This article is reprinted with permission from the
August 31, 2006
edition of
New York Law Journal.
2006 NLP IP Company.

SEC Adopts Final Rules on Executive Pay Disclosure

By Joseph E. Bachelder

On Aug. 11, 2006, the U.S. Securities and Exchange Commission (SEC) published its new executive compensation disclosure rules in final form (Final Rules). Page references in this column will be to the Aug. 11 release.[1] The Final Rules include new rules aimed at the problem of stock option exercise price manipulation, which are discussed below in connection with the tables and Compensation Discussion and Analysis (found, along with the release, at[2]

I. Overview

A. Persons Whose Compensation Is to Be Disclosed.

(i) Named Executive Officers. As in the case of the current rules (in effect since 1992), executive compensation reporting is directed primarily to five top executives, labeled "Named Executive Officers" (NEOs). Under the new rules, the CEO and CFO (now labeled, respectively, Principal Executive Officer, PEO, and Principal Financial Officer, PFO) are automatically NEOs. The other three NEOs are the highest paid of the remaining executive officers.[3] "Highest paid" for this purpose means the highest total compensation as shown in column (j) in the Summary Compensation Table less two elements of compensation for the year in question, increase in pension value and certain preferential earnings on deferred compensation, both reportable in column (h) of that table. (See Part II.A(4) of this column for further discussion.)

(ii) Directors. A new table (with accompanying narrative disclosure) is added to provide greater detail as to director compensation.

(iii) Proposals as to Three Other Employees Who Are Not NEOs. The SEC continues to propose, but has not yet adopted, a rule for reporting the compensation of up to three of the highest-paid employees who are not themselves executive officers and who are paid more than the lowest-paid NEO. There would be no tabular presentation and it would appear the proposal calls for total compensation for the fiscal year for each such employee and description of their job positions. The SEC invites further comments, including whether the names of these employees should be identified, before reaching any final conclusion on this proposal.[4]

B. Tabular Presentation (7 Tables).

The new disclosure rules contain six tables providing compensation and benefits data regarding NEOs and a seventh table providing compensation data as to directors. All of the tables are subject to rules regarding narrative (including in some cases, footnotes) to accompany them. Such narrative is in addition to the Compensation Discussion and Analysis section, as discussed below. The tables fall into four categories.

Category 1 Tables. Currently Reported Compensation.

i. Summary Compensation Table ("SCT")

ii. Grants of Plan-Based Awards Table (supplementing the SCT)

Category 2 Tables. Long-term Incentive (Equity and Non-Equity) and Stock Option Tables.

iii. Outstanding Equity Awards at Fiscal Year-End Table

iv. Option Exercises and Stock Vested Table

Category 3 Tables. Retirement and Deferred Compensation Tables.

v. Pension Benefits Table

vi. Nonqualified Deferred Compensation Table

Category 4 Table.

vii. Director Compensation Table (Patterned after the SCT for the NEOs.)

In addition to the foregoing tables, the Stock Performance Graph (in a change from the Proposed Rules) is being retained, but moved from the proxy statement to the 10-K.

C. Compensation Discussion and Analysis (CD&A).

The SEC describes the CD&A as the "centerpiece" of the proxy statement; it will be the company's (not the compensation committee's) discussion and analysis of compensation certified by the PEO and the PFO. It will be treated as a filing with the SEC (not merely a document furnished as part of the disclosure).[5] The CD&A is intended to be a much more extensive document than the Compensation Committee Report (CCR) has been. The CD&A ties together the principles and objectives of compensation programs and the data set forth in the tables. The CCR continues but is essentially reduced to a confirmation over the signatures of the members of the compensation committee that they have reviewed the CD&A, discussed it with management and recommended the CD&A's inclusion in the 10-K as well as the proxy statement (or, if applicable, the information statement). (The Proposed Rules would have eliminated the CCR.) It will continue to be treated as a document furnished to the SEC and not as a filing.

D. Compliance Dates.

For most companies the first proxy statement subject to the new rules will be the first proxy statement filed on or after Dec. 15, 2006 in respect of a fiscal year ending on or after that date.[6]

II. Seven Tables

A. Summary Compensation Table.

As under the current rules, the SCT sets forth in columnar form data on compensation for each NEO for each of the three most recent fiscal years, subject to phase-in rules.[7] On the other hand, the new SCT not only is organized differently in major respects from the current SCT, but it also requires more information on NEO compensation. The intention of the SEC is to require in one table all elements of compensation for the fiscal year being reported and the two preceding years (subject to the phase-in rule discussed in footnote 7 referenced above). Following are highlights as to some of the columns in the new SCT:

(1) Total Compensation Column. A new total compensation column (j) is added representing all amounts shown in the preceding columns (a) through (i). This number, especially for CEOs, is likely to generate significant comment from the media and others. Issuers, for the first time, will be required to show a single, aggregate number for all compensation and benefits for each fiscal year reported (subject to the phase-in rule mentioned above) for each NEO.

