article is reprinted with permission from the
November 30, 1992
New York Law Journal.
© 1992 NLP IP Company.
New SEC Pay Disclosure Rules
By Joseph E. Bachelder.
EFFECTIVE OCT. 21, the Securities and Exchange Commission adopted amendments to the executive compensation disclosure requirements 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 final rules differ in some significant respects from the proposed rules that were released last June by the SEC 2 and were the subject of this column in July. 3
Four new compensation tables. At the heart of the new disclosure rules are four new compensation tables. The "centerpiece" is the Summary Compensation Table, which replaces the old Cash Compensation Table. Instead of one column of data, as required by the Cash Compensation Table, the Summary Compensation Table contains seven columns of data. It requires these data for the last three fiscal years, not just the last fiscal year.
The Summary Compensation Table, like the other three tables noted, applies to the chief executive officer (CEO) and the four other executive officers 4 who are the highest paid and earn more than $100,000 in salary and bonus. (The CEO must be included in any event). These five executive officers will be referred to in this column as the "Named Officers." The new rules eliminate the requirement that compensation data be given for the executive officers as a group.
The remaining three new compensation tables (which present data only as to the last fiscal year) are:
* an option/SAR 5 grant table
* an option/SAR exercise table
* a long-term incentive plan (LTIP) awards table (covering long-term awards other than (i) stock options, (ii) SARs and (iii) with one limited exception, restricted stock).
Stock Performance Graph. A second "centerpiece" is the five-year Stock Performance Graph, which requires a comparison of the reporting company's five-year stock performance with (i) a broad equity market-based index (which must be the Standard & Poor's 500 Stock Index (S&) 500 Index) if the reporting company is included in the S&P 500) and (ii) an industry-based index or a peer group index constructed by the company.
Compensation Committee Report. A third "centerpiece" is the Compensation Committee Report, to be provided over the names of each of the compensation committee members. It is to cover
* policies in compensating executive officers during the last fiscal year and the relationship between corporate performance and such compensation
* bases for specific decisions as to CEO pay for the last fiscal year and the relationship between corporate performance and such compensation.
Other new disclosure requirements. These include:
* a separate section on compensation committee "interlocks" with other companies and "insider" members of the compensation committee
* if option of SAR repricing has occurred, an option/SAR repricing disclosure table (with 10 years of data plus a report).
Previous disclosure requirements that continue. Five such disclosure requirements (with some modifications) continue.
* Pension Plan Table
* Employment and termination arrangements
* Director compensation
* Equity ownership
* Plans submitted to shareholders
A substantial portion of the narrative description of LTIPs, pension plans, etc. has been omitted from the new rules. As will be noted below, however, a significant amount of narrative, in footnote or other form, is still required.
There are several exceptions under the new rules pertaining to "small business issuers," foreign private issuers and registered investment companies. 6 Small business issuers need not include in their proxy statement the Compensation Committee Report or the Stock Performance Graph and are eligible to file under the old rules until May 1, 1993. Small business issuers may also "phase-in" the three-year display required by the Summary Compensation Table. Foreign private issuers need only comply with the existing disclosure requirements under Items 11 and 20 of Form 20-F. 7 Finally, investment companies registered under the Investment Company Act are completely exempt from the new rules with the exception of directors' compensation disclosure.8
Summary Compensation Table
As previously stated, at the heart of the new disclosure rules in the Summary Compensation Table (SCT) (57 Fed. REg. 48,151). An illustrative SCT is included in this column.
As also already noted, the SCT requires a three-year presentation of data. Companies whose fiscal year ends on or after Dec. 15 (other than small business issuers and other exempted companies as noted above) must disclose their 1992, 1991 and 1990 compensation data in this table. Those companies whose fiscal year ends before Dec. 15 may disclose under the old rules for 1992 data; however, subsequent proxy statements must disclose compensation data on a last-three-fiscal year basis.
