Proposed Executive Comp Disclosure Amendments

By:  Cydney Posner

In a 370-page release, the SEC has proposed revisions to the disclosure rules regarding executive compensation, director compensation, related-party transactions,director independence and other corporate governance matters, as well as changes to 8-K reporting regarding compensation arrangements.  Special rules, not described below, would apply to small business issuers and foreign private issuers.

Overview

After having moved to a rigid tabular format for executive compensation disclosure in 1992, the SEC now finds that, "in light of the complexity of and variations in compensation programs, the very formatted nature of the current rules results in too many cases in disclosure that does not inform investors adequately as to all elements of compensation." As a result, the SEC's new proposal represents a "thorough rethinking of our current rules that would combine a broader-based tabular presentation with improved narrative disclosure supplementing the tables."

Under the proposal, compensation disclosure would begin with "Compensation Discussion and Analysis" ("CD&A"), which, like MD&A, would require a discussion and analysis of the material factors underlying compensation policies and decisions reflected in the data presented in the tables.

The analysis would be followed by three categories of information:

• a revised Summary Compensation Table ("SCT") that presents total compensation for the last three fiscal years paid currently or deferred and current plan compensation (both equity and non-equity, including current earnings), supplemented by two tables providing back-up information;
• holdings of equity interests that relate to compensation or are potential sources of future gains, with a focus on previously awarded equity (disclosed as current compensation in the SCT for those prior years), and that are "at risk," as well as recent realization on these interests, such as through vesting or exercises; and
• retirement and other post-employment benefits, including deferred compensation plans and other post-employment benefits, such as those payable in the event of a change in control.

Executive and Director Compensation

Compensation Discussion and Analysis

The proposed CD&A is designed to be an overview providing narrative disclosure to put compensation into context. The proposed CD&A would be required to explain material elements of the particular company’s compensation for named executive officers, focusing on the compensation objectives and material principles underlying the company’s executive compensation policies and decisions, and the most important factors relevant to analysis of those policies and decisions, without using boilerplate language or repeating the more detailed information set forth in the tables and related narrative disclosures that follow. The overview should respond to the following questions:

• what are the objectives of the company’s compensation programs?
• what is the compensation program designed to reward and not reward?
• what is each element of compensation?
• why does the company choose to pay each element?
• how does the company determine the amount (and, where applicable, the formula) for each element?
• how does each element, and the company’s decisions regarding that element, fit into the company’s overall compensation objectives and affect decisions regarding other elements?

• policies for allocating between long-term and currently paid-out compensation;
• policies for allocating between cash and non-cash compensation and among different forms of non-cash compensation;
• for long-term compensation, the basis for allocating compensation to each different form of award;
• for equity-based compensation, how the determination is made as to when the award is granted;
• what specific items of corporate performance are taken into account in setting compensation policies and making compensation decisions;
• how specific elements of compensation are structured to reflect these specific items of corporate performance as well as the executive’s individual performance;
• the factors considered in decisions to increase or decrease compensation to a material extent;
• how compensation or amounts realizable from prior compensation (e.g., gains from prior equity awards) are considered in setting other elements of compensation (e.g., how gains from prior awards are considered in setting retirement benefits);
• the impact of accounting and tax treatments of a particular form of compensation;
• the company’s equity or other security ownership requirements or guidelines (specifying applicable amounts and forms of ownership), and any company policies regarding hedging the economic risk of ownership;
• whether the company engaged in any benchmarking of total compensation or any material element of compensation, identifying the benchmark and, if applicable, its components (including component companies); and
• the role of executive officers in the compensation process.

As is currently the case, companies are not required to disclose target levels with respect to specific quantitative or qualitative performance-related factors considered in the determination of compensation nor any factors or criteria involving confidential commercial or business information, the disclosure of which would have an adverse effect on the company. The standard to be applied would be the same as the standard applied for CTRs. Similarly, to the extent a performance target has otherwise been disclosed publicly, disclosure would be required.

CD&A would be considered soliciting material and would be "filed" with the SEC, incorporated by reference into other documents and subject to the required management certifications, unlike the current comp committee report and performance graph, both of which are being eliminated-- very disappointing, too much boilerplate.

Compensation Tables

The proposal would substantially reorganize the compensation tables to help investors understand how the various elements of compensation relate to each other. However, there may be some "double counting" resulting from disclosure of both amounts currently earned (or potentially earned) and amounts subsequently paid out. Not to worry! This risk is "outweighed by the clearer and more complete picture it would provide to investors." Companies can use the narrative following the tables and the CD&A "to explain how disclosures relate to each other in their particular circumstances."

