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December 18, 2009 |
Schiff Hardin Public Companies Alert On December 16, 2009, the U.S. Securities and Exchange Commission ("SEC") adopted final rules ("Final Rules") requiring enhanced disclosure in proxy and information statements, annual reports and registration statements regarding compensation policies and practices, risk management and oversight, and other corporate governance matters. The SEC received more than 130 comment letters on the rule amendments it proposed on July 10, 2009, and the Final Rules largely adopt those proposed amendments, with certain key modifications arising from the SEC's consideration of the comments it received. The full text of SEC Release No. 33-9809 describing the Final Rules is available at http://sec.gov/rules/final/2009/33-9089.pdf. This alert provides a brief summary of the Final Rules and a few action items for companies to consider as they begin to grapple with the enhanced disclosure requirements. The Final Rules are effective February 28, 2010, with the caveat that certain amended rules concerning the reporting of equity-based awards are effective for any disclosure regarding a fiscal year ending on or after December 20, 2009. Public companies will therefore be required to comply with these enhanced disclosure rules in their proxy statements for the 2010 proxy season and should begin immediately to consider the impact of the amendments. Narrative Disclosures Concerning Risk Management. The Final Rules require that, to the extent a company's compensation policies and practices for its employees create risks that are reasonably likely to have a material adverse effect on the company, the company must discuss those risks. The rule aims to help investors identify whether the company has established a system of incentives that can lead to excessive or inappropriate risk taking by employees. The discussion should cover compensation policies and practices applicable to all employees, not just executive officers. Smaller reporting companies are not required to provide this additional disclosure. Furthermore, if a company 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, no disclosure is necessary, and an affirmative statement to that effect is not required. The SEC provided a non-exhaustive list of situations that may trigger a discussion under these rules, including where a company has compensation policies and practices:
The SEC also provided examples of issues that may need to be addressed in this discussion, including:
The "reasonably likely to have a material adverse effect" standard adopted in the Final Rules represents one of the significant modifications from the rules proposed in July, which would have required a discussion of risks that "may have a material effect." In adopting the standard, the SEC drew comparisons to the "reasonably likely" threshold utilized in the rules governing Management's Discussion and Analysis and stressed that the narrower threshold is intended to elicit the most relevant disclosures concerning potential harm to the company and to reduce overly voluminous or speculative disclosures. Another change from the proposed rule was to move the new requirements to a separate paragraph in Item 402 of Regulation S-K, independent of the Compensation Discussion and Analysis ("CD&A"). The SEC made this change in order to reduce potential confusion that could have resulted from including in the CD&A, which is otherwise limited to a company's named executive officers, a discussion of policies and practices applicable to all company employees. Reporting Full Grant Date Value of Equity Awards. The Final Rules include an amendment to Item 402 of Regulation S-K to require that for purposes of calculating the aggregate grant date fair value of stock options and other equity-based awards reported in the Summary Compensation Table and the Director Compensation Table, companies use Financial Accounting Standards Board Accounting Standards Codification Topic 718 (formerly Statement of Financial Account Standards No. 123(R)), instead of the previously mandated financial statement recognition amount. The SEC added a specific instruction for performance awards, stating that the value of those awards should be computed based upon the probable outcome of the performance conditions as of the grant date (as opposed to maximum performance) to better reflect how compensation committees take performance-contingent vesting conditions into account in granting such awards. The maximum value, however, must be reported in a footnote to the applicable table. To implement this updated disclosure requirement, companies providing Item 402 disclosure for a fiscal year ending on or after December 20, 2009 must recompute amounts (including in the total compensation column) for all the preceding years included in the applicable table. The amounts reflected in the stock and option awards columns should be calculated 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. If a person who is a named executive officer for fiscal year 2009 was disclosed as a named executive officer for fiscal year 2007, but not for 2008, the named executive officer's compensation for each of those three fiscal years must be reported. Note, however, that companies are not required to include different named executive officers for any prior fiscal year based on the recalculated compensation amounts for those years, nor to amend the disclosure in previously filed Forms 10-K or other filings. The Final Rules include additions to Item 401(f) of Regulation S-K that require enhanced disclosure regarding the qualifications of each incumbent director and any nominee for director listed in proxy and information statements on Schedules 14A and 14C, annual reports on Form 10-K and registration statements. These enhancements include disclosure of:
The enhanced disclosures required by the Final Rules differ in some ways from the rules proposed in July. Unlike the proposed amendments, the Final Rules do not require a recitation of specific experience, qualifications or skills that qualify an individual to serve as a committee member unless that person was specifically chosen because of a particular qualification related to service on a specific committee. The Final Rules also omit a specific requirement to discuss directors' or nominees' risk assessment skills. Additionally, the Final Rules amend Item 407(c) of Regulation S-K to require that companies disclose whether, and if so how, a nominating committee (or board) considers diversity in identifying director nominees. Further, if the nominating committee (or board) has such a diversity policy, the company must disclose how this policy is implemented, and how the nominating committee (or board) assesses the effectiveness of its policy. Interestingly, the SEC did not define "diversity" for purposes of its amended disclosures. Rather, the release states that, given the various concepts of diversity, including differences of viewpoint, professional experience, education, skill, race, gender and national origin, each company should be allowed to define diversity in a way it finds appropriate. Disclosure of Leadership Structure. The Final