The seven columns of data in the SCT are divided into three parts: Annual Compensation, Long-Term Compensation and All Other Compensation. Below is the information required, according to column (letters correspond to those given to the columns in the SCT):
(c) Salary: This column displays the dollar value earned by each Named Officer in each fiscal year shown in the SCT.
(d) Bonus: This column displays the dollar value earned in each fiscal year by each Named Officer.
It either salary or bonus is forgone in favor of another form of compensation (and not simply deferred), special rules apply. 9
(3) Other Annual Compensation: This column displays an aggregate dollar value of perequisites and other personal benefits (if such aggregate exceeds the lesser of $50,000 or 10 percent of salary and bonus), preferential or above-market earnings paid or payable (including such earnings if deferred at the election of the Named Officer) on restricted stock, options, SARs or deferred compensation, 10 all earnings paid or payable on long-term incentive compensation (including such earnings if deferred at the election of the Named Officer), tax gross-ups 11 and discounted stock purchases (unless available to all shareholders or to all salaried employees). The rules require that each perquisite or other personal benefit exceeding 25 percent of the total perquisites for each Named Officer must be identified by type and amount in a footnote or accompanying narrative discussion to this column.
The SEC has allowed companies to "phase-in" the "Other Annual Compensation" column (column [e]) so that companies reporting for the 1993 proxy season need only report 1992 "Other Annual Compensation" data in their 1993 proxy statement. For the 1994 proxy season, they will report 1992 and 1993 compensation data, and in their 1995 proxy statement they will report such compensation on a full three-year basis.
(f) Restricted Stock Awards: This column displays the aggregate dollar value of awards made in each fiscal year calculated by multiplying the stock's grant-date closing market price by the number of shares granted. The rules require a footnote to this column disclosing (1) the number and value of the aggregate restricted stock holdings at the end of the last fiscal year, (2) whether dividends will be paid on the restricted stock and (3) the number of shares and vesting schedule of any restricted stock award that vests in less than three years.
The award of performance-based restricted stock may be reported in the restricted stock column of the SCT or it may be disclosed in the LTIP Awards Table. In the latter case the award of the performance-based restricted stock should not be disclosed in the SCT; however, when the stock vests it will be disclosed as a LTIP payout in the SCT.
(g) Options/SARs: This column displays the number 12 off stock options and SARs granted (including any repriced options or SARs).
(h) LTIP Payouts: This column displays the dollar value of all payouts pursuant to any LTIPs. The rules require a footnote to this column if any LTIP payout resulted from the waiver of any specified performance target, goal or condition.
All Other Compensation
(i) All Other Compensation: this column is a catch-all column that displays an aggregate dollar value of any other compensation that could not properly be disclosed in any of the other six columns of compensation data. This may include, but is not limited to,
* termination of employment or change in control payments,
* above-market or preferential earnings not yet paid or payable on restricted stock, options, SARs or deferred compensation (for circumstances in which such earnings are paid or payable for the fiscal year in question see discussion under (e) Other Annual Compensation above),
* contributions or other allocations to vested and unvested defined contribution plans and
* certain insurance premiums paid by the company on behalf of the Named Officers.
Each element that makes up the aggregate value of "All Other Compensation" must be separately identified and quantified in a footnote, but only as to the last fiscal year.
As in the case of "Other Annual Compensation," data as to "All Other Compensation" are subject to a phase-in rule. See discussion of this rule in the last paragraph (e) Other Annual Compensation above.
Exclusion of column from SCT if no data to report. If there is no compensation disclosed in the compensation category covered by a particular column, the column can be eliminated from the SCT (e.g., if there were no restricted stock awards over the last three fiscal years, the restricted stock awards column may be eliminated 13 ).
Any company that has granted options or SARs to any Named Officer in the last fiscal year is required to include the option/SAR grants table (57 Fed. Reg. 48,153). This table displays as to the Named Officers for the last fiscal year the following columnar information (letters correspond to the letters given to the columns in this table;
column (a) identifies the Named Officer):
(b) The number of options/SARs granted under each award, although multiple grants may be aggregated if exercise price, expiration date and performance vesting thresholds (if any) are the same.