Summary Compensation Table. This table would continue to show the NEOs' compensation for each of the last three completed fiscal years (except for IPOs), whether or not actually paid out. However, the presentation would be simplified and would include a new column reflecting total compensation, aggregating total dollar value shown in the other columns of the SCT. The new column would appear as the first column providing compensation information. The new table would now also mandate disclosure for the principal executive and financial officers, as well as the three other highest paid executive officers. The proposal provides for two supplementary tables, followed by narrative disclosure of material information necessary to an understanding of the information disclosed in the tables. Here's the proposed new table:

Summary Compensation Table

Compensation that is earned, but deferred, would be included in the salary, bonus or other column, as appropriate, but the amount deferred must be disclosed in a footnote to the applicable column. (The amount deferred would also be reflected as a contribution in the deferred compensation presentation in another table--hence the double counting.) Where salary and bonus cannot be calculated as of the most recent practicable date, an Item 8-K report would be triggered by a payment, decision or other event that would make the amount calculable in whole or part. The Form 8-K would include disclosure of the salary or bonus amount and a new total compensation figure.

The SCT contains three columns relating to plan compensation. The Stock Awards Column would disclose stock-related awards that derive their value from the company’s equity securities or permit settlement by issuance of the company’s equity securities, such as restricted stock, restricted stock units, phantom stock, phantom stock units, common stock equivalent units or other similar instruments, including performance-based awards, but not awards that have option-like features. Options, stock appreciation rights and similar stock-based

compensation instruments that have option-like features would be disclosed in the next column. Valuation for both columns would be based upon the grant date fair value of the award determined under FAS 123R, not the number of underlying shares as is currently the case. (Note that, under FAS 123R, the compensation cost calculated as the fair value is generally recognized for financial reporting purposes generally over the vesting period; however, under the proposal, the compensation cost calculated as the grant date fair value would be shown as compensation in the year in which the grant was made.) The proposal would require a footnote referencing the discussion of the relevant FAS 123R assumptions in the notes to the company’s financial statements or in the MD&A, and these referenced sections would be deemed to be part of the disclosure provided under Item 402. These columns would also require disclosure, including footnote identification and quantification, of all amounts earned on outstanding awards for the fiscal year, whether or not paid during the fiscal year (not just above-market or preferential earnings, as is currently the case). Previously awarded options or freestanding stock appreciation awards that the company repriced or otherwise materially modified during the last fiscal year would be disclosed based on the total fair value of the award as so modified. (Other details about awards would be provided in supplemental tables for performance-based and non-performance-based awards.)

The third plan compensation column relates to non-stock incentive compensation, requiring disclosure of the dollar value of all other amounts earned during the fiscal year pursuant to incentive plans, which compensation is not based on the price of the company’s equity securities or settled in equity securities. An "incentive plan" is defined as any plan providing compensation intended to serve as an incentive for performance to occur over a specified period. Incentive plan compensation would be disclosed in the SCT in the year that the performance criteria under the plan were satisfied and the compensation earned, whether or not paid in that year. (The grant of the award under the plan would be disclosed in the supplemental performance-based awards table in the year of grant. No further disclosure would then be required when the actual payment was made.) Earnings on outstanding awards would also be included in the column. (And the difference between incentive compensation reported as earned under these plans and bonuses reported as earned under column (e) is……?)

The final column, "All Other Compensation," is intended to capture all other current compensation not reported in any other column, with the sole exception of perquisites and personal benefits if they aggregate less than $10,000 for a named executive. In addition, each item of compensation included in this column that exceeds $10,000 must be separately identified and quantified in a footnote. Items to be disclosed under this column would include, without limitation,

