Corporate Law Alert: Summary of Final SEC Executive Compensation Disclosure Rules

In August 2006, the SEC issued final rules governing disclosure of

• executive compensation,
• director compensation,
• executive compensation arrangements on Form 8-K,
• related-person transactions, and
• corporate governance matters.

The rules are intended to provide investors with a clear and more complete picture of compensation to principal executive officers, principal financial officers, and the other highest-paid executive officers and directors. The new rules, consistent with the original proposal, rely heavily on tabular disclosure, as well as increased narrative disclosure about compensation arrangements.

Key elements of the new rules include

• a new compensation discussion and analysis section, which explains in one place the policies and decisions related to named executive officer compensation;
• increased tabular disclosure regarding director and officer compensation;
• increased disclosure for post-employment compensation, including retirement and change-in-control payments;
• modified Form 8-K reporting of compensation events to focus disclosure on material compensation arrangements and amendments involving specified executive officers and executive officers named in the compensation table; and
• disclosure of company policies and procedures for the review, approval, or ratification of related-person transactions.

The final rules contain a number of significant disclosure obligations that were not included in the proposal, relating to programs, plans, and practices concerning the selection of stock option grant dates or exercise prices. The final rules release provides that companies will be required to address matters relating to executives’ option compensation in the new Compensation Discussion and Analysis section, particularly as they relate to the timing and pricing of stock option grants. In addition, tabular disclosure will be required in the new Grants of Plan-Based Awards table concerning grant date fair market value and the timing of grants under certain circumstances.

The new rules become effective as follows:

• for Forms 10-K and 10-KSB, for fiscal years ending on or after December 15, 2006;
• for Form 8-K, for triggering events that occur on or after November 7, 2006; and
• for Securities Act registration statements (including pre-effective and post-effective amendments), Exchange Act registration statements, and proxy statements that are filed on or after December 15, 2006, that include compensation and related-person disclosure for fiscal years ending on or after December 15, 2006.

Companies will not be required to "restate" compensation disclosure for fiscal years covered by the prior rules. Instead, the Summary Compensation Table will be required only for the most recent fiscal year. Prior years will not need to be disclosed at all. This will result in phased-in implementation of the new Summary Compensation Table over a three-year period. A similar phased transition to the new rules applies to related person transaction disclosures that are required for the last three fiscal years in certain registration statements under the Securities Act of 1933.

The final rules add a new Compensation Discussion and Analysis ("CD&A") section, consistent with the proposal. The section is intended to be an overview that will consist of narrative disclosure to provide context for the compensation disclosure provided elsewhere, much as Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is designed to provide context for the financial statements. Companies will be required to explain in the overview material elements of compensation for named executive officers by answering the following questions:

• What are the objectives of the company’s compensation programs?
• What is the compensation program designed to reward?
• What is each element of compensation?
• Why does the company choose to pay each element?
• How does the company determine the amount (and where applicable, the formula) for each element?
• How does each element and the company’s decisions regarding that element fit into the company’s overall compensation objectives and affect decisions regarding other elements?

The purpose of the CD&A is to provide material information about the compensation objectives and policies for named executive officers. The final rules release reiterates the SEC’s position that the CD&A should be sufficiently precise to identify material differences in compensation policies and decisions for individual named executive officers, but also comprehensive enough to provide the desired context for the tabular disclosures. The scope of the CD&A is also intended to include discussion of post-employment compensation arrangements and policies. The SEC cautions companies to avoid boilerplate language and insists that disclosure must be tailored specifically to the company.

The SEC gives the following examples of issues that would be appropriate for inclusion in the CD&A:

• policies for allocating between long-term and currently paid-out compensation;
• policies for allocating between cash and noncash compensation, and among different forms of noncash compensation;
• for long-term compensation, the basis for allocating compensation to each different form of award;
• how the determination is made as to when awards are granted, including awards of equity-based compensation such as options;
• what specific items of corporate performance are taken into account in setting compensation policies and making compensation decisions;
• how specific elements of compensation are structured and implemented to reflect these items of the company’s performance and the executive’s individual performance;
• the factors considered in decisions to increase or decrease compensation materially;
• company policies and decisions regarding the adjustment or recovery of awards or payments if the relevant company performance measures upon which they are based are restated or otherwise adjusted in a manner that would reduce the size of an award or payment;
• how compensation or amounts realizable from prior compensation (e.g., gains from prior option or stock awards) are considered in setting other elements of compensation (e.g., how gains from prior option or stock awards are considered in setting retirement benefits);
• the impact of accounting and tax treatments of a particular form of compensation;
• the basis for selecting particular events as triggering payment with respect to post-termination agreements (e.g., the rationale for providing a single trigger for payment in the event of a change-in-control);
• the company’s equity or other security ownership requirements or guidelines (specifying applicable amounts and forms of ownership), and any company policies regarding hedging the economic risk of such ownership;
• whether the company engaged in any benchmarking of total compensation or any material element of compensation, identification of the benchmark and, if applicable, its components (including component companies); and
• the role of executive officers in the compensation process.