(c) The percent the number included in column (b) represents of all options/SARs granted to all employees for that year.
(d) The per-share exercise or base price of the options/SARs granted (if this price is less than the market price of the underlying security on the date of grant, this column is divided and the market price is displayed in the second column).
(e) The date the options/SARs expire.
(f) and (g) Valuation of Option Grants. This involves assignment of a dollar value to the options/SARs by one of two valuation methods to be selected by the company:
First Alternative: The "Potential Realizable Value" method. This requires two columns showing the dollar amount of the spread (difference between market price and exercise price). One column, (f), shows the spread based on compounded growth in the stock price at 5 percent annually over the term of the option/SAR multiplied by the applicable number of shares and other column, (g), is based on a compounded growth rate of 10 percent annually. 14
Second Alternative: A "Grant Date Present Value" method. This employs an option pricing model. (Only one column, column [f], would be involved under this alternative.)
If the Grand Date Present Value method is selected, the rules require a footnote description of the valuation methodology. If the method chosen is the Black-Scholes option pricing model, or a variation of it, the rules require simply that the footnote indicate the use of such pricing model. If a method other than Black-Scholes is chosen, the valuation method and any material assumptions must be disclosed. 15
Additional footnotes required. In addition to the footnote just noted in connection with the Grant Date Present Value method, the Option/SAR Grant Table requires extensive additional information, either in footnote form or, in some cases, as separate narrative at the choice of the reporting company. This includes:
(i) footnotes as to any of the material terms of each grant, including the date of exercisability, awards (if any) granted in tandem with options/SAR awards, any reload features, tax gross-up features, etc.
(ii) if the exercise or base price is adjustable over the option/SAR's term pursuant to a prescribed standard or formula, the standards or formulas on which such adjustments are based and any constant assumptions used in calculating potential value (first alternative valuation method) if that method was used and
(iii) any provision of an option/SAR grant (other than an antidilution provision) that could cause the exercise price to be lowered, along with its potential consequences.
The Aggregated Option/SAR Exercises Table discloses all option/SAR exercises by the Named Officers in the last fiscal year as well as the number and value of unexercised options/SARs held at fiscal year-end (57 Fed. Reg. 48,154). The table displays the following columnar information (letters correspond to the letters given to the columns in this table; column [a] identifies the Named Officer):
(b) The aggregate number of shares in respect of which the options/SARs were exercised.
(c) The aggregate dollar value realized upon exercise.
(d) The number of unexercised options/SARs held at fiscal year-end (i) that are exercisable and (ii) that are unexercisable.
(e) The value of unexercised in-the-money [i.e., market value exceeds exercise price] option/SARs held at fiscal year-end (i) that are exercisable and (ii) that are unexercisable.
LTIP Awards Table
This table applies to any LTIP award that is not a stock option, SAR or restricted stock award (other than a performance-based restricted stock grant that the reporting company has chosen to report as an LTIP award) (57 Fed. Reg. 48,154). By definition, this table includes any plan that provides compensation applicable to performance occurring over a period longer than one fiscal year. 16 The rules state than an LTIP may include any contract, authorization or arrangement, whether or not set forth in a formal document and even if applicable to only one person.
This table displays the following columnar information (letters correspond to the letters given to the columns in this table; column [a] identifies the Named Officer):
(b) Number of shares, units or other rights awarded under any LTIP; however, if there are shares subject to the units or rights, the number of shares must also be disclosed.
(c) Performance or other time period until maturation or payout of the award.
(d)-(f) For plans not based on stock price, the dollar value of the estimated future payout for:
* a threshold amount (column [d]) (referring to the minimum amount payable assuming a minimum, or threshold, level of performance achieved)
* a target amount (column [e]) (referring to the amount payable if the specified performance target is reached)
* a maximum amount (column [f]) (referring to the maximum payout possible under the plan).