• Earnings on Deferred Compensation, including all such earnings deferred on a basis that is not tax-qualified, including non-tax qualified defined contribution retirement plans, whether or not the earnings are "above-market or preferential."
• Increase in Pension Value, reflecting the aggregate increase in actuarial value to the executive officer of defined benefit and actuarial plans (including supplemental plans) accrued during the year, including each plan that provides for the payment of retirement benefits, or benefits that will be paid primarily following retirement, including but not limited to tax-qualified defined benefit plans and supplemental employee retirement plans, but excluding defined contribution plans (which would be covered in another table).
• Perquisites and other personal benefits, unless they aggregate less than $10,000. The proposal would require footnote disclosure identifying all perquisites (if they aggregate over $10,000), and, if any perquisite were valued at the greater of $25,000 or 10% of total perquisites, its value would also be disclosed. The descriptions of perquisites must identify the "particular nature of the benefit received. For example, it is not sufficient to characterize generally as 'travel and entertainment' different company-financed benefits, such as clothing, jewelry, artwork, theater tickets and housekeeping services."
• Termination and change in control, including amounts paid or accrued under a plan or arrangement in connection with any termination (or constructive termination) of employment or a change in control. For other types of compensation resulting from a business combination, such as a retention bonus, acceleration of vesting periods or performance-based compensation intended to serve as an incentive for NEOs to acquire other companies or to enter into a merger agreement, disclosure would be required in the appropriate SCT column and elsewhere as required.
• Annual plan contributions or other allocations by the company to vested and unvested defined contribution plans.
• Insurance premiums, including the dollar value of any insurance premiums paid by the company for life insurance for the benefit of an NEO, not just premiums for term life insurance.
• "Tax gross-ups" or other amounts reimbursed during the fiscal year for the payment of taxes. Note that tax gross-ups for perquisites and other compensation would be separately quantified and identified as tax reimbursement, even if the associated perquisite were excluded.
• Compensation cost of discounted securities of the company or its subsidiaries purchased from the company or its subsidiaries (through deferral of fees or otherwise) at a discount from the market price of the security at the date of purchase, unless that discount were available generally either to all security holders or to all salaried employees of the company, computed in accordance with FAS 123R.
• Interpretive Guidance Regarding Perquisites. The release contains important interpretive guidance about perquisites that is immediately applicable. However, the SEC does not offer any bright-line definition of a "perquisite," assuming instead that companies and their advisors, who are more familiar with the facts and are "responsible for providing materially accurate and complete disclosure satisfying our requirements" can make the determination, although they are admonished to approach the subject "thoughtfully." The SEC cautions that the concept of perquisites and personal benefits should not be too narrowly interpreted to avoid disclosure.

In determining whether an item is a perquisite, companies should analyze whether the item is "integrally and directly related to the performance of the executive’s duties." If it is not, it will be a perquisite if "it confers a direct or indirect benefit that has a personal aspect, without regard to whether it may be provided for some business reason or for the convenience of the company, unless it is generally available on a non-discriminatory basis to all employees." The fact that the company has determined that an expense is an "ordinary" or "necessary" business expense for tax or other purposes or that an expense is for the benefit or convenience of the company and one that the company should pay for is not determinative or even "responsive to the inquiry." For example, that a company has decided to provide personal security to the CEO at all times does not mean that the security benefit is not a perquisite: "A company policy that for security purposes an executive (or an executive and his or her family) must use company aircraft or other company means of travel for personal travel, or must use company or company-provided property for vacations, does not affect the conclusion that the item provided is a perquisite or personal benefit." The SEC emphasizes that "integrally and directly related" to job performance is a narrow concept, including benefits such as

• office space (!) at a company business location, even if larger than that provided to other employees,
• a reserved parking space that is closer to business facilities but not otherwise preferential,
• additional clerical or secretarial services devoted to company matters,
• travel to and from business meetings,other business travel,
• business entertainment,
• security during business travel, and
• itemized expense accounts the use of which is limited to business purposes

• use of company-provided aircraft, yachts or other watercraft,
• commuter transportation services,
• additional clerical or secretarial services devoted to personal matters,
• investment management services,
• club memberships not used exclusively for business entertainment purposes,
• personal financial or tax advice,
• personal travel using vehicles owned or leased by the company,
• personal travel otherwise financed by the company,
• personal use of other property owned or leased by the company,
• housing and other living expenses (including but not limited to relocation assistance and payments for the executive or director to stay at his or her personal residence),
• security provided at a personal residence or during personal travel,
• commuting expenses (whether or not for the company’s convenience or benefit), and
• discounts on the company’s products or services not generally available to employees on a non-discriminatory basis.

Supplemental Annual Compensation Tables. The SCT would be followed by two tables intended to help explain the SCT.

Grants of Performance-Based Awards Table. This table would include information regarding grants and awards, whether or not stock-based, under performance-based plans (which thus provide the opportunity for future compensation if conditions were satisfied). Information disclosed would be generally equivalent to that currently required for grants of other long-term incentive plan awards. Disclosure in this table is intended to complement the disclosure in the SCT of grant date fair value of stock awards and option awards and the disclosure of annual amounts earned under non-stock based incentive compensation, showing the terms of grants made during the current year, including estimated future payouts, with separate disclosure for each grant.

