Important Disclaimer

SEC Adopts Proxy Disclosure Enhancements

December 28, 2009

On December 16, 2009, the Securities and Exchange Commission (SEC) adopted rules requiring enhanced and additional disclosure in proxy statements, annual reports, registration statements, and other reports regarding: (i) the relationship of a company's overall compensation policies to risk, (ii) grants of equity awards to executive officers and directors, (iii) potential conflicts of interest of compensation consultants, (iv) director and nominee qualifications, (v) company leadership structure, (vi) the board's role in managing risk, and (vii) the disclosure of shareholder voting results, among other things. The final rules can be viewed here (or at http://www.sec.gov/rules/final/2009/33-9089.pdf).¹

The rule amendments generally will be effective for all proxy statements and annual reports filed, and for registration statements declared effective on or after February 28, 2010.²

A summary of the amendments follows.

Enhanced Disclosure of Compensation Policies and Practices as They Relate to Risk Management

The SEC adopted amendments to Item 402 of Regulation S-K that require reporting companies, other than smaller reporting companies, to discuss their compensation policies and practices for all employees, including non-executive officers, to the extent that risks arising from such compensation policies and practices are "reasonably likely to have a material adverse effect on the registrant." The SEC's original proposal would have required disclosure if the risks "may have a material effect on the registrant." However, after considering various comments concerning this proposal, the SEC felt that a "reasonably likely" standard was more appropriate. In addition, they felt that requiring disclosure only in the event of a material "adverse" effect would help to minimize unnecessary disclosures concerning compensation arrangements that have a material effect that is not adverse.

A company's determination as to whether disclosure may be required will vary depending on the facts and circumstances faced by each company and the features and goals of its compensation programs. However, the SEC has provided several examples of situations that potentially could trigger discussion and analysis, such as compensation policies and practices:

• at a business unit of the company that carries a significant portion of the company's risk profile;
• at a business unit with compensation structured significantly differently than other units within the company;
• at a business unit that is significantly more profitable than others within the company;
• at a business unit where the compensation expense is a significant percentage of the unit's revenues; and
• that vary significantly from the overall risk and reward structure of the company, such as when bonuses are awarded upon accomplishment of a task, while the income and risk to the company from the task extend over a significantly longer period of time.

This list is not intended to be exclusive, so there may be additional situations that are not explicitly set out in the SEC's examples where a company's compensation programs could be reasonably likely to have a material adverse effect on the company such that disclosure is warranted. However, in assessing these situations, the SEC did note that a company may consider any compensation policies and practices designed to alleviate risk or balance incentives, such as clawbacks, forfeiture or recoupment policies, or other similar compensation recovery policies and stock ownership requirements.

If a company determines that risks arising from its compensation policies are reasonably expected to have a material adverse effect on the company, appropriate disclosure should accompany the reporting company's executive compensation disclosure but is not required to be included in the Compensation Discussion and Analysis section. The narrative disclosure is intended to be principles-based and tailored to the facts and circumstances of the company. The SEC has provided a non-exclusive list of issues that may require discussion, including:

• the general design philosophy of the company's compensation policies and practices for employees whose behavior would be most affected by the incentives established by the policies and practices, as such policies and practices relate to or affect risk taking by those employees on behalf of the company, and the manner of their implementation;
• the company's risk assessment or incentive considerations, if any, in structuring its compensation policies and practices or in awarding and paying compensation;
• how the company's compensation policies and practices relate to the realization of risks resulting from the actions of employees in both the short term and the long term, such as through policies requiring clawbacks or imposing holding periods;
• the company's policies regarding adjustments to its compensation policies and practices to address changes in its risk profile;
• material adjustments the company has made to its compensation policies and practices as a result of changes in its risk profile; and
• the extent to which the company monitors its compensation policies and practices to determine whether its risk-management objectives are being met with respect to incentivizing its employees.

Notably, if a company determines that the risks arising from its compensation policies are not reasonably expected to have a material adverse effect on the company, the new rules do not require companies to make an affirmative statement to that effect.

What You Should Do Now

We suggest that you:

• Update your board or compensation committee on the new rules.
• Consider whether your company's compensation policies and practices for employees generally are reasonably likely to have a material adverse effect on the company. If so, you should consider the information that will be needed to prepare appropriate disclosure based on the particular facts and circumstances of your company.