This table must display each LTIP award on a separate line as to each Named Officer, even if similar awards are made under the same plan. The material terms of any award, including a general description of the formula or criteria to be applied in determining the amounts payable, are to be disclosed in either a footnote or a narrative accompanying the table. If the dollar value of the target award (columns [d]-[f] if the plan is not based on stock price) is not determinable, a representative amount based on the previous fiscal year's performance is to be used.
Tandem Grant. A tandem grant of two instruments, only one of which is pursuant to an LTIP, should be reported only in the table applicable to the "other" instrument. For example, an option granted in tandem with a performance share would be reported only as an option grant, with the tandem feature noted in a footnote to the Option/SAR Grants Table.
The new rules (57 Fed. Reg. 48,157) require a stock performance line graph comparing the company's cumulative total shareholder return over a five-year period to two other indexes: (a) a broad equity market index such as the S&P 500 Index (as already noted, it must be the S&P 500 Index if the reporting company is included in that index) and (b) an index that it either (i) a nationally recognized industry index or (ii) a company-constructed peer group index. Each of the three lines of the Stock Performance Graph is to show how much a $100 investment made on the last trading day before the beginning of the fifth preceding fiscal year (this date is called the "measurement point") would be worth on the last day of each of the company's five preceding fiscal years (this period is called the "measurement period") assuming that all dividends are reinvested when paid. Thus, for example, for a calendar year company, the graph included in the 1993 proxy statement will show how much $100 invested on Dec. 31, 1987, grew, or declined, on each Dec. 31 over the following five years (ending, in the example, on Dec. 31, 1992).
While the SEC has chosen shareholder total return as its performance measure in the graph, a company may include other performance measures (such as revenues, pre-tax profits, earnings per share, return on average common shareholders' equity, etc.) in the proxy statement, provided the compensation committee describes the link between the measure(s) presented and the compensation discussed in the Compensation Committee Report described in the next section.
On of the most significant requirements of the new rules is the requirement that there be included in all proxy statements a Compensation Committee Report (57 Fed. Reg. 48,157) relating to specified aspects of compensation of the executive officers as a group and, separately, of the CEO in particular for the last fiscal year.
Executive Officer Compensation for the Last Fiscal Year. A discussion is required of the committee's compensation policies applicable to the reporting company's executive officers (including the Named Officers) for the last fiscal year. This discussion must include disclosure of the specific relationship of corporate performance to executive compensation for such fiscal year.
CEO Compensation for the Last Fiscal Year. A discussion is required of the factors and criteria upon which the CEO's compensation was based for the last fiscal year. In addition, a discussion is required of the relationship of corporate performance to the CEO's compensation for such fiscal year. This latter discussion should cover each measure of the reporting company's performance, whether qualitative or quantitative, on which the CEO's compensation was based.
General Instructions. The instructions to Item 402(k), setting forth the requirements as to the report, state that "[boilerplate] language should be avoided in describing factors and criteria underlying awards or payments of executive compensation." On the other hand, the SEC does not require a discussion of each individual committee member's reasons or motivations for supporting the committee's recommendations. What is required is a "description of the rationale of the committee for the reported compensation and its relationship to the company's performance." Disclosure is not required as to any factors or criteria that involve confidential commercial or business information, including target levels with respect to specific quantitative or qualitative performance-related factors, that would have an adverse effect on the company.
Report to be over name of Each Committee member. The report is to be made over the name of each member of the compensation committee. In the absence of a compensation committee, the names should be those of the board committee members performing equivalent functions or, if applicable, all members of the board of directors. Any modifications by the board of the compensation committee determinations that are the subject of the report must be explained over the names of all members of the board.
