On July 26, 2006, the Securities and Exchange Commission adopted significant changes to its rules for the disclosure of executive and director compensation, related party transactions, director independence, other corporate governance matters, and the security ownership of officers and directors. The new rules change disclosure in proxy statements, Form 10-Ks, registration statements, and the reporting of compensation arrangements in Form 8-Ks.

The new rules will take effect for:
  • Form 10-Ks and 10-KSBs that are filed for fiscal years ending on or after December 15, 2006;
  • Form 8-Ks, that are filed for triggering events that occur 60 days or more after the new rules are published in the Federal Register;
  • Proxy and information statements (covering registrants other than registered investment companies) that are filed on or after December 15, 2006 that are required to include Regulation S-K Item 402 and 404 disclosure for fiscal years ending on or after December 15, 2006;
  • Securities Act registration statements (covering registrants other than registered investment companies) and Exchange Act registration statements (including pre-effective and post-effective amendments, as applicable) that are filed on or after December 15, 2006, that are required to include Regulation S-K Item 402 and 404 disclosure for fiscal years ending on or after December 15, 2006.
Executive and Director Compensation
The changes refine the current tabular disclosure of compensation and combine it with a new narrative disclosure of the compensation of the principal executive officer, principal financial officer, the three other highest paid executive officers, and the directors.

Compensation Discussion and Analysis
A new Compensation Discussion and Analysis (CD&A) must address the objectives and implementation of executive compensation programs - focusing on the most important factors underlying each company's compensation policies and decisions. The CD&A will be considered filed and subject to certification by a company's principal executive officer and principal financial officer.

A new Compensation Committee Report (which will be furnished and not filed) must disclose whether the compensation committee has reviewed and discussed the CD&A with management and, based on this review and discussion, recommended that the CD&A be included in an issuer's Form 10-K and proxy statement.

The Regulation S-K Item 402 performance graph has been retained, but is now part of the disclosure covering the market price of common equity and related matters. The performance graph will be required in annual reports to security holders that accompany or precede proxy statements relating to annual meetings at which directors are elected.

Tabular and Narrative Disclosure
Following the CD&A section, executive compensation disclosure must be organized into three broad categories:
  • compensation over the last three years;
  • holdings of outstanding equity-related interests received as compensation that are the source of future gains; and
  • retirement plans, deferred compensation and other post-employment payments and benefits.
Compensation Over The Last Three Years
The Summary Compensation Table is still the principal disclosure vehicle for executive compensation, presenting compensation for each named executive officer over the last three years. The Summary Compensation Table must be accompanied by narrative disclosure and a Grants of Plan-Based Awards Table that explains the compensation information presented in the table. The Summary Compensation Table must include, in addition to columns for salary and bonus:
  • A dollar value for all equity-based awards, shown in separate columns for stock and stock options, measured at grant date fair value, computed pursuant to Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment ("FAS 123R");
  • A column reporting the amount of compensation under non-equity incentive plans;
  • A column reporting the annual change in the actuarial present value of accumulated pension benefits and above-market or preferential earnings on nonqualified deferred compensation;
  • A column showing the aggregate amount of all other compensation not reported in the other columns of the Summary Compensation Table, including perquisites. Perquisites must be included in the table unless the aggregate amount is less than $10,000, and interpretive guidance will be provided for determining what is a perquisite; and
  • A column reporting total compensation.
Disclosure Regarding Outstanding Equity Interests
This disclosure will include:
  • A table disclosing outstanding equity awards at fiscal-year end, showing outstanding awards representing potential amounts that may be received in the future, including information on the amount of securities underlying exercisable and unexercisable options, the exercise prices and the expiration dates for each outstanding option (rather than on an aggregate basis); and
  • A table disclosing option exercises and stock vested, showing amounts realized on equity compensation during the last fiscal year.
Retirement Plan And Post-Employment Disclosure
This disclosure will include:
  • A pension benefits table, showing the actuarial present value of each named executive officer's accumulated benefit under each pension plan, computed using the same assumptions (except for the normal retirement age) and measurement period as used for financial reporting purposes under generally accepted accounting principles;
  • A nonqualified deferred compensation table, showing, with respect to nonqualified deferred compensation plans, executive contributions, company contributions, withdrawals, all earnings for the year (not just the above-market or preferential portion) and the year-end balance; and
  • A narrative description of any arrangement that provides for payments or benefits at, following, or in connection with any termination of a named executive officer, a change in responsibilities, or a change in control of the company, including quantification of these potential payments and benefits assuming that the triggering event took place on the last business day of the company's last fiscal year and the price per share was the closing market price on that date.
Disclosure of Option Grants
The final rules release will provide additional guidance regarding disclosure of company programs, plans and practices relating to the granting of options, including the timing of option grants in coordination with the release of material nonpublic information and the selection of exercise prices that differ from the underlying stock's price on the grant date.

