SEC Proposes Major Overhaul of Executive Compensation Disclosure -- What You Need to Know This Year --

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1 650 Page Mill Road Palo Alto, CA PHONE FAX SEC Proposes Major Overhaul of Executive Compensation Disclosure -- What You Need to Know This Year -- February 2006 Introduction On January 17, 2006, the SEC voted unanimously to propose for comment a major overhaul of the executive compensation disclosure rules (the Proposed Rules ). The last major change in these rules occurred in In addition to changes in Item 402 of Regulation S-K, the SEC is proposing to revise Form 8-K as it applies to executive compensation arrangements, rewrite the related party disclosure rules contained in Item 404 of Regulation S-K, and consolidate all of the corporate governance disclosures in a new Item 407 of Regulation S-K. As proposed, the Plain English rules will apply to most executive compensation and related party disclosures. A copy of the SEC s proposing release can be found at In December 2005, the SEC proposed permitting broader use of the Internet for the delivery of proxy materials. Once adopted in final form, these rules are expected to greatly reduce the cost of proxy solicitations. See Anticipated Effective Date The comment period for the Proposed Rules ends April 10, While the timing of the effectiveness of the final rules is uncertain, we do not expect the final executive compensation disclosure rules to apply until the 2007 proxy season. The proposal concerning Internet delivery of proxy materials may be adopted earlier and would most likely be immediately effective. Interpretations Affecting This Year s Proxy Materials Although the executive compensation disclosure rule changes are not expected to apply until next proxy season, certain interpretations of the existing proxy rules contained in the Proposed Rules will apply to this year s proxy statement. In general, the release makes it clear that ALL compensation must be disclosed under both the Proposed Rules AND the existing rules. In particular, the SEC has provided further guidance with respect to perquisites that bears mentioning. The SEC notes that an item is not a perquisite if it is integrally and directly related to the performance of an executive s duties. However, it is a perquisite or personal benefit 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 such personal benefit is generally available on a non-discriminatory basis to all employees. Examples given by the SEC of items requiring disclosure as perquisites are as follows: club memberships not used exclusively for business entertainment purposes personal financial or tax advice personal travel using vehicles owned or leased by the company or otherwise financed by the company personal use of other property owned or leased by the company housing and other living expenses (including relocation assistance and payments for the

2 executive 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) discounts on the company s products or services not generally available to all employees on a non-discriminatory basis Examples provided by the SEC of items that would not be perquisites include: travel to and from business meetings other business travel business entertainment security during business travel itemized expense accounts, the use of which is limited to business purposes We recommend that the individuals at your company who are primarily responsible for the executive compensation disclosures in your proxy statement review the release, particularly the sections dealing with perquisites. Proposed Executive Compensation Disclosure Rules The SEC proposes to maintain the tabular approach to disclosing compensation, but proposes reorganizing the tables into three broad categories: (i) compensation for the last three fiscal years, in the Summary Compensation Table and two supplemental tables relating to incentive and equity awards; (ii) holdings of equity-related interests that are compensatory or potential sources of future gains; and (iii) post-employment compensation. Copies of the proposed tables are appended at the end of this Client Alert. The Proposed Rules will require a narrative discussion of the material factors necessary to understand the named executive officers compensation, including material terms of their employment agreements or arrangements. Named Executive Officers. The Proposed Rules would amend the existing rules to change the definition of named executive officer to include the principal financial officer in addition to the principal executive officer, the three other most highly compensated executive officers, and up to two former executive officers. Total compensation for the last fiscal year (instead of salary plus bonus) would determine which executive officers are included in the definition. The Proposed Rules also would require companies to provide a narrative description of the compensation of up to three non-executive officers if their total compensation exceeds that of any of the named executive officers. Compensation Discussion and Analysis. The SEC proposes requiring a Compensation Discussion and Analysis (CD&A) as an overview of the compensation objectives and policies for the named executive officers. The SEC intends for the CD&A to appear first in the executive compensation disclosures in the proxy statement and to be immediately followed by the tables. The CD&A is intended to be the MD&A equivalent of executive compensation and would replace the Compensation Committee Report and the Performance Graph. Unlike the current Compensation Committee Report, which is furnished, the CD&A would be considered filed, subjecting it to potential Exchange Act liability. The CD&A would focus on 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? The SEC wants companies to avoid boilerplate disclosure. If the compensation policy for a particular executive officer, such as the principal executive officer, is materially different from the other named executive officers, his or her 2