Potential Liability of Committee Members. Liability for information in the report, as well as in the graph, is limited in the same manner as is liability for the annual report to shareholders. Information in the report or the graph that is false or misleading is specifically exempted from the rather strict liability provided by §18 of the Securities Exchange Act. Statements that are knowingly false or misleading, however, remain subject to the general anti-fraud provisions of Rule 10b-5. In addition, of course, members of compensation committees, like all directors, in carrying out their responsibilities are subject to the usual standards of good faith and care applicable under state corporate laws generally.
The new rules (57 Fed. Reg. 48,156) require that a new section entitled "Compensation Committee Interlocks and Insider Participation" be included in the proxy statement that identifies all members of the compensation committee (or functional equivalent) and then identifies any member who in the last fiscal year was (i) a current employee or a current or past officer of the company or any of its subsidiaries or (ii) had a reportable relationship under Item 404 of Regulation S-K. Additionally, this section will identify any of the following relationships:
* where any executive officer of the reporting company (Company A) is a member of Company B's compensation committee and any executive officer of Company B is a member of Company A's compensation committee
* where any executive officer of Company A is a director of Company B and any executive officer of Company B is a member of Company A's compensation committee
* where any executive officer of Company A is a member of Company B's compensation committee and any executive officer of Company B is a director of Company A.
Not only are all insider and interlocking directors identified, but their Item 404 transaction disclosures -- ordinarily found in a section of the proxy statement entitled "Certain Relationships and Related Transactions" -- are now required to be included in this new section. 17
Any relationship described above will not require disclosure if it ends before Jan. 1, 1993. Also excluded from reporting is a relationship involving a tax-exempt entity within the meaning of §501(c)(3) of the Internal Revenue Code.
Under 57 Fed. Reg. 48,156, any downward adjustment to an exercise price or base price of any option or SAR held by a Named Officer during the last fiscal year will be treated as a new grant and trigger a compensation committee repricing report as to such adjustment and a table displaying all repricings of options/SARs held by any executive officer over the last 10 fiscal years (apparently whether or not that executive officer is currently employed). Any repricings on or before Oct. 21, 1992, are grandfathered.
The new rules continue to require the Pension Plan Table for most defined benefit and other actuarially based plans (57 Fed. Reg. 48,155); however, the narrative description formerly required of such plans has been eliminated.
All employment contracts between a company and a Named Officer must be disclosed under 57 Fed. Reg. 48,156. Additionally, the new rules require disclosure as to any termination of employment or change in control arrangements where the amount of all payments exceeds $100,000.
Regarding directors' compensation, there has been no change in the rule requiring disclosure (57 Fed. Reg. 48,156). A new instruction to the rule, however, states that "any arrangement, including consulting contracts, entered into in consideration of the director's service on the board" must be included and that the material terms of such arrangement must be disclosed. The SEC's introduction to the new rules states that charitable awards or legacy arrangements on behalf of directors must now be disclosed.
Regarding equity ownership of management (57 Fed. Reg. 48,158), item 403 of Regulation S-K has been amended to require disclosure of the company's equity securities beneficially owned 18 by each Named Officer.
As for plans submitted to shareholders (57 Fed. Reg. 48,158), Item 10 of Schedule 14A under the Exchange Act has been changed and now required the projected benefits of any compensation plan submitted for shareholder approval to be displayed in a tabular format for each Named Officer, executive officers as a group, non-executive directors as a group and employees as a group. If the benefits are not determinable, the benefits that would have been received for the last fiscal year if such plan had been in effect are to be used in the table. A summary description of such plan continues to be required; however, the requirement of summary descriptions of other compensation plans and the three-year disclosure requirement of benefits as to such plans have been eliminated. 19
|Summary Compensation Table|
|Annual Compensation||Long-term compensation|
Chairman and CEO
Note: Footnote references are required but are not displayed. See text of column for discussion.