Stock option disclosure must include clear tabular presentations of option grants including:
  • The grant date fair value;
  • The FAS 123R grant date;
  • The closing market price on the grant date if it is greater than the exercise price of the award; and
  • The date the compensation committee or full board of directors took action to grant the award if that date is different than the grant date.
Further, if the exercise price of an option grant is not the grant date closing market price per share, the rules will require a description of the methodology for determining the exercise price.

The CD&A must also provide enhanced disclosure about option grants to executives, seeking analysis and discussion, as appropriate, material information such as the reasons a company selects particular grant dates for awards or the methods a company uses to select the terms of awards, such as the exercise prices of stock options.

The following questions about the timing of stock options must be answered:
  • Is there any program, plan or practice to time option grants to executives in coordination with the release of material non-public information?
  • How does any program, plan or practice to time option grants to executives fit in with any program, plan or practice for option grants to employees generally?
  • What was the role of the compensation committee in approving and administering such a program, plan or practice? How did the board 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 other persons?
  • What was the role of executive officers in the program, plan or practice of option timing?
  • Is grant date of stock options to new executives coordinated with the release of material non-public information?
  • Is there, or has there been, a plan to time the release of material nonpublic information for the purpose of affecting the value of executive compensation?
Disclosure must be made where a company has not previously disclosed a program, plan or practice of timing option grants to executives, but has adopted such a program, plan or practice or has made one or more decisions since the beginning of the past fiscal year to time option grants.

Similar disclosure standards apply 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 if the company determines the exercise price of option grants 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.

We expect that these new disclosures will require further interpretive guidance from the SEC or its staff.

Director Compensation Table
Director compensation for the last fiscal year must be presented in a Director Compensation Table (along with related narrative), similar in format to the Summary Compensation Table described above.

Related Party Transactions, Director Independence and Other Corporate Governance Matters

Related Party Transactions

The amendments streamline the disclosure of related party transactions. The changes include:
  • Increasing the threshold for transactions required to be disclosed from $60,000 to $120,000;
  • Requiring disclosure of policies and procedures for the review, approval or ratification of related party transactions;
  • Eliminating the distinction between indebtedness and other types of related party transactions, and eliminating requirements for disclosure of specific types of director relationships; and
  • Specifying exceptions for some categories of transactions.
Director Independence and Other Corporate Governance Matters
A new Item 407 of Regulations S-K and S-B consolidates existing disclosure requirements regarding director independence and related corporate governance matters, in most cases without substantive change, and updates the disclosures regarding director independence to reflect the SEC's current requirements and current listing standards. These disclosures include:
  • Whether each director and director nominee is independent;
  • A description, by specific category or type, of any transactions, relationships or arrangements not disclosed as a related party transaction that were considered by the board of directors when determining if applicable independence standards were satisfied;
  • The identification of any audit, nominating and compensation committee members who are not independent; and
  • The compensation committee's processes and procedures for the consideration of executive and director compensation.
Security Ownership of Officers and Directors
The changes require disclosure of the number of shares pledged by management, and the inclusion of directors' qualifying shares in the total amount of securities owned.

Form 8-K
The disclosure requirements in Form 8-K have been modified to capture employment arrangements and material amendments to those arrangements only for named executive officers. The rules also consolidate all Form 8-K disclosure regarding employment arrangements under a single item. The rules also state certain assumptions to be used in calculating various disclosures, such as change in control and termination payments and benefits, the determination of equity fair values and pension calculations.

Plain English Disclosure in Proxy and Information Statements
The rules will require that the preparation of prepare most of this information using plain English principles in organization, language and design.

Final Rules
Although the text of the final rules is not currently available and not expected to be available for several days, the descriptions of these rules are based on a SEC press release and the statements made by commissioners and staff at the SEC's open meeting. The SEC press release relating to the new rules is available at http://www.sec.gov/news/press/2006/2006-123.htm.

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