Item 404 of Regulation S-K
Transactions with Related Persons,
Promoters
and Certain Control Persons
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Last Update: August 8, 2007
The bracketed date following each
interpretation is the latest date of publication or revision.
Note: For ease
of discussion, we refer to the
disclosure requirements and related
rules adopted in the Executive
Compensation rulemaking, including the
August 2006 Executive Compensation and
Related Person Disclosure rulemaking Securities Act Release No. 8732A
and the December 2006 Executive
Compensation amendments Securities Act Release No. 8765, as the new rules and we
refer to the disclosure requirements and related rules
that were changed in the Executive Compensation
rulemaking as the old rules.
Last Update: March 13, 2007
These interpretations replace the Item 404 of
Regulation S-K interpretations in the July 1997 Manual of Publicly
Available Telephone Interpretations and the March 1999 Supplement
to the Manual of Publicly Available Telephone Interpretations. Some
of the interpretations included herein were originally included
in the Manual of Publicly Available Telephone Interpretations (as
supplemented), and have been revised in some cases to reflect the
new rules. The bracketed date following each interpretation is the
latest date of publication or revision.
Note: For ease of discussion, we refer
to the disclosure requirements and related rules adopted in the
Executive Compensation rulemaking, including the August 2006 Executive
Compensation and Related Person Disclosure rulemaking (Securities
Act Release No. 8732A) and the December 2006 Executive Compensation
amendments (Securities Act Release No. 8765), as the "new rules"
and we refer to the disclosure requirements and related rules that
were changed in the Executive Compensation rulemaking as the "old
rules."
QUESTIONS AND ANSWERS OF GENERAL APPLICABILITY
Section 1. Item 404 General Guidance
Question 1.01
Question: If a company with a class of
securities registered under the Exchange Act that is current in
its Exchange Act reports files a Form S-1 that does not incorporate
information by reference, must Item 404(a) disclosure be provided
for fiscal years ending before December 15, 2006 if the company
already provided Item 404 disclosure for these years under the old
rules in a Commission filing?
Answer: No. Companies do not have to "restate"
Item 404(a) disclosure under the new rules if it was previously
reported under the old rules. [March 13, 2007]
Question 1.02
Question: If a company files a registration
statement for an initial public offering on Form S-1, or files a
Form 10 to register a class of securities under the Exchange Act,
must the company provide Item 404(a) disclosure pursuant to the
new rules for fiscal years ending before December 15, 2006?
Answer: Yes. Disclosure must be provided
in these filings pursuant to the new rules for the period specified
in Instruction 1 to Item 404. [March 13, 2007]
Section 2. Item 404(a) Transactions with
related persons
Question 2.01
Question: Item 404(a) requires, in pertinent
part, disclosure of any transaction since the beginning of the registrants
last fiscal year between the registrant and any 5 percent shareholder
where the amount involved exceeds $120,000 and the 5 percent shareholder
has a direct or indirect material interest in the transaction. Is
disclosure required of such a transaction that occurred since the
beginning of the registrants last fiscal year, but prior to the
date the person became a 5 percent shareholder?
Answer: Disclosure is required if the transaction:
(a) was continuing (such as through the ongoing receipt of payments)
after the date the person became a 5 percent shareholder; or (b)
resulted in the person becoming a 5 percent shareholder. If the
transaction concluded before the person became a 5 percent shareholder,
disclosure would not be required. [March 13, 2007]
Question 2.02
Question: How does a company value unexercised,
in-the-money stock options for purposes of determining whether the
$120,000 threshold of Item 404(a) has been met?
Answer: The value of unexercised, in-the-money
options should be determined for Item 404(a) purposes by determining
the difference between the fair market value of the securities underlying
the options and the exercise or base price of the options. Use of
the Black-Scholes or binomial option pricing method also would be
appropriate, provided that such use and the underlying assumptions
are clearly disclosed and the value thus calculated is greater than
zero and is otherwise reasonably related to the unrealized gain.
[March 13, 2007]
Question 2.03
Question: Is the condition that loans be
made on substantially the same terms as for "comparable loans with
persons not related to the lender" in Instruction 4.c.ii. to Item
404(a) satisfied if a bank makes loans available on the same terms
to all of its employees, the vast majority of whom are not "related
persons" as defined in Item 404, but the same terms are not offered
to non-employees?
Answer: No. The term "persons not related
to the lender" means persons with no relationship at all with the
lender other than the lending relationship, such as regular customers.
Employees are considered related to the lender by virtue of their
employment relationship. [March 13, 2007]
Section 3. Item 404(b) Review, approval or
ratification of transactions with related persons
Question 3.01
Question: Must a company include disclosure
regarding policies for the review, approval or ratification of related
person transactions under Item 404(b)(1) even when the company does
not have to report any transactions under Item 404(a)?