In the final rules release, the SEC lists elements and questions about option timing to which it believes a company should pay particular attention when drafting the appropriate corresponding disclosure:

• Does a company have any program, plan, or practice to time option grants to its executives in coordination with the release of material nonpublic information?
• How does any program, plan, or practice to time option grants to executives fit in the context of the company’s program, plan, or practice, if any, with regard to option grants to employees more generally?
• What was the role of the compensation committee in approving and administering such a program, plan, or practice? How did the board of directors or compensation committee take such information into account when determining whether and in what amount to make those grants? Did the compensation committee delegate any aspect of the actual administration of a program, plan, or practice to any other person?
• What was the role of executive officers in the company’s program, plan, or practice of option timing?
• Does the company set the grant date of its stock option grants to new executives in coordination with the release of material nonpublic information?
• Does the company plan to time, or has it timed, its release of material nonpublicinformation for the purpose of affecting the value of executive compensation?

The SEC also specifically states that, if a company has a program, plan, or practice of awarding options and setting the exercise price based on the stock’s price on a date other than the actual grant date, or determining the exercise price by using formulas based on average prices (or lowest prices) of the company’s stock in a period preceding, surrounding, or following the grant date, such a program, plan, or practice would also require disclosure, including, as appropriate, in the appropriate compensation table and in the CD&A. Again, as with the timing matters discussed above, the SEC reiterated in the final rules release that companies should carefully consider their own facts and circumstances and include all relevant material information in their corresponding disclosures.

As originally proposed, the CD&A would have replaced the compensation committee report entirely, as well as the stock performance graph. Under the final rules, the stock performance graph will now be required as part of the annual report, along with other stock price information. The compensation committee will still issue a signed report, but it will be limited to a statement regarding whether the committee has reviewed the CD&A and discussed it with management, and whether it recommended to the company’s board of directors that the CD&A be included in the annual report or proxy statement.

The CD&A is company disclosure, not a report of the compensation committee, and is incorporated into a company’s periodic filings. As a result, it is subject to the provisions of the Securities Exchange Act of 1934, including those relating to disclosure controls and procedures, CEO and CFO certification, and liability. In the final rules release the SEC stated that, in certifying the CD&A, the principal executive officers and the principal financial officers will be able to look to the compensation committee report.

Although similar to the current instructions with respect to the compensation committee report, the new rules are more restrictive as to when target levels can by excluded from compensation disclosure. The CD&A will not be required to disclose target levels with respect to specific quantitative or qualitative performance-related factors considered in setting compensation, nor will companies be required to disclose confidential commercial or business information, but only if such disclosure would reveal confidential trade secrets or confidential commercial or financial information that would result in competitive harm to the company. The SEC has repeatedly stated that, under the new rules, it intends to apply the same standards for information that can be excluded from the compensation committee report that it would apply in evaluating a confidentiality treatment request, that it will review these disclosures carefully, and that it will require issuers to amend filings if they cannot justify omission of target thresholds. If a company does properly omit target levels, it must state how difficult it will be to achieve the target.

The final rules reorganize the compensation tables and their related narrative disclosure into three broad categories, consistent with the original proposal:

• total compensation for the last fiscal year (and the two preceding fiscal years, as the rules are phased in);
• holdings of equity-based interests that relate to compensation or potential sources of future compensation, focusing on compensation-related, equity-based interests that were awarded in prior years and are at risk, as well as recent realization on these interests; and
• retirement and other post-employment compensation, including retirement and deferred compensation plans, other retirement benefits, and other post-employment benefits, such as those payable in the event of a change in control.

