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10/30/06 |
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Impact on Small Business Issuers of the SEC's Revised Executive Compensation and Related Disclosure Rules
Penny Somer-Greif
Kenneth B. Abel
On August 11, 2006, the Securities and Exchange Commission (the "Commission") released its new and amended rules governing executive compensation and related disclosures including related party transactions, director independence and other corporate governance matters. The new rules require that this information be written in plain English. In addition, the new rules revise the requirements for disclosure of entry into and modification of executive and director compensation arrangements on Current Reports on Form 8-K. This memorandum summarizes the new disclosure rules as they apply to small business issuers and provides guidance on what such companies should consider doing now to prepare to comply with the new disclosure requirements. Other than the amendments to Current Report on Form 8-K, which are effective November 7, 2006, the new rules will be applicable for disclosure about fiscal years ending on or after December 15, 2006.
The revised disclosure rules regarding executive and director compensation will continue to be located in Item 402 of Regulation S-B. Under the new rules, small business issuers are subject to substantially less disclosure than other issuers. Most importantly, small business issuers are exempt from what is perhaps the most challenging portion of the new rules, the Compensation Discussion and Analysis ("CD&A") section that must address the objectives and implementation of a company's executive compensation programs, focusing on the most important factors underlying each particular company's compensation policies and decisions. Under the new rules, small business issuers will be required to provide: The Summary Compensation Table will continue to be the principal disclosure vehicle for executive compensation, showing compensation for each named executive officer over the last two years. The summary compensation table will be accompanied by narrative disclosure to help explain the compensation information presented in the Summary Compensation Table. Compensation disclosure must be provided for a small business issuer's "named executive officers." The named executive officers will consist of the company's principal executive officer ("PEO"), the two most highly compensated executive officers (other than the principal executive officer) who were serving as executive officers at the end of the last fiscal year, and up to two additional individuals for whom disclosure would have been required except that the individual was not serving as an executive officer at the end of the last fiscal year. Similar to the current rules, disclosure must be provided for any individual that served as the small business issuer's principal executive officer during the past fiscal year. As under the current rules, disclosure need not be provided for any other executive officer whose compensation does not exceed $100,000. However, unlike the current rules, this figure is based on total compensation (including any severance benefits paid or accrued during the year), not solely salary and bonus. In a shift from the proposed rules, however, above-market or preferential earnings on non-qualified deferred compensation need not be considered in figuring total compensation for the determination of the named executive officers. In addition, while small business issuers can continue to exclude executive officers who are highly compensated based predominantly on amounts of cash compensation due to overseas assignments in making this determination, they can no longer exclude amounts that are "non-recurring and unlikely to continue." Together, these revisions mean that for some companies, the officers who are deemed the named executive officers may vary from year to year, and companies may have to keep track of compensation information for a larger pool of executive officers. The proposed rules included an additional item that would have required certain disclosures for up to three employees who were not executive officers of the company whose compensation for the last completed fiscal year was greater than any of the named executive officers. The Commission has reproposed and asked for comment on this proposal. As reproposed, employees who do not have responsibility for significant policy decisions, such as athletes, entertainers and salespeople, would be excluded. The Commission is considering limiting this disclosure, if adopted, to large accelerated filers.