Answer: Yes. Item 404(b)(1) requires disclosure
regarding policies for the review, approval or ratification of the
types of related person transactions that would be disclosed under
Item 404(a). [March 13, 2007]
Section 4. Item 404(c) Promoters and certain
control persons
None
INTERPRETIVE RESPONSES REGARDING PARTICULAR
SITUATIONS
Section 1. Item 404 General Guidance
None
Section 2. Item 404(a) Transactions with
related persons
2.01 The term "any immediate
family member," as used in Item 404, is defined to include, among
others, mothers and fathers-in-law, sons and daughters-in-law, brothers
and sisters-in-law, and stepchildren and stepparents. For purposes
of this item, such relatives are deemed to be: (1) only those persons
who are currently related to the primary reporting person (e.g.,
a person who is divorced from a directors daughter would no longer
be a son-in-law whose transactions must be reported); and (2) only
those persons who are related by blood or step relationship to the
primary reporting person or his spouse (e.g., the sister
of a directors spouse is considered a sister-in-law for purposes
of this item; the sisters husband, however, is not considered a
brother-in-law for purposes of this item). [March 13, 2007]
2.02 A is an officer and director
of Y corporation, a wholly-owned subsidiary of registrant X. A is
not an officer or director of X and holds only a nominal amount
of Xs shares. Y does business in an amount in excess of $120,000
with B, As brother. That relationship need not be disclosed in
Xs reports under Item 404(a), since A is not a person described
in Instruction 1 to Item 404(a). [March 13, 2007]
2.03 A corporation enters into
a lease in an amount substantially in excess of $120,000 with a
lessor completely unaffiliated with the corporation. The lease,
however, is negotiated through a related person specified in Instruction
1 to Item 404(a), who is paid a commission that is less than
$120,000 by the lessor for those services. Since the amount of that
persons commission is dependent upon the value of the lease, that
person is considered to have an interest in the lease transaction,
and the transaction, together with the commission, should be reported
if the interest is determined to be a direct or indirect material
interest. [March 13, 2007]
2.04 Y, the President and a
director of Z Corporation, a supplier of the registrant, is a member
of the registrants board of directors. The registrant solicited
bids from Z and various other companies on a supply contract involving
an amount in excess of the $120,000 threshold of Item 404(a). The
registrant plans to award the contract to Z, even though this supplier
did not submit the lowest bid in what purportedly was a competitive
bidding contest. Under these circumstances, the registrant cannot
avail itself of the exclusion in Instruction 7.a. to Item 404(a)
for transactions where the rates or charges involved are determined
by competitive bids. [March 13, 2007]
2.05 Instruction 7.a.
to Item 404(a) of Regulation S-K does not permit non-disclosure
of an equipment lease transaction between a company owned by a director
of a reporting company and the reporting company, simply because
the reporting company solicited proposals from other unrelated persons
and selected the directors company only after an internal analysis
of the available terms. The procedure used was not deemed to be
a competitive bid because it did not involve the formal procedures
normally associated with competitive bidding situations. There were
no specifications established for the lease being bid upon and there
was no indication of the basis upon which a bid was accepted. [March
13, 2007]
2.06 A contract between a reporting
company and the fund manager of the companys pension plan, who
is also a more than 5 percent beneficial owner under Rule 13d-3,
should be disclosed under Item 404(a) where the amount involved
in the contract exceeds $120,000. [March 13, 2007]
2.07 X is a director of the
registrant. Xs child is employed by the registrant and receives
yearly compensation exceeding $120,000. The childs compensation
is not reported under Item 402 since the child is not one of the
registrants named executive officers, nor is the child an officer
or director. The registrant was advised that the childs compensation
should be disclosed under Item 404(a) as a transaction in which
the director has a material interest. [March 13, 2007]
2.08 An agreement by a company
with a related person to repurchase company shares from the
related persons estate upon death with the proceeds of a
life insurance policy paid for by the company should be disclosed
pursuant to Item 404(a). [March 13, 2007]
2.09 In connection with a move
of company headquarters, a company purchased and resold the homes
owned by all affected employees. The price paid was determined by
an independent appraiser. The company was advised that the Division
staff will raise no objection if the company discloses under Item
404(a) only the general features of the program (including how the
price was determined) and the total amount spent by the company
on the program. [March 13, 2007]
2.10 Item 404(a) requires disclosure
of nonaccrual, past due, restructured and potential problem loans
from banks, savings and loan associations or broker-dealers extending
credit under Federal Reserve Regulation T. Instruction 4.c.
of Item 404(a) refers to Industry Guide 3, Statistical Disclosure
by Bank Holding Companies, for determining if loans are nonaccrual,
past due, restructured or potential problem loans. Guide 3 requires
disclosure of loans in these categories the end of each "reported
period." In a proxy statement, therefore, where the reported period
is the last fiscal year, only those loans which were in these categories
at the end of the last fiscal year are required to be reported.
[March 13, 2007]
2.11 A parent and its subsidiary
are both Exchange Act reporting companies. Some of the executive
officers of the parent may receive a portion of their compensation
from the subsidiary corporation. The Division staff advised that
if an executive spends 100% (or near 100%) of the executives time
for the subsidiary but is paid by the parent, then the compensation
paid by the parent has to be reported in the executive compensation
table of the subsidiary. However, if an allocation of the monies
paid by the parent would be necessary because the executive officer
splits time between the parent and the subsidiary, the payments
made by the parent need not be included in the subsidiarys executive
compensation table. In addition, in the event that the subsidiary
pays a management fee to the parent for use of the executives, disclosure
of the structure of the management agreement and fees would have
to be reported under Item 404. Compensation paid by the subsidiary
to executives of the parent company must be included in the parents
executive compensation table if such payments are paid directly
by the subsidiary. If the payments are part of a management contract,
disclosure of the structure of the management agreement and fees
would have to be reported under Item 404. [March 13, 2007]
2.12
When the
transaction under consideration is an employment arrangement,
"the amount involved in the transaction" includes all
compensation, not just the salary of the employee. [August 8,
2007]
2.13
The compensation
of an executive officer who is not a named executive officer is
approved by the Boards compensation committee, and the
executive officers compensation is not disclosed under Item
404(a) pursuant to Instruction 5.a to Item 404(a). An immediate
family member of this executive officer also is employed by the
company. The immediate family members compensation is disclosed
under Item 404(a). In this regard, Instruction 5.a to Item
404(a) does not apply to the immediate family member because she
was not an executive officer. [August 8, 2007]
Section 3. Item 404(b) Review, approval or
ratification of transactions with related persons
None
Section 4. Item 404(c) Promoters and certain
control persons
None
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