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October 17, 2006. The SEC’s New Executive Compensation Rules or What is a PFO and Why Should I Care? FEI Briefing. Christopher McGee Washington, DC. The Process and the Substance of Compensation Disclosure Have Changed. Full disclosure means full disclosure Not business as usual!

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Presentation Transcript
October 17 2006

October 17, 2006

The SEC’s New Executive Compensation RulesorWhat is a PFO and Why Should I Care?FEI Briefing

Christopher McGee

Washington, DC


The process and the substance of compensation disclosure have changed
The Process and the Substance of Compensation Disclosure Have Changed

  • Full disclosure means full disclosure

    • Not business as usual!

    • “All compensation, earned or paid, from all sources, for all services.”

  • Each public company must implement a coordinated information gathering and analysis effort

  • The Compensation Committee must participate in the effort at each stage


The new rules have made fundamental changes to the substance of compensation disclosure
The New Rules Have Made Fundamental Changes to the Substance of Compensation Disclosure

  • Full Disclosure Principle

  • Plain English

  • Significant Changes to Summary Compensation Table

  • New Disclosure Tables and Accompanying Narrative Disclosure

  • Compensation Discussion & Analysis

  • Related Person Transaction Disclosure Changes

  • Form 8-K Changes


What is different
What is Different? of Compensation Disclosure


Named executive officers
Named Executive Officers of Compensation Disclosure

  • Anyone who at any time during the previous fiscal year served as:

    • Principal executive officer (PEO)

    • Principal financial officer (PFO)

  • Three most highly-compensated executive officers (other than PEO and PFO) who were serving as executive officers as of the last day of the previous fiscal year

    • Based on total compensation excluding pension values and NQDC earnings

    • Officer is not an NEO if his or her total compensation does not exceed $100,000

  • Up to two additional individuals who would have been in the top three except they were no longer serving as executive officers at end of last fiscal year


Summary compensation table changes
Summary Compensation Table Changes of Compensation Disclosure

  • The Summary Compensation Tables have been materially changed in both form and substance (see sample table in Appendix).

  • Data that has been historically included (Base, Bonus, LTI) will still be included but with changed methodologies for reporting:

    • Bonuses will be split between guaranteed and performance based

    • LTI will split equity grants and option (or option like) awards and the valuation of the awards is to mirror the expensed value (i.e. Black Scholes) for equity.

  • Definition of Perquisites reduced to $10k and will also include “all other forms of compensation”

  • Additional data will be required that has never been required. Includes the change in value of Pension benefits and the increase in excess of market returns, on deferred compensation.


New supplemental tables
New Supplemental Tables of Compensation Disclosure

There are 6 new tables that are required for all filers. Details for each table and the associated narratives are included in the Appendix.

The 6 new tables are:

  • Grants of Plan-Based Awards Table

  • Outstanding Equity Awards at Fiscal Year-End Table

  • Option Exercise and Stock Vested Table

  • Pension Benefits Table

  • Nonqualified Deferred Compensation Table

  • Director Compensation Table


Narratives
Narratives of Compensation Disclosure

The rules require Narratives to accompany all tables. Details on the required narratives for each table are included in the appendix.

The key theme of the narrative requirements are that they must explain in sufficient detail:

  • Foundation for Salary and relative target to market

  • All methodologies, metrics and outcomes that drive awards of bonuses and LTI awards.

  • Rationale for benefits and perquisites.


Potential payments upon termination of employment or change in control summary
Potential Payments upon Termination of Employment or Change-in-Control Summary

.The description (no table required) must include the following detail:

  • Specific circumstances that would trigger payment or other benefits

  • Estimated payments and benefits that would be provided in each covered circumstance, whether it would or could be in lump sum or annual, disclosing the duration and by whom it would be provided

  • Factors used to determine appropriate payment and benefit levels

  • Any material conditions or obligations applicable to receipt of payments or benefits

  • Quantification of the benefits and payments in each covered circumstance (even if uncertainties exist), calculated by applying the following assumptions:

    • The triggering event took place on the last business day of the last fiscal year

    • The price per share of the company’s securities is the closing market price as of that date


Compensation disclosure and analysis
Compensation Disclosure and Analysis Change-in-Control Summary

  • Replaces Board Compensation Committee Report (see appendix for more detail)

    • Considered “filed” with, rather than “furnished” to, the SEC

    • See new Compensation Committee Report requirement

  • Intended to provide overview of executivecompensation program

    • Summary of each program element

    • Context for tabular and supplemental narrative disclosure

  • Company presentation – of compensation committee’s views of executive compensation program

  • Focus in on “analysis” of compensation policies and decisions

    • Less a recitation of the facts and more an explanation of what is actually going on


New compensation committee report
New Compensation Committee Report Change-in-Control Summary

  • New Compensation Committee Report

    • Presented over names of compensation committee members

    • Intended to ensure committee is actively involved in preparing CD&A

    • Resembles current Audit Committee Report that is required in proxy statement

      • Must state that committee has reviewed and discussed CD&A with management and recommended that report be included in proxy statement and annual report on Form 10-K