While the table requires disclosure for the past two fiscal years, small business issuers will not be required to re-state compensation disclosure previously provided under the current rules. Instead, the new requirements will be phased in so that, in the first year the requirements are applicable, only 2006 compensation disclosure will be required, while the next year, 2006 and 2007 disclosure will be required, and so on. Currently, salary or bonus amounts earned but deferred at the election of the named executive officer must be included in the table. Under the new rules, this treatment applies to all forms of compensation, not just salary and bonus, that is deferred for any reason, not just at the election of the named executive officer. The salary and bonus columns have been retained substantially in their current form, except that amounts based on the satisfaction of performance targets that are pre-established and substantially uncertain when communicated to the grantee will not be disclosed as bonuses in column (c) but rather as incentive plan compensation, as discussed further below. It appears that under the new rules the only amounts that will be included in the “bonus” column are discretionary bonuses not based on the attainment of specific performance factors that are communicated in advance to the named executive officer. Where salary or bonus amounts are not calculable, a footnote must be included disclosing that the amount is not calculable through the latest practical date and providing the date that the amount of salary or bonus is expected to be determined. When determined, such amount must be disclosed in a Current Report on Form 8-K under new Item 5.02(f). Such Form 8-K must also include a new total compensation figure that includes the newly-disclosed salary or bonus amount. Amounts of salary or bonus that a named executive officer chooses to receive in stock, equity-based or other forms of non-cash compensation pursuant to a company program that allows the officer to do so, should be disclosed not in the salary or bonus columns but instead in the appropriate column for such form of compensation. For example, if under such a plan a named executive officer chooses to receive company stock in lieu of $10,000 of a bonus he is entitled to, that $10,000 should be reported in the “Stock Awards” column (column (e)) and should not be reported in the bonus column for that year. If such award is made pursuant to a non-equity incentive plan and therefore not reportable in the table when granted, such amounts should be disclosed in a footnote to the salary or bonus column, as applicable, disclosing the award and cross-referencing the narrative disclosure to the Summary Compensation Table where the material terms of the award are reported. The Stock Awards column will disclose the dollar value of all stock-related awards granted during the year that derive their value from the small business issuer's equity securities or permit settlement by issuance of the small business issuer's equity securities, such as restricted stock, restricted stock units, phantom stock, phantom stock units, common stock equivalent units, and other similar instruments that do not have option-like features. The Option Awards column will disclose the dollar value of stock options, stock appreciation rights, and similar equity-based compensation instruments granted during the year that have option-like features, including awards that have subsequently been transferred. In each case, disclosure is required of the aggregate grant date fair value of such award(s) computed in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment ("FAS 123R"), for financial reporting purposes. Therefore, small business issuers will need to consult with their auditors or other financial advisors to determine the amounts to be included in these columns of the summary compensation table. Small business issuers must provide footnote disclosure of all assumptions made in the valuation or a cross-reference to the discussion of those assumptions (generally in the MD&A or the footnotes to the financial statements). If a small business issuer has adjusted or amended the exercise price of options or stock appreciation rights, or otherwise materially modified such awards in the last fiscal year, the amount reported in column (f) must include the incremental fair value with respect to that repriced or modified award, computed as of the date of repricing or modification pursuant to FAS 123R. In addition, any earnings on stock or option awards (such as dividends) that are not included in the grant date fair value computation must be included in the All Other Compensation column of the Summary Compensation Table when such dividends or other earnings are paid. The dollar value of all amounts earned during the fiscal year pursuant to non-equity incentive plans, including incentive plan awards not within the scope of FAS 123R and so not included in the Stock Award and Option Award columns, will be reported in column (g). Such compensation is considered earned (and therefore should be disclosed) in the year the relevant performance criteria under the plan is satisfied, regardless of when the award was granted or when it is paid. The Commission encourages companies to use the related narrative section, discussed below, to disclose material features of an award that are not reflected in the table, such as subsequent forfeitures of amounts reported in previous years. Earnings on outstanding non-equity incentive plan awards should be included in this column and identified and quantified in a footnote to the table. Small business issuers must disclose in this column any above-market or preferential earnings on non-qualified deferred compensation. Earnings are considered above-market if the applicable interest rate exceeds 120% of the applicable federal long-term rate. As noted above, amounts disclosed in this column are deducted from the amounts disclosed in the Total column in figuring total compensation for purposes of determining which officers are the named executive officers. All other compensation not required to be included in any other column must be disclosed under "All Other Compensation." The Commission reiterates in the rules and adopting release that the rules require disclosure of all compensation, even if not specifically referenced in the rules. Compensation