3 compensation should be discussed individually. The SEC envisions that the CD&A would differ from the narrative discussions following the compensation tables by providing more general discussion rather than an elaboration of the specifics of particular elements of compensation. The SEC cites the following examples of appropriate CD&A discussion: policies for allocation between long-term and current compensation policies related to equity compensation awards elements of corporate performance that are taken into account in setting compensation whether the company engaged in benchmarking to set compensation Summary Compensation Table and Supporting Tables. The Summary Compensation Table would for the first time require a total compensation figure for each of the last three fiscal years for each named executive officer, which total would appear in the first column following the named executive officer s name. In order to facilitate this, the new rules would require that option and stock appreciation right grant information be disclosed in dollar values based on the grant date fair value pursuant to FAS 123R, rather than the number of securities underlying an award. The Summary Compensation Table would include the following individual elements of total compensation: salary, bonus, stock awards, option awards, non-stock incentive plan compensation, and all other compensation. Non-stock incentive plan compensation would include performance-based compensation under a long-term plan that is not tied to the performance of the company s stock. The requirement to disclose all other compensation in the Summary Compensation Table is designed to ensure that no element of compensation is omitted. Any element of compensation that does not fit into another column would be reported under the all other category, including, for example, earnings on deferred compensation, increase in pension values, and perquisites. The SEC proposes requiring two supplemental annual compensation tables. Grants of performance-based stock awards showing the details of estimated future payouts would be disclosed in the Grants of Performance-Based Awards Table. If a stock award vests with the passage of time and is not performance-based, the number of shares underlying the award and other terms would be disclosed in another table, Grants of All Other Equity Awards Table. Equity Compensation Tables. The Proposed Rules would require two tables for disclosure of exercises and holdings of previously granted equity-based compensation, an Outstanding Equity Awards at Fiscal Year End Table and an Option Exercises and Vesting Table. These tables would require disclosure of the number of securities underlying awards that were exercised during the fiscal year and those that are still outstanding, along with their market value, as well as vesting and expiration-date information. The Outstanding Equity Awards table is intended to provide information about potential future amounts of compensation that a named executive officer might realize. The Option Exercises table would show the value already realized upon exercise of options or vesting of stock. Post-Employment Compensation Tables. To address concerns about the lack of disclosure surrounding post-employment compensation, the SEC is proposing two new tables: the Retirement Plan Potential Annual Payments and Benefits Table and the Nonqualified Defined Contribution and Other Deferred Compensation Plans Table. These new tables would focus on disclosure of estimated annual retirement payments under defined benefit plans and non-qualified defined contribution plans, and would be accompanied by narrative discussion of the elements of retirement compensation. The SEC is also proposing required disclosure of the arrangements that provide for payments at, following, or in connection with termination, resignation or severance of a named executive officer, including constructive termination or a change of control of the company. Specifically, 3

4 the SEC would require a narrative discussion of the circumstances that trigger payment, estimated payments and benefits (based on stated assumptions), factors used to determine the payment levels, and other material features of the arrangements. There would no longer be an exclusion for such arrangements that amount to less than $100,000. Director Compensation Table. The Proposed Rules would require tabular disclosure of director compensation for each director, together with narrative discussion of all of the elements of their compensation. The Director Compensation Table would require disclosure of the following elements of compensation: total compensation, director fees earned or paid in cash, dollar value of stock awards, dollar value of option awards, non-stock incentive plan compensation, and all other compensation, including perks. Proposed Form 8-K Revisions New Item 5.02(e) The SEC is also proposing amendments to Item 1.01 of Form 8-K, which requires real-time disclosure when a company enters into material definitive agreements or amends such agreements, and Item 5.02, regarding appointments and departures of directors and specified officers. The SEC has noted that the adoption of Item 1.01 of Form 8-K has significantly affected executive compensation disclosure practices. While the SEC views this real-time disclosure as important to investors, it also notes that many compensationrelated items have been disclosed that fall short of the unquestionably or presumptively material standard associated with the expanded Form 8-K disclosure items. The SEC proposes to create a more balanced approach that maintains the materiality threshold for Form 8-K disclosures by removing executive compensation disclosures from Item 1.01 of Form 8-K and adding compensation arrangements with Named Executive Officers to Item 5.02 of Form 8-K. Item 5.02 currently requires a brief description of the material terms of any employment agreement between the registrant and a newly appointed principal officer (defined as principal executive officer, president, principal financial officer, principal accounting officer, or principal operating officer) and information regarding departures of such principal officers and directors. The SEC proposes to modify Item 5.02 to capture generally the currently required information under that item, as well as additional information regarding departure of named executive officers and material employment compensation arrangements involving named executive officers that currently fall under Item Compensation disclosures regarding executive officers who are not named executive officers or principal officers would no longer trigger a Form 8-K filing. Proposed Item 5.02(e) would include a brief description of any material new compensatory plan, contract, or arrangement or new grant or award thereunder (whether or not written) and any material amendment to any compensatory plan, contract, or arrangement with any named executive officer, whether or not it is in connection with a triggering event specified in Item Consistent with existing guidance under Item 1.01, no disclosure would be required under Item 5.02 of grants, awards, or modifications if they are consistent with the terms of previously disclosed plans or arrangements and they are disclosed the next time the company is required to provide executive compensation disclosure under Item 402 of Regulation S-K. If the amount of salary and bonus of a named executive officer for the most recent fiscal year was not available in connection with disclosures previously made under Item 402 of Regulation S-K, they would have to be disclosed under Form 8-K Item 5.02(e) once they are determined. As is the case with Form 8-K disclosures under Item 1.01, the SEC would make available the limited safe harbors under Section 10(b) and Rule 10b-5 and the exclusion from the Form S-3 4

