article is reprinted with permission from the
July 29, 1992
New York Law Journal.
© 1992 NLP IP Company.
SEC Proposes Changes in Disclosure Rules
By Joseph E. Bachelder.
ON JUNE 23, THE Securities and Exchange Commission proposed wide-ranging changes in the disclosure of executive compensation applicable to proxy statements and other filings under the Securities Exchange Act of 1934 (Exchange Act) and to registration statements under the Securities Act of 1933 (Securities Act). 1
The proposed rules would amend Item 402 of Regulation S-K under the Securities Act and the Exchange Act, as well as Rule 14a-101 of Schedule 14A and Item 11 of Form 10-K under the Exchange Act. At the same time that it announced its proposals as to executive compensation disclosure, the SEC also reproposed shareholder communication rules (originally proposed in June 1991), which appear at 57 Fed. Reg. 29564 et seq. These reproposals are beyond the scope of this column.
These proposals can be divided into five categories for purposes of discussion: (1) more than a dozen tables that are to provide "shareholder friendly" disclosure of specific aspects of executive compensation; (2) a corporate performance presentation in the form of a line graph comparing the company's cumulative total shareholder return over the past five years to at least two indices of shareholder return, one of which must be the Standard and Poor's (S&P) 500 Stock Index; (3) a report by the Compensation Committee, signed by each member, on compensation policies and certain specific decisions; (4) in some circumstances, a report by the company containing additional information about the financial relationship of certain directors with the company, as well as information relating to certain interlocking directorships; and (5) in some circumstances, a report by the Compensation Committee on stock option repricing over the past 10 years. 2
Summary Compensation Table
The new Summary Compensation Table (57 Fed. Reg. 29585, 29599), replacing the cash compensation table, will display all annual and long-term compensation awarded to, earned by or paid to the five "named executives," as well as the "executive group" for the past three fiscal years. 3
The category of named executives specifically includes the chief executive officer (regardless of compensation level) plus the other four most highly paid "executive officers" (subject to an increased threshold of $100,000 of annual compensation). The "executive group" is defined to mean the "executive officers" of the company as a group.
The term "executive officers" continues to be defined as under current rules. An executive officer is any officer who performs a policymaking function, or any other person who performs similar policymaking functions for the company. 4 This could include executive officers of subsidiaries of the company if they perform such policymaking functions for the company. As under current rules, information with respect to the executive group shall include the number of persons in the group (without naming them) and compensation for the group is to be aggregated.
The only table requiring a three-year presentation of data is the Summary Compensation Table. All other compensation tables require display for only the last fiscal year except for the stock option/stock appreciation rights (SAR) repricing tables, which require data covering 10 years. The Summary Compensation Table will contain nine columns of compensation data relating to each of the named executives and to the executive group (10 if option/SAR repricing has occurred). Three of the columns deal with annual compensation, five of the columns deal with long-term compensation, one deals with "other compensation" and, if applicable, one deals with option/SAR repricing.
Following is a summary of the information to be furnished as to the named executives and the executive group in each of these columns:
2. Bonus (cash and noncash);
3. Other annual compensation, including (a) cash value of perquisites, 5 (b) the company's contributions, payments or other allocations to vested retirement plans, (c) amounts such as interest and dividends accrued or paid out under deferred compensation plans or other arrangements (except for accrued but unpaid dividends on company restricted stock which is reported as described in Item 5 below) and (d) annual company-paid premiums on insurance-funded or similar deferred compensation arrangements 6;
4. Restricted stock (valued at market value at date of grant);
5. Accrued (but unpaid) dividends on restricted stock;
6. Long-term incentive payouts (including amounts earned but deferred and excluding amounts reported in respect of stock options and SARs as described in Items 7 and 8 below;
7. Number of shares awarded under stock options;
8. Number of shares awarded in the form of freestanding SARs payable in stock or, in the election of the executive or the company, in stock or cash. (Reference in the following discussion to SARs will be to the type of SARs just noted in this Item 8; freestanding SARs payable only in cash will be referred to as cash SARs) 7;
9. Any other compensation not reported in the preceding eight columns. In addition to "any other compensation" provided to existing covered executives, this column is to include severance arrangements and so-called "golden parachute payments," the latter being in connection with a change in control of the company, if the amounts involved exceed $60,000 8; and
10. In certain circumstances, the number of shares subject to options or SARs as to which repricing has occurred (discussed further below).
