Compensation and Related Party Disclosure:
New Rules for the 2007 Proxy Season
On Nov. 7, 2006, the new compensation
and related party disclosure
rules adopted by the U.S.
Securities and Exchange
Commission over the summer
went into effect.1 The new rules
are a sweeping overhaul
of the old disclosure
rules, which were substantially
rewritten and
reorganized in an effort
to make the disclosure
clearer and easier for
investors to follow, analyze
and compare from
year to year, and from
company to company.
 Companies will be
required to comply with
the new rules in their annual
proxy statements and reports on
Form 10-K for fiscal years ending
on or after December 15,
2006. For calendar-year companies,
this means that they will
have to comply in the 2007 proxy
season, which is fast approaching.
Because of the significant
changes to the rules, some of
which are highlighted below,
compliance will require a great
deal of effort and diligence.
Compensation Disclosure.
The new disclosure rules
requires companies to provide
more detailed information in
their annual proxy statements
about the compensation paid to
their directors and named executive
officers. Under the new
rules, this category includes the
chief executive officer, chief
financial officer and the three
most highly compensated executive
officers other than the CEO
and CFO. Companies will have
to identify, describe and provide
dollar values for each element of
compensation that is awarded to
or earned by these individuals,
regardless of whether it has
been paid. These might include
cash and non-cash elements,
such as stock and option
awards, incentive payments
and awards,
deferred compensation
payments and contributions,
perquisites and
personal benefits, termination
and severance
payments and benefits,
retirement and pension
benefits, including
changes in pension values,
and any earnings on
the above items.
The disclosure rules relating
to two of these items, options
and perquisites/personal benefits,
or perks, were significantly
changed from the old rules in an
apparent response to
recent public attention
and investigation into
companies’ practices
relating to awards of
these items.
The SEC redesigned
the option disclosure
rules to include information
about all terms of
stock options that are
awarded. This will
include, for example, the
grant date and, if different, the
date the board of directors took
action with respect to the award,
as well as a discussion of the
company’s practices in determining
the exercise price, particularly
when the exercise price differs
from the market price.
Furthermore, any policies or
decisions relating to the timing
of option grants are required to
be addressed in the new
Compensation Discussion &
Analysis section, which is discussed
below. These new rules
were adopted, not with the
intention of encouraging or discouraging
the use of options as a
form of compensation, but rather
to ensure that companies provide
investors with full and
fair disclosure of all elements
involved.
 Similarly, the SEC believes
that information about perks
may be material to investors and
that the old rules permitted companies
to omit too much important
information. Therefore, the
SEC adopted new rules that
broaden the definition and substantially
lower the disclosure
threshold2 for perks, making
more types of perks subject to
disclosure.
The SEC’s new rules
require companies to
disclose a figure for total
compensation for each of
the named executive
officers and directors.
Companies should be
aware that the calculation
for "total compensation"
is the new determination
method by which
to identify the three
highest paid officers (other than
the CEO and CFO) for the
"named executive officers" category.
This new method is intended
to more accurately reflect
who, in fact, the highest paid
officers are, because it not only
takes into account salary and
bonus, which were the only
considerations under the old rules,
but also considers the value of
the assortment of other potential
compensation components that
may be awarded as part of compensation
packages.
Along with content changes,
the SEC revised the disclosure
format. The new rules require
both tabular and narrative
forms of presentation, which are
intended to complement each
other in order to create a comprehensive
picture of the compensation
packages awarded.
The tables must state dollar values
for each compensation element
awarded, and provide
other information, such as
details about awarded equity
that vested during, and is outstanding
as of the end of, the fiscal
year. The narrative sections,
which must be presented in
plain English, must discuss the
underlying principles, and give
detailed descriptions of the components,
of compensation.
The primary narrative section
under the new rules is the new
Compensation Discussion and
Analysis section (the "CD&A").
Similar to the Management’s
Discussion and Analysis section
currently required in annual
reports on Form 10-K, this new
section is intended to be an
overview of the company’s compensation
objectives, policies
and decisions, and to answer
the ‘what, why and how’ compensation
packages are awarded.
Companies are strongly cautioned
not to repeat the information
already disclosed in the
tables, or to use boilerplate language,
when drafting this section.
In addition, the information to
be included in the Compensation
Committee Report (the "CCR")
has been modified. Instead of
discussing the considerations
and policies of the compensation
committee in determining executive
compensation packages, the
SEC chose to redesign the CCR
to be more like the Audit Committee
Report, and now requires
that it state whether the compensation
committee discussed
the CD&A with management
and whether, based on this
review, it recommended to the
board that the CD&A be included
in the company’s annual
report and/or proxy statement.
Under the new rules, the
CD&A and CCR must be included
in a company’s proxy statement
and annual report on Form
10-K, and companies are permitted
to incorporate them by reference
from their proxy statements
to their Form 10-Ks. The
CD&A will be considered "filed"
rather than "furnished" with any
filing in which it is included, and
therefore subject to the liability
provisions of the Securities
Exchange Act of 1934, as amended.
In contrast, the CCR will continue
to be "furnished" to, rather
than "filed" with, the SEC,
except to the extent that it is
specifically incorporated by reference
into another filing. To the
extent the CD&A and any other
compensation disclosure is
included in or incorporated by
reference into a periodic report,
the disclosure would be covered
by the certifications that the
CEO and CFO are required to
make under the Sarbanes-Oxley
Act of 2002.
Related Party Transactions.
In order to provide
investors with a more complete
picture of financial arrangements
between a company and its executive
officers and directors, the
SEC revised the rules regarding
disclosure of related party transactions.
These new rules broaden
the scope of related party transactions,
so that more types of
financial relationships between a
company and its executive officers,
directors, significant shareholders
and their immediate family
members are subject to disclosure.
These new rules are
designed to make the disclosure
clearer and easier for investors to
follow, and require that the information
be presented in plain
English.
A new rule under this item
requires companies to describe
the material features of their
policies and procedures for
reviewing, approving or ratifying
related party transactions.
The SEC’s final rule release
notes that certain state corporate
laws and stock exchange
listing standards require companies
to have procedures in place
for transactions that involve
conflicts of interest, and the SEC
believes that this information
may be material to investors as
well.
Other Amendments.
The SEC consolidated the required
disclosure of corporate governance
matters into one item, and
expanded the disclosure relating
to director independence to
include, among other things, the
identities of each director and
whether or not they are "independent,"
as well as a description
of any transaction or relationship
not disclosed as a
"Related Party Transaction" that
was considered in determining
the director’s independence. The
SEC also made certain other
related and conforming changes,
including, among other things,
changes to Form 8-K items relating
to compensation arrangements,
and to other rules and
forms. For additional information
about these requirements,
please feel free to contact us.
Ms. Gruber and Ms. Amsel are attorneys
at the Law Offices of Vicki S. Gruber,
P.C. (www.vsgpc.com; (516) 845-8088),
which focuses on corporate and securities
law.
- 1. SEC Final Rule Release No. 33-8732; 34-
54302 dated Aug.11, 2006, effective Nov.
7, 2006.
- 2. Under the new rules, disclosure of perks
may be omitted if their aggregate value
for a named officer or director is less
$10,000, whereas the old rules permitted
omission if their aggregate value equaled
the lesser of $50,000 or 10 percent of the
total salary and bonus received for that
fiscal year.
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