The Securities and Exchange Commission’s (SEC) new rules governing proxy disclosures will take effect on February 28, 2010. The rules dictate enhanced disclosures in proxy statements on corporate governance and executive compensation, among other things. The rules, which can be viewed at http://www.sec.gov/rules/final/2009/33-9089.pdf, govern all proxy statements, annual reports, and registration statements filed after the effective date.

The new rules require additional disclosures regarding:

• The relationship between a company’s risk taking and its compensation policies;
• The value of equity (stock and option) awards to executive officers and directors;
• Potential conflicts of interest of compensation consultants;
• Qualifications of directors and nominees;
• Company leadership structure;
• The board’s role in managing risk; and
• Shareholder voting results on Form 8-K within four business days after a shareholder meeting.

Enhanced Disclosure of Compensation Policies Related to Risk Management

The new rules add a paragraph “(s)” to Item 40 of Regulation S-K that requires reporting companies (other than smaller reporting companies) to discuss and analyze their compensation policies for all employees, including non-executive officers, if those policies are “reasonably likely to have a material adverse effect” on the company. The facts and circumstances faced by each company, and the specific goals of its compensation policies, will determine the nature and extent of the specific additional required disclosures. However, the SEC did provide some examples (not intended to be an exhaustive list) of the sorts of situations that might trigger enhanced disclosure, such as: one particular business unit accounting for a significant portion of the company’s risk profile; one particular business unit having a significantly different structure from that of other units within the company; or one particular business unit being significantly more profitable than other units.

If a company determines that a risk arising from its compensation policies might reasonably be expected to have a “material adverse effect” on the company, then the appropriate disclosure must be included in the compensation section of the proxy statement and Form 10-K (it does not, however, need to be included in the Compensation Discussion and Analysis). Note that if a company determines that the risks arising from its compensation policies are not reasonably expected to have a material adverse effect, the new rule does not require the company to make an affirmative statement to that effect. 

Enhanced Executive Award Disclosure

The new rules also include revisions to Item 402 of Regulation S-K relating to the reporting of stock and option awards in both the Summary Compensation Table and the Director Compensation Table, and require disclosure of the aggregate date fair value of awards, not the dollar amount. The rule applies to both disclosure of compensation for named executive officers and the calculation of total compensation for determining a company’s named executive officer.

Awards that are subject to performance conditions merit their own specific instructions: The grant date fair value of such awards should be based on the probable outcome of the performance conditions, but to ensure that investors understand the potential maximum value of a performance award, companies must include a footnote in both the Summary Compensation Table and Director Compensation Table that discloses, assuming the highest level of performance, the maximum value payable under each performance award.

Compensation Consultant Disclosure

In order to give investors information that will allow them to assess potential conflicts of interest a compensation consultant might face when recommending executive compensation, the new rules require companies to disclose whether the board’s compensation consultant provides other non-executive compensation consulting services. If the fees paid for additional services exceed $120,000, companies also are required to disclose the compensation to the consultant for executive and director compensation services and, separately, the fees paid for other services.

And, if the compensation consultant was engaged by the company’s compensation committee, the company must disclose whether the decision to engage the compensation consultant for non-executive compensation consulting services was made or recommended by management, and whether the board or the compensation committee approved the additional services. The rules do not, however, require disclosure of fees for non-executive compensation consulting services that provide services only with respect to broad-based plans that do not discriminate in favor of executive officers or directors.

Disclosures Regarding Qualifications of Directors and Nominees

As amended, Item 401(e) of Regulation S-K requires companies to disclose the qualifications for each director and nominee, past directorships held by directors and nominees, and legal proceedings involving an executive officer, director, or nominee. Additionally, Item 407 requires a discussion of whether, and how, the nominating committee or board considered “diversity” in identifying director nominees. The SEC did not, however, attempt to define “diversity;” instead, it allows companies to define diversity “in ways that they consider appropriate,” which may include factors such as differences of viewpoint, professional experience, education, skill, and other qualities and attributes that contribute to board heterogeneity.

Disclosures about Company Leadership Structure and the Board’s Role in Managing Risk

The new rules also amend Item 407 of Regulation S-K, with a corresponding amendment to Item 7 of Schedule 14A, by requiring companies to provide a description of the board’s leadership structure that includes disclosure of whether the company chose to combine or separate the positions of principal executive officer and board chairman, and why the company believes that its board leadership structure is the most appropriate. If the company has combined the role of chief executive officer and board chairman, the rules require disclosure of whether the company has appointed a lead independent director and the specific role the lead independent director plays in the leadership of the board. Lastly, the SEC requires a discussion of the method the board of directors employs to oversee risk; for instance, through the entire board or through a designated committee.

The Disclosure of Shareholder Voting Results on Form 8-K

To expedite the timely reporting of shareholder voting results, the SEC added new Item 5.07 to Form 8-K requiring companies to disclose the final results of a shareholder vote within four business days following the end of the shareholder meeting at which the vote was held. Previously, such disclosure was required in the Form 10-Q quarterly report or the Form 10-K annual report (if the meeting was held during the company’s fourth quarter). If a company cannot report definitive voting results within four business days, the company must report the final results in an amended 8-K within four business days after the final results are known.

What’s Next?

The new proxy disclosure rules continue the SEC’s trend of reforming executive compensation policies and increasing board accountability to shareholders. And in another move aimed at reforming the proxy process, on February 22, 2010, the SEC published final amendments to its e-proxy rules (effective March 29, 2010). The new rules require all companies subject to the proxy rules to post their proxy materials on their websites and to send a Notice of Internet Availability of Proxy Materials (Notice) to their shareholders. The new rules also: (1) allow companies (or any other soliciting person) to include an explanation of the e-proxy process with the Notice; (2) reduce the boilerplate appearance of the Notice; and (3) eliminate the timing advantage that companies previously enjoyed over other persons soliciting proxies.  

However, neither the new disclosure rules nor the new e-proxy rules include changes to the proxy solicitation process that were included in the proposed rules. The SEC decided to defer consideration of those amendments pending consideration of current proposals that are intended to make it easier to include shareholder director nominations in proxy materials. Toward that end, the SEC re-opened the comment period with respect to the proposed shareholder director nomination rules.