Preparing the 2010 Proxy Statement
On December 16, 2009, the Securities and Exchange Commission adopted a number of amendments to its proxy disclosure rules that will be effective for the 2010 proxy season. The new rules will significantly affect the preparation of, and disclosure in, proxy statements.
The new rules address the valuation and reporting of equity awards in the compensation tables, risks arising from compensation practices, use of compensation consultants, and corporate governance matters, including board leadership structure, board diversity, the board’s role in risk management, and the specific skills of each director and nominee for director. They also require disclosure of shareholder voting results within four business days on Form 8-K, rather than in the next Form 10-Q or 10-K.
The staff of the SEC's Division of Corporation Finance issued additional guidance regarding the new rules on January 20, 2010, in the form of Compliance and Disclosure Interpretations (CDIs). This memo has been updated to reflect that guidance.
1. Changing How Stock and Option Awards Are Recorded in the Compensation Tables
The new rules require that the aggregate grant date fair value of equity-based awards granted during the fiscal year be recorded in the Summary Compensation Table and Director Compensation Table. Previously, these tables showed the dollar amount recognized for financial statement purposes for the fiscal year with respect to all awards. The SEC stated that reporting the aggregate grant date fair value of awards better reflects the board’s compensation decisions and that it is more meaningful to shareholders if the board’s compensation decisions for the given year cause the NEOs to change as a result of those decisions.
- For purposes of determining total compensation and identifying the NEOs for a particular year, the new rules require disclosure only of awards granted during that fiscal year.
- For example, for purposes of determining 2009 total compensation and identifying the 2009 NEOs, awards granted in 2008 and 2007 (or in any other previous year) and awards granted in 2010 (even if they relate to services performed in 2009) will not impact total compensation reported for 2009, unless there has been a material modification to the previously granted awards.
- The January CDIs provide that if the same award is both granted and forfeited in 2009, the aggregate grant date fair value of the award must still be included for purposes of determining total compensation for 2009 and the 2009 NEOs.
- Performance-based awards are subject to a special exception. The amount to be reported for awards subject to performance conditions is the aggregate grant date fair value based upon the probable outcome of the performance condition(s) as of the grant date (excluding the effect of estimated forfeitures), with a footnote to the SCT and DCT that discloses the maximum potential value.
- Time-based awards are not subject to the special exception. The amount to be reported for awards subject to time-based vesting is the full grant date fair value (excluding the effect of estimated forfeitures).
- To enable year-over-year comparisons, the 2009 SCT must contain recomputed values for stock and option awards granted in 2008 and 2007 (to reflect the full grant date fair value of those awards), with a corresponding adjustment to the total compensation columns for those years. However, if a person is an NEO for the first time in this year’s proxy statement, compensation for 2008 and 2007 is not required to be presented in the SCT for that person. The new rules also do not
- require companies to re-determine who their NEOs would have been for prior fiscal years based on the new reporting standard or to amend prior filings.
- Large “one-time” multi-year awards (for example, new-hire or retention grants) may cause a change in the NEOs for the year in which such award was granted, resulting in the omission of an executive officer who historically and otherwise would have been an NEO and subject to reporting for that year.
- Including additional narrative or footnote disclosure in this year’s proxy statement probably is advisable to clarify the change in equity-award reporting standards and the effect the change had on determining 2009 total compensation and 2009 NEOs.
2. Compensation Risk Management and Risk-Taking
The new rules require companies to discuss their compensation policies and practices for compensating and incentivizing their employees (not just executive officers). This disclosure is required only if the company determines that the risks arising from its compensation policies and practices “are reasonably likely to have a material adverse effect on the company” (which standard is similar to the MD&A disclosure standard). The SEC has noted that many companies may not be required to make any disclosures in response to this new requirement.
- Whether disclosure is required is specific to each company’s particular compensation programs and circumstances. If a company determines that its compensation policies and practices do not create risks that are reasonably likely to have a material adverse effect on the company, an affirmative statement to that effect is not required.
