SEC Adopts Expanded Compensation, Risk and Other Corporate Governance Disclosures
In December 2009, the Securities and Exchange Commission (“SEC”) approved a set of final rules generally designed to broaden the scope of information provided to shareholders in 2010 company proxy statements regarding certain matters relating to compensation, board leadership, risk oversight and other corporate governance matters.
REPORT CONTENTS
- Key Takeaways
- Effective Date
- Stock and Option Awards in the Summary Compensation Table and Director Compensation Table
- Compensation Consultants Disclosure
- Compensation Policies and Practices and Risk Management
- Director and Officer Disclosure
- Risk Oversight and Board Leadership Structure
- Consideration of Diversity in the Director Nomination Process
- Voting Results
- Conclusion
Key Takeaways
Companies will need to quickly gather and assess a considerable amount of information in order to prepare disclosure in response to the new rules. Furthermore, companies should also understand the impact of the new disclosure based on how it will be viewed by their investors and proxy advisory firms (see our last report, dated December 2, 2009: RiskMetrics 2010 U.S. Policy Updates: Key Changes on Executive Pay Policies, Poison Pill Policy, Board Independence). In light of the new rules, the coming weeks will place additional stress on boards and management. Companies should review information in a number of areas.
Disclosures Relating to Compensation:
- Assess the impact of grant date fair value reporting of equity awards on the determination of the company’s named executive officers.
- Assess whether the additional compensation consultant disclosures will apply. To do so, begin a process to identify engagements by the company (and its subsidiaries) of the consultant and any of the consultant’s affiliates, and gather all necessary information. Consider whether the compensation committee should establish procedures for additional services provided by compensation consultants, such as procedures for “preapproval,” similar to those used by audit committees for nonaudit services. Finally, companies should consider asking the compensation consultants used by their compensation committees what internal measures they are taking to ensure that their clients have all necessary information and are not tripped up by these new disclosure requirements.
- Evaluate executive compensation programs through the prism of “pay riskiness” and educate compensation committee directors as to how RiskMetrics (“RMG”) views compensation risk. While the compensation committee may ultimately disagree with RMG’s policy, members should be aware of it and its potential impact, nonetheless.
Disclosures Relating to Director Qualifications:
- Initiate a process for the nominating committee and/or the full board to determine the company directors’ and nominees’ qualifications, including the individuals’ experience, attributes or skills, for disclosure in the proxy statement. Boards may want to make use of the experience or skills matrices that they may already be using to determine if they currently have the right mix for the strategic path of their companies. By tying individual qualifications to boards’ and companies’ overall needs, companies are more likely to make their boards appear as the cohesive groups that they are and not as random groupings of individual skills. Whatever approach is taken, we recommend that companies be particularly thoughtful in providing this disclosure each year in the context of changing strategy and director needs. This could become very relevant if a company later becomes involved in a “vote no” campaign against one or more of its directors, or in a proxy fight, or later has a “proxy access” nominee in its proxy statement. In such a situation, the description of each director’s or nominee’s experience, qualifications, attributes and skills can be expected to be closely examined and possibly compared to those of competing nominees for that director’s or nominee’s seat on the board. Companies will take a variety of approaches in providing this type of disclosure, as it will reflect the view held by the board nominating committee or full board that the person is qualified to be nominated and serve as a director. Some companies may include it in the existing biographical information section, while other companies may provide the disclosure in a format similar to the independence-disclosure requirement.
- Initiate a process for the nominating or governance committee and board to consider the board’s leadership structure, including whether the same director serves as both chairman and CEO. If the same person holds both positions, companies should disclose whether they have a lead independent director and what role that person plays. In this regard, companies would be well advised to review the details that RMG considers when evaluating whether or not to support a shareholder proposal calling for an independent chairman. In many cases, companies may have lead or presiding directors that satisfy all or part of the RMG policy, but they may inadvertently omit such disclosure in their proxy statements. In other cases (and particularly when a company’s shareholder base is strongly influenced by RMG recommendations), companies may want to enhance the role of their lead or presiding directors in order to satisfy or exceed all elements of RMG policy.
- Revise director and executive questionnaires to include, as noted in more detail below, any information about past legal proceedings and past directorships (for directors). Also, include questions that would help gather information that would be considered by the board or nominating committee in assessing the qualifications of directors (and director nominees).