The total compensation number will include amounts ranging from current cash compensation (e.g., salary) to amounts that will not be paid out until the future (e.g., increase in pension value). Some compensation will be reported on a "when awarded" basis (e.g., stock options) and other compensation will be reported only in the year earned (e.g., performance-based long-term incentive awards). Many commenters criticized the "one number fits all" approach but the SEC adopted its proposal to show a single Total Compensation number.

(2) Option Awards Column. Unlike the reporting in the current SCT, the option column (f) will be reported based on award date value (i.e., Black-Scholes or equivalent) rather than reporting simply the number of underlying securities.

(3) Non-Equity Incentive Plan Compensation Column. This column (column (g)) corresponds to the old LTIP pay-outs column. An important difference, however, is that the new SCT eliminates the distinction between annual and long-term incentives. Instead, it provides that "bonuses" (column (b) of the SCT) are to be reported in the non-equity incentive plan table if the bonus is based on pre-established performance targets and the outcome is substantially uncertain. For many companies this will mean a shift of the traditional annual bonus out of the Bonus column to the Non-Equity Incentive Plan Compensation column. Unlike other plan-based awards reported in columns (e) and (f), the disclosure of the amount in this column is shown for the year in which earned.

(4) Change in Pension Value and Nonqualified Deferred Compensation Earnings Column. For the first time the SCT will show the increase in defined benefit pension value during the fiscal year being reported. This column (h) also will report the above-market or preferential earnings on nonqualified deferred compensation (currently reported in the SCT under "All Other Compensation").[8] As noted in Part I.A(i) of the column, the compensation shown in this column is not taken into account in determining the highest paid executive officers for purposes of designating NEOs.

B. Grants of Plan-Based Awards Table[9]

This table supplements the SCT by providing additional information relating to: Stock Awards (SCT column (e)), Option Awards (SCT column (f)) and Non-Equity Incentive Plan Compensation (SCT column (g)).

This new table includes (a) estimated future payouts under incentive plans awards (number of shares in the case of equity and dollar values in the case of nonequity) and (b) all other stock and stock option awards (that is, those that are not performance-based with all future payouts shown in number of shares). Column (b) of this Table requires disclosure of the grant dates of awards.[10] Column (k) of the Table requires disclosure of the exercise price of option awards. If the market price is higher than the exercise price, a column giving that information must be added. If the grant date of an option is different from the date the compensation committee (or other granting entity) met to approve the grant, a column must be added disclosing the date. The SEC discussion expects that these columnar presentations (together with required narrative discussion accompanying the Table) as they relate to option grants will assist in resolving problems associated with option price manipulation. Also reflecting SEC concern with option manipulation, the CD&A, as discussed below, requires explanation as to employer policies in choice of option grant dates and other practices associated with option prices.

C. Outstanding Equity Awards at Fiscal Year-End Table.

This table expands on the Option/SARs table in the current rules by adding other stock-based awards to it (other than performance-based awards which are covered in the Performance-Based Awards Table discussed above). (The "companion" to this table is the Option Exercises and Stock Vested Table discussed next.) This table includes stock and stock equivalent awards. It requires disclosure of the number of shares subject to awards and provides dollar values for "in the money" options (both exercisable and unexercisable) and for shares and share equivalents.

D. Option Exercises and Stock Vested Table.

This table discloses the numbers of shares and dollar values for option exercises and shares vesting for the last fiscal year. The information provided as to options is essentially the same as that provided in the corresponding table under the current rules. There is not, however, a corresponding requirement as to stock vesting for the last fiscal year under the current rules.

Tables Relating to Post-Employment Compensation.

(For special narrative requirements as to certain severance and change-in-control entitlements, see Part IV below.)

E. Pension Benefits Table.

The Pension Plan Table under current rules has been the subject of considerable criticism. It does not identify pensions accruing to individual executives. It presents pension levels based on categories of compensation and years of service (information regarding individual executives is in some cases to be reported in the narrative following the table, but this information has been incomplete and insufficient to provide a basis for calculating the actuarial present value of pension benefits).