1 57 Fed. Reg. 48,125 (Oct. 21, 1992). The new rules were announced in SEC Release Nos. 33-6962, 34-31327 and IC-19032 (Oct. 16, 1992). Specifically, these new rules amend Items 402, 403 and 601 of Regulation S-K (17 CFR §§229.402, 229.403 and 229.601). Items 8 and 10 of Schedule 14A (17 CFR §240.14a-101, Items 8 and 10), Items 11 and 14 of Form 10-K (17 CFR §249.310, Items 11 and 14), and corresponding changes to Items 402, 403 and 601 of Regulations S-B (17 CFR §§228.402, 228.403 and 228.601) and Item 13 of Form 10-KSB (17 CFR §249.31OB, Item 13).
2 57 Fed. Reg. 29,582 (Jul. 2, 1992); SEC Release Nos. 33-6940 and 34-30851 (Jun. 23, 1992).
3 New York Law Journal, (July 29, 1992).
4 For definition of "executive officer" see 17 CFR §240.3b-7.
5 Reference in the text to SARs, unless otherwise noted, will be to stock appreciation rights that are free-standing, rather than in tandem with a stock option.
6 57 Fed. Reg. 48,128. A "small business issuer" is generally defined as a company whose annual revenue is less than $25 million and whose "public float" is less than $25 million. See Item 10(a)(1) of Regulation S-B (17 CFR §228.10[a]).
7 17 CFR §249.220f.
8 57 Fed. Reg. 48,128.
9 57 Fed. Reg. 48,152 (Instruction 3 to Item 402[b][iii][A] and [B]).
10 "Above-market" interest is defined as an interest rate which exceeds 120 percent of the long-term applicable Federal rate, with compounding, pursuant to IRC §1274(d). A dividend (or dividend equivalent) is "preferential" only if earned at a rate higher than dividends on the company's common stock. Only the "above-market" or "preferential" amount is reported as compensation. 57 Fed. Reg. 48,152 (Instructions 3 and 4 to Item 402[b][iii][C]).
11 Tax gross-ups are reimbursements made to the Named Officers by the company for payment of personal income taxes on amounts received as compensation.
12 The SEC must intend the number of "options/SARs" in this column to represent the number of shares subject to the options/SARs. Since an option or an SAR could be, for example, for 1,000 or 100,000 shares of stock, it would be meaningless to disclose the number of options/SARs.
13 See 57 Fed. Reg. 48,151 (Item 402(a)(6). It would seem doubtful that the elimination of the restricted stock awards column would also eliminate the footnote, which accompanies this column, that discloses the number and value of restricted shares held at fiscal year-end as well as other information about such shares.
14 If the exercise price or base price of the stock option or SAR is less than the market price on the date of grant, a column must be added showing the "potential realizable value" assuming zero growth. If the exercise price or base price of the stock option or SAR exceeds the market price on the date of grant by N percent, then N percent appreciation may be shown for the option/SAR term in a separate column. Also, the reporting company may show in a separate column its historic rate of appreciation over a period equivalent to the term of such options/SARs. 57 Fed. Reg. 48,153-54 (Item 402 [c][vi][A] and Instruction 8 to Item 402 [c]).
15 The Black-Scholes option pricing model was developed by Fischer Black and Myron Scholes in the early 1970s. One of its important features is that the formula incorporates the estimated future stock price volatility as a material assumption. It is uncertain exactly what a Black-Scholes variation is. There are other option pricing models which have been developed for some time, such as the "minimum" option valuation model, the "capital asset" pricing model and the Kassouf option pricing model. Other option pricing models that have appeared more recently include models by Frederic W. Cook & Co., Hay Associates and Graef Crystal. Which of the above models, if any, could be labeled a "variation" of Black-Scholes is unclear; it would appear that the SEC will need to clarify this subject, perhaps by issuing an interpretive release.
16 57 Fed. Reg. 48,151 (Item 402[a][iii]).
17 It is possible that a cross reference to the section of the proxy statement that typically contains Item 404 transaction disclosures, "Certain Relationships and Related Transactions," will meet the new requirement.
18 See 17 CFR §240.13d-3(d)(1).
19 The data presented in the SCT and other tables generally obviate the need for this requirement.