This article is reprinted with permission from the
April 21 , 2006
edition of
New York Law Journal.
2006 NLP IP Company.

SEC Proposes New Rules on Executive Pay Disclosure: Part 2

By Joseph E. Bachelder

Today's column continues discussion of the new executive pay disclosure rules proposed by the Securities and Exchange Commission (SEC). Citations to the Federal Register, contained in the text and footnotes of the column, are to the SEC proposals as they appeared in the Federal Register on Feb. 8, 2006.[1]

On March 31, this column (New York Law Journal, at p. 3) reviewed the proposed Summary Compensation Table, the proposed Director Compensation Table and the proposed Compensation Discussion and Analysis. The following discussion focuses on the proposed rules requiring disclosure of anticipated payments and benefits to Named Executive Officers (NEOs) in connection with retirement and other terminations of employment and in connection with changes in control.[2]

The column covers:

(1) a new Retirement Plan Potential Annual Payments and Benefits table (see Proposed Table 1);[3]

(2) a new Nonqualified Defined Contribution and Other Deferred Compensation Plans table (see Proposed Table 2);[4] and

(3) a narrative discussion of potential payments and benefits, including estimates of amounts, in connection with different types of employment terminations and in connection with changes in control (see section on Narrative on Potential Termination and Change in Control [C/C] Remuneration).[5]

1. Retirement Plan Table

Chart 1

The Retirement Plan Table represents a significant change from the current Pension Plan Table. The current Pension Plan Table requires no identification of pension amounts to be paid to specific NEOs. Instead it provides for a matrix setting out pension amounts according to levels of covered compensation and years of service. While the current rule requires that the accompanying narrative explain the basis upon which benefits are determined and identify years of credited service for each NEO, the absence generally of explanation as to the actuarial and other assumptions involved in calculating the pension makes it difficult to determine with much precision the individual NEOs' actual pension amounts.[6]

Proposed Table 1 provides the name of each NEO and the amount of (a) the estimated normal retirement benefit and (b) the estimated early retirement benefit. (In addition, Proposed Table 1 requires information as to years of credited service, normal retirement age and early retirement age for each NEO).[7]

The proposed Retirement Plan Table does not require a column displaying the actuarial present value of the aggregate accumulated pension for each NEO. The instructions to the Proposed Table 1 do require narrative disclosure under certain circumstances in which the plan(s) provide(s) for a lump-sum payout of the retirement benefit. The proposed instruction provides:

If the plan permits a lump sum distribution at the election of the executive or the registrant, quantify the amount of such distribution that would be available on such election as of the end of the registrant's last fiscal year, and disclose the valuation method and all material assumptions applied in quantifying such amount. 71 Fed. Reg. at 6617.

It is not entirely clear from this instruction whether the SEC intends to require in the narrative accompanying the Retirement Plan Table disclosure of the lump-sum amount regardless of whether a lump-sum distribution can be elected currently.[8]

In any event, the lump-sum number referred to in the preceding paragraph may not be the same as the actuarial present value of the pension. For example, there may be a reduction factor for a lump-sum payment that differs from the assumptions in an actuarial present value calculation of the pension. And, as noted above, the lump-sum number is not required in the Retirement Plan Table itself.

The Summary Compensation Table, discussed in the March 31 column, requires, as to each NEO, disclosure of the increase during the year being reported of the actuarial present value of each defined benefit pension. This applies to both tax-qualified and non-tax-qualified defined benefit pensions. This number is to be included in the All Other Compensation column. (Identification of the amounts and explanation of assumptions required are in a footnote to that column). It would be helpful for year-to-year comparisons to include in the last column of Proposed Table 1 the aggregate actuarial present value, noted in the preceding paragraph, for the defined benefit pension(s) covered by the table. The SEC has given consideration to this. It invites comment on whether such a number should be required in the Retirement Plan Table. 71 Fed. Reg. at 6561.

In contrast to Proposed Table 1, Proposed Table 2, described next, does require a fiscal year-end aggregate value to be shown, in the last column on the right.

2. Nonqualified Defined Contribution

Chart 2

• NQ DC/DCP Table (officially the Nonqualified Defined Contribution and Other Deferred Compensation Plans Table). This table is entirely new. It is in response to critics who claim that much of deferred compensation is "camouflaged."[9] As stated in the introductory discussion to the NQ DC/DCP Table:

Our current rules elicit disclosure of the compensation when earned and only the above-market earnings on nonqualified deferred compensation. The full value of those earnings and the accounts on which they are payable are not currently subject to disclosure, nor are shareholders and investors informed regarding the rate at which these amounts — and the corresponding cost to the company — are growing. 71 Fed. Reg. at 6561.[10]

In Proposed Table 2, the SEC provides columns reporting, as to each NEO, the executive contributions (column (b)), the registrant contributions (column (c)) and the aggregate earnings (column (d)) in the last fiscal year. The next column, column (e), apparently requires the amount of aggregate withdrawals/distributions (if any) for the last fiscal year. (On this point, see the second footnote to Proposed Table 2.) The final column (column (f)) requires the aggregate balance of the executive's account at the end of the last fiscal year.