5 eligibility requirements for the new Item 5.02(e) disclosures. Interplay of Items 402 and 404 of Regulation S-K As noted above, the SEC requires that ALL compensation be disclosed. This includes disclosure under proposed Item 402 of Regulation S-K of all transactions between the company and a third party where a purpose of the transaction is to provide compensation to an executive. This is true even if the related party transaction giving rise to the compensation is disclosed elsewhere under Item 404. The SEC acknowledges that this may result in disclosure of some transactions under both Item 402 and Item 404, but believes that it is important that ALL executive compensation be captured in the tables. Policies and Procedures. Item 404(b) would require disclosure regarding the company s policies and procedures for the review, approval, or ratification of related party transactions. The description would include the types of transactions covered by the policy, the standards to be applied, the persons who are responsible for applying the policies and procedures and whether the policies are in writing. Promoters. Item 404(c) would require disclosure regarding promoters of a company and its transactions with those promoters if the company had a promoter at any time during the last five fiscal years. Unlike current disclosure requirements regarding promoters, disclosure would be required even if the company was organized more than five years ago. Certain Relationships and Related Party Transactions Disclosure Revised Reg. S-K Item 404 The SEC is proposing significant revisions to Item 404 of Regulation S-K, which requires disclosure of certain relationships and related party transactions. Fundamentally, the proposal uses a principles-based approach (rather than a rulesbased approach). It would, however, increase the threshold for required disclosure from $60,000 to $120,000. The three parts of revised Item 404 are as follows: Basic Related Party Transactions Disclosure. Proposed Item 404(a) requires a company to provide disclosure regarding any transaction between the company and a related party (or in which a related party has a direct or indirect material interest) since the beginning of the company s last fiscal year, or any currently proposed transaction, if the amount involved exceeds $120,000. Corporate Governance Disclosures New Reg. S-K Item 407 New Item 407 of Regulation S-K would consolidate under a single disclosure item various current disclosure requirements regarding director independence and corporate governance. In addition, the disclosure requirements would be updated to reflect the SEC s current requirements and applicable listing standards. Proposed Item 407(a) would require disclosure regarding the independence of directors, including whether each director and nominee for director of the registrant is independent, as well as a description of any relationships not disclosed under paragraph (a) of Item 404 that were considered when determining whether each director and nominee for director is independent. Listed companies would have to identify which directors are independent for the purposes of satisfying the majority independence requirements of the stock exchanges (including NASDAQ) and whether any member of the compensation or nominating committee is not independent. The independence disclosure would be required for any person who served as a 5

6 director during any part of the year for which disclosure must be provided, even if the person no longer serves as a director or if the director s term of office will not continue after the meeting. The proposals would also revise the current required disclosures regarding the audit committee and nominating committee to eliminate duplicative committee member independence disclosure and to update the required audit committee charter disclosure requirements. Accordingly, the audit committee charter would no longer be required to be delivered to security holders if it is posted on the company s website. The SEC is also proposing to require new disclosure regarding the compensation committee. Companies would be required to describe their processes and procedures for the consideration and determination of executive and director compensation, including: the scope of authority of the compensation committee; the extent to which the compensation committee may delegate any authority to other persons, specifying what authority may be so delegated and to whom; whether the compensation committee s authority is set forth in a charter and, if so, the company s website address at which a current copy is available if it is so posted and, if not so posted, attaching the charter 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 such consultants, stating whether they are engaged directly by the compensation committee or any person, describing the nature and scope of their assignment and the material elements of the instructions given to the consultants and identifying any executive officer whom the consultants contacted in carrying out their assignment. Internet Delivery of Proxy Materials On December 8, 2005, the SEC proposed amendments to the proxy rules that would permit issuers and shareholder proponents to furnish proxy materials to shareholders by posting them on an Internet site and simply providing shareholders with notice of the availability of the proxy materials, rather than mailing the proxy materials to all shareholders. The proposal contemplates that the notice itself would be a hardcopy mailing (unless the issuer had already obtained consent from the shareholder for electronic delivery) and also requires that hard copies of the proxy materials be made available to shareholders upon request at no cost. The proposed amendments would also enable persons other than the issuer who are waging a proxy fight against the issuer to do so with much lower expenses. Internet delivery of proxy materials would not be available for business combination transactions. Accelerated Filer Changes Reminder As a reminder, on December 21, 2005, the SEC established a new category of filers called large accelerated filers, which are companies with a public float of $700 million or more at the end of the second quarter of their last fiscal year. Accelerated filers now include only companies with a public float of at least $75 million but less than $700 million; non-accelerated filers continue to be companies with less than $75 million in public float. Based on these new categories, the SEC revised the due dates for periodic reports filed under the Securities Exchange Act of 1934 to the following: 6