A typical disclosure will include seven tables with supplemental narrative disclosure:

• Summary Compensation Table [Link to Table], with new columns for total compensation and "Change in Pension Value and Nonqualified Deferred Compensation Earnings," and revised columns for stock awards, option awards, and other nonequity incentive plan compensation;
• Grants of Plan-Based Awards [Link to Table], including both performance- and non-performance-based awards, which supplements the Summary Compensation Table and covers awards made in the most recent fiscal year;
• Two additional tables relating to equity compensation:
  • Outstanding Equity Awards at Fiscal Year-End [Link to Table], which discloses material information regarding prior awards outstanding at the end of the fiscal year; and
  • Option Exercises and Stock Vested [Link to Table], which shows the amount received in the prior fiscal year upon the exercise of options or vesting of stock;
• Two tables relating to post-employment compensation:
  • Pension Benefits [Link to Table], which discloses the present value of pension benefits payable at normal retirement age and, if available, at early retirement; and
  • Nonqualified Deferred Compensation [Link to Table], which provides a complete picture of contributions, earnings, distributions, and account balances under nonqualified deferred compensation plans; and
• A Director Compensation table [Link to Table], with columns that correspond to the Summary Compensation Table for executives.

The SEC has acknowledged that a risk of the multiple tables is that compensation could be double-counted, in that it may appear in more than one table. The SEC has modified the final tables in an effort to address this concern, and reiterated in the final rules release that, to the extent that there is a risk of double-counting, companies should address that through the narrative disclosure that accompanies the tables.

Summary Compensation Table.

The final rules continue to rely on the Summary Compensation Table as the principal disclosure vehicle for executive compensation. Compensation for the named executive officers for each of the last three fiscal years (once the rules have been fully phased in) will be required, and the table will include separate columns for salary, bonus, stock awards, option awards, nonequity incentive plan compensation, pension and deferred compensation earnings, all other compensation, and total compensation.

Named Executive Officers ("NEOs"). The principal executive officer, the principal financial officer, and the next three highest-paid executive officers, as well as up to two additional individuals for whom disclosure would have been required but for the fact that they were no longer serving as executive officers at the end of the year, will be included in the table. As is currently the case for the CEO, all persons who served as the principal executive officer or principal financial officer during the last year will be considered an NEO.

The SEC did not adopt, and has re-submitted for further comment, the proposal to require disclosure of compensation for an additional three nonexecutive officers with significant policy-making functions, to the extent that their total compensation exceeds that of any of the NEOs. The individuals would not need to be named, or be included in any tables.

Total Compensation. The Summary Compensation Table will have a new column for total compensation that will include an aggregate dollar amount for all compensation reflected on the table for each individual. To facilitate calculating a total, all amounts included in the table must be in dollars, including the stock and option award columns. Total compensation, less the amount included in the Change in Pension Value and Nonqualified Deferred Compensation Earnings column, will be used to determine the individuals required to be in the table; currently total salary and bonus is used to make this determination. For purposes of determining the highest paid executive officers, the final rules eliminate the exclusion for compensation that is "not recurring and unlikely to continue," but continue the exclusion for payments attributed to overseas assignments.

Salary and Bonus. The final rules retain the Salary and Bonus columns substantially in their current form, although amounts currently considered bonuses may under the new rules be classified as nonequity incentive plan compensation.

If salary and bonus cannot be calculated as of the most recent practicable date before distributing the proxy, the new rules require companies to file a current report on Form 8-K upon the earlier of the payment being made or the compensation being determinable, in whole or in part, rather than waiting until the following year’s proxy statement.

Stock Awards and Option Awards. The Stock Awards and Option Awards columns must include any awards made during the year that derive their value from the company’s equity securities. Valuation will be based on the grant date fair value as determined for financial reporting purposes, and the dollar value of the award, rather than the number of shares covered by the award, will be included in the table. Companies will be required to provide a footnote to the table referencing the relevant discussion of assumptions in footnotes to the financial statements, or in the MD&A, related to the determination of the fair value of the awards. Stock Awards include restricted stock and restricted stock unit awards as well as the full grant date value of contingent performance-based stock awards.

Non-Equity Incentive Plan Compensation. The Non-Equity Incentive Plan Compensation column will report the dollar value of all amounts earned during the relevant period under plans not within the scope of FAS 123R, Share-based Payments. The amounts in this column will be reported when earned, rather than when granted, given the absence of a comparable provision to FAS 123R for cash awards.

In the final rules release, the SEC has provided additional guidance on the relationship between the compensation to be included in this column, and that required in the Bonus column:

An award will be considered intended to serve as an incentive for performance to occur over a specified period if the outcome with respect to the relevant performance target is substantially uncertain at the time the performance target is established and the target is communicated to the executive. Compensation pursuant to such a non-equity award would be reported in the Summary Compensation Table as non-equity incentive plan compensation and the grant of the award would be reported as a non-equity incentive plan award in the Grants of Plan-Based Awards Table. In contrast, a cash award based on satisfaction of a performance target that was not pre-established and communicated, or the outcome of which is not substantially uncertain, would be reportable in the Summary Compensation Table as a bonus.