Proposed Table 2 also requires a footnote that would indicate (i) the extent to which earnings on deferred compensation are also reported in the proposed Summary Compensation Table and (ii) the extent to which the aggregate balance at last fiscal year-end has been previously reported in the Summary Compensation Table for prior years. The instructions to the proposed rules require a narrative explaining "material factors necessary to an understanding of each plan" covered by the table. 71 Fed. Reg. at 6618.

Proposed Table 2 does not provide for a column (or discussion in accompanying narrative or footnote) indicating the portion of earnings for the current year (column (d)) and in the aggregate (column (f)) that are attributable to the executive's own contributions (including elective deferrals). Arguably, applicable market rate earnings for the current year (relating to column (d)) and in the aggregate (column (f)) on all deferred amounts, should at least be footnoted to each of those two columns. (When a payment of compensation is being deferred, interest credited at a market rate on that deferred payment is, quite arguably, like a loan by the employee to the employer and therefore not in the category of compensation.)

3. Narrative

• Narrative on Potential Termination and Change in Control Remuneration. Parts 1 and 2 of this column concern plans providing fixed, predictable benefits. In contrast are arrangements relating to future terminations of employment and possible changes in control. Unlike the plans in Parts 1 and 2, the arrangements described in this Part 3 relate to events not certain to occur and the amounts that will be paid are, likewise, not certain to be paid. (Obviously, some form of termination of employment is inevitable but the form it will take in most cases is uncertain as of the fiscal year-end being reported.)

Under current disclosure rules, the "terms and conditions" of such arrangements are required to be disclosed if the amount involved, including all periodic payments or installments, exceeds $100,000. The SEC is not satisfied that the current disclosure rules result in adequate disclosure of potential payments and benefits in connection with terminations and in connection with changes in control. See discussion to proposed rules, 71 Fed. Reg. at 6562. The SEC is especially concerned that shareholders are not provided sufficient information to accurately evaluate the amounts involved in connection with such terminations and potential changes in control.

The proposed rules require narrative disclosure as to "each contract, agreement, plan or arrangement, whether written or unwritten" providing payments or benefits including perquisites in connection with:

• "any termination, including without limitation resignation, severance, retirement or a constructive termination of a named executive officer,"

• "a change in the named executive officer's responsibilities," or

• "a change in control of the registrant." 71 Fed. Reg. at 6618.

As to each NEO, the reporting company is required to:

(1) Describe and explain the specific circumstances that would trigger payment(s) or the provision of other benefits, including perquisites;

(2) Describe and quantify the estimated annual payments and benefits that would be provided in each covered circumstance, whether they would or could be lump sum, or annual, disclosing the duration, and by whom they would be provided;

(3) Describe and explain the specific factors used to determine the appropriate payment and benefit levels under the various circumstances that trigger payments or provision of benefits;

(4) Describe and explain any material conditions or obligations applicable to the receipt of payments or benefits, including but not limited to noncompete, nonsolicitation, nondisparagement or confidentiality agreements, including the duration of such agreements and provisions regarding waiver of breach of such agreements; and

(5) Describe any other material factors regarding each such contract, agreement, plan or arrangement. 71 Fed. Reg. at 6618.

The instructions to proposed Item 402(k) require "quantitative disclosure under these requirements even where uncertainties exist as to amounts in given circumstances payable under these plans and arrangements. In the event that uncertainties exist as to the provision of payments and benefits or the amounts involved, the registrant is required to make reasonable estimates and disclose material assumptions underlying such estimates in its disclosure." 71 Fed. Reg. at 6618.

The instructions also provide that such disclosure would call for "forward-looking information" as appropriate. Citing §27A of the Securities Act of 1933 and §21E of the Securities Exchange Act of 1934, the accompanying discussion to the proposed rules indicates that such forward-looking information "falls within the safe harbor for disclosure of such information." 71 Fed. Reg. at 6563.[11]

There has been much criticism directed to the requirement for quantification of something as speculative as future possible payments in connection with so many varieties of NEO terminations of employment, changes in NEO responsibilities and changes in control of the company.

The alternatives requiring disclosure of possible amounts involved are mind-boggling. In connection with terminations of employment, there undoubtedly will be different amounts to be paid under different types of terminations (still different amounts likely will be involved in connection with a change in control both before any termination of employment and after termination of employment). Certain benefits, such as those associated with stock option and other equity awards, will depend upon the price of the stock.

In connection with a change in control, disclosure would have to be given as to how gross-up payments, if provided, are to be calculated for purposes of the excise tax under §4999 of the Internal Revenue Code. (Or, if some other methodology is employed, such as a "cap" or "cut-back" in payments and other benefits that are subject to code §4999, disclosure would have to be made as to how these caps or cutbacks are calculated.) Any such gross-ups, caps or cutbacks are virtually incalculable today because they depend upon calculations of future taxes of each NEO in taxable years (up to five) preceding the year of the assumed change in control.


In a nutshell, if the SEC carries through with its proposals as to quantification of potential payments in connection with terminations of employment and changes in control, it will have created a new "cottage industry" for mathematicians and the compensation consultants employing them.