Most currently required textual descriptions of plans are eliminated under the proposals. On the other hand, in addition to the Summary Compensation Table, 12 more compensation tables are proposed. Generally, these tables cover each of the named executives and the executive group. Seven of these tables deal exclusively with stock options and SARs. Two of the seven are required only if there has been repricing of options or SARs.
The five remaining compensation tables are for:
* Restricted stock
* long-term stock price based plans (other than those just noted
* long-term non-stock price based plans
* pension and other retirement compensation (this table is required under the current rules
* new or amended compensation plans being submitted for shareholder approval.
In addition to the 12 compensation tables just noted, the proposed rules require a table listing total common equity-based holdings of each named executive and the executive group and a table, already noted, in the form of a line graph providing a five-year corporate performance comparison.
The table of assumed option/SAR values (57 Fed. Reg. 29587, 29600) sets forth as to each named executive and the executive group the "spread" (market price in excess of exercise price):
1. assuming a 50 percent growth in the market price at date of option grant;
2. assuming a 100 percent growth in such price; and
3. assuming a 200 percent growth in such price.
In addition to these three columns, the table is to add one column for each separate option grant, or tranche of an option grant, that in some form carries a premium such as an exercise price that is set (or may be later set) above market price at grant. For example, if the exercise price for an option grant (or a tranche thereof) was set at a premium of 25 percent above market price at date of grant, a separate column would be required showing the "spread" (which would be zero) assuming the market price rose 25 percent above the market price on date of grant. The purpose of this apparently is to allow comparison among the different option grants in a way that reflects premiums, if any, associated with some of the grants. In addition to a column as noted above, each such premium grant, or tranche, will require its own line in the table.
This table (57 Fed. Reg. 29589, 29601) will include the following totals and percentages:
As of last fiscal year-end
1. Common shares outstanding;
2. Common shares authorized for options and SARs;
3. Percentage that shares authorized are of total shares outstanding (Item 2 divided by Item 1);
4. Number of shares under options or SARs granted to date 9 under current authorization;
5. Percentage that shares outstanding under grants are of total authorized (Item 4 divided by Item 2);
Occurring during last fiscal year
6. Number of shares subject to option or SAR grants made during such year;
7. Number of shares subject to grants referred to in Item 6 that were made to named executives;
8. Percentage that shares subject to grants to named executives are of total shares subject to grants (Item 7 divided by Item 6);
9. Number of shares subject to grants referred to an Item 6 that were made to the CEO;
10. Percentage that shares subject to grants to the CEO are of total shares subject to grants (Item 9 divided by Item 6);
11. Number of shares subject to grants referred to an Item 6 that were made to the executive group; and
12. Percentage that shares subject to grants to the executive group are of total shares subject to grants (Item 11 divided by Item 6).
This table of individual option/SAR grants (57 Fed. Reg. 29589. 29601) requires a display for the last fiscal year as to each named officer and the executive group:
1. Options granted (with number of shares subject to each grant);
2. SARs granted (with number of shares subject to each grant);
3. Exercise price/base price per share under each grant;
4. Market price per share at date of grant;
5. Unconditional vesting date; and
6. Expiration date.
In a footnote to Item 5, the SEC indicates continued employment is not deemed a condition of vesting, which would seem to rule out vesting on any date other than date of grant in virtually all cases. It is unclear why the SEC uses "unconditional vesting date" rather than the date, or dates, on which the option or SAR becomes exercisable. Options frequently become exercisable in two or more annual installments. Options and SARs are rarely if ever unconditionally vested in the sense the SEC appears to mean.
The table of individual exercises of options/SARs (57 Fed. Reg. 29590, 29602) requires a display for the last fiscal year as to each named executive and the executive group:
1. Number of shares acquired on exercise;
2. Year of grant;
3. Year of expiration;
4. Annualized amount of gain; and
5. Total amount of gain realized.
The table of unexercised options/SARs held at year-end (57 Fed. Reg. 29590, 29602) requires a display for the last fiscal year-end as to each named officer and the executive group:
1. Total number of shares subject to options and SARs held at fiscal year-end, broken down between shares as to which the rights are vested and unvested; and
2. Dollar amount of "spread" (based on market price less exercise or base price at fiscal year-end), broken down between shares as to which the rights are vested and unvested.