Change in Pension Value and Nonqualified Deferred Compensation Earnings. This is a new column, and was not included in the proposal. This column will include earnings on compensation that is deferred on a non-tax-qualified basis, including non-tax-qualified defined contribution retirement plans, but only to the extent these earnings are above market or preferential, consistent with the current rules. Companies must also disclose in this column the aggregate increase in actuarial present value of the NEO’s accumulated benefit under defined benefit and actuarial plans (including supplemental plans), as calculated for the last fiscal year for financial reporting purposes. Each element of compensation included in this column must be separately identified and quantified in a footnote, regardless of the amount.

All Other Compensation. This column will include all other compensation not required to be included in any other column. This column will combine information previously disclosed in either "other annual compensation" or "other long-term compensation" into one column. The SEC has reiterated that truly all other compensation not reported elsewhere, or specifically excluded by the rules, should be included in this column. Each item of compensation included in the All Other Compensation column in excess of $10,000 must be separately identified and quantified in a footnote.

The All Other Compensation column must include, but is not limited to:

• perks and other personal benefits if the total is over $10,000 (see further discussion below),
• tax reimbursements,
• compensation costs computed in accordance with FAS 123R for discount purchases of company securities (unless the discount is generally available to all shareholders or salaried employees),
• termination or change-in-control payments,
• company contributions to vested and unvested defined contribution plans,
• any life insurance premiums paid by or on behalf of the company, and
• dividends or other earnings on stock or option awards if not taken into account when grant date fair value of such awards was determined.

The new rules continue to permit the omission of information regarding group life, health, hospitalization, and medical reimbursements that do not discriminate in scope or terms of operation in favor of executive officers or directors of the company and that are generally available to all salaried employees. The final rules no longer allow exclusion of relocation expenses.

Perquisites and Personal Benefits. Perks and other benefits must be included in the All Other Compensation column if perks exceed $10,000. This is a significant departure from the existing rules permitting omission of perks and other benefits if the aggregate amount was the lesser of $50,000 or 10 percent of total salary and bonus.

Footnote Disclosure. Each perk or other personal benefit that is included in the table must be identified, and the particular nature of the benefit must be accurately described. If a perk or benefit for the most recent fiscal year is valued at the greater of $25,000 or 10 percent of total perks, the value of that perk must be disclosed in the footnote. The final rules confirm that the aggregate incremental cost to the company is the relevant measure of value. Companies must disclose in the footnote the method used to calculate the aggregate incremental cost of amounts quantified in the footnote.

Interpretative Guidance. The final rules release reiterates that the SEC will not provide a bright-line definition for perks or personal benefits. The SEC instead has provided additional guidance as to the factors to be considered in determining whether an item is a perk or other personal benefit. The SEC indicated in the final rules release that an item is a perk or personal benefit if

• it is not "integrally and directly related to the performance of the individual’s duties," and
• it confers a direct or indirect benefit that has a personal aspect, without regard to whether it may be provided for some business reason or for the convenience of the company, unless it is generally available on a nondiscriminatory basis to all employees.

The SEC considers the concept of "integrally and directly related" to job performance to be narrow. In the final rules release, the SEC clarifies that "integrally and directly related" to job performance is intended to draw a critical distinction between an item that a company provides because the executive needs it to do the job, which makes it integrally and directly related to the performance of duties, and an item provided for some other reason, even when that other reason may involve both company benefit and personal benefit.

The SEC reiterates in the final rules release that even if a company appropriately determines that an expense is an ordinary or necessary business expense for tax or other purposes or that an expense benefits the company, such determination is not relevant for purposes of determining whether the expense is a perquisite or other personal benefit for disclosure purposes. The SEC is quite clear that business purpose or convenience does not affect the characterization of an item as a perquisite or personal benefit when it is not integrally and directly related to the executive’s performance of his or her job.

By way of example, the SEC indicates that a company policy stating that for security purposes an executive must use company aircraft or other company means of travel for personal travel, or must use company or company-provided property for vacations, does not affect the conclusion that the item provided is a perquisite or personal benefit.