to be included in this column includes, but is not limited to: Benefits paid pursuant to defined benefit and actuarial plans are not reportable in this column unless accelerated pursuant to a change in control. Perquisites and other personal benefits should be valued on the basis of aggregate incremental cost to the small business issuer. The adopting release provides guidance for determining whether an item is a perquisite or other personal benefit. Generally, an item is not a perquisite or personal benefit if it is "integrally and directly related to the performance of the executive's duties," and is a perquisite or personal benefit if it is not "integrally and directly related to the performance of the executive's duties" and "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 to all employees on a non-discriminatory basis." The fact that the small business issuer may have determined that the expense is an "ordinary" or "necessary" business expense for tax or other purposes or that it is for the benefit or convenience of the small business issuer does not impact whether it constitutes a perquisite or other personal benefit for disclosure purposes. So, for example, a first class flight to the location of a meeting the executive must attend is not a perquisite because he needs to attend the meeting to do his job, even though he may get some personal benefit by flying first class instead of coach. In contrast, the small business issuer's provision of a helicopter service for an executive to commute to work is not integrally and directly related to job performance, even though it benefits the small business issuer by getting the executive to work earlier, and thus is a perquisite or personal benefit. The adopting release provides additional examples of perquisites or personal benefits, including club memberships not used exclusively for business entertainment purposes, personal financial or tax advice, personal travel using vehicles owned or leased by the small business issuer (even if pursuant to company policy), personal travel otherwise financed by the small business issuer, personal use of other property owned or leased by the small business issuer, housing and other living expenses (including relocation assistance and payments to stay at the executive's or director's personal residence), security provided at a personal residence or during personal travel, commuting expenses (whether or not for the small business issuer's convenience or benefit), and discounts on company products and services not generally available to employees on a non-discriminatory basis. The new total compensation column discloses the aggregate of the total value of each form of compensation quantified in the other columns (i.e. the sum of columns (c) through (i)). The new rules require small business issuers to include a narrative description of any material factors necessary for an understanding of the information disclosed in the Summary Compensation Table, including, but not limited to: The next category of the revised executive compensation disclosure requirements relates to equity that has previously been awarded and that remains outstanding, and is unexercised or unvested, at year-end. The Outstanding Equity Awards at Fiscal Year-End Table will provide information about unexercised options, stock awards that have not vested, and equity incentive plan awards outstanding as of the end of the small business issuer's last fiscal year and the market value thereof as follows: (Table available here. (Word document: 55k ) Awards of options, stock appreciation rights and similar instruments with option-like features (reportable in columns (b) through (f)) must be reported on an award-by-award basis, rather than on an aggregate basis as had been proposed, unless the expiration date and exercise/base price of the instruments aggregated are identical. For each option award and similar instrument, the number of securities underlying unexercised options should be reported in column (b) to the extent exercisable and column (c) to the extent unexercisable. Shares underlying options and similar instruments awarded under an equity incentive plan and which are unearned, for example, if the award is based on the attainment of certain performance criteria that have yet to be met, should be disclosed in column (d). Once the applicable performance criteria are satisfied, these awards should be disclosed in columns (b) or (c), as appropriate, even if subject to forfeiture conditions. For each such option and similar instrument reported, the exercise or base price will be reported in column (e) and the expiration date in column (f). Unlike option awards, information regarding numbers and market values of nonvested stock and equity plan awards will be reported on an aggregate basis. Columns (g) and (h), respectively, should show the aggregate number of shares of stock or other units awarded that have not yet vested and the aggregate market value of such shares or units. The number of shares of stock, units or other rights that have been awarded under an equity incentive plan that have not yet vested and have not yet been earned will be reported in column (i), while the market value of such shares will be reported in column (j). Similar to options awarded under equity incentive plans, once earned, these amounts will be reflected in columns (g) and (h), as appropriate. The number of shares reported for equity incentive plan awards (columns (d) and (i)) or the payout value reported in column (j) should be based on achieving threshold performance goals, unless the previous year's performance exceeded such threshold, in which case the disclosure should be based on the next highest performance measure that exceeds the prior year's performance. If the award provides for only a single estimated payout, that amount should be reported. If the target amount is not determinable, small business issuers must provide a representative amount based on the previous year's performance. Market value is to be computed by multiplying the closing market price of the small business issuer's stock at the end of the last fiscal year by the number of shares or units or the amount of equity incentive plan awards, as applicable. Awards that have been transferred other than for value must be reported in the appropriate column of the table, along with a footnote identifying any