For chief financial officers of many public companies, compensation disclosures have become a major headache in planning the annual meeting and related annual SEC filings. What once was a technical but stable set of disclosure rules has now become a highly active arena for complex regulatory initiatives.
“Say-on-pay” is the latest in a series of innovations, courtesy of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. But buckle up: Other changes are still in the pipeline.
Part 1 of this article presents a timeline showing the dramatic acceleration since 2006 in the pace of new rulemaking on compensation disclosures. Part 2 will discuss how companies are dealing with “say-on-pay” with some lessons for smaller reporting companies for the 2013 proxy, and new rules mandated by Dodd-Frank but that have not yet emerged from the Securities and Exchange Commission. Part 2 will appear in the next issue of New England In-House.
The requirement that public companies disclose executive and director compensation dates back almost to the dawn of the Securities Exchange Act of 1934.
The modern era of executive compensation disclosure began in 1982, with the SEC adopting a tabular presentation for executive compensation. In 1992, the SEC added a small narrative component (the Compensation Committee Report). The role of narrative disclosures was greatly expanded 14 years later, at least for larger public companies.
In 2010, the Dodd-Frank Act served notice of another major shift: Compensation would no longer be just a topic of mandatory disclosure by a public company to its shareholders, but also a topic for mandatory dialogue with its shareholders.
1938: Proxy statements required to disclose prior year compensation of a nominee to be voted upon, if he is among the three most highly compensated persons of the company.
1982/1983: Adoption of Item 402, Regulation S-K: This put into place the now-familiar tabular presentation of executive compensation and initially applied to the five most highly compensated executive officers or directors of the registrant whose total compensation exceeds $50,000 each. These requirements were soon revised to apply to the five most highly compensated executive officers whose cash compensation exceeds $60,000.
Adoption of Item 404, Regulation S-K: This put into place uniform rules for disclosing related-party transactions involving management, for transactions exceeding a $60,000 threshold.
1992: Extensive changes to Item 402, including: (1) New requirement for narrative discussion of compensation philosophy and practices, through a Board Compensation Committee Report. However, smaller issuers were exempted from these requirements. (2) Covered executives redefined to include the CEO and the four other most highly compensated executive officers with more than $100,000 of annual cash compensation. (3) Summary Compensation Table expanded to show three years of information. (4) New requirement for a performance graph showing issuer stock prices vs. peer group stock prices.
Sept. 2006: Extensive changes to Items 402, 404 and 407, including: (1) New requirement for Compensation Discussion and Analysis narrative (the CD&A), plus a Compensation Committee Report regarding compensation committee review of the CD&A. However, small business issuers were exempted from these requirements. (2) Significant reformatting of the tabular presentation of executive compensation, including expanded disclosure of total compensation and expanded disclosure of holdings and exercises regarding prior stock compensation awards. Small business issuers required to include only the CEO and the top two other executive officers, and only for a two-year period. (3) Requiring disclosure of the full grant date fair value (determined pursuant to FAS 123R) of equity-based awards granted in the relevant year, regardless of vesting. (4) New requirement for Director Compensation Table. (5) Increase in related-party threshold from $60,000 to $120,000 (of, if less, 1 percent of average total assets), and an expanded definition of immediate family members. (6) Expanded disclosure of compensation committee practices, including the use of compensation consultants to assist in determining executive and director compensation.
In December 2006, the commission further amended Item 402 to alter the reporting of grant date fair market value (moving disclosure of the full grant date value from the Summary Compensation Table to a different table, and exempting small business issuers from having to disclose the full grant date value).
Changes to definition of “smaller reporting company,” i.e., companies with less than $75 million in public float (versus companies with both less than $25 million in float and less than $25 million in annual revenues). Phasing out of the “SB” forms, while maintaining differential treatment of smaller companies.
Dec. 2009: Further changes to Items 402 and 407, including: (1) New requirement to disclose risks posed by compensation policies and practices that are “reasonably likely to have a material adverse effect” on the company. Does not apply to smaller reporting companies. (2) The Summary Compensation Table and Director Compensation Table must disclose the expected and maximum aggregate grant date fair value of awards (thereby reversing the December 2006 revisions and extending this requirement to smaller reporting companies). (3) Expanded disclosure of fees paid to compensation consultants, where fees for ancillary services exceed $120,000 a year.
July 2010: Dodd-Frank Wall Street Reform and Consumer Protection Act amends the Securities Exchange Act in several important respects to mandate new SEC rulemaking on compensation-related topics, including:
• Adds new Section 14A to require periodic shareholder voting on executive compensation, and shareholder voting on grants of golden parachutes in connection with merger transactions.
• Adds new Section 10C to require that compensation committees meet enumerated standards of independence; that a compensation committee have authority and a sufficient budget to hire its own compensation consultant and other advisors; and that compensation committees consider enumerated factors affecting independence of compensation consultants and other advisors.
• Adds new Section 10D to require issuers to adopt and enforce policies on clawbacks of incentive compensation in cases in which the issuer restates its financial statements.
• Adds new Section 14(i) to require issuers to disclose information that shows the relationship between executive compensation actually paid and the financial performance of the issuer; and to require issuers to disclose the ratio between total CEO compensation and the median compensation paid to all other employees.
Adds new Section 14(j) to require issuers to disclose whether their directors and officers are permitted to purchase derivatives that allow them to hedge against decreases in the market value of issuer stock granted to them or otherwise held by them.
Jan. 2011: Amendments of proxy rules to require shareholder “say-on-pay,” “say-on-frequency” and “say-on-golden parachute” votes, which need not be binding. (1) The vote on executive compensation (say-on-pay) must be held at least once every three years. (2) The vote on how often the say-on-pay vote should occur (one, two or three years) must be held at least once every six years. The proxy statement must explain the general effect of these votes, including whether the vote is purely advisory and non-binding. (3) A vote on golden parachute compensation must be held whenever the issuer is soliciting shareholder approval of an acquisition, merger or sale of all or substantially all of its assets. Smaller reporting companies were temporarily exempted from “say-on-pay” and “say-on-frequency” votes until 2013, but were not exempted from “say-on-golden-parachute” votes.
As part of these amendments, the SEC also revised S-K Item 402 and tender offer rules to require expanded disclosure of golden parachutes in the context of acquisition transactions, etc.
June 2012: Adoption of new Rule 10C-1 defining standards for compensation committee independence. In October and November 2012, the SEC published notices of proposed listing standards submitted by NYSE, NASDAQ and other securities markets to implement these requirements. In January 2013, the SEC approved the proposed standards, as amended.
April 2012: brought signs that the regulatory pendulum might be slowing. With rare bipartisan support, Congress enacted the Jumpstart Our Business Startups — or JOBS — Act, which cut back on some of the recent Dodd-Frank compensation regulations (up to six years’ relief from say-on-pay and say-on-frequency votes, and from required disclosures of pay versus performance and the ratio of CEO compensation to median compensation) — but only for “emerging growth companies” that go public after Dec. 8, 2011.
The pace of new rulemaking in the compensation area has lately slowed for another, more practical reason: Dodd-Frank’s mandates have simply overwhelmed the SEC’s capacity to adopt new rules.
The next installment of this article will discuss in further detail the Dodd-Frank rules that the SEC has put in place, and the complex and controversial rules that are still in the pipeline.
Gabriel B. Weiss is an associate and Gregory S. Fryer a partner at Verrill Dana, which has offices in Boston, Portland, Maine, and Stamford, Conn.