter disclosure requirements. A company would no longer need to deliver the audit committee charter to shareholders if it posts the charter on the company’s Web site.

The amendments also call for disclosure regarding compensation committees similar to that regarding audit and nominating committees. For example, if the compensation committee’s authority is set forth in a charter or other document, the company would have to disclose the Web site address at which a current copy is available. If the charter is not so posted, it must be attached to the proxy statement as an appendix at least once every three years.

In addition, the company would have to describe its processes and procedures for the consideration and determination of executive and director compensation, including:

• The scope of authority of the compensation committee (or persons performing the equivalent functions);

• The extent to which the compensation committee (or persons performing the equivalent functions) may delegate any authority to other persons, specifying what authority may be so delegated and to whom;

• Any role of executive officers in determining or recommending the amount or form of executive and director compensation; and

• Any role of compensation consultants in determining or recommending the amount or form of executive and director compensation, identifying such consultants, stating whether such consultants are engaged directly by the compensation committee (or persons performing the equivalent functions) or any other person, describing the nature and scope of their assignment, the material elements of the instructions or directions given to the consultants with respect to the performance of their duties under the engagement and identifying any executive officer within the company the consultants contacted in carrying out their assignment.

The amendments would consolidate into this compensation committee disclosure requirement the existing Item 402 requirement to disclose compensation committee interlocks and insider participation in compensation decisions.

The proposed amendment to Item 403(b) would require footnote disclosure of the number of shares pledged as security by named executive officers, directors and director nominees. Similar disclosure would not be required of shareholders who are not members of management, other than pledges that may result in a change of control currently required to be disclosed.

Generally, the amendments would affect foreign private issuers only in certain limited circumstances. However, in each instance, the SEC has requested comments as to whether greater application of the amendments should be considered.

The three areas affecting foreign private issuers are as follows:

Currently, a foreign private issuer will be deemed to comply with Item 402 of Regulation S-K if it provides the information required by Items 6.B. and 6.E.2. of Form 20-F, with more detailed information provided on an individual basis if otherwise made publicly available. The amendments would continue this treatment of these companies and clarify that the treatment of foreign private issuers under Item 402 parallels that under Form 20-F.

The SEC has proposed revising the exhibit instructions to Form 20-F under which foreign private issuers would be required to file any employment or compensatory plan with management or directors (or portion of such plan) only when the foreign private issuer either is required to publicly file the plan (or portion of it) in its home country or if the foreign private issuer had otherwise publicly disclosed the plan.

The amendments to the exhibit instructions to Form 20-F are intended to be consistent with the existing disclosure requirements under Form 20-F relating to executive compensation matters for foreign private issuers. In the same way that executive compensation disclosure under Form 20-F largely mirrors the disclosure that a foreign private issuer makes under home country requirements or voluntarily, so too the public filing of management employment agreements as an exhibit to Form 20-F would under the amendments mirror the public availability of such agreements under home country requirements or otherwise.

Currently a foreign private issuer will be deemed to comply with Item 404 of Regulation S-K if it provides the information required by Item 7.B. of Form 20-F. The amendments would retain this approach, but would require that if more detailed information is required to be disclosed by the company’s home jurisdiction or a market in which its securities are listed or traded, that same information must also be disclosed under Item 404.

Members of Orrick’s Compensation & Benefits, Corporate, and Securities Litigation groups are available to assist you with questions regarding the various aspects of the proposed rule changes.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.