[1] These proposals appeared on Feb. 8, 2006 as Executive Compensation and Related Party Disclosure; Proposed Rule, Securities and Exchange Commission, 71 Fed. Reg. 6542 (Feb. 8, 2006). (The proposals announced would be codified at 17 CFR Parts 228, 229, 239, 240, 245, 249 and 274. The points covered in today's column would appear primarily in Part 229.) Citations to the proposals in the column will be to the Federal Register page (or to the first page if more than one page is involved) on which the cited proposal appears. In some cases, the introductory discussion by the SEC to the proposed rule may be relevant and will be cited parenthetically after the citation to the proposed rule.

[2] While the March 31 column and today's column cover major elements of the proposed new rules, there are important elements that are not discussed in these two columns.
For example, the discussion in these columns does not cover four of the proposed tables, two supplementing the Summary Compensation Table (the Grants of Performance-Based Awards Table and the Grants of All Other Equity Awards Table) and two tables providing separate detail as to stock option and SAR awards (the Outstanding Equity Awards at Fiscal Year-End Table and the Option Exercises and Stock Vested Table). Among other subjects of the proposed regulations not covered are proposals regarding Form 8-K and disclosure as to certain relationships, related transactions and corporate governance issues. Also not covered are the proposed transition rules and a general mandate to issuers to use "plain English" in their disclosures. It also should be noted that for "small business issuers," separate rules (17 CFR Part 228) are proposed with fewer tables and less narrative than applicable under proposed Part 229. The two columns do not discuss these separate rules for "small business issuers."

[3] 71 Fed. Reg. at 6616 (for SEC discussion of proposal see 71 Fed. Reg. at 6560).

[4] 71 Fed. Reg. at 6617 (for SEC discussion of proposal see 71 Fed. Reg. at 6561).

[5] 71 Fed. Reg. at 6618 (for SEC discussion of proposal see 71 Fed. Reg. at 6562). This narrative discussion, required as to potential payments upon termination, change in control or change in responsibilities, is to be distinguished from the required footnotes to the Summary Compensation Table regarding payments and benefits actually provided to an NEO during the fiscal year being reported. For the proposal as to the latter see 71 Fed. Reg. at 6612. (Item 402(c)(2)(ix)(E).)

[6] The current Pension Plan Table disclosure requirements are contained in Item 402(f) of Regulation S-K. 17 CFR §229.402(f)(2005).

[7] Under the rules as proposed, the numbers shown in the Retirement Plan Table (Proposed Table 1) columns for early retirement and normal retirement may not be comparable for purposes of comparing plans of different companies. Plans of different companies (and even plans of the same company) may have different definitions of "early" and "normal" retirement, including differences in age requirements.

[8] In the "Request for Comment" accompanying the discussion of the Retirement Plan Table (Proposed Table 1), the following questions are raised:
Should this item require quantification of the aggregate actuarial value of a plan benefit as of the end of the company's last fiscal year without regard to whether the plan permits a lump sum distribution? If so, why? Alternatively, would this information provide meaningful disclosure only if the named executive officer currently is eligible to retire under the plan with a lump sum distribution? 71 Fed. Reg. at 6561.
This Request for Comment appears to say that the instruction for narrative accompanying the Retirement Plan Table (Proposed Table 1) intends that the estimated lump-sum distribution amount be disclosed notwithstanding that neither party (employer or employee) can elect distribution during the fiscal year in question. The language, however, is not entirely clear.

[9] In a footnote to its introductory comments on the NQ DC/DCP Table (Proposed Table 2), the SEC cites critics of non-disclosure of earnings on deferred compensation:

See Lucian A. Bebchuk and Jesse M. Fried, "Stealth Compensation via Retirement Benefits," 1 Berkeley Bus. L.J. 291, 314-316 (2004); See also The Corporate Counsel (Sept.-Oct. 2005) at 6-7 and Gretchen Morgenson, "Executive Pay, Hiding Behind Small Print," N.Y. Times, Feb. 8, 2004, §3, at 1. 71 Fed. Reg. at 6561, f.n. 152.

[10] In its introductory comments to the proposed rules, the SEC also notes that, under current rules, earnings are required to be disclosed "only to the extent of any portion that is 'above-market or preferential.'" 71 Fed. Reg. at 6552. In a footnote to this statement, the SEC notes,

[In connection with] current Items 402(b)(2)(iii)(C)(2) and 402(b)(2)(v)(B) . . . [a]n instruction specifies that interest is above-market only if the rate exceeds 120 percent of the applicable federal long-term rate. Furthermore, earnings disclosure is currently required in the Other Annual Compensation column or the All Other Compensation column, depending upon when paid or payable, complicating the preparation process and generating confusion among users of the Summary Compensation Table. 71 Fed. Reg. at 6552, f.n. 99.

[11] The Private Securities Litigation Reform Act of 1995 (H.R. 1058, 104th Cong. (1995)) which added, among others, §§27A and 21E, respectively, to the Securities Act of 1933 and the Securities Exchange Act of 1934, provides that a company cannot be held liable for a "forward-looking statement [that] is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement." 15 USC §77z-2(c)(1)(A)(i)(2003).