Revised Stock and Option Award Disclosure in Compensation Tables

The final rules also include amendments to Item 402 of Regulation S-K regarding the reporting of stock awards and option awards in the Summary Compensation Table and Director Compensation Table. The amendments require disclosure of the aggregate grant date fair value of awards computed in accordance with FASB ASC Topic 718 (formerly SFAS 123(R)), rather than the dollar amount recognized during the fiscal year for financial statement purposes. This change will affect both the disclosure of compensation for named executive officers as well as the calculation of total compensation for determining a company's named executive officers.

Special instructions are included for the valuation of awards subject to performance conditions, as defined in the Glossary to FASB ASC Topic 718. Specifically, for purposes of the Summary Compensation Table, Grants of Plan-Based Awards Table, and Director Compensation Table, the grant date fair value of such performance awards should be based on the probable outcome of the performance conditions, measured as of the grant date. As proposed, the value of such performance awards would have been based on the maximum amount of the performance-based award, which the SEC agreed would likely overstate the intended level of compensation and result in investor misinterpretation with respect to compensation decisions. However, to ensure that investors understand the potential maximum value of a performance award, companies will be required to include a footnote to the Summary Compensation Table and Director Compensation Table disclosing the maximum value payable under each performance award assuming the highest level of performance.

To facilitate year-to-year comparison of the Summary Compensation Table, companies with fiscal years ending on or after December 20, 2009, will be required to recalculate the grant date fair value of stock awards and option awards and update the total compensation column for all named executive officers in each of the three most recently completed fiscal years. To the extent that the change in total compensation for a previously reported fiscal year would change who the named executive officers were in that year, companies will not be required to change the persons previously identified as named executive officers except under one circumstance. Specifically, where a named executive officer in the most recently completed fiscal year (2009) was not included as a named executive officer in the preceding fiscal year (2008) but was in the fiscal year prior to that (2007), the company must then report the named executive officer's compensation for each of the three most recently completed fiscal years.

What You Should Do Now

We suggest that you:

• Update your compensation committee on the new rules.
• Calculate the grant date fair value of stock and option awards granted during fiscal 2009 and compile information with respect to the grant date fair value of stock and option awards granted in prior fiscal years that will need to be included in the 2009 summary compensation table.
• For awards subject to performance conditions, calculate the grant date fair value based on the probable outcome of the performance conditions, and calculate the maximum value payable assuming the highest level of performance.

Compensation Consultant Disclosure

The SEC amended Item 407 of Regulation S-K to require enhanced disclosure in proxy statements regarding compensation consultants and potential conflicts of interest when:

• the consultant was engaged to provide advice or recommendations on executive and director compensation, other than with respect to broad-based plans or based on non-customized information, as described in further detail below;
• the same consultant (or its affiliates) also provided additional non-executive compensation consulting services to the company with respect to non-executive compensation; and
• the aggregate fees paid for such non-executive compensation consulting services exceeded $120,000 during the company's fiscal year. This $120,000 threshold is the same dollar threshold used with respect to transactions with related persons in Item 404 of Regulation S-K, which also deals with potential conflicts of interest.

If these three conditions are satisfied, the company now must disclose:

• the aggregate fees paid for determining or recommending the amount or form of executive and director compensation; and
• the aggregate fees paid for non-executive compensation consulting services provided by the compensation consultant or its affiliates.

In addition, if the compensation consultant was engaged by the company's compensation committee (or persons performing equivalent functions), the company must disclose whether the decision to engage the compensation consultant or its affiliates to provide non-executive compensation consulting services was made or recommended by management, and whether the compensation committee or the board approved such other services.

In adopting these amendments, the SEC did provide two limited exceptions to the enhanced compensation consultant disclosure requirements.

First, the enhanced disclosure will not be required if the board, compensation committee, or other persons performing equivalent functions and management engage separate consultants to advise on executive or director compensation as long as the consultant advising the board, compensation committee, or other persons performing equivalent functions does not provide additional non-executive compensation consulting services to the company. This exception is available without regard to whether the compensation consultant engaged by management is invited to participate in board meetings.

Second, the enhanced disclosure will not be required if: (i) the compensation consultant is engaged solely to recommend the amount or form of executive or director compensation in connection with broad-based plans that do not discriminate in favor of executive officers or directors, or (ii) the compensation consultant's services are limited to providing information, such as surveys, that are not customized for a particular company or are customized based on parameters not developed by the compensation consultant, provided that the compensation consultant does not provide advice or recommendations in connection with the provision of such information.