As noted earlier, it does not appear that the SEC recognizes that a key condition attaching to the grant of options and SARs generally is gradual exercisability over several years, not unconditional vesting.
"Repricing" means lowering the exercise price of an option or the base price of an SAR (by amendment, by swapping a new award for the old or otherwise). In such event, two tables and a report on option/SAR "repricings" are required (57 Fed Reg. 29596, 29606), as well as an added column to the Summary Compensation Table. 10
1. Option/SAR Repricing Table. This table provides detailed information regarding option and SAR repricing, including names of each executive officer as to whom a repricing has occurred, date of each repricing, number of shares under each option or SAR involved in a repricing, data allowing calculation with each repricing and the length of the option period remaining at the time of each repricing. Apparently certain of this information will be required in the aggregate (such as total number of executive officers affected, aggregate number of shares under options and SARs repriced, etc.).
The SEC intends that the table cover the past 10 fiscal years, according to the conversation with Elisse B. Walter, deputy director of corporation finance for the SEC. Proposed Rules Item 402 (j)(2)(iii)(B) states explicitly that the table is for the past fiscal year, but Ms. Walter explains that this is a typographical error and that the SEC intends the period covered by the table to be 10 years -- just like the other table and the report, as discussed below. 11
2. Summary of option/SAR repricing percentages. This table requires the percentage of all outstanding shares subject to options or SARs over the past 10 fiscal years represented by shares subject to options or SARs that were repriced or amended for the CEO, the executive group and "other employees." These percentages are based on aggregates for the 10-year period (no year-to-year breakdown is required) and ignore changes in individuals making up the different categories (e.g., if there were three different CEOs during the period they would be treated as one).
3. Report on repricings, giving reasons for each (57 Fed. Reg. 29596 only). According to the SEC's introductory discussion, the Compensation Committee (or the board of directors if there is not such a committee) will be required to provide a report discussing in detail all repricings for executive officers over the 10-year period referred to above and giving the reasons for the repricings. 12
4. Addition of column to Summary Compensation Table. As noted earlier, a column must be added to the Summary Compensation Table indicating the number of shares under options or SARs as to which the repricings took place. According to Ms. Walter, the SEC intends the coverage given by this column to cover the past three fiscal years, just like the other columns in the Summary Compensation Table.
Finally, it is noted that, in what apparently is another typographical error, Proposed Rules Item 402 (j)(2)(iii) indicates that, if there is a repricing, the obligation to furnish the two look-back tables and the Report applies to the proxy statements appearing for three years following the year of the repricing. Ms. Walter, again citing typographical error, indicates the information is required only in the proxy statement for the year following the fiscal year in which repricing occurs.
Restricted Stock Table
This table (57 Fed. Reg. 29591. 29603) requires for the last fiscal year as to each named officer and the executive group:
1. Number of shares granted;
2. Length of restricted period;
3. Total number of shares held at year-end; and
4. Aggregate market value of shares held at year-end.
Under 57 Fed. Reg. 29591, 29603 there are the following long-term incentive compensation tables:
Stock price-based plans. The types of plans covered by this table according to the SEC's explanation include phantom stock, cash SARs, restricted stock units and dividend equivalents. This table requires for the last fiscal year as to each named executive and the executive group:
As to Awards Made
1. Number of shares, units or other rights;
2. Grant date value if determinable; and
3. Performance or other period until maturation or payout;
As to Payouts Made
4. Dollars or dollar value of payout distributed, or earned but deferred.
Non-stock price based plans. The types of plans covered by this table according to the SEC's explanation include an insurance funded deferred compensation plan that "rolls out" the cash value to the executive and a performance unit plan tied to the attainment of a specific corporate performance target such as earnings per share. This table is similar to the stock price based table except that awards are expressed in unit and dollar values and target values (numbers of shares if the award is stock-related but non-stock price based) and, in some cases, minimum and maximum target values (number of shares, if applicable) must be shown. 13
As already noted, the pension table (57 Fed. Reg. 29593, 29604) is the same as that required by the current rules. It projects pension levels at different levels of covered compensation and years of service. Some textual discussion will still be required but for most plans the rather detailed narrative currently required, such as how the plan operates and who is covered by the plan, will be eliminated.
