Meeting of ABA Committee on Employee Benefits with SEC Staff

By: Cydney Posner

Every year, the ABA Joint Committee on Employee Benefits meets informally with SEC staff to discuss outstanding issues. The JCEB's notes are then made publicly available, although, this year their release was delayed almost a year. As a result, some of this information seems a little stale. The responses reflect the views of the SEC staff.

S-K Item 703

S-K Item 703 requires disclosure of repurchases by issuers or affiliates, and questions have arisen regarding whether certain issuer transactions under benefit plans are "repurchases " under the rule. The staff responded that:

• Option Plan Transactions. "Net" exercises, where shares are never issued under an option but are retained by the company to pay the exercise price or withholding or other taxes associated with the exercise, do not require Item 703 disclosure because they involve shares that are never issued. Because a stock-for-stock exercise involves delivery of already outstanding shares, it is required to be disclosed under Item 703, including delivery of shares by attestation. Option exchange programs are not covered by Item 703 if the options are not registered under Section 12. Issuer repurchases are required to be disclosed under Item 703.
• Cash Settlement of Restricted Stock. Cash settlement of restricted stock units do not require disclosure because the RSUs are not equity securities registered under Section 12 and, therefore, the cash settlement is not a repurchase covered by the rule. Similarly, a net issuance of shares upon the vesting of RSUs, where the number of shares issued is net of the number required to satisfy tax withholding obligations or other taxes associated with the vesting, does not require Item 703 disclosure.
• Restricted Stock Forfeitures. In connection with restricted stock transactions, withholding shares to pay taxes due upon vesting of restricted stock is required to be disclosed under Item 703 because it involves delivery of already outstanding shares in payment of a tax obligation. Forfeitures of restricted stock upon failure to satisfy vesting conditions without the payment of any consideration do not require disclosure because they are not repurchases, but if a payment is made upon the forfeiture of outstanding restricted stock (even if the payment is only nominal par value) then it is a repurchase that must be disclosed. A cash-out of restricted stock is required to be disclosed.
• Qualified Plan Transactions. Tax-qualified employee benefit plans, such as 401(k) plans or employee stock ownership plans (ESOP), may effect purchases as a result of netting participant elections to sell and buy issuer stock (e.g. investment elections under a 401(k) plan), or on the open market pursuant to employee investment elections or where the plan requires employer cash contributions to be invested in employer stock. Item 703 disclosure would be required if the purchaser is the issuer, is purchasing on behalf of the issuer or is an "affiliated purchaser" as defined in Rule 10b-18(a)(3). However, if the transactions are effected by an "agent independent of the issuer" as defined under Rule 10b-18(a)(4), they need not be disclosed under Item 703. This position is consistent with that taken with regard to Rule 10b-18.