What You Should Do Now

We suggest that you:

• Update your board or compensation committee on the new rules.
• Assess the scope of your company's engagement, if any, with compensation consultants, including fee arrangements, for purposes of: (i) determining whether the structure of current arrangements may compromise (or give the appearance of compromising) the objectivity of the compensation consultants in making recommendations with respect to executive or director compensation as a result of the revenue stream generated by the additional non-executive compensation services provided; and (ii) determining whether enhanced disclosure will be required under the new rules.

Expanded Disclosure Regarding Directors, Director Nominees, and Executive Officers

The final rules adopted amendments to Item 401(e) of Regulation S-K requiring additional disclosure regarding the qualifications of directors and director nominees, past directorships held by directors and director nominees, and the time period for disclosure of legal proceedings involving directors, director nominees, and executive officers.

Background and Qualifications of Directors and Nominees.

The final rules require companies to disclose the particular experience, qualifications, attributes, or skills held by each director and any director nominee that led the company to conclude that such persons should serve (or continue to serve) as directors based on the company's business and structure at the time the disclosure is being made. The same disclosure must be provided in the proxy-soliciting materials of a proponent seeking to nominate a director nominee. The expanded disclosure is required for all director nominees and all directors, even if they are not standing for reelection. Although proposed, the final rule does not require this disclosure with respect to service as a committee member.

Past Directorships.

Item 401 currently requires disclosure of any public company directorships held by each director and director nominee at the time of the disclosure. The final rules expand disclosure of other public company directorships to include service at any time during the previous five years (even where such director or director nominee no longer holds such directorship).

Legal Proceedings Involving an Executive Officer, Director, or Nominee.

The final rules also expand disclosure of legal proceedings involving an executive officer, director, or director nominee to include new proceedings and to increase the time period of reportable proceedings from five to ten years. Item 401(f) has been amended to add the following proceedings as reportable:

• Any judicial or administrative proceedings resulting from involvement in mail or wire fraud, or fraud in connection with any business entity
• Any judicial or administrative proceedings based on violations of federal or state securities, commodities, banking, or insurance laws and regulations, or any settlement to such actions
• Any disciplinary sanctions or orders imposed by a stock, commodities, or derivatives exchange or other self-regulatory organization

Consideration of Diversity in Director Nomination.

The final rules also amended Item 407(c) of Regulation S-K to require companies to disclose whether—and, if so, how—a board or nominating committee considers diversity in identifying director nominees. If the board or nominating committee has a policy with regard to the consideration of diversity, the final rules require a description of how such policy is implemented and how the board or nominating committee assesses the effectiveness of such policy.

The SEC has not attempted to define diversity in context of the final rules. Rather, the rules permit each company to define diversity as considered appropriate, which may include such factors as differences of viewpoint, professional experience, education, skill, and other individual qualities and attributes that contribute to board heterogeneity, including characteristics such as race, gender, and national origin.

What You Should Do Now

We suggest that you:

• Update your board or nominating committee on the new rules.
• Update your D&O questionnaires.
• Consider the SEC's disclosure rules when evaluating persons for nomination or re-nomination to your board. For example, consider further discussing as a nominating committee and documenting the particular experience, qualifications, attributes, or skills, in light of your company's business, that qualify each director to serve on the board.
• Discuss with the nominating committee how it considers diversity in its nominating decisions, and whether the nominating committee should adopt a policy with respect to diversity in identifying director nominees.

Disclosure of Leadership Structure and Risk-Management Oversight

The final rules also adopted amendments to Item 407 of Regulation S-K and a corresponding amendment to Item 7 of Schedule 14A to require a description of the board's leadership structure, including disclosure of whether and why each company has chosen to combine or separate the positions of principal executive officer and board chairman, and why the company believes that such board leadership structure is the most appropriate. If the same person serves as both CEO and chairman of the board, the final rules require disclosure of whether the company has appointed a lead independent director and the specific role such lead independent director plays in the leadership of the board. Finally, companies must describe how the board of directors oversees risk management—for example, whether through a review by the entire board or a committee of the board.