Rules include an amendment to Item 407 of Regulation S-K and a corresponding amendment to Item 7 of Schedule 14A requiring disclosure of a company's board leadership structure and a discussion of why the company believes its board leadership structure is the best structure for the company at the time of the filing. This required disclosure includes (i) whether and why the company has chosen to combine or separate the principal executive officer and board chair positions and (ii) whether and why the company has a lead independent director and the role of the lead independent director in the leadership of the board. Disclosure of the Board's Role in the Risk Oversight. An additional amendment to Item 407 of Regulation S-K requires disclosure in proxy statements and information statements about the board's involvement in the oversight of risk for the company, including information about how a company perceives the role of its board and the relationship between the board and senior management in managing the material risks the company faces. In this regard, companies should describe how the board administers its risk oversight function, such as through the whole board or through a separate risk or audit committee, and who supervises the day-to-day risk management responsibilities. The Final Rules include amendments to Item 407 of Regulation S-K requiring enhanced disclosure regarding compensation consultants and their affiliates when the consultants play a role in determining or recommending the amount or form of executive and director compensation and also provide other services to the company. These enhanced disclosure requirements, which are aimed at highlighting potential conflicts of interest, can be summarized as follows: Board Consultant Provides Other Services to the Company. If the board, compensation committee or other persons performing the equivalent functions (collectively, for these purposes, the "board") has engaged its own consultant to provide advice or recommendations on the amount or form of executive and director compensation, and the board's consultant or its affiliates also provide other non-executive compensation consulting services to the company, enhanced disclosure is required if the fees for the non-executive compensation consulting services exceed $120,000 during the company's last completed fiscal year. In these circumstances, companies must disclose: (1) the aggregate fees paid for services with regard to determining the amount or form of executive and director compensation, and (2) the aggregate fees paid for any non-executive compensation consulting services provided by the compensation consultant or its affiliates. Additionally, in this circumstance, companies must disclose whether the decision to engage the compensation consultant or its affiliates for non-executive compensation consulting services was made or recommended by management, and whether the board has approved these other services. Board Has Not Engaged Its Own Consultant, But a Consultant Provides Both Executive Compensation Services and Non-Executive Compensation Services to the Company. If the board has not engaged its own consultant, disclosure of aggregate fees paid to a consultant (including its affiliates) providing both executive compensation consulting services and non-executive compensation consulting services to the company is required, but only if the fees for the non-executive compensation consulting services exceed $120,000 during the company's last completed fiscal year. The SEC believes there is less potential for conflicts of interest in this circumstance, but subject to the $120,000 threshold, still felt that enhanced disclosure is necessary since the board is not receiving its own independent advice from a consultant. Both Board and Management Have Their Own Consultant. Fee and related disclosure is not required for consultants engaged by management (whether the engagement is only for executive compensation consulting services, or for both executive compensation consulting and other non-executive compensation consulting services), as long as the board has its own consultant. The SEC believes the potential for conflicts of interest is mitigated in this circumstance since the board is receiving insight from its own consultant. It should be noted, however, that the disclosures set forth above are still required if the consultant engaged by the board also provides non-executive compensation services to the company in an amount exceeding $120,000 for the last completed fiscal year. Exceptions. Services involving only broad-based non-discriminatory plans or the provision of information, such as surveys, that are not customized for the company, or are customized based on parameters that are not developed by the consultant and about which the consultant does not provide advice, are not treated as executive compensation consulting services for purposes of the compensation consultant disclosure rules. The Final Rules require disclosure of voting results from a shareholder meeting to be made within four business days after the end of the meeting in a current report on Form 8-K, rather than being made in a Form 10-Q or Form 10-K filed with respect to the period during which the meeting was held (as previously required). If definitive voting results are not available within four business days of the meeting, the company is required to disclose preliminary voting results on a Form 8-K within four business days of the meeting and then file an amended Form 8-K within four business days after final voting results are certified. The new disclosures are accomplished through the adoption of a new Item 5.07 to Form 8-K. Given the applicability of these new and amended rules to proxy statements for the upcoming 2010 proxy season, companies should immediately begin to prepare for compliance with the rules and consider the extent to which the amended rules may require new or enhanced disclosures in their proxy statement and other public filings. The following are a few actions items that companies and their counsel should consider as they look toward the quickly approaching proxy season:
If you have any questions concerning this alert or the SEC's enhanced disclosure rules, do not hesitate to contact any member of Schiff Hardin's Public Companies Team. We also invite you to attend and participate in Schiff Hardin's GC Roundtable on January 7, 2010 - an interactive session to hear about and discuss these and other developments facing companies and their counsel as we head into the 2010 proxy season. More information concerning the Roundtable is available at the event Web site or from any member of the Public Companies Team. ABOUT PUBLIC COMPANIES AT SCHIFF HARDIN With a long-standing expertise in the federal securities laws, Schiff Hardin is well-positioned to provide public companies across the United States with the full range of services necessary to compete effectively in today's global marketplace. Our primary goals are to know our clients, learn their business and their industry, and work closely with them to address the many legal, regulatory and other challenges currently facing public companies. For more information, see our Web site. |