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Release No. 33-6962 Release No. 34-31327 Release No. IC-19032 October 16, 1992
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 Table of Contents
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I. EXECUTIVE SUMMARY
To improve shareholders understanding of all forms of compensation paid to senior executives and directors, the criteria used by the board of directors in reaching compensation decisions, and the degree of relationship between compensation and corporate performance, the Commission earlier this year published for comment substantial revisions to its rules governing disclosure of executive compensation in proxy and information statements and other Commission filings. 12 Designed to furnish shareholders with a more understandable presentation of the nature and extent of executive compensation, the proposals sought to consolidate the requisite disclosure in a series of tables setting forth each compensatory element for a particular fiscal year. The proposed new disclosure system relied on several specific new elements, as well as reformatting of existing required disclosures for greater clarity.
First, all compensation paid to specified senior executives over the past three years was to be set forth in a new Summary Compensation Table. This table would show both annual and long-term compensation in a single, comprehensive overview. Second, the Compensation Committee of the board of directors would be required to report on the corporate performance factors that it relied on in making specific compensation awards for reporting executives, as well as describe the general policies of the committee in determining senior executive compensation. Third, the cumulative total return to shareholders of the registrant over a period of at least the previous five years would be required to be set forth in a line graph, together with the comparable return to shareholders for the stocks included in (i) the Standard and Poors 500 Composite Stock Price Index (S&P 500); and (ii) any recognized industry index (e.g., the Dow Jones Transportation Average) or a group of peer companies selected by the registrant.
Public response to the Commissions requests for comment on the proposed revisions was substantial. The Commission has received more than 900 letters of comment addressing the proposals. Commenters include approximately 555 individual and institutional shareholders, 245 registrants and registrant organizations, and a combined total of over 100 members of the executive compensation consultant, accounting, legal and academic communities. The comment letters reflect a general consensus that reform of the current executive pay disclosure system is appropriate and necessary.
Many of the commenters offered recommendations or suggestions for refinement of the original proposals to accomplish more effectively the goal of assuring that all material facts regarding executive compensation are clearly and fully disclosed. Other commenters suggested methods for reducing the cost or burden of collecting the necessary information, as well as for limiting the applicability of the new requirements to certain types of registrants. Still other commenters expressed strong concerns with respect to potential litigation arising from the new disclosure elements. A number of changes have been made in response to these comments.
As under the proposals, the Summary Compensation Table will cover senior executive compensation in each of the registrants last three fiscal years, followed by tables containing more specific data on the components of compensation for the last completed fiscal year. However, in response to public comment, the disclosure as to all executive officers as a group has been deleted. The former requirement to provide individualized disclosure as to the five highest paid executive officers has been modified. Under the new Summary Compensation Table (and all other tables), the covered individuals will be the Chief Executive Officer (CEO) (regardless of pay level), and the four most highly compensated executive officers in addition to the CEO. Except for the CEO, disclosure is limited to those executives with salary and bonus of over $100,000 (an increase from the former $60,000 threshold) for the last completed fiscal year.
The Board Compensation Committee Report has been retained, but revised to limit the description of performance factors on which the Committee specifically relied to the compensation of the CEO alone, together with a discussion of the Committees general policies with respect to executive officer compensation. This will avoid possibly repetitive descriptions as to each of the named executive officers. In addition, language in the proposal that was read by some as suggesting the need to disclose discussions of subjective personal factors relating to an executives performance (e.g., traits of judgment, personality, etc.) has been revised to make it clear that the mandated disclosure is solely with respect to corporate performance criteria (e.g., profitability, sales growth, return on equity, market share) on which the Committee relied in reaching its decision concerning CEO compensation. Finally, this report will be given the same legal status as the annual report to security holders required pursuant to the proxy rules and, as such, will not be deemed to constitute soliciting material or to be filed for purposes of Section 18 of the Exchange Act. 13 In the Commissions view, the remedy for any shareholder who is not satisfied with the Committees report should be to vote against re-election of committee members as directors, not to litigate claims in the courts.
In addition to the Summary Compensation Table, the rules as proposed included several tables providing more detailed information concerning grants, exercises and value of outstanding stock options, long-term incentive plans and other information. As adopted, the rules eliminate certain of the proposed detailed tables or portions thereof, and combine others into single tables. These revisions are designed to eliminate redundant information and to improve the clarity of information presented. Hypothetical rates of stock price appreciation to be used in presenting potential realizable values of stock options and SARs have been reduced. As an alternative to use of hypothetical values, presentation of grant-date option (or SAR) values calculated through use of a recognized valuation formula, such as the Black-Scholes option pricing model, will be permitted. Registrants also are permitted to add additional hypothetical situations, such as a zero return to shareholders, as well as other information not required by the rules.
The Performance Graph has been revised slightly. Instead of mandating comparison of the registrants cumulative total shareholder return in all cases to the return on the S&P 500, the rule will allow issuers whose stock is not included in the S&P 500 to select any broad market index that does include their stock or the stock of companies that trade in the same national securities exchange or The National Association of Securities Dealers Automated Quotations System (NASDAQ) market, or are of comparable market capitalization. A comparison of the registrants return also must be made to the return on either a published industry index or a registrant-determined peer index. In addition, in view of the purpose of this graph as a general depiction of one measure of corporate performance to be used by shareholders in evaluating the quality of decisions made by directors standing for re-election, the Performance Graph will be given the same legal status as described above for the Board Compensation Committee Report. This also is intended to insure that issuers will not be subjected to litigation concerning their selection of a peer company or industry index for inclusion in the Performance Graph, since no single other company or industry index will be perfectly comparable to a given issuer.
The final rules also provide that the Board Compensation Committee Report and the Performance Graph are required to be included only in proxy and information statements relating to the annual election of directors; they need not be included in or incorporated by reference into any of the registrants filings under the Exchange Act or Securities Act. Like those items, the Report on Option/SAR Repricing also is required only in annual election proxy and information statements. The proposed disclosure of additional information regarding the relationships between compensation committee members and the registrant or other entities (Compensation Committee Interlocks and Insider Participation) has been substantially revised, as discussed below.
Small business issuers eligible to report and register securities under the recently adopted small business disclosure system 14 will not be required to include many of the required new disclosures, including the Board Compensation Committee Report and the Performance Graph. In addition, small business issuers will be exempt from portions of other disclosure requirements and will have the option under the Transition Provisions of using the version of the rules in effect prior to the effective date for all filings before May 1, 1993.
