Proxy Disclosure Of Stock-Based Comp To Change Under SEC Final Rule Approved Today; Other Disclosures Relate To Governance, Risk and Compensation

At an open commission meeting earlier today, the U.S. Securities and Exchange Commission voted 4-1 (Commissioner Kathleen Casey objecting) to approve a Final Rule requiring new disclosures relating to risk, compensation and corporate governance. See the SEC press release: SEC Approves Enhanced Disclosure About Risk, Compensation and Corporate Governance, and SEC's Final Rule: Proxy Disclosure Enhancements. Under the new rule, proxy disclosure of stock-based compensation in the Summary Compensation Table will shift from focusing on the annual amount of stock-based compensation provided in the financial statements, to disclosure of the aggregate grant date fair value of awards when they are granted, as detailed further below.

Effective date:

• The Final Rule is effective Feb. 28, 2010.
• With respect to changes in how stock-based compensation is to be reported in the Summary Compensation Table in the proxy statement, those changes are effective for fiscal years ending on or after Dec. 20, 2009. Transition provisions will require comparative information to be recomputed for the past two years.

Major Provisions of Final Rule
The major provisions in the Final Rule approved by the commission today, as outlined in SEC's press release, include:

• Require Disclosure of a Company's Compensation Policies and Practices as They Relate to the Company's Risk Management:
• Enhance Information About Directors and Nominees:
• Disclose How Diversity Is Considered in the Director Nomination Process:
• Provide Information About Board Leadership Structure and the Board's Role in Risk Oversight
• Require Quicker Reporting of Voting Results
• Revise the Summary Compensation Table (for share-based awards, described below)
• Enhance Disclosure About Compensation Consultants

Change to Proxy Disclosure of Stock-based Comp

The SEC's press release notes that proxy disclosure of stock-based compensation will change as follows:

The amended rule requires companies to report the value of options when they are awarded to executives (the aggregate grant date fair value), instead of the current requirement to report the annual accounting charge.

As described by Corp Fin staff member Sean Harrison during the open commission meeting, the Final Rule will require disclosure of the full grant date fair value (in accordance with FASB Codification Topic 718) He noted this is a change from the current SEC disclosure requirement, which calls for disclosure of the “dollar amount recognized for financial statement reporting purposes.” He added, “The amendment would include an instruction clarifying the amount to be included in the [compensation] tables is the value at grant date based on probable outcome.. not maximum potential value… [However] maximum potential [value] would be .. disclosed in footnotes.”

In response to a question from Chairman Mary L. Schapiro, Corp Fin Director Meredith Cross explained:

Under the current rules, the disclosure of the accounting charge flows through year after year after year, not withstanding whatever it is that the comp committee is doing in a given year. As a result, there is a significant disconnect between the option amount recorded in the Summary Compensation Table, and what the comp committee has been doing in paying the executives. The rule as changed would include a number that is reflective of what the comp committee thought they should pay the executives , which we think is much more consistent with the purposes of our rule.

The Final Rule states:

We are persuaded that the value of performance awards reported in the Summary Compensation Table, Grants of Plan-Based Awards Table and Director Compensation Table should be computed based upon the probable outcome of the performance condition(s) as of the grant date because that value better reflects how compensation committees take performance-contingent vesting conditions into account in granting such awards. We are adopting new Instructions to these tables to clarify that this amount will be consistent with the grant date estimate of compensation cost to be recognized over the service period, excluding the effect of forfeitures. To provide investors additional information about an award’s potential maximum value subject to changes in performance outcome, we will also require in the Summary Compensation Table and Director Compensation Table footnote disclosure of the maximum value assuming the highest level of performance conditions is probable. Such footnote disclosure will permit investors to understand an award’s maximum value without raising the concerns associated with requiring its tabular disclosure....

...To facilitate year-to-year comparisons, consistent with our proposal, we will implement the Summary Compensation Table amendments by requiring companies providing Item 402 disclosure for a fiscal year ending on or after December 20, 2009 to present recomputed disclosure for each preceding fiscal year required to be included in the table, so that the stock awards and option awards columns present the applicable full grant date fair values, and the total compensation column is correspondingly recomputed. The stock awards and option awards columns amounts should be computed based on the individual award grant date fair values reported in the applicable year’s Grants of Plan-Based Awards Table, except that awards with performance conditions should be recomputed to report grant date fair value based on the probable outcome as of the grant date, consistent with FASB ASC Topic 718. In addition, if a person who would be a named executive officer for the most recent fiscal year (2009) also was disclosed as a named executive officer for 2007, but not for 2008, the named executive officer’s compensation for each of those three fiscal years must be reported pursuant to the amendments.82 However, companies are not required to include different named executive officers for any preceding fiscal year based on recomputing total compensation for those years pursuant to the amendments, or to amend prior years’ Item 402 disclosure in previously filed Forms 10-K or other filings.

NOTE: By making the above change, the SEC is in effect reversing what was described by some as a 'midnight' change in regulation, when the SEC issued a press release on Friday, Dec. 22, 2006, calling for proxy disclosure of stock-based comp based on annual, rather than aggregate, amounts.

Board Oversight Of Risk Management
One change made in the Final Rule vs. the proposed rule was noted in a question raised by Commissioner Kathleen Casey during the open commission meeting, and in Corp Fin Director Cross's response, shown below.

Casey:
[Regarding] Board oversight of risk management, how do we anticipate issuers complying with this requirement; are there any changes you made from the proposal?

Cross:
The principal change we made was to change to 'risk oversight' instead of risk management,' we meant that [risk oversight], we fixed it, since the board oversees risk, does not manage risk.

COSO Thought Papers on Risk Oversight, ERM
Separately, (not specified in the SEC rule, but on a related topic) the Committee of Sponsoring Organizations of the Treadway Commission (COSO) released a four-page thought paper in October on, Effective Enterprise Risk Oversight: The Role of The Board of Directors. Additionally, in November, COSO released a 24-page thought paper entitled, Strengthening Enterprise Risk Management for Strategic Advantage. The papers are avaialable by free download from COSO's website, http://www.coso.org/.

FEI is one of the founding members of COSO. We have a limited number of hard copies of the 24-page thought paper, if you would like us to send you a copy, please email me to request one.

Disclosures Relating to Risk and Compensation
During today's open commission meeting, Cross explained another change made from the earlier proposal, relating to disclosures regarding risk and compensation:

The amendments we are recommending today would require companies to address their compensation policies and practices for all employees - not just executive officers - if the compensation policies and practices create risks that are reasonably likely to have a material adverse effect on the company. This disclosure threshhold - 'reasonably likely to have a material adverse effect' - was revised from the proposals in response to comments; and we believe it will elicit disclosures about incentives in a company's compenation policies and practices that would be most relevant to investors.

Refer to SEC's press release, which provides a useful and very readable summary of additional key components of the Final Rule.

SEC Reopens Public Comment Period on Shareholder Proxy Access
Separately, the SEC announced earlier this week that it is re-opening the public comment period for its shareholder director nomination proposal (aka shareholder proxy access). The new comment deadline will end 30 days after publication of the release in the Federal Register

During today's open commission meeting, Commissioner Elisse Walter noted:

As Oliver Wendell Holmes said, “The great thing in the world is not so much where we stand, as the direction where we are moving.”

Note: Walter's statement above may resonate not only with respect to the proxy disclosure matters voted on today, but also with respect to the upcoming consideration of the proxy access rules, a topic on which various groups among the SEC's constituents have some strongly held (and in some cases, diametrically opposed) views.

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