No basic change is proposed in the information required to be presented in report and table regarding plans being submitted to shareholders for approval (whether as new or amended plans; 57 Fed. Reg. 29597, 29607). However, a new table is required that sets forth the amounts that will be received by or allocated to the named executives and the executive group in the future. If such future amounts are not determinable, the table is supposed to state the amounts that would have been received by or allocated to each during the last fiscal year, if the plan had been in effect for that year. The three-year date previously required for new or amended plans would be eliminated. As discussed above, however, three years of complete compensation data will appear in the Summary Compensation Table.
The total common equity based holdings table 14 (57 Fed. Reg. 29593, 29605) requires for each named executive and the executive group the following:
1. Unrestricted stock beneficially owned, excluding shares subject to options or SARs;
2. Shares subject to options or SARs, whether or not the options or SARs are immediately exercisable; and
3. Restricted stock.
To enable shareholders to evaluate the discussion by the Compensation Committee, the company will be required to produce a new chart showing the performance of the company's stock over the past five years, the corporate performance graph (57 Fed. Reg. 29595, 29607). This chart will be in the form of a line graph comparing cumulative total shareholder return for the company, the S&P 500 stock index and an industry based on a peer group compiled by the company.
The presence in the proxy statement of the corporate performance graph will be troublesome in the case of an underperforming company whose Compensation Committee has been overly generous in its senior executive compensation decisions. Especially difficult for such a committee will be the required reconciliation of corporate performance as shown in the corporate performance graph with pay increases of particular named executives, as described in the next section.
Responding to shareholders' concerns about the relationship of executive pay to company performance, under 57 Fed. Reg. 29593, 29605, the SEC would require, the Compensation Committee, or, if there is no such committee, the entire board of directors, to prepare a report signed by each member that "shall provide a clear and concise statement setting forth the specific factors, criteria and goals underlying the committee's decisions on, or approval of, awards and payments of cash and noncash compensation" to each of the named executives for the last fiscal year. 15 The proposed rules go on to provide that if the company's corporate performance was a factor in a compensation decision as to a named executive then "each element or measure of performance earnings, quality rates, market share) that the committee relied upon" in reaching such compensation decision shall be described. The proposed rules then indicate that if "factors, criteria or goals" other than corporate performance criteria were important as to a decision on an element of compensation for a named executive such other factors, criteria or goals should be identified and explained. 16 The SEC emphasizes that boilerplate language will not be acceptable and that a very specific discussion will be required.
In three situations the company must disclose additional information (57 Fed. Reg. 29596, 29605). These situations are: (1) the Compensation Committee is not composed solely of outside directors, (2) the company has interlocking Compensation Committee members with another company 17 or (3) the company has repriced options in the last fiscal year. The additional information 18 includes: (a) disclosure of any interlocking Compensation Committee (or board) memberships of any of the company's executive officers, (b) disclosure, for the prior three fiscal years, of all direct and indirect contracts, fees, loans, awards or financial interests in excess of $60,000 in the aggregate involving the company or any of its affiliates and (i) the Compensation Committee (or board) member or (ii) any company or other entity of which such Compensation Committee (or board) member is an officer, director, partner, employee or owner of more than 10 percent of the common equity of the company, (c) description of any means by which any member of the Compensation Committee (or board) could benefit from actions of the company or its executive officers, and (d) description of all discussions between any of the named executives 19 and any member of the company's Compensation Committee (or board) with an interlocking relationship concerning compensation matters pertaining to either company.
No basic change in reporting on director compensation is proposed (57 Fed. Reg. 29597, 29605). The SEC, however, in its introductory discussion, indicates that it intends to include in the category of "other arrangements" those programs described as "charitable award" or "director legacy" programs pursuant to which a company makes a donation to a third party in the director's name.
The SEC's introductory discussion repeatedly urges comments on the proposed rules. According to the summary preceding the table of contents to the SEC proposals, anyone wishing to submit comments should submit them in triplicate on or before Aug. 31, to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, N.Y., Stop 6-9, Washington, DC 20549. File reference is S7-16-92.