    • Unlike CD&A, considered “furnished” to SEC, so does not carry liability implications of CD&A


New compensation committee report continued
New Compensation Committee Report (continued) Change-in-Control Summary

  • Separate narrative disclosure regarding compensation committee structure and operation

    • Comparable to current audit and nominating committee disclosure

  • Specific disclosure related to executive and director compensation:

    • Scope of committee’s authority

    • Extent of ability to delegate authority

    • Charter (must provide website link or attach to proxy statement every three years)

    • Role of any executive officers in determining or recommending executive or director compensation

    • Role of consultant in determining or recommending executive or director compensation, identifying consultant, stating whether engaged by committee, and describing nature of assignment and material instructions


Appendix
Appendix Change-in-Control Summary


Changes to summary compensation table
Changes to Summary Compensation Table Change-in-Control Summary

  • Only includes discretionary and guaranteed amounts

  • All compensation disclosed in dollars ($)

  • Represents total of all other columns in table

  • Total excluding pension values and NQDC earnings determines officers to include

  • Stock-related awards with option-like features

  • Valuation based on grant date fair value (FAS 123R)

Summary Compensation Table(values in 000s)

  • Value of all other incentive awards earned in fiscal year (includes most annual incentives)

  • Awards where performance measure(s) not share price and not settled in equity

  • Grant details covered in supplemental table

  • Stock-related awards in year grant made that derive value from equity value, without option-like features

  • Valuation based on grant date fair value (FAS 123R)

  • Include awards with performance-based conditions

  • Earnings not disclosable if factored into fair value

  • Annual change in actuarial present value of accumulated defined benefit pension plans (including unvested benefits)

  • Above-market or preferential earnings on nonqualified deferred compensation


Sct all other compensation
SCT – All Other Compensation Change-in-Control Summary

  • “All Other Compensation” column will include:

    • Perquisites and other personal benefits

    • Tax “gross-ups” and reimbursements

    • Discount stock purchases (unless arrangement is broadly available)

    • Amounts paid or accrued under severance and change-in-control arrangements

    • Company contributions to defined contribution plans (but not earnings)

    • Value of insurance premiums paid by company for NEO life insurance

    • Dollar value of dividends or earnings not factored into award fair value


Sct all other compensation perquisites
SCT – All Other Compensation – Perquisites Change-in-Control Summary

  • Perquisite disclosure requirements

    • If aggregate value is $10,000 or more, must disclose/identify each perquisite

    • If individual perquisite has value in excess of greater of $25,000 or 10% of total perquisites, must quantify and disclose value

  • “Perquisites” not defined - instead apply two-step analytical framework:

    • An item is not a perquisite if it is “integrally and directly related to the performance of the executive’s duties”

    • Doesn’t cover items that merely facilitate job performance

    • An item is a perquisite if 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

    • Item not covered if generally available on a non-discriminatory basis to all employees


Sct narrative disclosure
SCT – Narrative Disclosure Change-in-Control Summary

Following the tabular disclosure, a company must provide a narrative description of any material factors necessary to understand the information disclosed in the table, for example:

  • A description of the material terms in the NEOs’ employment agreements

  • Disclosure of repricings or other material modifications of outstanding awards

  • An explanation of the amount of salary and bonus in proportion to total compensation


Grants of plan based awards table
Grants of Plan-Based Awards Table Change-in-Control Summary

  • Grants made during last completed fiscal year

  • Estimated future payouts for both equity and non-equity incentive plans

  • Separate disclosure for each award

Grants of Plan-Based Awards

  • Additional “Approval Date” column required if differs from grant date

  • If the per-share exercise price of options is less than closing market price on grant date, additional column required showing closing market price on grant date; must also add footnote explaining pricing methodology

  • If the award provides only for a single estimated payout, that amount should be reported as target


Plan based awards narrative
Plan – Based Awards Narrative Change-in-Control Summary

The narrative disclosure following this table must describe the terms of the disclosed awards, for example:

  • a general description of the formula or criteria to be applied in determining the amounts payable

  • Vesting schedule

  • Performance-based conditions


Outstanding equity awards at fiscal year end table
Outstanding Equity Awards at Fiscal Year-End Table Change-in-Control Summary

  • All outstanding grants at fiscal year end

  • Grant-by grant disclosure for each option

  • Unrealized option gain no longer disclosed

  • Based on achieving threshold performance unless prior year’s performance was higher

Outstanding Equity Awards at Fiscal Year-End

  • Vesting dates disclosed in footnote

  • Individual exercise price and expiration dates must be provided for each award


Option exercise and stock vested table
Option Exercise and Stock Vested Table Change-in-Control Summary

  • Number of shares acquired through exercise (options) or vesting (stock)

  • Value realized at time of exercise (spread) or vesting (share price)