If the company determines that the benefit is not integrally and directly related to the performance of the executive’s duties, the second step of the analysis comes into play. In determining whether the item confers a direct or indirect benefit that has a personal aspect, the SEC indicates in the final rules release, by way of example, that a company’s provision of helicopter service for an executive’s commute to work is not integrally and directly related to job performance (although it would benefit the company by getting the executive to work faster) and that it clearly bestows a benefit that has a personal aspect.

Further examples set forth in the final rules release as items that will be required to be disclosed as perks are

• club memberships not used exclusively for business entertainment purposes,
• personal financial or tax advice,
• personal travel using vehicles owned or leased by the company,
• personal travel otherwise financed by the company,
• personal use of other property owned or leased by the company,
• housing and other living expenses (including, but not limited to, relocation assistance and payments for the executive or a director to stay at his or her personal residence),
• security provided at a personal residence or during personal travel,
• commuting expenses (whether or not for the company’s convenience or benefit), and
• discounts on the company’s products or services not generally available to employees on a nondiscriminatory basis.

The SEC does provide examples of items that would not be perks or personal benefits, including the provision of BlackBerrys and laptop computers, travel to and from business meetings, business travel generally, business entertainment, security during business travel, and itemized expense accounts, the use of which is limited to business purposes.

Grants of Plan-Based Awards Table.

The Grants of Plan-Based Awards table is intended to supplement the Summary Compensation Table disclosure of stock and option awards, and to include disclosure of nonequity incentive plan awards in the year of grant. The table will disclose the number of shares of stock or units comprising the underlying awards. The table will also show terms of grants made during the current year, including estimated future payouts for both equity incentive plans and nonequity incentive plans, with separate disclosure for each grant.

If the per-share exercise price or base price of options, stock appreciation rights, and similar option-like instruments is less than the market price on the grant date, a separate column must be added to the table showing the market price on the grant date. Companies must also provide a description of the methodology used for determining the exercise or base price of options if the exercise or base price is not the grant date closing market price, either by footnote to the table or in the accompanying narrative section. The final rules also require an additional column disclosing the date the compensation committee or full board of directors took action, or is deemed to have taken action to grant equity-based awards, if that date is different from the grant date, as determined pursuant to FAS 123R. The final rules also add a new instruction specifying that if a nonequity incentive plan award is denominated in units or other rights, then a separate adjoining column will be required to disclose the units or other rights awarded.

Narrative Disclosure to Support Summary Compensation Tables

In addition to the tables and their footnotes, companies are required to provide a narrative description of any additional material factors necessary to an understanding of the information disclosed in the Summary Compensation Table and the Grants of Plan-Based Awards table. This narrative disclosure is not intended to duplicate the CD&A, but instead should focus on and provide specific context to the quantitative disclosures, such as a description of material terms in an NEO’s employment agreements or amendments to employment agreements or equity awards.

The final rules eliminate the 10-year repricing table. Instead, the expectation is that any material changes to awards, including repricings, will be discussed in the supplemental textual disclosure. As the SEC has previously indicated, merely filing material compensation agreements will not be sufficient. The material terms of those agreements will need to be described in this narrative disclosure.

The SEC has indicated in the final rules release that the factors that could be considered material and described in the narrative disclosure will include

• extension of exercise periods,
• change of vesting or forfeiture conditions,
• change or elimination of applicable performance criteria,
• change of the basis on which returns are determined, or
• any similar modification.

The narrative disclosure should also describe award terms relating to awards included in the Grants of Plan-Based Awards Table including, for example,

• a general description of the formula or criteria to be applied in determining the amounts payable,
• the vesting schedule,
• a description of the performance-based conditions and any other material conditions applicable to the award,
• whether dividends or other amounts will be paid, and
• the applicable rate and whether that rate is preferential.

Additional Equity Award Tables

Outstanding Equity Awards at Fiscal Year-End Table. This new table requires:

• For each option outstanding at fiscal year end, the number of shares for which the option is exercisable and unexercisable, the exercise price and the expiration date. The vesting dates for each option must be disclosed by footnote.
• For outstanding restricted stock or similar awards, the aggregate number of unvested shares at fiscal year end and the market value of those shares. Vesting dates must be disclosed by footnote.
• Separate columns are provided for disclosing options or stock awards that are "equity incentive plan awards;" i.e., awards with performance-based vesting. The instructions provide that companies should report in the table the threshold payout amount of outstanding performance-based awards, although a higher payout level must be reported if the previous year’s performance exceeded the threshold level.

Option Exercises and Stock Vested Table. This table must show the amounts received or realized upon exercise of options or similar instruments, and the vesting of stock or similar instruments during the most recent fiscal year. The table is similar to a portion of the current aggregate option/SAR exercises in the last fiscal year and fiscal year-end option/SAR values table, except that it also includes the vesting of restricted stock and similar instruments.