1 The proposed rules as to executive compensation disclosure were published in the Federal Register on July 2, starting at 57 Fed. Reg. 29582. There are a number of omissions and typographical errors, some of them substantive, in the proposals as published in the Federal Register. The SEC staff advises that, except for the correction, published July 14, 1992, at 57 Fed. Reg. 31156, of one omission (regarding termination arrangements) mistakes will be corrected, after the comment period, in the adopting releases.
2 Two notes are made as to the terminology used in the column. First, reference to "company," unless otherwise stated, is a reference to a registrant within the meaning of Rule 100(a)(4) of the Securities Act and Rule 12b-2 of the Exchange Act. Second, the proposed rules (and the introductory discussion by the SEC) repeatedly refer to "numbers of options" or "numbers of SARs" when the intended reference is to "numbers of shares" granted under such options or SARs. Instead of using the SEC's terminology (which the author finds very confusing), this column will refer to the number of shares "subject to such option or SAR grants," or words to similar affect.
3 As of this writing, the proposed rules do not provide for a transition period for the three-fiscal year display in the 1993 proxy. Under the proposed rules companies will be required to display all compensation for the last three fiscal years, commencing with the first proxy statement under the new rules (for most companies, this will mean the 1993 proxy statement, assuming the SEC finalizes the proposed rules on schedule). At an earlier stage of the SEC deliberations, at least one SEC commissioner favored a transition period. Commissioner Mary Shapiro stated in April that she "would object to making this feature retroactive [because this] would require costly reviews and recalculations, particularly during the first year, the burdens of which would outweigh the benefits." 24 Sec. Reg. & L. Rep. (BNA) 483. In a recent conversation, the commissioner indicated that there may be no transition period because of a compromise reached within the SEC, the trade-off apparently being that the new rules do not provide for a present value method of valuing stock option grants. Elisse B. Walter, deputy director of the SEC Division of Corporation Finance, in a recent conversation, stated that questions regarding a transition period "will be considered in light of the comment process."
4 Rule 3b-7 under the Exchange Act.
5 The cash value of perquisites need not be reported if the aggregate amount is the lesser of $25,000 or 10 percent of annual salary and bonus reported for each named executive (with respect to the executive group, the aggregate amount is the lesser of $25,000 times the number of persons in the group or 10 percent of the aggregate annual salary and bonus reported for the group). Proposed Rules Item 402(b)(2)(ii)(C)(1), 57 Fed. Reg. 29599.
6 According to the SEC's introductory discussion, items not included are economic benefits under group life, health, hospitalization, medical reimbursement or relocation plans that do not discriminate in scope, terms or other operation in favor of executive officers and directors and that are available generally to all salaried employees. 57 Fed. Reg. 29586.
7 Freestanding SARs are also known as nontandem SARs. Tandem SARs or tandem cash SARs are not subject to separate disclosure rules. A "tandem SAR" or "tandem cash SAR" means an SAR granted in tandem with a stock option the holder can exercise one or the other, and to the extent the holder exercises rights under one it diminishes proportionately the rights of the holder under the other.
8 The persons as to whom the golden parachute or other severance arrangements are to be reported, according to Proposed Rules Item 402(b)(2)(iv)(B), 57 Fed. Reg. 29600, are the named executives. However, according to the SEC's introductory discussion, this last reporting requirement applies to any "named executive officer or member of the executive officer group. . . ." 57 Fed. Reg. 29588.
9 The option/SAR summary table as contained in Proposed Rules Item 402(d) refers to grants "to date." 57 Fed. Reg. 29601. However, the text of Item 402(d)(l)(ii)(D), following the table, refers to grants "as of the prior fiscal year."
10 The SEC has stated that "[while] repricing transactions effected before publication of these proposals will not trigger the mandated disclosure, subsequent repricing action will result in the 10-year look back and thus require disclosure of all repricing of options or SARs held for executive officers, including repricings prior to publication of this release." 57 Fed. Reg. 29596.