Investment companies registered under the Investment Company Act of 1940 (Investment Company Act) 15 will be subject only to the provisions of revised Item 402(g) with respect to disclosure of compensation of directors and the compensation disclosure requirements included in the forms on which they register as investment companies. In addition, the rules adopted today do not affect compensation disclosure by foreign issuers.
II. REVISED ITEM 402 OF REGULATION S-K
A. General
1. Treatment of Specific Types of Issuers
a. Small Business Issuers
Both in its proposals to revise executive compensation disclosure requirements and its recent adoption of the newly integrated small business disclosure system, 16 the Commission sought comment on the extent to which small businesses should be subject to the new provisions governing disclosure of executive compensation, particularly the requirements to provide the Board Compensation Committee Report, the Performance Graph, and the Compensation Committee Interlocks and Insider Participation disclosure. Representatives of small and high technology (hi-tech) companies argued that exceptions should be made for such companies, based on the relative costs of compliance, the typical structures of their boards, and the significantly different compensation practices among start-up, developing and hi-tech companies. While a few commenters took issue with such an exclusion, arguing that shareholders need for the full panoply of executive pay disclosure was no less in the case of smaller companies, there was significant commenter support, from shareholders and others, for special provisions tailored to smaller issuers.
Under the rules adopted today, small business issuers eligible to use the small business integrated disclosure system 17 will be required to provide only the Summary Compensation Table, the option and SAR grant and exercise tables (omitting the option valuation information), the long-term incentive plan awards table, and disclosure concerning option or SAR repricing (omitting the 10-year repricing history), named executive officer employment contracts and termination/severance arrangements, and director compensation. 18 Any small business issuer that elects not to use the small business forms and schedules nonetheless may provide this more streamlined compensation disclosure. 19 In addition, as a transition matter, small business issuers are eligible to file under the rules in effect prior to the effective date until May 1, 1993.
b. Registered Investment Companies
Investment companies registered under the Investment Company Act have been excluded from the executive compensation and registrant performance disclosure requirements of revised Item 402, because the management functions of most such companies are performed by external managers. Instead, registered investment companies will comply with disclosure requirements prescribed by applicable Investment Company Act registration statements. Compensation of investment company directors, however, will continue to be disclosed in accordance with revised Item 402(g). 20
c. Foreign Private Issuers
No change has been made to the existing disclosure obligations with respect to executive and director compensation of foreign private issuers using Form 20-F. 21 Language has been added to Item 402 clarifying that a foreign private issuer may satisfy the requirements by reporting the information required by Items 11 and 12 of Form 20-F, even if filing reports on forms for domestic issuers. 22
2. Transition Provisions
The new rules are effective immediately upon publication in the Federal Register. Any registrant may use the new rules at any time thereafter. To facilitate a smooth transition to use of the new rules, however, the following transition provisions will be allowed by the Commission. Registrants other than small business issuers are required to comply with the new rules for (1) any new registration statement under the Securities Act, and any new registration statement or periodic report under the Exchange Act, filed on or after January 1, 1993; and (2) any new proxy or information statement filed on or after January 1, 1993, except that proxy or information statements filed with respect to the annual election of directors by registrants whose current fiscal year ends on or after December 15, 1992, are required to comply with the new provisions whenever filed.
Small business issuers are required to comply with the new rules for any new registration statement under the Securities Act, any new registration statement or periodic report under the Exchange Act, and any new proxy or information statement filed on or after May 1, 1993.
There are specific transition provisions with respect to certain items in the Summary Compensation Table, Board Compensation Committee Report, Compensation Committee Interlocks and Insider Participation disclosure, and Report on Option/SAR Repricing, as discussed below.
3. Application to Specific Types of Filings
Item 402 has been restructured to specify those disclosure provisions that are required in all filings calling for Item 402 compensation information, and those provisions applicable only to a proxy or information statement relating to an annual meeting of security holders (or special meeting or written consents in lieu of such meeting) at which directors are to be elected. The provisions applicable only to such proxy or information statements are the Board Compensation Committee Report, the Performance Graph, and the Report on Option/SAR Repricing. These items will not be required to be included directly in any other filing, or incorporated by reference into any Securities Act or Exchange Act filing. 23
4. General Provisions of Revised Item 402
Several new general provisions have been added to amended Item 402 in light of the comments received. First, the revised item includes an express statement that it requires disclosure of all compensation to the named executive officers and directors for services rendered in all capacities to the registrant and its subsidiaries. 24 Just as under former Item 402(a)(1), the source of the compensation has no bearing on the application of new Item 402. 25 As under the former requirements, however, the Item states that registrants need not provide disclosure of any transaction between the registrant and a third party that is reported in response to the relationships disclosure requirements of Item 404 of Regulation S-K. 26 Further, registrants are expressly permitted to exclude any table, or any column otherwise prescribed by a given table, absent a compensatory item required to be reported in such table or column in any of the covered fiscal years. 27
In response to comment, and to streamline further the requisite disclosure, the proposed categorization of compensatory instruments has been revised. Options and freestanding SARs, whether exercisable in cash or stock, will receive the same treatment under the revised Item. 28 Awards under restricted stock plans that are subject to performance-based conditions to vesting, in addition to the lapse of time and/or continued employment, will be permitted to be reported as long-term incentive plan items.
5. Designation of Named Executive Officers and Elimination of Executive Officer Group
There was wide support from all categories of commenters to require individualized disclosure of CEO compensation, regardless of pay level, and to raise the threshold for individualized disclosure regarding other executives from $60,000 to $100,000. Similarly broad commenter support was expressed for elimination of the executive officer group information. Several commenters suggested that the number of executive officers subject to individual disclosure could be reduced without loss of material information to shareholders, and with the concomitant benefit of streamlining the information required. At the same time, others suggested that the Commission expand disclosure beyond the five named executives originally proposed to elicit individualized information as to all executive officers serving on the registrants board, or even as to all directors, whether or not employed by the registrant in any other capacity. Some commenters objected to basing the selection of the highest paid executives on the sum of amounts contained in all three of the annual compensation columns in the Summary Compensation Table, because of the potentially wide variety of noncomparable compensation that could be reported in the third, or Other Annual Compensation, column.
