Exploring Corporate Governance Around the World

By Allison Garrett, Senior Vice President for Academic Affairs at Oklahoma Christian University

Tuesday, January 17, 2006

SEC Proposes Changes to Executive Compensation Disclosure

The SEC voted today to publish proposed executive compensation rule changes for comment. The proposed rules will address:
  • executive and director compensation,
  • related party transactions,
  • director independence and other corporate governance matters, and
  • security ownership of officers and directors.

Filings that will be affected by the new rules include proxy statements, annual reports, registration statements and current reporting on Form 8-K.

The SEC's proposed tinkering will make the SEC rules regarding executive compensation even more inconsistent with the IRS regulations. The regs implementing IRC section 162(m) provided that directors who have more than $60,000 in transactions with the issuer would not be independent for purposes of judging whether the executives met the criteria for award of compensation in excess of $1 million. But directors who don't have discloseable transactions under the SEC's rules can award options. In other words, the criteria for compensation committee membership as expressed by the SEC and the IRS differ.

The proposed regs deviate from the top 5 approach that has been used in the past for disclosure purposes. The CEO and 4 other most highly compensated are the executives subject to the IRS regs under 162(m). Now we have the SEC requiring disclosures about the CEO and CFO and top 3 other executives. Whew! It's hard to know whose compensation the members of the compensation committee should be voting on and disclosing.

Excerpts from the SEC's press release today follow:

1. Executive and Director Compensation
The proposals would refine the currently required tabular disclosure and combine it with improved narrative disclosure to elicit clearer and more complete disclosure of compensation of the principal executive officer, principal financial officer, the three other highest paid executive officers and the directors.
New company disclosure in the form of a Compensation Discussion and Analysis would address the objectives and implementation of executive compensation programs - focusing on the most important factors underlying each company's compensation policies and decisions.
Following this new section, executive compensation disclosure would be organized into three broad categories: compensation over the last three years; holdings of outstanding equity-related interests received as compensation that are the source of future gains; and Retirement plans and other post-employment payments and benefits.
A reorganized Summary Compensation Table would be the principal vehicle for showing three-year compensation and would include additional information.
A new column would report total compensation.
A dollar value will be shown for all stock-based awards, including stock and stock options, measured at grant date fair value, computed pursuant to Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, to provide a more complete picture of compensation and facilitate reporting total compensation.
The "All Other Compensation" column would include the aggregate increase in actuarial value of pension plans accrued during the year and all earnings on deferred compensation that is not tax-qualified.
The threshold for disclosing perquisites would be reduced to $10,000 and interpretive guidance is provided for determining what is a perquisite.
Two supplemental tables would report Grants of Performance-Based Awards and Grants of All Other Equity Awards.
Disclosure regarding outstanding equity interests would include
the Outstanding Equity Awards at Fiscal Year-End Table, which would show outstanding awards representing potential amounts that may be received in the future; and
the Option Exercises and Stock Vested Table, which would show amounts realized on equity compensation during the last year.
Retirement plan and post-employment disclosure would include
the Retirement Plan Potential Annual Payments and Benefits Table, which would disclose annual benefits payable to each named executive officer;
the Nonqualified Defined Contribution and Other Deferred Compensation Plans Table, which would disclose year-end balance, and executive contributions, company contributions, earnings and withdrawals for the year; and
disclosure of payments and benefits (including perquisites) payable on termination or change in control, including quantification of these potential payments and benefits.
A Director Compensation Table, similar to the Summary Compensation Table, and related narrative would disclose director compensation for the last year.
2. Related Person Transactions, Director Independence and Other Corporate Governance Matters
The proposals would update, clarify, and slightly expand the disclosure provisions regarding related person transactions. Principal changes would include a disclosure requirement regarding policies and procedures for approving related party transactions, a slight expansion of the categories of related persons and a change in the threshold for disclosure from $60,000 to $120,000. The requirement to disclose these transactions would also be made more principles-based, and would require disclosure if the company is a participant in a transaction in which a related person has a direct or indirect material interest.
A proposed new item (Item 407 of Regulations S-K and S-B) would require
disclosure of whether each director and director nominee is independent;
a description of any relationships not otherwise disclosed that were considered when determining whether each director and director nominee is independent; and
disclosure of any audit, nominating and compensation committee members who are not independent.
Proposed Item 407 also would consolidate corporate governance related disclosure requirements currently set forth in a number of places in the proxy rules and Regulations S-K or S-B. This would include disclosure regarding board meetings and committees, and specific disclosure about nominating and audit committees. Proposed Item 407 would also require similar disclosure regarding compensation committees and a narrative description of their procedures for determining executive and director compensation.
3. Security Ownership of Officers and Directors
The proposals would require disclosure of the number of shares pledged by management.
4. Form 8-K
The proposals would modify the disclosure requirements in Form 8-K to capture some employment arrangements and material amendments thereto only for named executive officers. The proposals would also consolidate all Form 8-K disclosure regarding employment arrangements under a single item.
5. Plain English Disclosure
The proposals would require companies to prepare most of this information using plain English principles in organization, language and design.

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