11 There is support for the 10-year look-back position in the SEC's introductory discussion to the proposed rules. While Proposed Rules Item 402(j)(2)(iii)(B), as noted, indicates the information is only for the fiscal year, the heading given to this table in the SEC's introductory discussion is "Ten-Year Option/SAR Repricing." 57 Fed. Reg. 29596. This table also is referred to elsewhere in the SEC's introductory discussion as the "Ten-Year Option/SAR Repricing Table." 57 Fed. Reg. 295900.
12 The detailed reporting and 10-year look-back period caused by repricing may be considered by some to be draconian. It is the SEC's position that shareholders have substantial reservations about stock option repricing and therefore should be provided with extensive information concerning the company's repricing practices for the past 10 fiscal years. These tables and the report are described in the SEC's introductory discussion at 57 Fed. Reg. 29596 and in Proposed Rules Item 402(j)(2)(iii), 57 Fed. Reg. 29606.
13 According to the non-stock price based plans table, as it appears in Proposed Rules Item 402(f)(2), 57 Fed. 29604, the display of stock denominated awards under a non-stock price based plan are to be expressed in terms of number of shares. However, in the text of Item 402(f)(2) following the table the rule states that the award is to be expressed in terms of dollar value for each stock denominated award.
14 It appears from the SEC comments in its introductory discussion to the proposed rules that it intends beneficial ownership and the date of ownership to be consistent with Item 403(b) of Regulation S-K. For this discussion see 57 Fed. Reg. 29593 (n. 43). Under the proposed rules, beneficial ownership of unrestricted stock (Item 1 above) is to be determined in accordance with Rule 13d-3 under the Exchange Act. Instruction 2 to Proposed Rules Item 402(h), 57 Fed. Reg. 29605. Stock-based instruments other than "unrestricted stock" (presumably meaning unrestricted common stock but the term is not defined in the proposed rules) are to be considered as giving rise to beneficial ownership only if they are convertible into shares of the company's common stock. Item 403(b) of Regulation S-K (requiring disclosure of security ownership by management) likewise requires beneficial ownership to be determined in accordance with Rule 13d-3. While the proposed rules are silent as to the date of ownership for disclosure purposes, it should be noted that Item 403(b) calls for inclusion of such equity-based holdings as of the "most recent practicable date."
15 Proposed Rules Items 402(j)(1), 57 Fed. Reg. 29605.
16 Proposed Rules Item 402(j)(1)(ii), 57 Fed. Reg. 29605, contains language suggesting that if corporate performance were a substantial factor in reaching a compensation decision as to a particular executive, other factors, criteria, etc. may be ignored in the disclosure. In view of the SEC's introductory discussion, see 57 Fed. Reg. 29593, and plain common sense, the author assumes the facial meaning of the language of Proposed Rules Item 402(j)(1)(ii) does not reflect the actual intent of the SEC.
17 This would mean that at least one of Company A's executive officers sits on Company B's Compensation Committee while at least one of Company B's executive officers sits on Company A's Compensation Committee. (It is not necessary for Company B to be a registrant in order for Company A, if a registrant, to be deemed to have interlocking Compensation Committee members.) If Company A lacks a Compensation Committee (or its equivalent) the test becomes whether an executive officer of Company B is a member of the board of Company A. The same would be true, in reverse, if Company B lacks a Compensation Committee (or its equivalent). Proposed Rules Item 402(j)(2)(i)(B), 57 Fed. Reg. 29605.
18 This additional information is not required of a company deemed a "small business issuer" if the situation that otherwise would require it is one described in clause (1) or clause (2) of the first sentence of the text. A "small business issuer" is defined by the proposed rules as an "issuer that (i) had revenues of less than $15 million during its last fiscal year; (ii) is not a foreign private issuer or a foreign government; (iii) is not an investment company; and (iv) is not a wholly owned subsidiary of a non small business issuer." Instruction 2 to Proposed Rules Item 402(j)(2), 57 Fed. Reg. 29606.
19 Another inconsistency in the SEC's terminology occurs between the use of the term named executive for the executives covered by the description requirement of clause (d), as used in Proposed Rules Item 402(j)(2)(ii)(D), 57 Fed. Reg. 29606, and the term "senior executive officer" used for this same purpose in the introductory discussion to the Proposed Rules. 57 Fed. Reg. 29597.