Grants of Performance-Based Awards

For purposes of this table, awards would be considered performance-based if they were subject to either a performance condition or a market condition, as those terms are defined in FAS 123R. FAS 123R provides that a performance condition is "a condition affecting the vesting, exercisability, exercise price or other pertinent factors used in determining the fair value of an award that relates to both (a) an employee’s rendering service for a specified (either explicitly or implicitly) period of time and (b) achieving a specified performance target that is defined solely by reference to the employer’s own operations (or activities). Attaining a specified growth rate in return on assets, obtaining regulatory approval to market a specified product, selling shares in an initial public offering or other financing event, and a change in control are examples of performance conditions for purposes of this Statement. A performance target also may be defined by reference to the same performance measure of another entity or group of entities. For example, attaining a growth rate in earnings per share that exceeds the average growth rate in earnings per share of other entities in the same industry is a performance condition for purposes of this Statement. A performance target might pertain either to the performance of the enterprise as a whole or to some part of the enterprise, such as a division or an individual employee." An award also would be considered to have a performance condition if it were subject to a market condition, which is "a condition affecting the exercise price, exercisability, or other pertinent factors used in determining the fair value of an award under a share-based payment arrangement that relates to the achievement of (a) a specified price of the issuer’s shares or a specified amount of intrinsic value indexed solely to the issuer’s shares or (b) a specified price of the issuer’s shares in terms of a similar (or index of similar) equity security (securities)."

Grants of All Other Equity Awards Table. The second table supplementing the SCT would provide information about the equity-based compensation awards granted in the last fiscal year that were not performance-based, such as stock, options or similar instruments where the payout or future value is tied to the company’s stock price, not to other performance criteria. This table is intended to complement the SCT disclosure of the aggregate grant date fair value of stock, units and similar instruments with disclosure relating to the number of underlying securities and other material terms of the grants. Repriced awards must be included in the table, with the award’s total fair value after modification shown as a new award. Footnotes would be required to describe the material terms of a grant.

Grants of All Other Equity

Narrative Disclosure to SCT and Supplemental Tables. The narrative disclosure requirement is intended to provide context for the preceding tabular disclosure, by requiring textual discussion of any additional material factors necessary to an understanding of the information disclosed in the tables. By comparison, the CD&A is intended to address broader topics, such as the objectives and implementation of executive compensation policies.

The material factors in the narrative may include matters such as

material terms in the NEOs’ employment agreements or arrangements, whether written or unwritten (provisions regarding post-termination compensation would need to be addressed in the narrative section only to the extent of disclosure in the SCT);

• any repricing or other material modification of any outstanding option or other stock-based award during the last fiscal year (the 10-year repricing table would be eliminated), including the fact of the repricing, extension of exercise periods, change of vesting or forfeiture conditions, change or elimination of applicable performance criteria, change of the bases upon which returns are determined or any other material modification;
• award terms, such as a general description of the formula or criteria to be applied in determining the amounts payable, the vesting schedule, a description of the performance-based conditions (but excluding confidential commercial or business information) and any other material conditions applicable to the award, whether dividends or other amounts would be paid, the applicable rate and whether that rate is preferential;
• any material waiver or modification of any specified performance target, goal or condition to payout under any reported incentive plan payout (on the basis that each action can materially affect previously disclosed information about the plans), including whether the waiver or modification applied to one or more NEOs or applied to all compensation subject to the condition; and
• information regarding defined benefit and deferred compensation plans, such as material assumptions underlying the determination of the amount of increase in actuarial value of defined benefit or actuarial plans or the provisions in a plan or otherwise for determining earnings on deferred compensation plans, including defined contribution plans, that are not tax-qualified.

Exercises and Holdings of Previously Awarded Equity. The SEC is proposing two include two tables in this category, replacing the current Aggregated Option Exercises and Year-End Option Values table: one table that would report equity that has previously been awarded and remains outstanding, unexercised and unvested, and one that would report amounts realized on this type of compensation during the most recent fiscal year.

Outstanding Equity Awards at Fiscal Year End. This table would require disclosure regarding outstanding awards under, for example, stock option (or stock appreciation rights) plans, restricted stock plans, incentive plans and similar plans, including numbers of shares and market-based values as of fiscal year end. As outgoing Corp Fin director, Alan Beller, characterized it, this table would reflect an executive's "skin in the game."