7 Category of Filer (Public Float at Q2 End) Large Accelerated Filer ($700 million or more) Accelerated Filer (at least $75 million but less than $700 million) Non-accelerated Filer (less than $75 million) Revised Deadlines For Filing Periodic Reports Form Form 10-K 10-Q Deadline Deadline 75 days for fiscal years ending before December 15, days 60 days for fiscal years ending on or after December 15, days (no further acceleration) 40 days 90 days 45 days The adopting release is at This memorandum is intended only as general information about the matters discussed, and should not be construed as legal advice. For more information about these matters, please contact your Wilson Sonsini Goodrich & Rosati partner. C:\Documents and Settings\mbeh\Local Settings\Temporary Internet Files\OLK13\ _4.DOC (21388) 7

8 APPENDIX: Proposed New Executive Compensation Tables SUMMARY COMPENSATION TABLE Name and Principal Position Year Total Salary Bonus Awards Option Awards Non- Incentive Plan Compensation All Other Compensation PEO (a) (b) (c) (d) (e) (f) (g) (h) (i) PFO A B C PEO = principal executive officer PFO = principal financial officer A, B, & C = three other most highly compensated executive officers A-1

9 GRANTS OF PERFORMANCE-BASED AWARDS Name Performance - based and based Incentive Plans: number of shares, units or other rights Performancebased Options: number of securities underlying Options Non- Incentive Plan Awards: number of units or other rights Dollar amount of consideration paid for award, if any Grant Date for or Option Awards Performance or other period until vesting or payout and Option Expiration Date Threshold or Estimated future payouts Target or Maximum or PEO (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) PFO A B C A-2

10 GRANTS OF ALL OTHER EQUITY AWARDS Name Number of Securities Underlying Options Granted Exercise or Base Price ($/Sh) Expiration Date Number of Shares of or Units Granted Vesting Date Grant Date (a) (b) (c) (d) (e) (f) (g) PEO PFO A B C A-3

11 OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END Name Number of securities underlying unexercised Options Exercisable/ Unexercisable In-the-money amount of unexercised Options Exercisable / Unexercisable Number of shares or units of held that have not vested Market value of nonvested shares or units of held that have not vested Incentive Plans: Number of nonvested shares, units or other rights held Incentive Plans: Market or payout value of nonvested shares, units or other rights held (a) (b) (c) (d) (e) (f) (g) PEO PFO A B C A-4

12 OPTION EXERCISES AND STOCK VESTED Name of Executive Officer Number of Shares Acquired on Exercise Or Vesting Value Realized Upon Exercise Or Vesting Grant Date Fair Value Previously Reported in Summary Compensation Table (a) (b) (c) (d) PEO - Options PFO - Options A Options B Options C Options A-5

13 RETIREMENT PLAN POTENTIAL ANNUAL PAYMENTS AND BENEFITS Name Plan name Number of years credited service Normal retirement age Estimated normal retirement annual benefit Early retirement age Estimated early retirement annual benefit (a) (b) (c) (d) (e) (f) (g) PEO PFO A B C A-6

14 NONQUALIFIED DEFINED CONTRIBUTION AND OTHER DEFERRED COMPENSATION PLANS Name Executive contributions in last FY Registrant contributions in last FY Aggregate earnings in last FY Aggregate withdrawals/ distributions Aggregate balance at last FYE (a) (b) (c) (d) (e) (f) PEO PFO A B C A-7

15 DIRECTOR COMPENSATION Name Total Fees earned or paid in cash Awards Option Awards Non- Incentive Plan Compensation All Other Compensation (a) (b) (c) (d) (e) (f) (g) A B C D E A-8