The requirement to disclose information for the executive group has been eliminated, and the provisions governing designation of the persons subject to individualized disclosure as named executive officers revised in light of these comments. 29 As was proposed, the named executive officers will consist of the CEO plus the other four most highly compensated executive officers. Status and compensation levels in the last completed fiscal year will determine the identity of the named executive officers for all Item 402 disclosure, both tabular and narrative. In determining the officers covered, status at the end of the last completed fiscal year governs. Individualized disclosure of the CEOs compensation will be required under amended Item 402, regardless of pay level. On the other hand, individualized disclosure with respect to the other four most highly compensated executives will not be required with respect to anyone with compensation of $100,000 or less in the last completed fiscal year. In a change from the proposal, determination of the most highly compensated executives will be based on the total of the amounts required to be shown in the Salary and Bonus columns of the Summary Compensation Table for the last completed fiscal year.
Instruction 2(C) of former Item 402(a) of Regulation S-K regarding bonus and overseas assignments has been retained in the new item. 30 The item as adopted also includes an instruction to remind registrants that any officer of a subsidiary with policymaking functions may be an executive officer of the registrant who may be subject to individualized pay disclosure. 31
B. Summary Compensation Table
The Summary Compensation Table 32 was praised by shareholder commenters as the linchpin of the Commissions revised executive compensation disclosure scheme. This tabular, three-year summary will provide shareholders with a comprehensive overview of the registrants executive pay practices. Through this more objective, formatted presentation of compensation information, which in the past often has been furnished in widely dispersed and disjointed narrative, shareholders will be able to understand clearly compensation for the last completed fiscal year, to identify trends in the registrants compensation of its top managers, and to compare such trends with those disclosed by other registrants.
As widely recognized and endorsed by shareholder commenters, the Summary Compensation Table is intended to provide an easily understood overview of executive compensation in a single location within the proxy or information statement. Suggestions from a number of commenters to split the Summary Compensation Table into multiple tables would have defeated this purpose, and therefore have not been adopted. Similarly, any presentation of the Summary Table that would obscure viewing it as a unitary item of disclosure is not permitted. At the suggestion of some commenters, and as illustrated below, however, registrants will be permitted to include vertical lines of demarcation to distinguish among the columns in the Summary Compensation Table. Additionally, the table has been streamlined and a number of compensation items redefined in response to comment.
Some commenters suggested that the Commission provide a three-year transition for the Summary Compensation Table because of the difficulty of compiling the data in the form required, particularly with respect to the executive group. In light of the elimination of the executive group information, the Commission does not believe that a three-year phase-in is generally necessary. However, to facilitate adaptation to the revised requirements, registrants will be permitted a transition period for disclosure of the amounts reported in the Other Annual Compensation and All Other Compensation columns of the new table. Accordingly, these columns need not include information for fiscal years ended before December 15, 1992. Small business issuers, however, will be permitted to use a three-year phase-in for all columns of the Summary Compensation Table.
Commenters also raised questions about the Items application to periods when the registrant was not a reporting company. The Item provides that, if the registrant was not a reporting company during the entire three-year period, no information need be provided for any year, other than the most recent completed fiscal year, during which the registrant was not an Exchange Act reporting company. 33
The rules as adopted include the proposed provision that compensation reported in the Summary Compensation Table for a named executive officer includes that persons compensation for the full covered fiscal year, including compensation attributable to the portion of the year in which the executive did not serve in that capacity. 34 Commenters questioned the effect of a change in the CEO or other named executive officers during the three years covered by the Summary Compensation Table. Information is required to be provided for any covered year during which the incumbent served (for any portion of the year) as CEO, but not for prior fiscal years. For the year in which the CEO assumed his or her position, disclosure must be provided of all compensation for the full year for services rendered to the registrant and its subsidiaries, including compensation prior to becoming CEO. With respect to any of the other named executives, disclosure of historic pay is required if such executive was an executive officer of the registrant during the years covered, notwithstanding a change in position. Consistent with treatment of the CEO, if a named executive became an executive officer during one of the reporting years, all compensation during that year should be included.
The Summary Compensation Table is set forth below, followed by an explanation of the nature and scope of compensation elements included.
| SUMMARY COMPENSATION TABLE1 | ||||||||
| Annual Compensation2 | Long Term Awards | Compen-sation Payouts | ||||||
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(a) |
(b) |
(c) |
(d) |
(e) | ||||
Name and principal position |
Year |
Salary $ |
Bonus $ |
Other Annual Compen-sation $ |
Restricted Stock Awards $ |
Options / SARs # |
LTIP Payouts $ |
All Other Compen-sation $ |
CEO |
1992 |
|||||||
1991 |
||||||||
1990 |
||||||||
A |
1992 |
|||||||
1991 |
||||||||
1990 |
||||||||
B |
1992 |
|||||||
1991 |
||||||||
1990 |
||||||||
C |
1992 |
|||||||
1991 |
||||||||
1990 |
||||||||
D |
1992 |
|||||||
1991 |
||||||||
1990 |
||||||||
1. Annual Compensation--Salary and Bonus Columns
No substantive change has been made to the proposal with respect to the reporting of salary and bonus, with one minor exception discussed below. Under the amended regulation, the dollar value of base salary and annual bonus, whether denominated in cash, stock or other rights, will be broken out in separate columns of the Summary Compensation Table. Commenters for the most part recognized the legitimate interest of shareholders and other users of proxy and information statements in the distribution of annual compensation dollars between fixed salary and the generally more performance-sensitive bonus. While several commenters observed that some bonuses are not tied to performance, but instead represent merely a percentage of salary, this type of information would be disclosable in the Board Compensation Committee Report.