Outstanding Equity Awards at Fiscal Year-End

The "in-the-money amount" would be calculated by determining the difference, at fiscal year end, between the market price of the underlying securities and the exercise or base price. The market value of stock (including restricted stock) and incentive plan award holdings would be calculated by multiplying the closing market price of the company’s stock at fiscal year end by the number of unvested stock or incentive plan award holdings. The proposal would require footnote disclosure of the expiration dates of options, stock appreciation rights and similar instruments held at fiscal year end, separately identifying those that are exercisable and unexercisable, and the vesting dates of shares of stock (including restricted stock) and incentive plan awards held at fiscal year end. If the expiration date of an option had occurred after fiscal year-end but before the date on which the disclosure is made, the footnote would need to state whether the option had been exercised or had expired.

Option Exercises and Stock Vesting. This table would disclose the amounts received upon exercise of options or similar instruments or the vesting of stock during the most recent fiscal year. Grant date fair value, as previously reported in the SCT for the year of award, would be used in lieu of the 5%/10% columns in the current table.

Option Exercises and Stock Vested

Post-Employment Compensation. The proposal would significantly enhance the disclosure regarding post-employment compensation. The current pension plan tables would be replaced with new tables and narrative regarding defined benefit pension plans and non-qualified defined contribution plans and other deferred compensation. The proposal would also revise the requirements regarding disclosure of termination and change-in-control arrangements.

Retirement Plan Potential Annual Payments and Benefits Table. This new table would require disclosure of estimated annual retirement benefits to be payable at normal retirement age and, if available, early retirement. Separate lines of tabular disclosure would be required for each plan in which an NEO participated, including under tax-qualified defined benefit plans, supplemental employee retirement plans and cash balance plans, but excluding defined contribution plans, which would have separate disclosure.

Retirement Plan Potential Annual Payments and Benefits Table

Quantification of benefits would reflect the form of benefit currently elected by the NEO, such as joint and survivor annuity or single life annuity, specifying that form in a footnote. Where the NEO is not yet eligible to retire, the benefits would be calculated assuming the same compensation as reported for the company’s last fiscal year. Disclosure would be required for NEOs who left during the year. If the credited years of service differed from the actual years of service for any NEO, a footnote quantifying the difference and any resulting benefit increase would be required.

A narrative description of material factors necessary to an understanding of each plan would follow the table, including:

• the material terms and conditions of benefits available under the plan, including the plan’s retirement benefit formula and eligibility standards, and early retirement arrangements;
• if the executive or company could elect a lump sum distribution, the amount of the distribution that would be available on election as of the end of the company’s last fiscal year, disclosing the valuation method and material assumptions applied in quantifying the amount;
• the specific elements of compensation, such as salary and various forms of bonus, included in applying the benefit formula, identifying each element;
• If there were multiple plans, the reasons for each plan; and
• company policies with regard to matters such as granting extra years of credited service.

balances under nonqualified defined contribution and other deferred compensation plans, that is, plans providing for deferral of compensation that do not satisfy the minimum coverage, nondiscrimination and other rules that "qualify" broad-based plans for favorable tax treatment under the IRC. A typical 401(k) plan, by contrast, is a qualified deferred compensation plan. Nonqualified defined contribution and other deferred compensation plans are generally unfunded, and their taxation is governed by Section 409A of the IRC. (Note that the SCT would require disclosure of all earnings on compensation that is deferred on a basis that is not tax-qualified.)

Nonqualified Defined Contribution and Other Deferred Compensation Plans Table

To avoid the double-counting problem, a footnote would quantify any amounts reported under "contributions" and "earnings" that were also reported as compensation for that year, as well as amounts reported under "aggregate balance" that were previously reported in the SCT for prior years.

The table would be followed by a narrative description of material factors necessary to an understanding of the disclosure in the table, including:

• the types of compensation permitted to be deferred and any limitations (by percentage of compensation or otherwise) on the extent to which deferral would be permitted;
• the measures of calculating interest or other plan earnings (including whether these measures were selected by the NEO or the company and the frequency and manner in which the selections may be changed), quantifying interest rates and other earnings measures applicable during the company’s last fiscal year; and
• material terms with respect to payouts, withdrawals and other distributions.

• the specific circumstances that would trigger payments or benefits, including perquisites;
• the estimated payments and benefits that would be provided in each circumstance and whether they would or could be lump-sum or annual, disclosing the duration and by whom they would be provided;
• the specific factors used to determine the appropriate payment and benefit levels under the various circumstances that would trigger payments or benefits;
• any material conditions or obligations applicable to the receipt of payments or benefits, including non-compete, non-solicitation, non-disparagement or confidentiality covenants and their duration;
• provisions regarding waivers of breach;
• tax gross-ups; and
• any other material features necessary for an understanding of the provisions.

