SEC issues new interps regarding Reg S-K Item 402, executive compensation

By Cydney Posner

The SEC has posted some new interps relating to executive compensation:

Item 402(c) —Summary Compensation Table

• Under Instruction 2 to Item 402(c)(2)(iii) and (iv), companies are to include in the Salary or Bonus columns any amount of salary or bonus forgone at the election of an NEO under which stock, equity-based or other forms of non-cash compensation have instead been received. Where the value of the non-cash compensation is the same as the amount of salary or bonus foregone, the amounts are reported only in the Salary or Bonus column and not in any other column of the SCT. However, if the amount of salary or bonus foregone was less than the value of the equity-based compensation received, the incremental value of the equity award would be reported in the Stock Awards or Option Awards columns. If the agreement pursuant to which the NEO had the option to elect settlement in stock or equity-based compensation was within the scope of FAS 123R (e.g., the right to stock settlement is embedded in the terms of the award), then the award would be reported in the Stock Awards or Option Awards columns. In both of these special cases, the amounts reported in the Stock Awards and Option Awards columns would be the dollar amounts recognized for financial statement reporting purposes with respect to the applicable fiscal year, and footnote disclosure should be provided regarding the circumstances of the awards. Appropriate disclosure about equity-based compensation received instead of salary or bonus must be provided in the Grants of Plan-Based Awards Table, the Outstanding Equity Awards at Fiscal Year End Table and the Option Exercises and Stock Vested Table.
• With respect to perquisites and personal benefits, if the total amount exceeds $10,000, each perquisite or other personal benefit must be identified at least by type, even if it has no aggregate incremental cost. Any item for which an executive officer has actually fully reimbursed the company for its "total cost" should not be considered a perquisite or other personal benefit and therefore need not be separately identified by type. In this regard, for example, an executive officer would have "fully reimbursed" the company for a meal at a country club if she reimbursed not only the cost of the meal, but also a proportional amount of the country club dues paid by the company.
• An equity award subject to disclosure pursuant to Item 402(c)(2)(v) or (vi) may be disclosed as a negative number because the expense is reversed under FAS 123R, such as when an award is forfeited during the fiscal year, achievement of a performance-based condition becomes no longer probable or when liability accounting applies to an award, such as a cash-settled stock unit program, and the stock price declines during the year. In that event, only the previously expensed portions of awards that were previously reported in the SCT may be reversed in the SCT. Therefore, an expensed amount that relates to periods before effectiveness of the new rules or before the person became an NEO should not be deducted from the amount reported in, or shown as a negative number in, the Stock Awards or Option Awards column.
• Item 402(c)(2)(ix)(D) requires disclosure in the "All Other Compensation" column of the amount paid or accrued to any NEO pursuant to a plan or arrangement in connection with termination of employment or a change in control of the company. An amount is reportable as "accrued" under this Item if it is an amount for which payment has become due. If the NEO's performance necessary to earn an amount is complete, it is an amount that should be disclosed. For example, if the NEO has completed all performance to earn an amount, but payment is subject to a six-month deferral in order to comply with IRC section 409A, the amount should be disclosed. In contrast, if an amount will be payable two years after a termination event if the NEO cooperates with (or complies with a covenant not to compete with) the company during that period, the amount is not reportable because the executive officer’s performance is still necessary for the payment to become due. However, amounts that are payable in the future, as well as amounts reportable under Item 402(c)(2)(ix)(D), are all reportable under Item 402(j).
• Item 402(c)(2)(ix)(G) requires disclosure in the "All Other Compensation" column of the dollar value of any dividends or other earnings paid on stock or option awards, when those amounts were not factored into the grant date fair value required to be reported for the stock or option award. If a company credits stock dividends on unvested restricted stock units, but does not actually pay them out until the restricted stock units vest, those dividends should be reported in the year credited, rather than the year vested (and actually paid).

Item 402(d) — Grants of Plan Based Awards Table

• Where an equity incentive plan award is denominated in dollars, but payable in stock, the award should be disclosed in the Grants of Plan-Based Awards Table by including the dollar value and a footnote to explain that the award will be paid out in stock in an amount calculated at the time of the payout. In this limited circumstance, and if all the awards in this column are structured in this manner, it is acceptable to change the captions for columns (f) through (h) to show "($)" instead of "(#)."

Item 402(f) — Outstanding Equity Awards at Fiscal Year-End Table

• Instruction 3 to Item 402(f)(2) states that the issuer should report the market value of equity incentive plan awards using the closing market price at the end of the last completed fiscal year; however, the number of shares or units reported should be based on achieving threshold performance goals, "except that if the previous fiscal year's performance" has exceeded the threshold, disclosure is based on the next higher measure. For this purpose, the "previous fiscal year" means the same year as the "last completed fiscal year."
• Where awards will vest based on total shareholder return over a multi-year period, it is permissible to base disclosure on the actual multi-year performance to date (through the end of the last completed fiscal year). The number of shares or units reported in columns (d) or (i), and the payout value reported in column (j), should be based on achieving threshold performance goals, except that if performance during the last completed fiscal year (or, if the payout is based on performance to occur over more than one year, the last completed fiscal years over which performance is measured) has exceeded the threshold, the disclosure should be based on the next higher performance measure (target or maximum) that exceeds the last completed fiscal year's performance (or, if the payout is based on performance to occur over more than one year, the last completed fiscal years over which performance is measured).