Compensation earned for services performed in a given year, but deferred at the election of the executive officer, will be reported as annual compensation in the column for the type of compensation to which it corresponds (salary or bonus). Registrants may not avoid inclusion of annual cash or non-cash payments in the salary or bonus columns simply by labeling such payments as something other than salary or bonus. Where the amount of bonus or salary earned for services performed in the last completed fiscal year is not calculable in sufficient time to be reported in the proxy or information statement, the instructions specify that the Summary Compensation Table in such proxy or information statement must so note. The Summary Compensation Table in the next years proxy (or information) statement must include that bonus or salary amount for the fiscal year in which it was earned. 35
The Commission has decided to modify the previously proposed treatment of foregone salary or bonus pursuant to registrant programs under which executives receive stock, stock-based instruments or some other form of compensation in lieu of a portion of annual compensation earned. 36 Registrants will not be required to report or disclose the amount of salary or bonus forgone in the appropriate column, but must include the dollar value of such forgone amounts in calculating whether a particular executive is among the most highly compensated and whether a particular executives annual salary and bonus in the aggregate exceed the new $100,000 threshold for individualized disclosure. 37 Awards of non-cash compensation made to an executive in lieu of salary or bonus amounts nevertheless must be disclosed where these awards otherwise are required to be reported in the Summary Compensation Table. For example, options or restricted shares received in a given fiscal year instead of annual cash compensation otherwise payable in that year would be disclosed in the Summary Compensation Table in the corresponding option or restricted stock grant column. Restricted stock received in lieu of salary or bonus will be included in the aggregate year-end information on restricted stock holdings required to be reported for each named executive officer. Where the grant of a particular form of non-cash compensation does not appear in the Summary Compensation Table, as would be the case with respect to a grant of performance shares or units received in exchange for forgone salary or bonus, a footnote must be added to the salary or bonus column so disclosing and identifying the table where such grant is included. 38
2. Other Annual Compensation
All additional forms of annual cash and non-cash compensation paid, awarded or earned, including registrant contributions to retirement plans, were proposed to be reported as Other Annual Compensation. Both the nature and scope of the information proposed to be reported under this column have been revised substantially in response to comment.
As restructured, the Other Annual Compensation column is required to cover specified other compensation not properly categorized as salary or bonus. 39 The items specified are: perquisites; payments to cover an executives taxes (commonly known as gross-ups); earnings paid or payable, but deferred at the election of the named executive officer, on deferred compensation, restricted stock and stock options/SARs at above-market interest rates or through preferential dividend payments; all earnings paid or payable, but deferred at the election of the named executive officer, on long-term incentive plan (LTIP) compensation; 40 and preferential discounts on stock purchases.
As proposed, the Other Annual Compensation column would have been footnoted to identify its different components. That general provision has been revised to require only disclosure of certain perquisites.
a. Perquisites
Several commenters suggested that, to reflect inflation, the perquisites and other personal benefits reporting threshold should be raised from the lesser of $25,000 or 10% of reported salary and bonus, and that the requirements to itemize each perquisite or benefit in a footnote be eliminated. Given the effect of inflation since the last revision of Item 402 in 1983, which has been taken into account in the Commissions upward adjustment of the dollar benchmark for designating the named executives, the Commission similarly has increased the perks/personal benefits threshold in the final rule to call for disclosure only when the aggregate value of these items exceeds the lesser of either $50,000 or 10% of total salary and bonus disclosed in the Summary Compensation Table. 41
As proposed, the registrant would have been required to identify each perquisite included in the amount reported in a footnote to the Other Annual Compensation column. The Item has been revised to require footnote or textual narrative disclosure of the nature and value of any particular perquisite or benefit only for those perks valued at more than 25% of the sum of all perquisites reported as Other Annual Compensation for that executive. 42
b. Earnings on Deferred Compensation, Restricted Stock, Options and SARs
Commenters took issue with the proposed change to require reporting of all interest on deferred compensation, and all dividends on restricted stock. These commenters objected to characterizing all interest and dividends as compensation, whatever the rates of return. The Commission is persuaded of the merit of the commenters view that market-rate and non-preferential earnings on deferred compensation, restricted stock, and options/SARs should not be reported as compensation. Accordingly, the Item has been revised to require disclosure only of above-market or preferential earnings paid or payable by the registrant or any of its subsidiaries. 43 Such amounts will be reported as Other Annual Compensation if paid (or payable but deferred at the named executives election) with respect to the fiscal year and calculable in sufficient time to be reported in the proxy or information statement. If not so paid or payable in the fiscal year, such amounts will be reported under the residual All Other Compensation column.
To avoid the problems cited by various commenters in allowing registrants to exercise judgment as to what constitutes market rate interest, the item now defines the term market rate. 44 Interest will be deemed to be above-market, thereby triggering a disclosure obligation, only if the rate of interest is in excess of 120% of the applicable federal long-term rate (AFR). 45 In contrast to former Item 402, this determination will be made by reference to the market rate in effect only at the time the interest rate was set. 46 Under the former item, the measurement was taken both at the time the plan was established and at the time the interest was earned. The change is designed to pick up interest rates intended by the registrant to be compensatory. Only the above-market portion of interest earned in the fiscal year is required to be reported as compensation; that compensation should be reported in the Other Annual Compensation column if paid or payable in that year; otherwise, it should be reported in the All Other Compensation column of the Summary Compensation Table.
The value of dividends (or dividend equivalents) will be reported in the Summary Compensation Table only where the named executive receives preferential dividends. 47 Dividends (or dividend equivalents) are preferential only if they are earned at a more favorable rate than dividends on the registrants common stock. Where dividends (or dividend equivalents) earned are preferential, only the dollar value of the preferential portion thereof is required to be reported as compensation; that compensation should be reported in the Other Annual Compensation column if paid or payable in that year, and otherwise in the All Other Compensation column.
c. Earnings on LTIP Compensation
In contrast to earnings on deferred compensation, restricted stock and options/SARs, the full amount of all earnings on LTIP compensation must be reported as compensation because such earnings do not represent payments for the registrants use of the executives deferred funds. Earnings on LTIP compensation may be reported as part of the amount ultimately realized, unless such amount is paid or payable (but deferred at the election of the named executive officer) prior to payout or maturation. If paid or payable at such earlier time, these earnings would be reported as Other Annual Compensation for the year paid or payable.
d. Discounted Stock Purchases
This column includes discounts on stock of the registrant and its subsidiaries purchased by named executive officers from the registrant or its subsidiaries, unless such discounts are available generally, either to all shareholders or to all salaried employees. 48 Such discriminatory discounts provide compensation to the executive equal in value to the difference between the purchase price paid by the executive and the fair market value of the stock at the date of purchase. 49
3. Restricted Stock Awards
No change has been made in the final version of Item 402 with respect to the Summary Compensation Table column for reporting the full market value of aggregate restricted shares awarded in a given fiscal year to a named executive. Given the minimal risk of forfeiture and the concomitant likelihood of appreciation above the grant-date market value attendant to the vast majority of restricted share awards, which are contingent only upon the passage of time and/or continued employment with the registrant, no discount to market is appropriate to reflect interim constraints on transferability. Deductions for any consideration the executive-recipient has paid for the restricted stock granted, however, may be reflected in the aggregate amount disclosed. 50
Where a restricted stock plan includes performance-based conditions on vesting, the registrant may elect to treat these items as LTIP compensation. 51 Grants of such items would be reported in the table specifically provided for LTIP awards. If so reported at grant, the value of any of these so-called performance restricted shares must be reported in the Summary Compensation Table on payout or maturation.