Effective Date
These new rules generally have an effective date of February 28, 2010. However, a week after the rules were approved, the SEC issued interpretative guidance clarifying the effectiveness of the rules:
- Forms filed prior to February 28, 2010, are generally not required to comply with the new disclosure rules (even if they relate to fiscal years ending on or after December 20, 2009, or to annual meetings being held on or after February 28, 2010), with the exception of preliminary proxy statements. Preliminary proxy statements filed prior to February 28, 2010, must comply with the new disclosure rules if the company expects to file its definitive proxy statement on or after February 28, 2010.
- Forms filed prior to February 28, 2010, may voluntarily comply with the new disclosure rules. However, the SEC provides that a filing may utilize the new equity compensation rules only if it also complies with the other new requirements.
- A new registrant that files a registration statement on or after December 20, 2009, must comply with the new disclosure rules in order for the statement to be declared effective on or after February 28, 2010.
Stock and Option Awards in the Summary Compensation Table and Director Compensation Table
Item 402 of Regulation S-K requires valuation of equity awards in the Summary Compensation Table and Director Compensation Table based on the grant date fair value of awards during the covered year, rather than reporting the dollar amount as an accounting expense during the covered year for all outstanding awards. For performance awards, grant date fair value will be based on the probable outcome of performance conditions, with disclosure regarding award value in the event of “maximum performance.” Under the new rules, companies do not have to change the individuals who constitute named executive officers as a result of the recalculations, but must recalculate amounts for each preceding fiscal year required in the table.
Compensation Consultants Disclosure
Item 407 of Regulation S-K requires enhanced disclosure of fees paid to certain compensation consultants who provide advice to the board or compensation committee regarding executive or director compensation and who also provide other services to the company. If the board or compensation committee has engaged its own compensation consultant and that consultant or its affiliates provide other services to the company (not relating to executive officer or director compensation) in excess of $120,000 during the fiscal year, the company is then required to disclose:
- the aggregate fees paid for advising on the form and amount of executive and director compensation and the amount paid for additional services;
- whether management made or recommended the decision to engage the consultant or its affiliates for those additional services; and
- whether other services were approved by the board or compensation committee.
If management has retained a consultant to advise on the form or amount of executive compensation, and the consultant or its affiliates provide other services to the company in excess of $120,000 during the fiscal year, and the board or compensation committee has not engaged its own compensation consultant, then the company is required to disclose the aggregate fees paid for advising on executive compensation and for the other services. The rule does contain certain exceptions for services that are provided by compensation consultants in connection with certain nondiscriminatory plans and for the providing of surveys that are specifically intended for a particular company or that are designed only according to parameters set by someone other than the consultant.
Compensation Policies and Practices and Risk Management
Item 402 of Regulation S-K requires that companies analyze and discuss their compensation policies and practices for all employees if the compensation policies and practices create risks that are “reasonably likely to have a material adverse effect” on the company. The new rule applies to all compensation for employees, not just executive officers. The new rule also provides a list of examples of matters that a company may need to address for employees or business units when disclosure is required under the new rule. This new disclosure will appear in a separate compensation-related disclosure section and not in the companies’ Compensation Disclosure and Analysis. Small reporting companies are not subject to this new disclosure requirement.
The SEC staff (the “Staff”) specified that the objective of this rule is to provide information that is most significant for investors and a focus on compensation policies that could create such financial risks. If a company and its board determine that no such financial risk exists, no additional disclosure is required.
Additionally, note that in response to this new disclosure, as well as concerns about excessive risk-taking contributing to the financial system crisis, RMG’s evaluation of problematic pay practices related to management say on pay proposals in 2010 will now include an assessment of the “riskiness” of a company’s pay practices. RMG will provide a comprehensive review of a company’s pay programs and highlight aspects that might be of concern due to potential risk-motivating pay elements. Practices that incentivize excessive or inappropriate risk-taking — such as the use of a single performance metric for both short- and long-term plans, or mega annual equity grants that provide unlimited upside with no downside risk — will be considered problematic. In its evaluation, RMG will also take into account aspects such as the company’s clawback policies and long-term stock-holding requirements that may mitigate these risk-related concerns.
As we have stated previously, we encourage some companies, based on a review of their investor composition and the complexity of their compensation programs, to consider additional means of communicating their compensation policies, rather than relying on the proxy statement as a means to do so.
Director and Officer Disclosure
Item 401 of Regulation S-K is amended to require that companies provide additional biographical disclosure relating to directors and officers with respect to the following:
- The experience, qualifications, attributes and skills of directors and director nominees that led to the conclusion that, in light of the company’s business and structure, these persons should serve as directors at the time of the disclosure
- All public company directorships held by directors and directors nominees during the past five years
- The involvement of directors, director nominees and executive officers in legal proceedings during the prior ten years
The required disclosures regarding experiences, qualifications, attributes and skills of directors apply to current directors who serve before or after the annual meeting, not just to those directors who are standing for re-election.