Post-Employment Compensation

The final rules significantly revise disclosure of post-employment compensation, with some significant variations from the proposal. The final rules

• replace the current pension plan table, alternative plan disclosure, and some of the other narrative descriptions with a table regarding defined benefit pension plans and enhanced narrative disclosure;
• include a new table, and narrative disclosure that will disclose information regarding nonqualified defined contribution plans; and
• significantly expand disclosure regarding compensation arrangements triggered on termination and change in control.

Pension Benefits Table. This new table will require disclosure regarding retirement benefits under defined benefit plans, including tax-qualified and supplemental plans. The SEC has simplified the disclosure compared to the proposal. Rather than requiring an estimate of future payouts, as proposed, companies will instead be required to disclose actuarial present values of an NEO’s accumulated benefit under the relevant plans, computed as of the same pension plan measurement date, and with the same assumptions, used for preparation of audited financial statements. All material assumptions applied must be described in the narrative discussion accompanying the table. Companies may refer to such a discussion in the footnotes to the financial statements or MD&A.

The table calls for a separate line of tabular disclosure for each plan in which an NEO participates. If the credited years of service for the NEO under any plan differ from the actual years of service with the company, a footnote quantifying the difference and any resulting benefit increase will be required.

A narrative discussion will be required to disclose any material factors necessary to an understanding of each plan disclosed in the table. The SEC has indicated that this narrative disclosure should include, among other things,

• material terms and conditions of benefits available under the plan, including the plan’s retirement benefit formula and eligibility standards, and early retirement arrangements;
• the specific elements of compensation, such as salary and various forms of bonus, included in applying the benefit formula identifying each element;
• if NEOs are participating in multiple plans, the reason for providing each plan; and
• company policies with regard to matters such as granting extra years of credited service.

Nonqualified Deferred Compensation Table. This table discloses contributions, earnings, and balances under nonqualified defined contribution plans. Under both the current rules and the new rules, only above-market earnings on nonqualified deferred compensation are disclosed in the Summary Compensation Table. All earnings on nonqualified deferred compensation in the last fiscal year will be required to be disclosed in this table. To address the overlap between this table and the Summary Compensation Table, this table will require footnote quantification of the extent to which amounts in the contributions and earnings columns are reported in the Summary Compensation Table in the year in question and the extent to which amounts reported in the Aggregate Balance at Last FYE column were reported in the Summary Compensation Table for prior years.

The table will be followed by a narrative description of material factors necessary to an understanding of the disclosure in the table, including

• types of compensation permitted to be deferred, and any limitations (by percentage of compensation or otherwise) on the extent to which deferral is permitted;
• the measures of calculating interest or other plan earnings (including whether such measures are selected by the NEO or the company and the frequency and manner in which such selections may be changed), quantifying interest rates and other earnings measures applicable during the company’s last fiscal year; and
• material terms with respect to payouts, withdrawals, and other distributions.

Other Potential Post-Employment Payments. The final rules require disclosure of specific aspects of any written or unwritten arrangement that provides for payments at, following, or in connection with the resignation, severance, retirement, or other termination of an NEO, a change in the NEO’s responsibilities, or a change in control of the company. This disclosure must be provided in narrative form and must include the following information regarding termination and change-in-control provisions:

• the specific circumstances that would trigger payment or the provision of other benefits, including perks;
• quantification of estimated payments and benefits that would be provided in each covered circumstance, and whether they would or could be lump sum or annual, disclosing the duration and by whom they would be provided;
• how the appropriate payment and benefit levels are determined under the various circumstances that would trigger payment or provision of benefits;
• any material conditions or obligations applicable to the receipt of payments or benefits, including, but not limited to, noncompete, nonsolicitation, nondisparagement, or confidentiality covenants; and
• any other material features necessary for an understanding of the provisions.

In quantifying the estimated payments, companies must assume that the triggering event occurred as of the end of the last fiscal year and the price per share for equity payouts is the closing market price as of that date. Companies will not be required to estimate future payouts, as was contemplated in the proposal.

Director Compensation

The final rules significantly increase the disclosures surrounding director compensation and perks. Director compensation will be required to be disclosed very similarly to the information required for NEOs in the Summary Compensation Table, although only for the last fiscal year. The All Other Compensation column in the Director Compensation Table must, in addition to the types of compensation required in this column of the Summary Compensation table, include

• all consulting fees, and
• awards under director legacy or charitable award programs.