such transferred award and the nature of such transfer. Further, the vesting dates of options, shares of stock and incentive plan awards held at year-end must be disclosed by a footnote to the column in which the award is reported. The new rules require small business issuers to provide a narrative description, to the extent material, of: Pursuant to the new rules small business issuers will be required to provide a Director Compensation Table disclosing all fees and other payments paid to each director. The table is similar to the Summary Compensation Table but requires disclosure only for the most recent fiscal year: (Table available here. (Word document: 50k) All cash fees paid for services as a director, such as retainer fees, committee fees, meeting fees and chairmanship fees, should be disclosed in column (b). Otherwise, the directions and instructions applicable to the Summary Compensation Table (i.e. calculation of the dollar value of stock and option awards and the amounts to include in each column of the table) generally apply to the analogous columns in the Director Compensation Table, except that consulting fees and the annual costs of payments and promises of payments pursuant to director legacy and similar charitable award programs must be included as "all other compensation." Small business issuers must also provide footnote disclosure of (i) the aggregate number of stock awards and option awards outstanding for each director at year-end, and (ii) the total dollar amount payable under legacy and similar charitable award programs and the material terms of each such program. Two or more directors may be grouped in a single row if their compensation is identical and all are clearly named. A narrative description of any material factors necessary for an understanding of the information in the table must follow the Director Compensation Table. Examples include a description of standard compensation arrangements and a description of any different compensation arrangement applicable to a specific director. The new rules amend the Form 8-K requirements with respect to management contracts and compensatory plans. Currently, Item 1.01 of Form 8-K requires disclosure of entry into or the material amendment of a material contract, including compensation arrangements. In practice, this has resulted in reporting companies disclosing on Form 8-K even most routine compensation decisions involving company officers and directors. The amendments eliminate compensation arrangements from disclosure under Item 1.01, move this disclosure to Item 5.02, and narrow the types of arrangements that must be disclosed on Form 8-K. The Commission considers this a more balanced approach to the disclosure of compensation arrangements that will elicit disclosure of such arrangements when "unquestionably or presumptively material" and limit Form 8-K disclosure of such arrangements that fall below this threshold. In reality, however, it appears that the Commission's revisions to the Form 8-K requirements limit the scope of persons for whom this disclosure is required, but not the events that require disclosure. Current Item 5.02 requires disclosure of certain information with respect to appointment, retirement, resignation or termination of a reporting company's principal executive officer, president, principal financial officer, principal accounting officer, principal operating officer or any person performing similar functions (the "covered officers") or the election of a new director other than by a vote of security holders at an annual or special meeting. The new rules add the named executive officers to the list of covered officers for whom this disclosure must be provided. The new rules provide that for purposes of Item 5.02 of Form 8-K the "named executive officers" are the named executive officers as listed in the company's most recent annual report or proxy statement in which the required compensation disclosure appears. Amended Item 5.02 will require a brief description of any material plan, contract or arrangement to which a covered officer (included a named executive officer) or director is a party or in which he or she participates that is entered into or materially amended, or any grant or award to such officer or director or modification thereto, in connection with the appointment or election of such officer or director. In addition, if a reporting company enters into or materially amends a material compensatory plan, contract or arrangement to which its principal executive officer, principal financial officer, or other named executive officer is a party, or makes a material grant or award or a material modification of a grant or award under any such plan, contract or arrangement, whether or not in connection with a hiring, termination or other event otherwise requiring disclosure under Item 5.02, the company must provide a brief description of the terms and conditions thereof, including the amounts payable, under a new Item 5.02(e) to Form 8-K. Therefore, in the absence of further clarification, annual salary increases and similar matters should still be disclosed on Form 8-K consistent with past practice, but only for a company's principal executive officer, principal financial officer, and other named executive officers. As under the current rules, grants or awards or modifications thereof that are materially consistent with the previously disclosed terms of such awards, grants or modifications need not be disclosed. Therefore, small business issuers will want to ensure that they have previously disclosed the terms of compensation arrangement under which such grants or awards can be made and that they have filed copies thereof with the Commission, including any forms of agreements under such arrangements. Finally, as discussed above, if a company was unable to calculate a named executive officer's salary and/or bonus when such disclosure was required and omitted this information from the Summary Compensation Table, it must disclose such amounts when they become calculable, and provide a new total compensation figure for such officer, in new item 5.02(f) of Form 8-K. The new rules also provide that a company may omit the Item 1.01 heading from a Form 8-K if other headings are applicable to the relevant disclosure and all information required by Item 1.01 is included. The amendments to Form 8-K are applicable for events