- If a company determines that disclosure is required, the company must discuss its compensation practices and policies as they relate to risk management practices and risk-taking incentives. While the new rules do not specify where this disclosure should be presented, the January CDIs recommend that it be presented together with the disclosures currently required by Item 402 of Regulation S-K (relating to executive compensation).
The SEC has provided examples of situations that could necessitate disclosure, such as compensation policies and practices:
- At a business unit that carries a significant portion of the company’s risk profile (think AIG’s financial products unit);
- At a business unit with compensation structured significantly different than other units within the company;
- At business units that are significantly more profitable than others within the company;
- At business units where compensation expense is a significant percentage of the unit’s revenues; and/or
- That vary significantly from the overall risk and reward structure of the company.
3. Director and Nominee Disclosure
Individual Qualifications. The new rules require companies to disclose, for each director and nominee, the particular experience, qualifications, attributes, or skills that led the board to conclude that such person should serve as a director of the company.
- As clarified by the January CDIs, the disclosure must be provided on an individual-by-individual, as opposed to group, basis.
- For each person, the company must disclose why the person’s particular and specific experience, qualifications, attributes, or skills led to the board to conclude that such person should serve as a director of the company, in light of the company’s business and structure, at the time that a filing containing the disclosure is made. The January CDIs provide that it would not, for example, be sufficient to disclose simply that a person should serve as a director because he or she is an audit committee financial expert.
- This expanded disclosure applies not only to nominees, but also incumbent directors who are not up for reelection (such as directors on classified boards).
- The January CDIs note that for some boards, particularly those that do not conduct annual self-evaluations, it may be necessary to implement additional disclosure controls and procedures to ensure the required information is elicited and reported in a timely manner.
Past and Current Directorships; Legal Proceedings. The new rules also:
- Require each director and nominee to disclose directorships held at any time during the past five years at any public company or investment company (in addition to current directorships held at such companies).
- Expand the list of legal proceedings for which disclosure may be required and lengthen the time during which disclosure of legal proceedings is required from five to ten years.
4. Diversity in Identifying Nominees for Director
The new rules require companies to discuss whether, and if so how, the nominating committee (or full board) considers diversity in selecting candidates for nomination as directors. In addition, if the company has a policy regarding the consideration of diversity in selecting board nominees, the company must discuss how the policy is implemented and how the board assesses the policy’s effectiveness.
The new rules do not, however, define “diversity” or “policy.” With respect to diversity, the SEC recognizes that companies define diversity in various ways, reflecting different perspectives. Some companies may conceptualize diversity expansively to include differences of viewpoint, professional experience, education, skill, and other individual qualities and attributes, while other companies may focus on diversity concepts such as race, gender and national origin. As a result:
- Companies should focus their disclosure on the diversity that is sought in establishing the appropriate board composition and the board’s efforts to assess diversity with respect to the composition of the board.
- Companies that do not have a stand alone diversity policy should so indicate and consider including disclosure that sets forth how the board considers diversity, any principles contained in the company’s governance documents, charters or codes of conduct or ethics that require the consideration of diversity, and how the board assesses the effectiveness of its diversity efforts.
5. Disclosure About Board Leadership Structure and the Board’s Role in Risk Oversight
Leadership Structure. The new rules require companies to disclose:
- Whether and why the company has chosen to combine or separate the CEO and board chair positions, and the reasons why the company believes its board leadership structure is appropriate for the company at the time of filing the proxy statement; and
- If the same person serves as CEO and board chair, whether the company has a “lead independent director” and the specific role of the lead independent director.