Footnote disclosure will generally be required for the Director Compensation table to the same extent as under the Summary Compensation Table for NEOs. In addition, a footnote must disclose the total number of options and unvested stock awards outstanding for each director at fiscal year-end. To the extent that director compensation does not vary from one director to another, a company could group the directors in a single row of the table.

Although there are no supplemental tables for directors, the narrative disclosure accompanying the table should disclose any material information necessary to understand the information included in the table, including a breakdown of the types of fees received by directors.

The final rules limit reporting of compensation events on Form 8-K to material compensation arrangements and amendments involving only specifically identified executive officers. In making this revision, the SEC took the opportunity to state its belief that many of the compensation arrangements currently being disclosed on Form 8-K are not presumptively material.

The final rules remove employment compensation arrangements from the material contract portion of Form 8-K (Item 1.01) and instead cover such arrangements under a modified and broader Item 5.02, which previously dealt only with the appointment or departure of directors and specified officers (the principal executive officer, president, principal financial officer, principal accounting officer, principal operating officer, or any person performing similar functions). The modifications to Item 5.02

• expand the information regarding retirement, resignation, or termination to include all NEOs for the company’s previous fiscal year, in addition to the "specified officers";
• expand the disclosure required on appointment of a director or specified officer beyond employment agreements to capture a brief description of any material plan, contract, or arrangement entered into, or materially amended, in connection with the appointment or any grant or award to any such person in connection with such appointment;
• add new Item 5.02(e) to require, with respect to NEOs for the prior year, a brief description of any material new compensatory plan, contract, or arrangement, or new grant or award (whether or not written), and any material amendment to any compensatory plan, contract, or arrangement (or any modification) regardless of whether this occurs in connection with appointment of the officer; grants or awards or modifications will not be required to be disclosed under Item 5.02(e) if they are consistent with the terms of previously disclosed plans or arrangements and they are later included in executive compensation disclosure; and
• add a new disclosure obligation to describe salary and bonus for the most recent year for an NEO to the extent it was not available and not included in the material disclosed in the proxy statement.

The SEC stated in the final rules release that the disclosure required under Form 8-K is not intended to be as broad as that required to be included in the annual compensation information provided in the proxy statement. The Form 8-K disclosure need only be a brief description and is not intended to be an update to the annual information. In addition, the SEC extended to new Item 5.02(e) the safe harbor from 10b-5 liability and loss of S-3 eligibility previously provided for late reports under selected Form 8-K items.

The final rules add a requirement for footnote disclosure in the beneficial ownership table of the number of shares pledged as security by NEOs, directors, and director nominees. The final rules do not require this disclosure for shares held by significant shareholders who are not members of management.

The final rules include significant revisions to the disclosure of Certain Relationships and Related Transactions as previously required under Item 404 of Regulation S-K. The revisions are intended to streamline the disclosure requirements and make them more principles-based. The final rules consist generally of four parts:

• Item 404(a) contains a general disclosure requirement for related-person transactions, including those involving indebtedness;
• Item 404(b) requires disclosure regarding the company’s policies and procedures for the review, approval, or ratification of related-person transactions;
• Item 404(c) requires disclosure regarding promoters of the company; and
• new Item 407 consolidates current corporate governance disclosure requirements and requires disclosure regarding the independence of directors, and descriptions of any category of relationships not disclosed under Item 404(a) that were considered when determining whether each director or nominee for director was independent.

The final rules require disclosure of any transactions during the last year or any currently proposed transaction

• in which the company was or is to be a participant,
• in which the amount involved exceeds $120,000 (increased from $60,000), and
• in which any related person had or will have a direct or indirect material interest.

In the final rules release, the SEC emphasizes that a company is obligated to disclose transactions in which it is a "participant," as opposed to a "party," and that that is intended to capture transactions in which a company receives a benefit without being a contractual party.

Transactions with immediate family members of directors, executive officers, and significant shareholders continue to require disclosure. The definition of "immediate family member" continues generally to include spouse, parents, children, and siblings, including by marriage, and has been modified to add other persons sharing the same household.

The materiality standard for disclosure has been retained. As such, companies must continue to evaluate whether the related person had or will have a direct or indirect material interest in the transaction using the standard materiality test. The relationship of the related persons to the transaction, and with each other, and the amount involved in the transaction are factors to be considered in determining the materiality of the information to investors.