Item 402(g) — Option Exercises and Stock Vested Table

• A company grants stock options that are immediately exercisable in full as of the grant date, subject to the company’s right to repurchase (at the exercise price) if the executive terminates employment with the company before a specified date. If the executive officer exercises the option before the repurchase restriction lapses, he or she effectively receives restricted stock subject to forfeiture until the repurchase restriction lapses. In this circumstance, the Outstanding Equity Awards Table should show the shares received as stock awards that have not vested (columns (g) and (h)) until the repurchase restriction lapses. The exercise should not be reported in the Option Exercises and Stock Vested Table, but instead, as the shares vest and cease to be subject to repurchase, those shares should be reported as stock awards (columns (d) and (e)) in the Option Exercises and Stock Vested Table. If the executive officer exercises the option after the repurchase restriction lapses, it is reported in the same manner as a regular stock option.

Item 402(h) — Pension Benefits

• A cash balance pension plan is a defined benefit plan in which the retiree’s benefits may be determined by the amount represented in a hypothetical "account" for that participant. The "accrued benefit" is the amount credited to a participant’s cash balance account as of any date, which the participant has the right to receive as a lump sum upon termination of employment. A company may not report the "accrued benefit" as the present value of the accumulated benefit. Rather, as with other defined benefit plans, the amount disclosable as the present value of accumulated benefit for a cash balance plan is the actuarial present value of the NEO’s accumulated benefit under the plan, computed as of the same plan measurement date used for purposes of the company’s audited financial statements for the last completed fiscal year.

Item 402(i) — Non-Qualified Deferred Compensation Table

• Item 402(i)(2)(iv) requires disclosure of the dollar amount of aggregate interest or other earnings accrued during the registrant’s last fiscal year. "Earnings" include dividends, stock price appreciation (or depreciation), and other similar items. Because the purpose of the table is to show changes in the aggregate account balance at fiscal year end for each NEO, "earnings" should encompass any increase or decrease in the account balance during the last completed fiscal year that is not attributable to contributions, withdrawals or distributions during the year.

Item 402(j) — Potential Payments upon Termination or Change-in-Control

• In the event that options are accelerated upon a termination or change in control, to calculate the value of the award, the company should use the "spread" between exercise and market price (as of fiscal year end) rather than the FAS 123R value recognized in connection with the acceleration. Since Item 402(j) requires disclosure of the amount that an NEO would have received assuming the event took place on the last business day of the registrant’s last completed fiscal year, disclosure of the "spread" at that date is consistent with Instruction 1 to 402(j), which prescribes using the closing market price per share of the registrant’s securities on last business day of the registrant’s last completed fiscal year.
• Instruction 5 to Item 402(j) provides that a company need not provide information with respect to contracts, agreements, plans or arrangements to the extent they are available generally to all salaried employees and do not discriminate in scope, terms or operation in favor of executive officers of the company. Where a company’s employee stock option plan provides for full and immediate vesting of all outstanding unvested awards upon a change in control and even though this provision is included in each optionee’s award agreement (whether the recipient is an executive officer or an employee), Instruction 5 would not allow the company to omit disclosure of these awards when quantifying the estimated payments and benefits that would be provided to NEOs: the standard that the "scope" of arrangements not discriminate in favor of executive officers would not be satisfied where the option awards to executives are in amounts greater than those provided to all salaried employees.
• Item 402(j) requires quantitative disclosure of estimated payments and benefits, applying the assumptions that the triggering event took place on the last business day of the company’s last completed fiscal year and that the price per share of the company’s securities is the closing market price as of that date. The date used for Item 402(j) quantification disclosure can affect the quantification of tax gross-ups with respect to the IRC section 280G excise tax on excess parachute payments, such as by suggesting that benefits would be accelerated or by changing the five-year "base period" for computing the average annual taxable amount to which the parachute payment is compared. Where the last business day of the last completed fiscal year for a calendar year company is not December 31, the company may calculate the excise tax and related gross-up on the assumption that the change in control occurred on December 31, rather than the last business day of its last completed fiscal year, using the company stock price as of the last business day of its last completed fiscal year. The company may not substitute January 1 of the current year for the last business day of the company’s last completed fiscal year, which would change the five-year "base period" to include the company’s last completed fiscal year.
• Following the end of the last completed fiscal year, but before the proxy statement is filed, an NEO (not the PEO or PFO) leaves the company, and a Form 8-K is filed. This NEO will not be an NEO for the current fiscal year based on Item 402(a)(3)(iv). The NEO's severance package is not newly negotiated but instead has the same terms that otherwise would apply. In these limited circumstances, it is permissible to provide Item 402(j) disclosure for the NEO only for the triggering event that actually occurred (even though beyond the scope of Instruction 4 to Item 402(j) because it took place after the end of the last completed fiscal year), rather than providing the disclosure for several additional scenarios that no longer can occur.
• A company will file a proxy statement for its regular annual meeting that also will solicit shareholder approval of a transaction in which the company would be acquired. Although the company has post-termination compensation arrangements that apply generally, if the acquisition is approved, all the NEOs will be covered by termination agreements that that will be specific to the acquisition. The company may not disclose only the termination agreements that are specific to the pending acquisition because the acquisition may not close, in which case, the company’s generally applicable post-termination arrangements would continue to apply. In addition, comparison of the acquisition-specific agreements with the generally applicable post-termination arrangements may be material.