Option Exercises and Stock Vested


Pension benefits table
Pension Benefits Table Change-in-Control Summary

  • Must add footnote if credited service and actual years of service differ, and quantify difference and resulting benefit augmentation

  • Replaces current Pension Plan Table

Pension Benefits

  • Actuarial present value of accumulated benefit under the plan

  • Retirement age assumed to be “normal” age as defined in the plan, or earliest unreduced age if none

  • Separate disclosure for each plan

  • Plans include: tax qualified defined benefit plans, SERPs, cash balance plans

  • Excludes defined contribution plans (next table)


Nonqualified deferred compensation table
Nonqualified Deferred Compensation Table Change-in-Control Summary

  • Must disclose in footnote contributions, earnings, and balance amounts previously disclosed in Summary Compensation Table

Nonqualified Deferred Compensation

  • Disclosure of all earnings (vs. only when earned and above market) on deferred compensation, that is not tax-qualified


Deferred compensation narrative
Deferred Compensation Narrative Change-in-Control Summary

The company must disclose all material factors necessary to understand table, including:

  • types of compensation permitted to be deferred and any deferral limitations

  • the measures of calculating interest or other plan earnings

  • material terms with respect to payouts, withdrawals and other distributions


Director compensation table
Director Compensation Table Change-in-Control Summary

  • Formatted tabular disclosure now required, in light of growing complexity of director compensation programs

Director Compensation

  • All other, including:

    • Perquisites and personal benefits

    • Consulting fees

    • Director legacy programs

  • Grouping of multiple directors in a single row permitted, as long as all of their elements and amounts of compensation are identical

  • Pension values and nonqualified deferred compensation earnings disclosed in separate column


Director compensation narrative
Director Compensation Narrative Change-in-Control Summary

  • Additional material information necessary to understand tabular information

  • Perquisite disclosure required only if value of benefits is $10,000 or more


Compensation disclosure and analysis1
Compensation Disclosure and Analysis Change-in-Control Summary

  • Principles-based disclosure

    • CD&A must discuss six specific items:

      • Program objectives

      • Behaviors that program is designed to reward

      • Each element of compensation

      • Rationale for each element

      • Methodology (including formula) used to determine amount for each element

      • How each element and decisions regarding that element fit into overall compensation objectives and affect decisions regarding other elements

    • Must also discuss any other material information that is necessary to an investor’s understanding of the executive compensation program

      • Rules include examples of other potentially material matters to be discussed


Compensation disclosure and analysis2
Compensation Disclosure and Analysis Change-in-Control Summary

  • CD&A will be considered “filed” with, rather than “furnished” to, the SEC

    • Subject to full liability under the federal securities laws

      • May be included in Securities Act registration statements

      • Will be included in annual report on Form 10-K and possibly other Exchange Act reports

    • Also subject to CEO/CFO certification requirements when included in annual report on Form 10-K

      • CEO and CFO must formally attest to report’s accuracy and completeness


Compensation disclosure and analysis3
Compensation Disclosure and Analysis Change-in-Control Summary

  • Discussion of performance-based compensation

    • Must address specifics of performance-based compensation

      • Specific items of corporate performance used in program

      • How specific forms of pay are structured to reflect corporate and/or individual performance

    • Need not disclose target measures/levels if:

      • Involves trade secrets

      • Involves confidential commercial or financial information, the disclosure of which would cause competitive harm for company

      • Standard for determining competitive harm is whether company could receive confidential treatment of information from SEC


Compensation disclosure and analysis4
Compensation Disclosure and Analysis Change-in-Control Summary

  • New discussion of stock option grant practices

    • Responds to stock option backdating controversy

    • Must address how determination is made as to when awards are granted, including equity-based compensation such as options

    • Must also address option compensation, particularly timing and pricing of option grants, including

      • Why the company selects particular dates for granting awards

      • How option terms and conditions are established, such as how exercise prices are determined

      • Whether company has program or practice to coordinate timing of grants with release of material, nonpublic information and, if so, scope and nature of arrangement

    • Disclosure is in addition to new Grants of Plan-Based Awards Table that includes information about grant dates, grant date share prices and exercise prices


Compensation disclosure and analysis5
Compensation Disclosure and Analysis Change-in-Control Summary

  • Other issues

    • Explaining the compensation-setting process

      • Should address in manner that emphasizes rationale for each pay element in context of total compensation

      • Use of compensation tools

      • Peer groups and benchmarking

      • Time period covered

    • Discussing compensation of each named executive officer

    • Integration with existing disclosure controls and procedures


Compensation disclosure and analysis6
Compensation Disclosure and Analysis Change-in-Control Summary

  • Preparing the CD&A:

    • Management will prepare draft report

      • A multi-disciplinary exercise involving executives, directors, HR, legal, others

    • Compensation committee will review draft report and provide input

    • CEO and CFO must certify contents of report as included in annual report on Form 10-K

    • New Compensation Committee Report will comprise part of due diligence process

    • Need to coordinate with filing of annual report on Form 10-K


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