that occur on or after November 7, 2006. New Item 407 of Regulation S-B updates and consolidates existing disclosure requirements regarding director independence and committees of the board of directors. Except for new disclosure relating to the structure and operation of the compensation committee, most of this disclosure was previously required in a company’s proxy statement pursuant to Items 7(d) through 7(h) Schedule 14A and/or, for listed companies, by Nasdaq or applicable Exchange rules. Other than information with respect to (i) director independence, (ii) material changes to the procedures by which security holders may recommend nominees to the company’s board of directors, (iii) for listed issuers, whether the company has a separately-designated audit committee and any exemptions from the independence requirements relating to audit committees, and (iv) an audit committee financial expert (which was previously required to be disclosed in Form 10-KSB), all of which will be required by Part III of Form 10-KSB, Item 407 information will appear solely in the proxy statement, which means that it will not be covered by the certifications given by the company’s chief executive and chief financial officers. Small business issuers that file their proxy statement with the Commission within 120 days of fiscal year-end can continue to include the Item 407 information required in the Form 10-KSB in their proxy statements and incorporate that information into their Annual Reports on Form 10-KSB. However, small business issuers that do not have securities registered under Section 12 of the Exchange Act and therefore are not required to file proxy statements with the Commission, must now include the director independence disclosure in their Annual Reports on Form 10-KSB and will be required to provide this type of disclosure for the first time in their upcoming annual reports. This section of the memorandum outlines the disclosure that will be required by new Item 407, including disclosure currently required by Item 7 of Schedule 14A. Pursuant to new Item 407(a) of Regulation S-B, small business issuers will be required to provide disclosure regarding the independence of each director, including whether each director and, if applicable, nominee, is independent, and a description of any transactions, relationships or arrangements not disclosed pursuant to Item 404 of Regulation S-B that were considered in determining independence. Such disclosure will be required for any person who served as a director during any part of the year for which this disclosure is required, even if such director is no longer serving or, if the information is presented in a proxy statement, will not continue to serve after the meeting to which the proxy statement relates. Small business issuers that are listed on or (when the information is included in a registration statement) that have applied for listing on a national securities exchange (which now includes Nasdaq) or national securities association must use the definition of independence prescribed by the Exchange’s or Association’s applicable listing standards. Small business issuers that are not so listed must use an independence definition of one of such Exchanges or Associations of its choosing, but must use the same definition consistently for all directors and for purposes of determining the independence of its committee members, as discussed below. Further, if a small business issuer relies on an exemption provided in the applicable listing standard’s independence requirements, such as for controlled companies, it must disclose the exemption relied upon and its basis for such exemption. If a small business issuer has adopted its own (additional) definitions of independence, it must disclose whether those definitions are available on its website and if they are not, include them as an appendix to its proxy or information statement at least once every three years or sooner if materially amended.
As currently required by Item 7 of Schedule 14A, pursuant to new Item 407(b)(3) small business issuers will be required to state whether they have standing audit, nominating and compensation committees of the board of directors (or committees performing similar functions), identify each committee member, state the number of meetings of each committee held during the past year, and briefly describe the functions performed by each such committee. Small business issuers will also have to identify any member of each such committee that is not independent, using the same definition of independence that it uses for determining independence of the board of directors as a whole. In addition to the information noted below, small business issuers must disclose whether each of the compensation, audit and nominating committees has a charter. If so, the small business issuer must either (i) post a copy of such charter on its website, disclose that the charter is so available and indicate the website address, or (ii) attach a copy of the charter as an appendix to its proxy statement at least once every three years, and disclose when it was last so attached in years in which the charter is not included. As a result, small business issuers that post their audit committee charter on their website will no longer also have to include it as an appendix to their proxy statement. The new rules require new disclosure about compensation committees, which is included in new Item 407(e) to Regulation S-B, including: Under the new rules, various existing requirements with respect to the audit committee have been consolidated in new Item 407(d) of Regulation S-B. This includes: In addition, listed small business issuers must state whether they have a separately-designated audit committee in accordance with Section 3(a)(58)(A) of the Exchange Act, or a committee performing similar functions, identify each committee member (or state that the entire board is acting as the audit committee), and provide required disclosure regarding any applicable exemption from the audit committee listing standards. New Item 407(c) of Regulation S-B will require disclosure regarding the nominating committee (or persons performing similar functions) and director nominations process that is consistent with the information currently required by Item 7(d)(2) of Schedule 14A, including: The new rules revise and streamline the related party