• Disclosure of Severance Agreement. Even if an executive is not a Named Executive Officer in the year he terminates employment, if he was an NEO for the most recently completed fiscal year at the time the severance agreement was negotiated, the severance agreement must be described in the proxy statement pursuant to S-K Item 402(h) (payments to be received on termination of employment), assuming the dollar thresholds of that Item are exceeded. It need not be reflected in the Summary Compensation Table because it was not accrued or payable in that prior year. The severance agreement must be filed under S-K Item 601(b)(10)(iii)(A). Disclosure would also be required under Item 1.01 of Form 8-K. Both the proxy statement and 8-K disclosure should quantify the amount payable under the severance arrangement.
• Pension Disclosure. If a company provides the alternative pension plan disclosure pursuant to Reg S-K Item 402(f)(2) (which requires disclosure of the estimated retirement benefits payable to each named executive officer at normal retirement age) and if an NEO works beyond normal retirement age, the company must disclose the estimated retirement benefit payable as of a recent date under Rule 12b-20 and the antifraud rules to avoid confusing investors about the status of the NEO. Note that Rule 402(f)(2) narrative disclosure is available only if plan benefits are not determined primarily by final compensation (or final average compensation) and years of service.
• Outside Director Perks. There is no de minimis exclusion for compensation to outside directors, even for small items such as travel costs for a spouse when accompanying the director to board meetings. It is not permissible to describe the benefit without valuing it. S-K Item 402(g) requires that the "amounts" of director compensation be stated. From the staff's perspective, this requires disclosure of the dollar value of compensation. For valuation purposes, the same aggregate incremental cost to the company standard prescribed in Instruction 2 to Item 402(b)(2)(iii)(C) would apply.
• Gross-up on Perks. If a company provides perks having a value of less than the $50,000 threshold and grosses up the recipient for taxes on the perks, the proxy must still disclose the gross-up even if the aggregate of perks and gross-up still remains below the $50,000 threshold. The requirement to disclose gross-ups is separate from the requirement to disclose perks and does not allow any exclusion. Gross-ups should be disclosed in the Summary Compensation Table in the column expressly calling for that disclosure, "Other Annual Compensation," even if the benefit to which the gross up applies is included in a different column.
• Imputed Income on Split Dollar Policy. A company has previously funded a split dollar insurance benefit (which was appropriately reported in the Summary Compensation Table in the years payments were made). The company is no longer making payments under the policy and the executive is not currently receiving any benefits under the policy, but the executive is now subject to imputed income under the tax rules. The company grosses up the executive on the imputed income. The company need only report the tax gross-up, but need not report the imputed income; the tax rules are not determinative of how or when something is reported.
• Disclosure Rules. The staff is currently looking at revision of the compensation disclosure rules of S-K Items 402 and 404. There is no particular goal or timeframe for this review, and it may or may not result in any changes.
• S-K Item 404. In Item I.25 of the Telephone Interpretations Manual, the staff has taken the position that a transaction between a registrant and an entity of which a director or director nominee is an executive officer, which transaction does not exceed 5% of the revenues of either the registrant or the entity, need not be disclosed under Item 404(b), nor is it required to be analyzed separately under Item 404(a) (which has a $60,000 threshold) if the director or nominee does not receive any "special benefit" from the transaction. An equity ownership of more than 10% would be material for purposes of Item 404(a), and therefore, this analysis regarding 404(a) disclosure would not apply. The staff contends that the interpretation focused on Instruction 9 to 404(a), which says there may be instances, in addition to those specifically addressed in the Instructions to 404(a), where the insider's interest is not a "material interest" and in those instances disclosure is not required. The Interpretation then looks to the thresholds in 404(b) in deciding whether an interest is "material" for purposes of applying Instruction 9. However, Instruction 8 to 404(a) identifies specific situations where an interest is "not material," including ownership of less than 10%. The implication of this Instruction is that an ownership interest of more than 10% would be material for purposes of 404(a).

• Holding Period for Deferred Compensation. An affiliate participates in a non-qualified deferred compensation plan that is not registered under the 1933 Act and elects an investment return that is based on the issuer's common stock (i.e. phantom stock). Payment is made by delivery of actual shares of common stock on the date specified in accordance with the plan. The Rule 144 holding period for the stock that is ultimately paid out begins on the date the deferred amount is credited to the individual's phantom stock account in the plan, so long as this is the date the individual irrevocably assumes the economic risks of ownership of the shares. This should be the case whether or not the phantom stock can be settled in cash as an alternative to delivery of shares (and whether the choice of cash or shares as a settlement option is made by the employer or the employee).
• Acting in Concert. Where a tax-qualified retirement plan places a limit on the aggregate number of shares of employer stock that can be sold at one time and, under the plan, participants shares are proportionately reduced in the event that, the aggregate, their elected sales exceed the plan's limit, the participants are not considered to be "acting in concert" for purposes of Rule 144, where they have no information about the other participants who wish to sell. So long as there is no express or implied agreement among the participants, there is no "acting in concert."

• Shares Registered on S-8. A 401(k) type of employee benefit plan provides for employee and employer matching and nonelective contributions and permits investment in company stock. Where the offer of employer stock under the plan is registered on Form S-8, it is clear that those transactions in which employee contributions are used to purchase shares must be registered on the S-8. In addition, employer matching contributions which, pursuant to the plan terms or in the employer's discretion, are required to be invested in employer stock and employer matching contributions that are invested in employer stock at the participant's election must also be registered. Nonelective employer contributions that, pursuant to the plan terms or in the employer's discretion, are required to be invested in employer stock and nonelective employer contributions that are invested in employer stock at the participant's election need not be registered. Shares acquired with matching contributions must be registered, while shares acquired with nonelective contributions need not be registered. The need for registration of the shares acquired with matching contributions would not necessarily be eliminated if the plan acquired the shares on the open market. Release 33-4790 sets out the general standards for when issuer involvement in a benefit plan is minimal enough to avoid the need for registration. In the typical 401(k) plan, these standards are not likely to be satisfied.
• EU Prospectus Requirements. The European Union has issued prospectus requirements which will affect equity plans of US issuers. The staff is looking into whether US issuers could use the S-8 prospectus to satisfy the EU requirements.

To the date of the meeting, there had not been any public actions by the SEC under SOX 304 (disgorgement of incentive compensation in connection with certain restatements).

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