Part II of this article, dealing with Expansion of Disclosure Requirements Related To Compensation, will appear in the March, 2010 issue of The Metropolitan Corporate Counsel.
Recently, the U.S. Securities and Exchange Commission approved measures that expand required disclosures in the areas of executive compensation and corporate governance, just in time for the 2010 proxy season. A copy of the SEC's adopting release is available at http://www.sec.gov/rules/final/2009/33-9089.pdf.
The effective date of the amendments is February 28, 2010. Therefore, proxy and information statements and Form 10-Ks and 8Ks, among others, filed on or after this date would need to comply. Because interpretive issues often arise following the release of new rules, we recommend that companies monitor SEC staff guidance during the following months.
The rule amendments focus on enhancing disclosure in the following areas:
• Director and Director Nominee Qualifications and Experience
• Other Directorships and Legal Proceedings
• Diversity Consideration in the Nomination Process
• Leadership Structure and Rationale
• Board Role in Risk Oversight
• Reporting of Voting Results
• Compensation Policies and Practices as Related to Risk Management
• Valuation of Equity Awards
• Fees Paid to Compensation Consultants and Potential Conflicts
The SEC's original July 2009 proposal included amendments regarding proxy solicitation procedures. However, in light of the interrelationship of those proposals to the SEC's separately pending proxy access proposal, the SEC has deferred action on these proposed amendments.1
Expansion Of Disclosure Requirements Related To Governance
Director and Director Nominee Qualifications and Experience
As amended, Item 401 of Regulation S-K expands the required disclosures to include, for each director and nominee, the particular experience, qualifications, attributes or skills that led the board to conclude that the person should serve as a director of the company. Previously, the rules only required disclosure of the minimum qualifications to be a nominee and brief biographical information.
This new disclosure appears to require a justification, in some sense, of the board service of each nominee and continuing director (i.e., why was the person selected as a director?), and also, in respects, to get to what the board views as the "fit" between service and the board's needs.2The disclosure called for by these rules implies that there is an articulable set of factors underlying a person's nomination, even if different members of the nominating committee believe different factors are relevant to a particular candidate's nomination or weigh the factors differently. Note that, unchanged by the amendments, there continues to be a separate disclosure requirement in Item 407(c)(2)(v) of Regulation S-K regarding the specific minimum qualifications and specific qualities or skills required by the nominating committee for a nominee.
• Actions to Take: The nominating committee, the board and the company will need to carefully consider how to articulate in annual disclosures the qualifications of each director and nominee. Disclosure requirements aside, we recommend that the nominating committee review annually with the board the composition of the board as a whole, including the balance of independence, business specialization, technical skills, diversity and other desired qualities that the directors bring to the board. Company counsel should begin a dialogue with the nominating committee chair early in each calendar year. As a starting point, the nominating committee chair and company counsel should consider requesting updated CVs from each of the directors (some companies may choose to include additional questions in the D&O questionnaire). Companies should begin drafting this section of the proxy statement early since each director will likely take a keen interest and may have comments.
Other Directorships And Legal Proceedings
The amendments to Item 401 of Regulation S-K require disclosure of other directorships held by each director or nominee at any public company during the previous five years, rather than only current directorships. The amendments also extend from five to ten years the disclosure of legal proceedings involving directors, director nominees and executive officers. In addition, the range of legal proceedings now includes: (i) judicial or administrative proceedings resulting from involvement in mail or wire fraud or fraud in connection with any business entity; (ii) judicial or administrative proceedings based on the violation of the federal or state securities, commodities, banking or insurance laws or regulations or any settlement thereof; and (iii) any disciplinary sanctions or orders imposed by a stock, commodities or derivatives exchange or other self-regulatory organization. Settlement of private litigation is not required to be disclosed. Such disclosures are intended to assist investors in evaluating the character and competence of directors.
• Actions to Take: Company counsel should revise D&O questionnaires to reflect these changes.
Diversity Consideration In The Nomination Process
As amended, Item 407(c) of Regulation S-K requires disclosure of whether and, if so, how the nominating committee considers diversity in identifying nominees for director. If the nominating committee or the board has a policy with regard to the consideration of diversity in identifying director nominees, the final rules require disclosure of how this policy is implemented and how the nominating committee or the board assesses the effectiveness of its policy. The SEC has not imposed a definition of "diversity."