disclosure requirements of Item 404 of Regulation S-B. In general, the new rules: As under the current rules, in the case of a bank, savings and loan association or broker-dealer extending credit under Federal Reserve Regulation T, disclosure of loans to related parties that are not disclosed as nonaccrual, past due, restructured or potential problems may consist of a statement, if true, that the loans to such persons (i) were made in the ordinary course of business, (ii) were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with unrelated persons, and (iii) did not involve more than the normal risk of collectibility or present other unfavorable features. Item 404(b) of Regulation S-B retains the current requirement that small business issuers list all parent entities, including the basis for control and the percentage of voting securities owned by the small business issuer’s immediate parent, if any. Unlike other reporting companies, small business issuers are not required to disclose their policies and procedures for the review, approval or ratification of related person transactions under the new rules. Under the new rules, directors' qualifying shares (shares directors are required to own under applicable law, rule or regulation) must now be included in the beneficial ownership table. Previously, directors qualifying shares were specifically excluded. In addition, small business issuers must disclose in a footnote to the table the number of shares pledged as security by executive officers, directors and director nominees. While a full discussion of the CD&A is beyond the scope of this memorandum, for the reasons discussed below we believe it is important that small business issuers be aware of the general requirements regarding the CD&A. For other than small business issuers, compensation disclosure will now begin with a narrative discussion providing a general overview of the company’s overall compensation program – the CD&A. The CD&A must provide a discussion and analysis of the material elements of the company’s compensation for the named executive officers as reflected in the tables and should focus on the material principles underlying the company’s executive compensation policies and decisions and the most important factors relevant to an analysis of those polices and decisions. Therefore, the CD&A should analyze what the company is trying to accomplish with its compensation programs – what are the objectives of the company’s compensation programs, and how do its compensation programs and decisions further or otherwise relate to those objectives? For example, if the compensation program is designed to “attract, retain and motivate the executive officers,” the CD&A should discuss how the various elements of the company’s compensation programs do that and otherwise further the company’s compensation objectives. While what is included in the CD&A will vary from company to company based on its own compensation programs, such disclosure must include a discussion of: While small business issuers will not be required to provide a CD&A, we believe that small business issuers should still remain somewhat mindful of the requirements of this section. For one thing, with the recent media attention on the issue of executive compensation, it is feasible that the presentation of a CD&A or similar disclosure may become a "best practice" that is expected by investors, analysts and others regardless of whether the presentation is required under Commission rules. Second, many small business issuers will not remain small business issuers indefinitely. While the CD&A discussion will be required for disclosure the year after a company no longer qualifies as a small business issuer, the former small business issuer's first CD&A will discuss compensation decisions made and programs adopted while the company was still a small business issuer — perhaps many years before. Therefore, when entering into compensation arrangements or adopting new forms of compensation, small business issuers may want to consider potential future disclosures they might have to make regarding such arrangements, and compensation arrangements and amounts they may have to justify in the CD&A, in future years when and if they are no longer small business issuers. Finally, the need to focus on compensation policies and determinations in order to draft the CD&A disclosure is likely to lead to public companies, boards of directors and compensation committees having a greater understanding of the purposes and goals of their executive compensation programs, and may have the effect of changing the amounts or forms of executive compensation and more closely aligning executive pay with company performance. Small business issuers will not want to be left behind in these and other developments that may flow from the revised compensation disclosure rules, in particular, the CD&A. Become familiar with the new executive and director compensation reporting requirements that will be applicable to your company and begin reviewing all compensation arrangements (whether written or unwritten) and gathering the information that will be necessary to compile the disclosure, including determining which elements of compensation each named executive officer and director receives, particularly perquisites and change in control and severance payments, well in advance. Consider putting together a mock-up of the required compensation tables and related disclosures using 2005 compensation data to ensure that the needed information is available and processes are in place to prepare the required disclosure, and so unexpected problems or delays do not stymie the process when you are preparing this information for the first time. Review your company's employment and other arrangements and determine what post-employment or change in control payments and benefits are payable to the named executive officers and consider what disclosure is required pursuant to the new rules. Review the company's disclosure controls and procedures. Disclosure controls and procedures may have to be updated to accurately keep track of the required information, particularly one-time compensation transactions such as moving expenses, and to account for the revisions to Form 8-K. Identify now who will do the work involved in the compensation disclosure process, including tracking and gathering the necessary