Under the proposal, registrants would have been required to include in a footnote the vesting schedule for all restricted stock awarded. As adopted, the Item requires footnote disclosure of vesting terms only for those awards that provide for vesting of all or part of the shares awarded in less than three years from the date of grant. 52 Restrictions on full ownership of restricted shares typically lapse over a period of at least three to five years. 53 Therefore, footnote vesting information is required for awards that do not reflect those typical conditions.
Data on the number and value of aggregate restricted shareholdings at the end of the last completed fiscal year have been removed from the proposed Restricted Stock Grant Table to a footnote to the Restricted Stock Award column of the Summary Compensation Table. Except for this information, the Restricted Stock Grant Table was largely redundant of information disclosable elsewhere under amended Item 402 and therefore has been deleted.
4. Option/SAR Grants
Separate option and freestanding SAR columns originally proposed have been combined, at the suggestion of commenters, to streamline presentation of the requisite award information. 54 As noted above, the total number of options and SARs reported must include cash-only SARs as well as those payable in stock. Rather than adding a separate column for repriced options or SARs to the Summary Compensation Table, as proposed, registrants are required to include options repriced during a covered fiscal year as new grants of options in this column. 55
5. LTIP Payouts
No change has been made to the reporting of LTIP payouts or maturation, 56 other than to require the inclusion of the value of any restricted performance shares that vest during a covered fiscal year if not previously reported in the Summary Compensation Table as an award of restricted stock. 57 Registrants therefore must disclose the dollar value of cash or stock-denominated awards actually realized, or matured but deferred at the election of a named executive officer, in a particular fiscal year.
Under the original proposal, registrants would have been required to disclose all performance-related conditions to payout in a footnote to this column. As adopted, footnote disclosure is required only of the waiver of performance targets or other conditions to realization of an award in connection with a reportable payout. 58
6. All Other Compensation
Any compensation to a named executive officer that is not reported under any other column of the Summary Compensation Table must be reported under the All Other Compensation column, 59 other than option and SAR exercises and LTIP awards. 60 In contrast to the proposal, the footnote identifying and quantifying compensation reported in this column may be restricted to the last completed fiscal year. Item 402(b) includes a list of specific items that would be reportable in this column. These items, which are not exclusive, are discussed below.
a. Amounts Paid, Payable or Accrued under Termination, Severance and Change-of-Control Arrangements
As proposed, the full value of any golden parachute or other amount paid, payable or accrued 61 in a fiscal year covered by the Summary Compensation Table, in connection with a change-in-control or a named executives termination or severance, would be reported in this column. 62
b. Earnings on Deferred Compensation, Restricted Stock, Options and SARs
As discussed above, earnings on deferred compensation, restricted stock, options and SARs are treated as compensation only when they are above-market, in the case of interest, or preferential, in the case of dividends or dividend equivalents. 63 Where such earnings with respect to a covered fiscal year are not reported as Other Annual Compensation, they should be reported in the All Other Compensation column. Thus, the proposed column for accrued dividends on restricted stock has been eliminated.
c. Earnings on LTIP Compensation
As noted above, the full amount of earnings on LTIP compensation is treated as compensation. These amounts should be reported in the All Other Compensation column, unless reported in the Other Annual Compensation column. 64 If the applicable interest rate varies depending on specified conditions (for example, a minimum period of continued service), the reported amount should be calculated assuming all conditions to receiving interest at the highest rate are met.
d. Registrant Contributions to Defined Contribution Plans
Disclosure is required of the annual contributions or other allocations of the registrant or any of its subsidiaries on behalf of any named executive officer to defined contribution plans (DCPs), whether tax-qualified plans, excess benefit plans, or non-qualified supplemental executive retirement plans, known as SERPs. In light of commenter concerns that such contributions might be misperceived as currently available to the employee during the reporting period, the location for reporting of these amounts has been changed from the Other Annual Compensation column to the All Other Compensation column. 65
Responding to questions raised in the proposing release, several commenters advised that the revised Item should require disclosure of the entire amount of a registrants annual DCP contribution for the year in which made, regardless of whether benefits are vested or unvested at that point. These commenters stated that the timing of vesting should not be controlling because for many of these plans, particularly discriminatory plans, substantial unvested amounts might never be disclosed. This could occur, for example, where contributions are made annually on behalf of an executive to a DCP SERP with a retention, or golden handcuff, feature under which vesting will not occur until at or after retirement. The Commission agrees with these comments and has amended the rules to cover such contributions. 66
The requirements of Item 402 have been revised to clarify that defined benefit or actuarial plans are not covered in the Summary Compensation Table. 67 Information concerning defined benefit or actuarial plans therefore will continue to be reported pursuant to the provisions of Item 402(f) governing pension plan disclosure.
e. Compensatory Split-Dollar Insurance Payments
Under the proposal, the annual premiums paid by the registrant in the covered fiscal year with respect to split-dollar insurance arrangements relating to the named executive officers would have been required to be reported in the Other Annual Compensation column of the Summary Compensation Table. Commenters objected to this treatment, urging that it overstated the compensatory aspect of these arrangements, because the registrant-paid premiums normally are refunded to the registrant on termination of the policy.