• Actions to Take: Companies may not be prepared adequately for this disclosure because it was not one of the July 2009 proposed amendments. Company counsel should bring this item to the attention of the board and work with the nominating committee to provide responsive disclosure.
Board Leadership Structure And Rationale
As amended, Item 407 of Regulation S-K requires disclosure about the board's leadership structure and why the company believes it is the best structure for the company. Companies will have to disclose whether and why they have chosen to combine or separate the CEO and board chair positions. In circumstances where such positions are combined, the amendments require the company to disclose whether and why the company has a lead independent director and the specific role the lead independent director plays in the leadership of the company. As noted in the proposing release and reiterated by the SEC at its open meeting, these amendments are intended to provide greater transparency to investors, but are not intended to influence the company's decision about its board leadership structure.
• Actions to Take: At companies having a combined CEO/Chairman, boards should review the justification for the combined position. Many companies have already publicly taken a position on this issue in response to shareholders' Rule 14a-8 proposals to separate these positions.
Board Role In Risk Oversight
As amended, Item 407 of Regulation S-K requires disclosure about the board's role in the oversight of risk and the effect, if any, that this has had on the company's leadership structure. This requirement is intended to provide investors with an understanding of how the board administers its oversight function, such as through the entire board, a separate risk committee or the audit committee. In the adopting release, the SEC enumerated credit risk, liquidity risk, and operational risk as some of the risks that should be addressed. The SEC also suggested that, where relevant, companies may want to address whether the individuals who supervise the day-to-day management responsibilities report directly to the board as a whole or to a board committee or how the board or committee otherwise receives information from such individuals.
• Actions to Take : We recommend that companies consider what changes, if any, should be made to their risk management philosophies, policies and processes in light of the heightened scrutiny applicable to risk oversight.
• Reporting of Voting Results. The amendments transfer from Forms 10-Q and 10-K to a new item on Form 8-K (5.07) the disclosure of the results of a shareholder vote. Now, such disclosure will have to be made within four business days after the end of the meeting at which the vote was held. In response to concerns that voting results may not be available in time to meet the Form 8-K deadline, companies are instructed to file preliminary results within the four business day period and then file an amended Form 8-K within four business days after the final results are known. The SEC also clarified that if the company believes that preliminary results will not be indicative of the final results, the company may include additional disclosure to this effect in the Form 8-K.
• Actions to Take: Companies will need to add a new item to their annual meeting checklists and disclosure controls and procedures. In addition, companies and their investor relations personnel should be prepared to deal proactively with the media and investors following the release of voting results. For example, results announced shortly following a meeting likely trigger greater media interest (possibly instigated by activist investors) particularly when there has been substantial support in favor of a shareholder proposal or when there have been significant "withheld" or "against" votes cast on incumbent directors. 1 See Release No. 33-9046 (June 10, 2009). On December 15, 2009, the SEC announced that it reopened the comment period on its proxy access proposal for 30 days after the publication of the SEC release in the Federal Register. The SEC sought comment specifically on four studies that had been submitted towards the end of the comment period. A copy of the SEC's release is available at http://www.sec.gov.
2 Directors and nominees may be concerned that the disclosure of certain experience and capabilities (e.g., expertise as an investment banker) may inappropriately suggest that such person bears greater responsibility for certain decisions than other board members due to his or her expertise in a particular area, and therefore is subject to a higher degree of liability. A similar concern was raised in 2002 when the SEC proposed rules requiring disclosure of the name of a company's audit committee financial expert (if any). In that case, the SEC addressed this issue by stating that such identification does not impose on such person any duties, obligations or liability that are greater than the duties, obligations and liability imposed on such person as a member of the audit committee and the board of directors in the absence of such designation or identification. The new rules do not include such a safe harbor but no negative implication of greater responsibility appears to have been intended.
Howard Dicker, Cathy Dixon, Holly Gregory, P.J. Himelfarb, Robert Messineo and Ellen Odoner are all Partners in Weil Gotshal's Public Company Advisory Group.