information. Also, realize that compensation procedures may have to be improved in order to provide the CD&A and other disclosure the Commission is requiring. In addition, ensure that any standard repricing or material modification provisions, or any formulas the company routinely uses to modify options or other equity-based awards, are included in the company's option, incentive and similar plans or in the forms of awards or agreements thereunder in order to limit or avoid disclosure of any such modifications in the narrative to the Summary Compensation Table. Boards of Directors of non-listed small business issuers, which have not previously had to determine and disclose director independence, need to consider which definition of independence they will use and what other additional types of transactions they believe may affect independence. Boards should start considering which directors are and are not likely to be considered independent, and whether it may be appropriate to get new or additional directors who are independent if too many current directors are not. Small business issuers that do not have separate audit, nominating and compensation committees, or committees performing similar functions, should consider whether it might now be prudent to form such committees in light of company practice in these areas and/or the upcoming disclosure requirements. Small business issuers that determine not to form separate committees should clarify the board's reasons for not forming such committees, especially for the nominating and compensation committees for which disclosure of such reasons will be required. Also, such small business issuers should ensure they document which directors perform the functions of such committees and determine whether they are independent. Non-listed small business issuers that have non-independent directors sitting on the audit, nominating and compensation committees or performing the functions of such committees should consider whether such persons should be removed from these committees, or be prepared to disclose that non-independent directors sit on these committees in their upcoming annual reports on Form 10-KSB or annual proxy statement, as applicable. Going forward, carefully consider the reasons, purposes and philosophy involved when entering into new compensation arrangements, adopting new compensation programs, and taking similar actions. Ensure the adoption of such arrangements and programs, the reasons for doing so and how the action fits within the company's compensation philosophy, is adequately documented so that when and if such actions needs to be explained in a CD&A, the records exist that will allow current management to draft the required disclosure. Finally, in preparation for the upcoming requirements regarding disclosure of compensation committee processes, review your company's processes and procedures for considering executive and director compensation. If necessary, consider formalizing and documenting such procedures. Small business issuers that do not have a director nominations policy or director communications policy should consider whether it would be appropriate to adopt one. Small business issuers that do not adopt such policies should be prepared to disclose why their board believes it is appropriate for the company not to have such policies in their upcoming annual reports on Form 10-KSB or annual proxy statements. Small business issuers that have not done so should clarify whether they have a formal policy regarding director attendance at the annual meeting of stockholders and/or consider whether to adopt one pursuant to the required disclosure requirements. Small business issuers that have not recently reviewed and/or updated their audit, nominating and compensation committee charters should review such charters to ensure they are up to date and conform to the current standards of accepted practice, as well as the committees' actual functions and operation. In particular, the compensation committee charter may need to be revised to schedule extra compensation committee meetings or eliminate references to a set number of meetings that may no longer be adequate. Small business issuers that do not have such charters should consider, in light of the current operation of such committees and the upcoming disclosure requirements, whether it might be appropriate to adopt such committee charters. The sections in director and officer questionnaires that inquire about beneficial ownership should be updated to inquire about pledged shares and remove any reference that exempts directors' qualifying shares from disclosure. Small business issuers that have not previously updated their questionnaires to cover all relationships that could affect a director's independence should do so. Finally, the questionnaires should be updated to reflect the revised definition of "immediate family." Small business issuers that do not use director and officer questionnaires to gather this type of information should consider doing so given the breadth of information that needs to be gathered from directors, as well as to have a record that the information was obtained. Finally, consider the revised related-party disclosure requirements and ensure that the directors designated as "non-employee" directors under Rule 16b-3 of the Exchange Act will continue to so qualify, or replace such directors with those who meet will meet the Rule 16b-3 definition under the new provisions of Item 404 of Regulation S-B. Keep in mind that some directors who are disqualified under the current rules may now qualify as non-employee directors. We will continue to monitor developments in this area and update you regarding the latest guidance and industry positions regarding best practices regarding executive compensation and related disclosure. If you have any questions about the information in this memorandum, please contact Penny Somer-Greif at 410-347-7341 or Ken Abel at 410-347-7394. The above is a summary of the Commission's new and revised rules governing disclosure of executive and director compensation, related party transactions, certain corporate governance matters and certain related matters as they relate to small business issuers, and should not be construed as legal advice. |
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Ober, Kaler, Grimes & Shriver
Maryland Washington, D.C. Virginia |