As adopted, the portion of the premium paid by the registrant in the covered fiscal year pursuant to a split-dollar arrangement that is attributable to term life insurance coverage for the executive officer will continue to be reported in full. 68 In response to the commenters concern, however, registrants will be given the option of reporting either: (1) the full dollar value of the remainder of the premiums paid by or on behalf of the registrant during the covered fiscal year; or (2) the current dollar value of the benefit to the executive officer of the remainder of the premium paid by or on behalf of the registrant during the fiscal year. The benefit must be determined for the period, projected on an actuarial basis, between the payment of the premium and its refund at the earliest possible time to the registrant. 69 In addition, consistent with the treatment of registrant contributions to defined contributions plans, reporting of split-dollar premiums paid by a registrant (including the term insurance portion) has been moved to the All Other Compensation column. 70
C. Option/SAR Tables
A number of commenters suggested streamlining the series of Options/SAR tables originally proposed, particularly to consolidate tables and, to the extent consistent with shareholder informational needs, to reduce the amount of detail required. Accordingly, amended Item 402 prescribes two tables--a combined table including individual grant and related potential valuation table, and a combined table including aggregated exercise and year-end holdings value information. The proposed Option/SAR Summary Report that detailed the nature and extent of the registrants use of options has been deleted, and a new column added to the grant table to reflect the percent of options and SARs granted to all employees in the year represented by each grant to each named executive officer. Much of the information contained in that summary report was duplicative of information provided for the named executives under revised Item 402, or in the annual report on Form 10-K or the annual report to security holders. 71
1. Individualized Option/SAR Grants in the Last Fiscal Year
The newly combined grant/potential value table requires, for each of the named executive officers, information regarding individual grants of options/SARs made in the last completed fiscal year, and their potential realizable values. 72 Small business issuers are not required to include the valuation information required under columns (f) and (g). 73 This information originally was proposed to be furnished in the tables entitled Values Based on Assumed Rates of Stock Price Appreciation for Options Granted in Last Fiscal Year and the Individual Grants in the Last Fiscal Year. The reconstituted table, as adopted, appears below:
| Option/SAR Grants in Last Fiscal Year | |||||||
| Individual Grants | Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Term | Alternative to (f) and (g) Grant Date Value |
|||||
|
(a) |
(b) |
(c) |
(d) |
(e) |
(f) |
(g) |
(h) |
|
Name |
Options/ |
% of Total Options/ SARs Granted to Empl0yees in Fiscal Year |
Exercise or Base Price ($/Sh) |
Expiration Date |
5% ($) |
10% ($) |
Grant Date Present Value $ |
CEO |
|||||||
A |
|||||||
B |
|||||||
C |
|||||||
D |
|||||||
a. Individualized Grant Information
A broad cross-section of the commenters supported the need for the individualized grant data called for by the table. Required information on individual option grants includes the number of options/SARs granted, the percent of total grants to employees represented by each grant, the per-share exercise or base price, and the expiration date. Repriced options or SARs must be reported as new grants. 74 A separate column must be added disclosing the grant-date market price of the registrants stock if options or SARs are granted at an exercise price below fair market value. 75
A single grant with different exercise or base prices, performance vesting thresholds, 76 or expiration dates will be reported as separate grants with respect to each tranche with a different exercise or base price, performance threshold or expiration date. Multiple grants in a fiscal year may be aggregated where they have the same exercise or base price and expiration date, and are not subject to disparate performance vesting thresholds. 77
As under the proposal, the final rules mandate disclosure of performance criteria and other material terms of the option or SAR granted. 78 Examples include option reload mechanisms, tandem instruments, tax reimbursement, or gross-up provisions, and provisions (other than antidilution provisions) structured to adjust the option exercise price. If the exercise or base price of an option or SAR could be lowered at any time during its term (other than through operation of an antidilution provision), the registrant must clearly and fully disclose these provisions and their potential consequences either by footnote or accompanying textual narrative. 79
b. Potential Realizable Value Information or Alternative Grant-Date Option/SAR Value
In the proposing release, the Commission indicated that it had considered requiring option grant-date valuation disclosure in the Summary Compensation Table, but concluded that shareholders might be better served by data reflecting a range of potential realizable values calculated on the basis of various assumed stock price appreciation rates over a period of 10 years. A number of commenters urged the Commission to reconsider its decision not to require option valuation, on the ground that such valuation is recognized as valid and generally relied upon in the market. Other commenters argued against mandating a specific valuation, while a number went further to argue that no value-related information should be required, either because they believed any future stock price appreciation that might be realized on exercise does not represent compensation to the executive-recipient, or any information relating to potential realizable gain would be inherently speculative and therefore inappropriate.
In light of the significant commenter support for grant-date valuation, Item 402(c) has been revised to allow registrants to report the grant-date option or SAR value. Those registrants that do not opt to disclose grant-date value would instead provide the data called for by the mandated potential option value columns. Repriced options or SARs reported as new grants would be subject to this disclosure.
The potential value columns of the new table have been refined in light of the comments received. Changes to the proposed assumed rates of stock price appreciation were made in response to comments that the appreciation rate should be specified at an annual rate to accommodate different option periods, and that the highest rate proposed, 200%, was unrealistic for many companies. In response to these concerns, the rule provides for assumed annual appreciation rates and use of the actual option or SAR term. In determining the potential appreciation applicable to a given option or SAR, the registrant will apply the annual appreciation rate compounded annually for the full term of the option or SAR. Registrants will report potential option or SAR gain values based on assumed annualized rates of stock price appreciation of 5% and 10% over the term of the option or SAR granted, with appreciation to be determined as of the expiration date of the option or SAR. 80 Assuming a 10-year term and annual compounding, this would result in total potential appreciation of 63% and 159%, respectively.
Where the registrant chooses to use the grant-date valuation alternative, the valuation should be footnoted to describe the valuation method used. Where the registrant has used a variation of the Black-Scholes option pricing model, the description may be limited to a simple indication of the use of such pricing model. In the event another valuation method were to be used, the registrant would be required to describe the methodology as well as any material assumptions.
For awards of discount options or SARs with an exercise or base price below the market price of the underlying stock, a new 0% column must be added. In a change from the proposal, the final rules permit, but do not require registrants that have established minimum stock price appreciation levels, sometimes referred to as hurdles, or any other performance-related conditions to vesting, to insert additional columns to demonstrate the effect of the premium strike price. Registrants also would be free to add columns reflecting either zero appreciation, where assuming the exercise or base price is at or above the market price on the date of grant, and historical appreciation, 81 respectively, information that a number of commenters suggested would be useful. With respect to indexed options, registrants that wish to reduce the potential realizable gain to reflect the impact of indexing must disclose the operative assumptions applied, either in a footnote or narrative accompanying the table. 82
2. Aggregated Option/SAR Exercises in Last Fiscal Year and Fiscal Year-End Option/SAR Values
To streamline further the information required with respect to options, the proposed Option Exercise Table and Options Held at FY-End Table have been simplified and consolidated into a single table. 83 This table, as adopted, is depicted below:
Unlike the proposal, the rules as adopted permit presentation of option/SAR exercise information on an aggregated basis for each named executive. Many of those commenting on the proposed individualized exercise format did not see the need for separate disclosure of each exercise to assess registrant compensation practices. Information concerning expiration dates and annualized gain have also been eliminated as unnecessary.