The NEOs would be identified on the basis of total compensation for the most recent fiscal year, not just base salary and bonus as is currently the case. However, the dollar threshold for determination of NEOs (other than PEO and PFO) would remain at $100,000. While the potential exclusion for overseas assignments would remain, the current exclusion for other compensation that is "not recurring and unlikely to continue" would be eliminated.

Interplay of Items 402 and 404. The current instruction that allows reporting under Item 404 instead of Item 402 for compensation to an NEO resulting from a transaction between the company and a third party would be eliminated. As a result, Item 402 would require disclosure of all such compensation, even if the transaction could still be reportable as a related-person transaction under Item 404.

Other Proposed Changes. Currently, information regarding nondiscriminatory group life, health, hospitalization, medical reimbursement or relocation plans may be omitted. However, because relocation plans may, in operation, favor executives, the SEC is proposing to require relocation plan disclosure. The SEC is also propose to revise the definition of "plan" so that it is more principles-based.

Compensation of Directors. Director compensation would now be disclosed in a tabular format, like the SCT, but providing data for only one year, accompanied by narrative.

Director Compensation

The following items, among others, would be disclosable under "All Other Compensation":

• perquisites and other personal benefits if the total were $10,000 or greater;
• earnings on non-qualified deferred compensation;
• tax reimbursements;
• annual company contributions or other allocations to vested and unvested defined contribution plans;
• the compensation cost computed in accordance with FAS 123R of any discounted security purchased from the company or its subsidiaries, unless the discount were generally available to all security holders or to all salaried employees of the company;
• aggregate annual increase in actuarial value of all defined benefit and actuarial pension plans;
• annual company contributions to vested and unvested defined contribution and other deferred compensation plans;
• all consulting fees;
• awards under director legacy or charitable awards programs; and
• the dollar value of any insurance premiums paid by, or on behalf of, the company for life insurance for the director’s benefit.

The SEC is also proposing revisions to Item 1.01 of Form 8-K, entry into a material definitive agreement or material amendment to such an agreement. In its understated way, the staff has recognized that the item has "elicited executive compensation disclosure regarding types of matters that do not appear always to be unquestionably or presumptively material…." As a result, the SEC is proposing to amend Items 1.01 and 5.02 to require 8-K disclosure of fewer employee compensation events. In addition, General Instruction D of Form 8-K is proposed to be amended.

Proposed Revisions to Items 1.01 and 5.02 of Form 8-K. In adopting Item 1.01 of Form 8-K, the SEC instructed issuers to apply the standards of Item 601(b)(10) to determine the types of agreements that are material to a company and not in the ordinary course of business. This standard does not provide an exception for agreements with directors and NEOs that are "immaterial in amount or significance." The use of the of Item 601(b)(10) standard has led to the filing of a suffocating volume of Forms 8-K and an equal volume of headaches among issuers. As a result, the SEC is proposing to amend Item 1.01 (and 1.02) to eliminate employment compensation arrangements and to cover those arrangements under an amended broader Item 5.02, which currently addresses the appointment or departure of directors and specified officers. Amended Item 5.02 would now also capture additional information regarding material employment compensation arrangements involving NEOs.

More specifically, the proposal would:

• expand the information regarding retirement, resignation or termination to include all persons falling within the NEO definition for the previous fiscal year, whether or not included in the list currently specified in Item 5.02 (which covers the PEO, PFO, president, principal accounting officer, principal operating officer or persons performing similar functions);
• expand the disclosure items under Item 5.02 for covered officers or directors to require a brief description of any material plan, contract or arrangement entered into or materially amended, or any grant or award under those plans, in connection with any of the triggering events specified in Item 5.02;
• expand the disclosure specified above for NEOs to apply whether or not in connection with a triggering event (grants or awards or modifications thereto would not be required to be disclosed if they were consistent with the terms of previously disclosed plans or arrangements and are disclosed the next time the company is required to provide new disclosure under Item 402 of Reg S-K); and
• add a requirement for disclosure of salary and bonus information for the most recent fiscal year that was not available at the latest practicable date in connection with disclosure under Item 402.

Extension of Limited Safe Harbor and Exclusion of Item 502(e) from Form S-3 Eligibility Requirements. The proposal would extend the safe harbors regarding Section 10(b) and Rule 10b-5 and Form S-3 eligibility in the event that a company failed to timely file reports required by proposed Item 5.02(e) of Form 8-K. The 10b-5 safe harbor would apply until the filing due date of the company’s quarterly or annual report for the period in question. (Unfortunately, the proposal does not extend the S-3 eligibility exception to all of Item 5.02, which may require similar materiality judgments.)