The new Pension Benefits Table requires disclosure of the number of years of each NEO's credited service and the actuarial present value of each NEO's accumulated pension benefits.[11]

The Final Rules' inclusion of an actuarial present value of the pension benefit is a significant change from the Proposed Rules which provided only for the estimated retirement benefit at normal and early retirement ages. This addition of actuarial present value for pension benefits will undoubtedly attract much attention from the media and others due to the fact that many NEOs have built up very substantial actuarial present values for their pensions, which have not been the direct subject of required disclosure.[12]

F. Nonqualified Deferred Compensation Table.

This new table reports all earnings on deferred compensation. In addition to recording the last fiscal-year contributions (both by the executive and the employer), the table reports (i) aggregate earnings in the last fiscal year, (ii) any withdrawals and distributions in that year and (iii) the aggregate balance at the end of the fiscal year. This table remains in the form it took in the Proposed Rules. It includes all earnings in the last fiscal year, not just those that were above-market or preferential as disclosed in the SCT.[13]

G. Director Compensation Table.

This table, contained in the Proposed Rules, continues the proposals with modifications similar to those in the final version of the SCT (but with a slightly different format to begin with (e.g., current cash compensation is reported as "fees" rather than as "salary" and "bonus")). It is the author's belief that this table may prove to be one of the most significant changes in proxy statement reporting. Its significance will include a possible "ratcheting effect" on director compensation similar to that attributed to executive compensation following prior expansions in SEC executive compensation disclosure requirements (most significantly, the broadened disclosure under the rules adopted in 1992). As in the case of NEOs, option timing and dating practices must be described; in this case the reporting is in the narrative disclosure to the Director Compensation Table. A supplemental Grants of Plan-Based Awards Table is not required for directors.


As in the Proposed Rules, the CD&A, as noted above, is a much expanded version of the CCR and is to be certified by the CEO and the CFO and will be treated as a document filed by the Company and not by the Compensation Committee. (As noted above, the Final Rules require the members of the Compensation Committee to sign a "short form" CCR (a furnished document, not a filed document) that confirms they have reviewed and approved the CD&A).

The Final Rules, like the Proposed Rules, describe the CD&A as a "principles-based" filing and, like the Proposed Rules, the Final Rules set out several key areas for discussion:

• What are the objectives of the company's compensation programs?

• What is the compensation program designed to reward?

• What is each element of compensation?

• Why does the company choose to pay each element?

• How does the company determine the amount (and, where applicable, the formula) for each element?

• How do each element and the company's decisions regarding that element fit into the company's overall compensation objectives and affect decisions regarding other elements? SEC Release No. 33-8732 at pp. 28-29.

For detailed examples of what the SEC is looking for in the CD&A discussion, see Item 402(b)(2), SEC Release No. 33-8732 at pp. 331-333.

Confidential Information. In connection with disclosure of performance targets (primarily in connection with incentive plans), employers will not be required to disclose "specific quantitative or qualitative performance-related factors" if the compensation committee or the board of directors considers disclosure "would result in competitive harm for the registrant." SEC Release No. 33-8732 at p. 334.[14] While the registrant does not need to seek permission to exclude information in the first instance, it must discuss in its disclosure "how difficult it will be for the executive or how likely it will be for the registrant to achieve the undisclosed target levels or other factors." Id.

As also noted earlier in this column, the SEC, in light of the current concern about stock option manipulation, includes in the CD&A provision for additional information relating to the setting of stock option exercise prices. In its introductory discussion to the new rules, the SEC states that "[i]f the company had since the beginning of the last fiscal year, or intends to have during the current fiscal year, a program, plan or practice to select option grant dates for executive officers in coordination with the release of material non-public information, the company should disclose that in the Compensation Discussion and Analysis section." SEC Release No. 33-8732 at pp. 23-24. This is in addition to the tabular disclosure discussed above. For discussion of the elements and questions regarding option timing that the SEC expects issuers to pay particular attention to in the CD&A, see SEC Release No. 33-8732 at pp. 23-26.

IV. Severance

• Severance and Change-in-Control Entitlements.

The Final Rules, Item 402(j), continue the requirement of the Proposed Rules that registrants disclose in narrative form as to each NEO severance, vesting of awards and other benefits and entitlements associated with terminations of employment and changes in control. Item 402(j) appears at pages 360-362 of the Final Rules. For purposes of this narrative, it can be assumed that the triggering event takes place on the last day of the fiscal year being reported. Given the variety of events that may trigger different types of post-termination and change-in-control entitlements, for many companies this will be a lengthy and very complex narrative.[15] (Some companies may decide to use tabular presentation of some of the data.) The Final Rules provide that, given the "forward-looking" nature of much of the information, it will fall within the safe harbors for disclosure of such information.[16]


[1] The Aug. 11, 2006 release, SEC Release No. 33-8732, is available as a PDF at the SEC's Web site at At the time of the writing of this column, the new rules had not been published in the Federal Register. The proposed rules ("Proposed Rules") were issued Jan. 27, 2006 and appeared in the Federal Register on Feb. 8, 2006. 71 Fed. Reg. 6542. The Proposed Rules were the subject of two prior columns by the author. New York Law Journal March 31, 2006 and April 21, 2006.