Item 402(k) — Director Compensation Table

• The Instruction to Item 402(k)(2)(iii) and (iv) requires footnote disclosure, for each director, of the grant date fair value of each equity award granted during the company’s last completed fiscal year, not for all outstanding awards. Similarly, the instruction requires footnote disclosure only for the aggregate number of stock awards and the aggregate number of option awards outstanding at fiscal year end, including only unexercised options and unvested stock awards (including unvested stock units).
• A charitable matching program available to all employees must be included in the DCT and may not be excluded on the basis of the exclusion for "information regarding group life, health, hospitalization, or medical reimbursement plans that do not discriminate in scope, terms or operation, in favor of executive officers or directors of the registrant and that are available generally to all salaried employees" in the Item 402(a)(6)(ii) definition of "plan." The DCT disclosure applies to "the annual costs of payments and promises of payments pursuant to director legacy programs and similar charitable award programs." Any company-sponsored charitable award program in which a director can participate would be a "similar charitable award program."
• A company has an executive officer (not an NEO) who is also a director. This executive officer does not receive any additional compensation for services provided as a director, and the conditions in Instruction 5.a.ii to Item 404(a) of Reg S-K are satisfied. The compensation that this director receives for services as an executive officer does not need to be reported in the DCT under Item 402(k) of Reg S-K. The director may be omitted from the table, provided that footnote or narrative disclosure explains that the director is an executive officer, other than an NEO, who does not receive any additional compensation for services provided as a director.
• A company has a director who also is an employee (but not an executive officer). Item 404(a) requires disclosure of the transaction pursuant to which the director is compensated for services provided as an employee. (Instruction 5 to Item 404(a) does not apply because the person is not an executive officer or does not have compensation reported for services as a director in the DCT required by Item 402(k).) However, because disclosure of this employee compensation transaction in the DCT typically would result in a clearer, more concise presentation of the information, in this situation, if the employee compensation transaction is reported in the DCT, it need not be repeated with the other Item 404(a) disclosure. Footnote or narrative disclosure to the DCT should explain the allocation to services provided as an employee.
• A current director previously was an employee of the company and receives a pension that was earned for services rendered as a company employee. If payment of the pension is not conditioned upon his service as a director, the pension benefits do not need to be disclosed in the DCT, whether or not the director receives compensation for services provided as a director. If service as a director generates new accruals to the pension, disclosure would be required in column (f) of the DCT.

Shell Companies

• Following a merger among operating companies, there is no concept of "successor" compensation. Therefore, the surviving company in the merger need not report on compensation paid by predecessor corporations that disappeared in the merger. Similarly, a parent corporation would not pick up compensation paid to an employee of its subsidiary prior to the time the subsidiary became a subsidiary (i.e., when it was a target). Moreover, income paid by these predecessor companies need not be counted in computing whether an individual is an NEO of the surviving corporation. A different result may apply, however, in situations involving an amalgamation or combination of companies. A different result also would apply where an operating company combines with a shell company, as defined in Rule 405. Where shareholders of a shell company will vote on combining the shell company with an operating company that will then be subject to the reporting requirements of Section 13(a) or 15(d) of the Exchange Act, the disclosure document soliciting shareholder approval of the combination must disclose:
  • Item 402 disclosure for the shell company before the combination;
  • Item 402 disclosure regarding the operating company that the operating company would be required to make if filing a 1934 Act registration statement, including a CD&A; and
  • Item 402 disclosure regarding each person who will serve as a director or an executive officer of the surviving company required by Item 18(a)(7)(ii) or 19(a)(7)(ii) of Form S-4, including CD&A disclosure that may emphasize new plans or policies (as provided in the Release 33-8732A text at n. 97).

The Form 10-K of the combined entity for the fiscal year in which the combination occurs would provide Item 402 disclosure for the NEOs and directors of the combined entity, in compliance with Item 402(a)(4) of Reg S-K and Instruction 1 to Item 402(c) of Reg S-K.

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