What You Should Do Now

We suggest that you:

• Update your board or nominating committee on the new disclosure requirements relating to board leadership structure.
• Update your board or audit committee, which often has been delegated authority to oversee management's implementation of risk management, on the new disclosure requirements relating to oversight of risk management.
• Consider the SEC's expanded disclosure rules when re-examining your company's corporate governance generally, and when considering changes to the company's leadership structure specifically.
• If it has not been done recently, comprehensively re-evaluate and discuss with the board or audit committee your company's risk-management function.

Real-Time Disclosure of Shareholder Voting Results

The SEC added new Item 5.07 to Form 8-K requiring companies generally to disclose the final results of a shareholder vote within four business days following a shareholder meeting (or the solicitation of written consent from shareholders). Such disclosure previously was required in the quarterly report on Form 10-Q covering the quarter that the meeting was held or the annual report on Form 10-K if the meeting was held during a company's fourth quarter. Where a company is unable to obtain the definitive voting results within four business days, companies will be required to file the preliminary voting results within four business days and file an amended Form 8-K within four business days after the final voting results are known.

What You Should Do Now

We suggest that you:

• Prepare to file a Form 8-K within four business days of any shareholder meeting held or solicitation of shareholder action by written consent on or after February 28, 2010.

Update on the SEC's Proxy Access Rule Proposal

In June 2009, the SEC proposed changes to the federal proxy rules that would require a company, under certain circumstances, to include in its proxy statement disclosure concerning nominees for director by a shareholder or group of shareholders, and to include the names of those nominees on the company's proxy card. In addition, the proposed rules would require a company to include in its proxy materials, under certain circumstances, shareholder proposals that would amend, or that request the board to take action to amend, a company's governing documents regarding nomination procedures or disclosures related to shareholder nominations, provided the shareholder proposal does not conflict with the SEC's disclosure rules, including the proposed new rules. The proposal was published for comment in the Federal Register on June 18, 2009, and the initial comment period closed on August 17, 2009. On December 14, 2009, the SEC announced that it was re-opening the public comment period for its shareholder director-nomination proposal to seek views on additional data and related analyses received by the SEC at or after the close of the original public comment period. Comments on the data and related analyses are due no later than 30 days after the publication of the SEC's release in the Federal Register. The SEC release re-opening the comment period can be found here (or at http://www.sec.gov/rules/proposed/2009/33-9086.pdf). Despite re-opening the comment period, the SEC staff continues to expect to make a final recommendation to the SEC early next year.

Additional Legislative Proposals on Corporate Governance Issues

On December 11, 2009, the House of Representatives passed The Wall Street Reform and Consumer Protection Act of 2009 (Wall Street Reform Act). The bill includes proposals related to certain corporate governance matters, including shareholder "say on pay," independent compensation committees, and proxy access. The Wall Street Reform Act follows numerous other bills pending before Congress containing significant corporate governance changes (and incorporates provisions from several pending legislative proposals). For a detailed discussion of corporate governance legislation proposed during 2009, see our WSGR Alerts "Recent Developments and Important Considerations for Companies Preparing for the 2010 Proxy Season" (available here or at http://www.wsgr.com/WSGR/Display.aspx?SectionName=publications/PDFSearch/wsgralert_2010_proxy_season.htm) and "Update on Important Considerations for Companies Preparing for the 2010 Proxy Season" (available here or at http://www.wsgr.com/WSGR/Display.aspx?SectionName=publications/PDFSearch/wsgralert_2010_proxyseason.htm). Given the intense lobbying expected, multiple competing legislative initiatives, and recently proposed SEC rules, it remains unclear what form any legislation, if signed into law, would take. However, we recommend that management and directors of public companies pay close attention to this legislation as it evolves, because it is likely to result in significant changes to corporate governance practices. Wilson Sonsini Goodrich & Rosati will continue to monitor these legislative proposals in the new year, and we intend to issue additional alerts as necessary.

Please contact Ralph J. Barry, Katharine A. Martin, Ann Yvonne Walker, Richard Cameron Blake, Vijaya Gadde, Jessica L. Rice, your regular Wilson Sonsini Goodrich & Rosati contact, or any member of the firm's corporate and securities practice, employee benefits and compensation practice, or securities litigation department with any questions you may have about these matters and the potential implications they could have for your company.

Please click here for a printable version of this WSGR Alert.