Other than substituting the terms exercisable and unexercisable for the proposed vested and unvested terminology at commenters request, the required information with respect to options and freestanding SARs held at fiscal year-end is unchanged from the proposal. Though some commenters questioned the need for this information, others indicated that, in assessing option awards in a given year, the amount and potential value of options held by an executive officer were important items of information.
An instruction states that the value of exercised options and unexercised in-the-money options is calculated by subtracting the exercise or base price from the fair market value of the securities underlying the options or SARs as of the exercise date or the fiscal year-end, respectively. 84 Thus, the withholding of shares to pay the exercise price or taxes will not affect the calculation. 85
D. LTIP Awards
As proposed, long-term incentive plan 86 compensation granted to the named executive officers during the last fiscal year would have been required to be disclosed in tabular format on a plan-by-plan basis. However, consistent with other efforts to streamline and consolidate the data sought, the proposed Stock Price-Based Plans table (LTIP Table A) and the Non-Stock Price-Based Plans table (LTIP Table B) have been consolidated, 87 the information sought streamlined, and the payout information deleted as duplicative of information in the Summary Compensation Table. 88
The revised, consolidated table is as follows:
As under the proposal, the final rule encompasses awards under long-term incentive plans that are stock-based, 89 where the measurement of the benefits to be received by the executive is a function of movements in the market price of the underlying registrant security, as well as plans prescribing performance criteria other than or in addition to market price. 90 As noted above, restricted stock awards whose vesting is conditioned upon the satisfaction of a specified performance goal as well as the passage of time will be reported in this table if not reported as awards of restricted stock in the Summary Compensation Table. Tandem grants of two instruments, only one of which may be covered by this provision, would be required to be reported only in the table applicable to the other instrument; duplicative reporting as a long-term incentive plan award is not required. For example, the grant of an option in tandem with a performance share or unit would be disclosed as an option grant. 91
Other required disclosures carried over from the proposal are the estimated payouts realizable in relation to the performance targets, and a description in footnote or narrative text of both the performance-based formula or measure and the range of performance necessary to achieve the threshold, 92 target 93 and maximum 94 payout amounts. As suggested by some commenters, the rule permits a registrant to substitute a representative amount if it is unable to determine the target award range. Estimated payout information is not required for plans based solely on stock price. Actual amounts paid or payable (but deferred at the election of the named executive officer) at maturation, both for such plans and non-stock price-based plans, must be disclosed in the Summary Compensation Table.
Registrants may use more generalized disclosure to the extent necessary to preclude disclosure of confidential business information. 95 A general statement similar to the following would satisfy this requirement for a performance plan tied to achieving certain specified growth rates of a registrants return on equity.
Illustration: Payouts of awards are tied to achieving specified levels of return on equity. The target amount will be earned if 100% of the targeted EPS growth rate is achieved. The threshold amount will be earned at the achievement of 90% of the targeted EPS growth rate and the maximum award amount will be earned at achieving 130% of the targeted EPS growth rate.
E. Pension and Other Defined Benefit or Actuarial Plan Disclosure
Item 402(f), which covers pension and other defined benefit or actuarial retirement plans, has been adopted substantially as proposed, except that it does not include disclosure with respect to defined contribution plans. 96 Rather, like the former Item 402 requirement, the revised item limits disclosure to estimated post-retirement benefits under pension and other defined benefit or actuarial plans. No information regarding these plans is required to be presented in the Summary Compensation Table.
The principal change from the former requirements is that the revised item focuses on estimated annual benefits payable, thus eliminating the plan descriptions cited by many commenters as both unnecessary and confusing. 97 As under the former requirements, two methods of providing the estimated benefits information are provided: for plans under which benefits are determined primarily by final (or average final) compensation, a table showing benefits by compensation and years of service classifications; 98 and for plans under which benefits are determined in a different manner, a description of the formula and the estimated annual amounts payable for each of the named executives.
With respect to plans under which benefits are determined primarily by final compensation, registrants must disclose the entire pensionable compensation base, and include all prospective benefits in the mandated table, whether payable under qualified or non-qualified plans. While the former item required that covered compensation be related to the compensation reported in the Cash Compensation Table, the revised item refers instead to the broader compensation base reflected in the Summary Compensation Table. 99
Questions were raised by commenters as to the need to disclose annual accruals in connections with defined benefit or actuarial plans pursuant to this or any other part of Item 402. Such disclosure is not required.
F. Director Compensation
No change has been made to former Item 402 requirements governing disclosure of director compensation, except for a clarifying instruction. 100 Under the broad language of the former and current provisions, disclosure of any standard or non-standard compensation arrangement must be made in textual narrative, naming each director thus compensated and stating the specific amounts paid. An instruction has been added to the former requirement to make it clear that the material terms of non-standard arrangements with directors, including consulting arrangements, must be described. Registrants must include the full amount paid under any consulting arrangement in the last completed fiscal year.
As discussed in the proposing release, questions have arisen under former Item 402 as to its application in the case of charitable award or director legacy programs. Under such programs, registrants typically agree to make a future donation to one or more charitable institutions in a participating directors name, payable by the registrant upon the directors death or retirement, or some other designated event. Funding vehicles for these programs commonly take the form of corporate-owned insurance policies on the lives of participating directors.
Various corporate and other commenters maintained that charitable award or legacy arrangements need not be disclosed, since the directors are not receiving value through the arrangement. Others commenters contended that such arrangements should be disclosed to shareholders since the arrangements clearly relate to directors board service, and the premiums can be considerable, particularly relative to amounts paid annually to directors, and are material in assessing the relationship of directors to the registrant. The Commission agrees, and thus reaffirms its initial conclusion that such arrangements are required to be disclosed pursuant to the requirements of Item 402(g).
In response to the Commissions request for comment on the need to revise the director compensation disclosure provisions governing disclosure of other arrangements entered into in consideration of a directors service, several commenters endorsed the need for clarification of the nature and scope of the mandated disclosure with respect to director charitable award or legacy arrangements. Application of the new instruction will require registrants to identify each director participant and the amount of the total legacy or award.
G. Employment Contracts and Termination, Severance and Change-of-Control Arrangements
The Commission has amended the proposed line item requiring a narrative description of registrant termination of employment and change-of-control arrangements to encompass all employment contracts with the CEO or any other named executive, and, consistent with the upward adjustment of the dollar benchmark for designating named executives, to raise the reporting threshold from $60,000 to $100,000. 101 A number of commenters pointed out that shareholders have a clear interest in knowing what contractual commitments the board has made on behalf of the registrant, both with respect to present inducements to join the registrants top management and future promises, and that the Commission should not delete the requirement to disclose employment contracts in its revision of Item 402.