General Instruction D to Form 8-K. Here's another proposal that should certainly be extended further. For events that trigger a Form 8-K filing under multiple items, General Instruction D currently permits a company to file one Form 8-K, so long as the company identifies by item number and caption all applicable items being satisfied and provides all of the substantive disclosure required by each of the items. The proposal would revise General Instruction D to permit companies to omit the Item 1.01 heading (but, unfortunately, only the Item 1.01 heading) in a Form 8-K that covers other Items, so long as the substantive disclosure required by Item 1.01 was included in the Form 8-K.

Beneficial Ownership Disclosure

The proposal would amend Item 403(b) to add a requirement for footnote disclosure of the number of shares pledged as security by NEOs, directors and director nominees. The SEC believes that the use of these shares as collateral subjects them to material risks or contingencies that have the potential to influence management’s performance and decisions. The proposal would not extend to five percent shareholders. (Note that pledges that may result in a change of control are currently required to be disclosed.) In addition, the proposal would specifically require disclosure of beneficial ownership of directors’ qualifying shares because, in the SEC's view, the beneficial ownership disclosure should include a complete tally of the securities beneficially owned by directors.

Certain Relationships and Related Transactions Disclosure

The proposal would make substantial revisions to Item 404 of Reg S-K "Certain Relationships and Related Transactions," intended to streamline and modernize this disclosure requirement, while making it more principles-based.

Transactions with Related Persons. Proposed amended S-K Item 404(a) would consist of a general statement of the principle for disclosure, followed by specific disclosure requirements and instructions. The proposed amended Item would integrate disclosure regarding indebtedness currently required under Item 404(c ). The current complex 404(b) disclosure regarding certain transactions with entities affiliated with directors would be eliminated, allowing significant simplification of D&O questionnaires.

Broad Disclosure Principle. Revised Item 404(a) would articulate the broad principle that a company must provide disclosure regarding

• "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 term "transaction" would be broadly defined to include "any financial transaction, arrangement or relationship or any series of similar transactions, arrangements or relationships," including "indebtedness and guarantees of indebtedness."

As proposed, the term "related person" would cover the same list of persons covered by current Item 404(a). A person who was a "related person" during only part of the last fiscal year may have had a material interest in a transaction with the registrant during that year. In that case, the SEC expects that disclosure would be required if the requisite relationship existed at the time of the transaction, even if the person were no longer a related person at the end of the year. Because of the potential for abuse and the close proximity in time between the transaction and the person’s status as a "related person," the SEC believes that it is appropriate to require disclosure for transactions in which directors, executive officers and their immediate family members had a material interest at any time during the fiscal year. However, transactions with persons who have been or who will become significant shareholders (or their family members), but who were not significant shareholders at the time of the transaction, would be excluded, except that disclosure would be required for a transaction that begins before a significant shareholder becomes a significant shareholder and continues (for example, through the on-going receipt of payments) on or after the person becomes a significant shareholder.

The definition of the term "immediate family member" of a related person would be expanded to include stepchildren, stepparents and any person (other than a tenant or employee) sharing the household of a related person.

The term "amount involved" would mean the dollar value of the transaction, or series of similar transactions, and would include:

• in the case of any lease or other transaction providing for periodic payments or installments, 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
• 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.

• disclosure with regard to all related persons covered by the related-person transaction disclosure requirement, including significant shareholders (which is not currently covered under Item 404(c ));
• disclosure of all material indirect interests in indebtedness transactions of related persons, including significant shareholders and immediate family members (currently, Item 404(c) requires disclosure of specific indirect interests of directors, nominees for director, and executive officers of the registrant in indebtedness through corporations, organizations, trusts and estates); and
• loans by companies other than financial institutions would be treated like any other related-person transactions.

• 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, without regard to the amount of profit or loss involved.

Exceptions. The proposed rules provide exceptions for categories of transactions not within the broad principle articulated above. Disclosure of compensation to an executive officer would not be required if:

• the compensation is reported pursuant to Reg S-K Item 402 or
• 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 were a named executive officer, and the compensation had been approved as such by the compensation committee.