The final rules continue to require disclosure of indebtedness of related persons (other than significant shareholders who are not otherwise related persons) to the company, even though indebtedness incurred after July 29, 2002 is largely prohibited by section 402 of the Sarbanes-Oxley Act of 2002. Loans to immediate family members of directors or executive officers, or to entities in which such persons have an interest, might be picked up by the remaining disclosure requirement.

The final rule release clarifies that disclosure will be required for any transaction between the company and any person who was a related person during any part of that year, even if the transaction occurred at a time when the individual was not a related person, other than significant shareholders and their family members who are not otherwise part of management. Disclosure of transactions with significant shareholders is required, however, for a transaction that begins before a significant shareholder becomes a significant shareholder and continues on or after the person becomes a significant shareholder.

Employment and compensation transactions with directors and NEOs that are reported under the compensation disclosure rules do not need to be repeated as disclosure of related-person transactions. Disclosure of compensation transactions with executive officers who are not NEOs is also not required, but only if such compensation was approved or recommended by the company’s compensation committee. However, if an immediate family member of a director, executive officer, or significant shareholder is employed by the company and receives compensation exceeding the $120,000 annual disclosure threshold, disclosure of that person’s compensation is required as a related-person transaction, subject to the general materiality standard.

Procedures for Approval of Related-Person Transactions. The final rules require a description of the material features of the company’s policies and procedures for the review, approval, or ratification of transactions of related persons that would be reportable under Item 404(a). Examples of the types of features that will need to be disclosed include

• the types of transactions covered by such policies and procedures and the standards to be applied,
• the person or group of persons on the board of directors who is responsible for applying the policies and procedures, and
• whether such policies and procedures are in writing, and if not in writing, how they are evidenced.

The final rules also require identification of any transactions since the beginning of the last fiscal year required to be reported under Item 404(a) for which the company’s policies and procedures on review, approval, or ratification were not followed, other than transactions entered into before the person became a related person, unless the transaction continues after commencement of that relationship.

The new rules consolidate into new S-K Item 407 existing disclosure requirements regarding director independence and related corporate governance disclosure requirements under a single disclosure item, and update the disclosure requirements regarding director independence to reflect current requirements and current exchange listing standards.

Independence. Companies will be required to identify independent directors (and in the case of disclosure in proxy or information statements, nominees for director) under applicable exchange listing standards, or if the company is not listed, under an exchange definition consistently applied. Companies will also be required to disclose any members of the compensation, nominating, and audit committees who had not been determined to be independent under relevant committee independence standards.

If a company uses any additional independence definitions, the final rules require that these definitions be disclosed by the company, including disclosure on the company’s Web site. Companies are also required to disclose, for each director or director nominee identified as independent, a description of the specific category or type of transactions, relationships, or arrangements considered by the board of directors in evaluating the director’s or nominee’s independence, to the extent that these relationships were not disclosed in the related-person disclosures.

If the company is relying on an exemption from the independence standards, that reliance must be disclosed, along with a discussion of the basis for the company’s determination that the exemption is available.

Compensation Committee Processes and Procedures. The final rules apply to the compensation committee disclosure requirements that previously applied only to the audit and nominating committees. These include disclosing whether the board of directors has a standing committee, and if not, why not, and disclosing whether the compensation committee’s authority is set forth in a charter or other document, and if so, identifying the company’s Web site where a current copy is available if posted, and if not posted, attaching the charter to the proxy statement once every three years. The expanded disclosure also requires companies to describe processes and procedures for the consideration and determination of executive and director compensation including

• the scope of authority of the compensation committee (or persons performing equivalent functions) and the extent to which the compensation committee (or persons performing equivalent functions) may delegate any authority to other persons, specifying what authority may be so delegated and to whom;
• any role of executive officers in determining or recommending the amount or form of executive and director compensation; and
• any role of compensation consultants in determining or recommending the amount or form of executive and director compensation, identifying such consultants, stating whether such consultants are engaged directly by the compensation committee (or persons performing equivalent functions) or any other person, describing the nature and scope of their assignment, and describing the material elements of the instructions or directions given to the consultants with respect to the performance of their duties under the engagement. The final rules do not include the proposed requirement that companies identify any executive officer within the company the consultants contacted in carrying out their assignment.

The final rules require that all compensation, beneficial ownership, related person transaction and corporate governance disclosures be provided in plain English under principles similar to those applicable to portions of prospectuses and risk factors in Form 10-Ks.

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This Summary focuses on the new rules applicable to issuers for whom general disclosure requirements are contained in Regulation S-K, and does not discuss changes applicable to small business issuers covered by Regulation S-B.