[2] Due to the length (approximately 400 pages) and scope of the Aug. 11, 2006 release, this column focuses only on the executive compensation disclosure rules. Among other topics not covered are related party transactions, corporate governance and Form 8-K filings. Also, the rules applicable to issuers pursuant to Item 402, the rules of which are the subject matter of this column, do not apply in all instances to the same extent or in the same way to small business issuers, foreign private issuers, business development companies and registered investment companies. An additional point not covered in the column is the SEC's emphasis on Plain English presentation of information contained in the proxy statement. See §240.15d-20 of Part 240 -General Rules and Regulations, Securities Exchange Act of 1934 ("Exchange Act"). SEC Release No. 33-8732 (Aug. 11, 2006) at p. 420.

[3] For a definition of "executive officers," see SEC Release No. 33-8732, footnote 327 at p. 117, referencing applicable rules under the Securities Act of 1933 ("Securities Act") and the Exchange Act.

[4] Many commenters complained that to adopt this proposal (sometimes called the "Katie Couric" proposal) would reveal compensation of persons in special categories such as entertainers in telecommunication companies and non-management business producers in other enterprises that could hurt employers and would risk their losing employees. The SEC, in its current release, suggests limiting the employees covered by the proposal to those who are not executive officers but who have policy-making roles. Examples given are "the director of the news division of a major network; the principal creative leader of the entertainment function of a media conglomerate; or the head of a principal business unit developing a significant technological innovation." SEC Release No. 33-8732 at p. 92.

[5] As a result, the certification is subject to SEC Regulation 14A or 14C and to the liabilities of Section 18 of the Exchange Act. In addition, to the extent the CD&A is included or incorporated by reference into certain periodical reports, it will be covered by certifications by the PEO and PFO required under the Sarbanes-Oxley Act of 2002. (For further reference to SEC authority in this respect, see footnote 99 to the release containing the Final Rules. SEC Release No. 33-8732, p. 40).

[6] For registered investment companies, compliance is required for any new proxy or information statement filed on or after Dec. 15, 2006. Other transition information can be found at SEC Release No. 33-8732 at pp. 195-197.

[7] Under phase-in rules, for the first fiscal year being reported under the new rules, issuers may (but are not required to) conform the preceding two fiscal years to the SCT reporting under the new rules. Otherwise, they will be required to phase in one additional preceding fiscal year until all three years are being reported on the new basis.

[8] An above-market or preferential return is "determined for interest by reference to 120% of the applicable federal long-term rate and for dividends by reference to the dividend rate on the company's common stock." SEC Release No. 33-8732 at p. 66. In both respects, the new rules continue current practice. (The Proposed Rules would have required inclusion in the SCT of all earnings on nonqualified deferred compensation. Under the Final Rules, the total earnings on nonqualified deferred compensation are shown in the Nonqualified Deferred Compensation Table.)

[9] The Grants of Plan-Based Awards Table in the Final Rules consolidates two tables which had been called (i) Grants of Performance-Based Awards Table and (ii) Grants of All Other Equity Awards Table in the Proposed Rules.

[10] The Final Rules define the grant date as "the grant date determined for financial statement reporting purposes pursuant to FAS 123R." SEC Release No. 33-8732 at p. 87. This is the same definition as that given in the Proposed Rules.

[11] The new table also contains a column disclosing actual pension payments made to an NEO during the fiscal year. This would be an unusual circumstance, presumably occurring only in an NEO's last year of service.

[12] The author discussed the subject of large aggregate pension values of senior executives in a prior column. New York Law Journal May 23, 2005.

[13] In order to avoid confusion to readers who might otherwise double-count earnings, footnote disclosure is required to indicate earnings on deferred compensation (i) currently also reported in the SCT and (ii) previously reported in the SCT for prior years.

[14] The standards to be applied in determining competitive harm are the same, according to instructions to Item 402(b), as applied "when a registrant requests confidential treatment of confidential trade secrets or confidential commercial or financial information pursuant to Securities Act Rule 406 (17 CFR 230.406) and Exchange Act Rule 24b-2 (17 CFR 240.24b-2), each of which incorporates the criteria for non-disclosure when relying upon Exemption 4 of the Freedom of Information Act (5 USC. 552(b)(4)) and Rule 80(b)(4) (17 CFR 200.80(b)(4)) thereunder." SEC Release No. 33-8732 at p. 334.

[15] As to each NEO, Item 402(j) requires the issuer to:

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

(2) Describe and quantify the estimated 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 how the appropriate payment and benefit levels are determined 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 non-compete, non-solicitation, non-disparagement 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. SEC Release No. 33-8732 at pp. 360-361.

[16] See SEC Release No. 33-8732, footnote 86 at p. 35 referencing Securities Act §27A and Exchange Act §21E.