With respect to transactions involving indebtedness, the following items would be excluded from the calculation of the amount of indebtedness:

• amounts due from the related person for purchases of goods and services subject to usual trade terms, for ordinary business travel and expense payments and for other transactions in the ordinary course of business need not be disclosed;
• if the lender were a bank, savings and loan association or broker-dealer extending credit under Federal Reserve Regulation T and the loans were not disclosed as nonaccrual, past due, restructured or potential problems, disclosure may consist of a statement, if correct, that the loans were made in the ordinary course of business, 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 did not involve more than the normal risk of collectibility or present other unfavorable features.

• the interest arose only:
  • from the person’s position as a director of another corporation or organization that was a party to the transaction; or
  • from the direct or indirect ownership by that person and all other related persons, in the aggregate, of less than a 10% equity interest in another person (other than a partnership) that was a party to the transaction; or
  • from both such position and ownership; or
• the interest arose only from the person’s position as a limited partner in a partnership in which the person, and all other related persons, had an interest of less than 10%, and the person was not a general partner of and did not have another position in the partnership.

• the types of transactions covered;
• the standards to be applied;
• the persons or groups of persons on the board of directors or otherwise who were responsible for applying these policies and procedures; and
• whether the policies and procedures were in writing and, if not, how they were evidenced.

Promoters. Under proposed new Item 404(c ), disclosure regarding promoters would be required in registration statements on Forms S-1, SB-2, 10 and 10-SB if the company had a promoter at any time during the last five fiscal years. The proposed disclosure is consistent with that currently required, except that disclosure is not currently required for companies organized more than five years previously, even if the company otherwise had a promoter within the prior five years. The proposal would also require the same disclosure for any person who acquired control, or was part of a group that acquired control, of an issuer that was a shell company.

Corporate Governance Disclosure. The proposal would create a new Reg S-K Item 407 to update and consolidate the disclosure requirements regarding director independence and related corporate governance disclosure under a single item. The proposal would require disclosure of the identities of the directors and, for proxies or information statements, director nominees, that the company identified as independent (and committee members not identified as independent), using a definition of independence that was in compliance with the listing standards applicable to the company. If the company were not a listed issuer, the proposal would require that the company use a definition of independence of an exchange or Nasdaq specified by the company. The company would be required to apply the same definition consistently to all directors and to all members of its compensation, nominating and audit committees. If a company had adopted definitions of independence, it would be required to post them on its website or include them in an appendix to its proxy materials at least once every three years (or disclose in which of the prior three fiscal years the policies were so included).

For each director or nominee identified as independent, the company would be required to 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, even if the person no longer served as director at the time of filing the registration statement or report or, if the information were in a proxy statement, even if the director’s term of office would not continue after the meeting. The SEC makes the point here that "the independence status of a director is material while the person is serving as director and not just as a matter of reelection." However, in the context of an IPO, disclosure would not be required regarding any former director if he or she were no longer a director at the time of the offering.

The proposals would also eliminate duplicative committee member independence disclosure and revise requirement regarding audit committee charters to provide that the charter would no longer be required to be delivered to shareholders if it were posted on the company’s website. The SOX 407 disclosure regarding audit committee financial experts would also be integrated into Item 407, as would the Item 402 disclosure regarding compensation committee interlocks as well as the various proxy disclosure requirements regarding attendance at board and committees meetings. The current disclosure requirements for regarding audit and nominating committees would be extended to compensation committees. The company would also be required 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 and the persons to whom the compensation committee may delegate authority;
• whether the compensation committee’s authority was set forth in a charter, the website address where a current copy was available if it was so posted (if not so posted, a copy would need to be attached to the proxy statement once every three years);
• 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 the consultants, stating whether they were engaged directly by the committee or any other person, describing the nature and scope of their assignment, the material elements of the instructions or directions given to them and identifying any executive officer contacted by the consultants contacted in carrying out their assignment.

Plain English

Under proposed new rules 13a-20 and 15d-20, companies would be required to prepare their executive and director compensation, related-person transactions, beneficial ownership and corporate governance disclosures included in Exchange Act reports using plain English principles. Under the proposed rules, if the executive compensation, beneficial ownership, related-person transaction or corporate governance disclosure were incorporated by reference into an Exchange Act report from a company’s proxy or information statement, the disclosure would be required to be in plain English in the proxy or information statement.

Transition

Following adoption, the proposed new rules would become effective as follows:

• for Forms 10-K and 10-KSB, for fiscal years ending 60 days or more after publication in the Federal Register;
• for Forms 8-K, for triggering events that occur 60 days or more after publication;
• for Securities Act registration statements (including post-effective amendments) and Exchange Act registration statements that become effective 120 days or more after publication; and
• for proxy statements that are filed 90 days or more after publication.

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