Risk Oversight. Companies must also now disclose information about the board’s role in risk oversight. The SEC has stated that this disclosure is intended to provide 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 facing the company. Rather than discussing the particular risk decisions or deliberations of the board, the disclosure should focus on:
- The manner in which the board performs its risk oversight function, such as through the entire board, a particular committee, or a separate risk committee, and the reason for that structure;
- Whether individuals who supervise the day-to-day risk management responsibilities report directly to the entire board or to a board committee;
- The manner in which the board or committee receives information from those individuals responsible for managing risk; and
- How the board’s process for overseeing risk affects the board’s leadership structure.
6. Compensation Consultant Disclosure
The new rules require enhanced compensation consultant fee disclosure where:
- The compensation consultant or any of its affiliates provided additional services to the company, such as human resources or benefit plan consulting, during the prior fiscal year in excess of $120,000.
- If the compensation committee (or full board) and management each engaged their own compensation consultant, no disclosure is required for any services performed by management’s compensation consultant (regardless of amount).
Where enhanced disclosure is required, a company must disclose:
- The aggregate fees for determining or recommending the amount or form of executive and director compensation and the aggregate fees for all additional services provided to the company; and
- With respect to compensation consultants engaged by the compensation committee or the board: (1) whether the decision to engage the consultant for the additional services was made or recommended by management and (2) whether the compensation committee or the board approved the engagement of the consultant to perform the additional services.
Where enhanced disclosure is not required, the new rules permit, but do not require, an affirmative statement to that effect.
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If you have any questions on these matters, please do not hesitate to contact Alan K. MacDonald, Luke J. Frutkin, or any member of the Firm’s Corporate Governance or Public Companies and Securities Practice Groups.
 Effective Date. The new rules apply to companies that have a fiscal year ending on or after December 20, 2009 that file a Form 10-K or proxy statement on or after February 28, 2010. For detailed information about effective dates, see the Compliance and Disclosure Interpretations referenced in note 4, below.
 The text of the final rules is available at http://www.frostbrowntodd.com/files/upload/SEC_Rules.pdf
 See new Item 5.07 to Form 8-K.
 The SEC issued additional guidance regarding compliance with the new rules in the form of Compliance and Disclosure Interpretations released on December 22, 2009 and January 20, 2010, available here and here, respectively.
 Aggregate grant date fair value is computed in accordance with FASB ASC Topic 718 (formerly known as FAS 123R).
 A smaller reporting company is required to provide disclosure only for the two most recent fiscal years (e.g., 2009 and 2008).
 If a person who will be an NEO in this year’s proxy statement was also an NEO in 2007 (but not in 2008), then all three years must be presented for that person in this year’s proxy statement. A smaller reporting company in that situation would need to provide disclosure only for 2009.
 In such a case, companies should consider including compensation disclosure for the omitted executive officer(s) to supplement the required disclosures, particularly where the omitted officer(s) will likely appear as NEOs again in the following year.
 See Item 402(s) of Regulation S-K. Item 402(s) does not apply to smaller reporting companies that provide the scaled disclosures specified in Items 402(m) through (r) of Regulation S-K.
 Determining whether disclosure is required is a two-part process: (1) identify the risks created by the company’s compensation policies and practices (such as, for example, performance metrics, employee incentives, and form of compensation), and (2) evaluate whether those risks are “reasonably likely to have a material adverse effect on the company.”
 The SEC has provided examples of the issues that the company may need to address where the company determines that disclosure is required. See Item 402(s) of Regulation S-K and the final rule release cited in footnote 1, above.
 See Item 401(e)(1) of Regulation S-K.
 In the January CDIs, the staff stated that for each director who is not up for reelection, the evaluation of such director’s particular and specific experience, qualifications, attributes, or skills and the conclusion as to why the director should continue serving on the board, should be as of the time that the filing containing the disclosure is made.
 In addition, the enhanced disclosure requirement generally does not apply to a consultant that is engaged solely to provide consulting on broad-based plans that do not discriminate in favor of executive officers or directors and that are generally available to salaried employees or to a consultant whose only role is limited to providing non-customized survey information.