Risk Oversight and Board Leadership Structure
A new disclosure under Schedule 14A and Item 407 of Regulation S-K requires a discussion of the following:
- A company’s board leadership structure, including whether the roles of chairman and chief executive officer are combined or separated
- If the roles of chairman and chief executive officer are combined, whether the company has a lead independent director and a description of the function of that director within board leadership
- Why the company believes its arrangement is the most appropriate for the company
The new rule also requires disclosure of the scope of the board’s role in the risk oversight of the company. This disclosure will include a description of how the board manages its oversight function, whether by a risk committee that is separate from the board, by the audit committee or by the full board. Disclosure is also required with respect to the effect of the risk oversight function on the board’s leadership structure, such as how the oversight function is coordinated if different board committees are responsible for specific oversight functions. For example, a board may delegate to its governance committee the responsibility for examining and determining how the board and its committees should best be involved in overseeing the risk management conducted by management. The governance committee may determine that the oversight function should primarily be an audit committee function. However, the audit committee should have joint meetings with other committees, from time to time, on specific aspects of risk oversight (e.g., the compensation committee with respect to the riskiness of certain pay practices and compensation features, and the governance committee on the right role for each committee and the board as a whole). This will not be a “one size fits all” process, but will best be determined by each board in accordance with such things as its culture, governing procedures, business and appetite for risk. Companies will be well advised to provide sufficient detail in this regard so that investors and the proxy advisory firms can determine whether they have appropriate processes in place that are accurately described in their proxy statements.
Consideration of Diversity in the Director Nomination Process
Item 407(c) of Regulation S-K, the disclosure requirements applicable to board and nominating committees, has been amended to require disclosure of (i) whether a nominating committee considers diversity as a factor in identifying nominees for directors, and (ii) if a nominating committee does consider diversity as a factor, how it does so. The amended rule requires disclosure of how the board or nominating committee measures the effectiveness of a policy with respect to diversity, and how a policy with regard to the consideration of diversity in identifying director nominees is executed. The Staff noted that the rules do not define “diversity,” so companies may develop and disclose their own standards with respect to diversity. As with similar recently mandated disclosures of formal policies, those companies without formal diversity policies are likely to aggregate their informal views on board diversity into a formal policy, so that they have something to which to refer in their new disclosure. It is likely to become a best practice for companies to have such a policy and to disclose how it is effective and is executed. Such policies and disclosure need not be long or overly specific.
Voting Results
Companies are now required to disclose the voting results from shareholder meetings within four business days after the end of the meeting at which the vote was held, using a Form 8-K, as opposed to the original requirement of filing those results using a Form 10-K and a Form 10-Q. The added item on Form 8-K will result in a more timely disclosure of voting results and will further increase scrutiny of the annual meeting process and outcome. In fact, boards may even feel increased pressure to promptly address shareholder concerns that are reflected in the voting results. Furthermore, an instruction for the new item on Form 8-K provides that if final results are not known within four business days of the meeting, then preliminary voting results must be filed and an amended Form 8-K must be filed within four business days of the availability of the final results of the shareholder vote. There is also an exemption to the four-day deadline with respect to contested elections under certain circumstances.
Conclusion
While companies will be spending the next few weeks reviewing their proxy disclosures from a compliance standpoint, we continue to remind them to be mindful that a proxy statement will be, in many cases, the sole source of information for institutional investors making proxy voting decisions. It is therefore important that the proxy statement be reviewed from an investor’s standpoint. In certain circumstances, it may mean that communication of these practices and policies should not always be done by means of proxy statement disclosure alone, but through other means of shareholder outreach as well.
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Georgeson has a team of experts who will continue to monitor this situation for you and who can advise you in connection with these enhanced disclosure requirements. If you have any questions, please feel free to contact your account executive or any of the following Georgeson executives:
David Drake,
President
212-440-9861, ddrake@georgeson.com
Rachel Posner, Senior Managing Director & General Counsel
212-440-9921, rposner@georgeson.com
Rajeev Kumar, Senior Managing Director, Research
212-440-9812, rkumar@georgeson.com
Rhonda Brauer, Senior Managing Director, Corporate Governance
212-805-7168, rbrauer@georgeson.com