H. Board Compensation Committee Report
The proposal to require a report by the Board Compensation Committee of the bases for named executive officer compensation and the relationship of such compensation to company performance provoked the strongest comment of any of the proposals concerning executive compensation. While shareholders expressed great enthusiasm for the report, the corporate community and practicing bar raised substantial concerns. Some argued that the report was an undue intrusion into the internal affairs of the company and interfered with the operation of the state-law business judgment rule; others argued that the report would interfere unduly with the functioning of the Committee and would deter people from serving as directors. Some questioned the authority of the Commission to require such disclosure, and suggested that the Commission has not previously required, and should not begin to require, disclosure of the bases for board or committee actions. These commenters contended that individual directors vote on a particular matter for a myriad of reasons, at times adopting compromise positions, and that disclosure of such information therefore should not be required. A number of commenters also raised concerns about the appropriateness of public assessments of individual officers performances, particularly in the case of those other than the CEO, and the need for disclosure of proprietary business information in the discussion of the performance of these executive officers. Finally, many raised concerns about the potential for litigation with respect to these reports, particularly in light of the signature requirement.
The Commission continues to believe that disclosure of the Compensation Committees policies will enhance shareholders ability to assess how well directors are representing their interests, and thus is an appropriate and necessary improvement to the disclosure concerning executive compensation in the proxy statement clearly within the Commissions authority. The disclosure does not impose new fiduciary standards on directors, or require any particular actions or procedures. Also, it is not inconsistent with the business judgment standards that, where applicable, protect reasonable and good faith action by the directors. While some contend that requiring a discussion of the bases for Compensation Committee or Board action is unprecedented, extensive disclosure is required as to the Boards basis for concluding that a going-private or roll-up transaction is fair to shareholders. 102
The Commission does not intend to disrupt the discussions among the Compensation Committee members. To the extent that the proposing release, in its analogy to the Managements Discussion and Analysis requirement, 103 suggested to readers that the report should outline these discussions, that is not the intent of the requirement. To the contrary, the report requires disclosure of the bases for the Committees action, and the Committees discussion of the relationship, if any, between corporate performance and executive compensation. It does not require a discussion of each individual Committee members reasons or motivations for supporting the Committees recommendations. A description of the rationale of the Committee for the reported compensation and its relationship to performance is all that is required.
In response to concerns expressed by commenters with respect to application of the proposed report requirement to the named executive officers subordinate to the CEO, the Commission has revised the requirement to limit the specific discussion to the CEO. 104 In place of the discussion of the compensation of each of the other named executives and its relationship to registrant performance, a discussion is required of the compensation policies with respect to the registrants executive officers, including the extent to which such compensation (in the aggregate) is performance-related, and the performance measures that are considered (e.g., sales, earnings, return on assets, return on equity or market share). 105 As under the proposal, the Committee would not be required to disclose target levels with respect to specific quantitative or qualitative performance-related factors, or any factors or criteria involving confidential commercial or business information, disclosure of which would adversely affect the registrant. 106
The Commission appreciates the concern registrants have expressed about litigation. The purpose of the report is to inform shareholders of the Committees good-faith rationale for its compensation actions. If shareholders are not satisfied with the decisions reflected in the report, the proper response is the ballot, not resort to the courts to challenge the disclosure. To make clear the Commissions intentions in this regard, the provisions requiring the report, as well as the related requirement for the Performance Graph discussed below, have been revised to provide for the same treatment of such disclosures as accorded information required to be delivered to shareholders in connection with the annual election of directors in the annual report. 107 Specifically, the disclosure will not be deemed soliciting material or to be filed under Section 18. 108
The rules also have been revised to specify that the Board Compensation Committee Report and the Performance Graph are required only in a proxy or information statement relating to an annual meeting of security holders (or special meeting or written consents in lieu of such meeting) at which directors are to be elected. 109 Accordingly, this information is not deemed to be incorporated by reference into any Securities Act or Exchange Act filing, except to the extent that the registrant specifically incorporates it by reference into such filing.
While the Board Compensation Committee Report will continue to be made over the names of the Compensation Committee members, the requirement for individual signatures has been deleted in response to comment. The signature requirement was intended simply to increase the Committee members focus on the specific disclosure obligation. The requirement that the report be made over the names of the Committee will accomplish the same purpose and avoid the practical difficulties involved in obtaining manual signatures. 110
Questions have been raised as to the consequences of board review of the Compensation Committee action or recommendations with respect to executive compensation. No additional disclosure or report will be necessary, unless the Board of Directors rejects or modifies, in any material way, the action or recommendations of the Compensation Committee with respect to CEO compensation or executive officer compensation policies. In such case, the report would be made over the names of the members of the Board and would include disclosure of the reasons that the Board was providing the report rather than the Compensation Committee. 111
If the registrant does not have a compensation committee or other board committee performing equivalent functions, the requirements with respect to the Compensation Committee Report will apply to the entire board of directors.
Finally, in response to the concerns raised by commenters about requiring discussion of compensation decisions with respect to particular executives made prior to the adoption of the new requirements, the decisions made prior to the effective date of revised Item 402 with respect to the CEOs compensation may be excluded from Board Compensation Committee Report disclosure.
I. Performance Graph
With certain modifications, the Commission has adopted the proposal requiring registrants to provide a line graph comparing the registrants cumulative total shareholder return with a performance indicator of the overall stock market and either a published industry index or registrant-determined peer comparison. In prescribing such a comparison, the Commission recognizes that many and varied performance benchmarks other than shareholder return are used in the design of executive compensation packages. However, as reflected in many shareholder letters of comment, shareholder return is a primary benchmark for shareholders and investors in assessing corporate performance.
In response to commenters recommendations that registrants, particularly those not in the S&P 500, be given the flexibility to select another broad market index, revised Item 402(l) now affords registrants that are not included in the S&P 500 a choice to use another broad equity market index 112 that includes companies that trade on the same exchange or NASDAQ market, or are of comparable market capitalization. Registrants will be expected to use the same index from year to year, absent an accompanying narrative explanation of the reasons for the change. 113 In addition to providng this explanation, a registrant that selects a new index for comparison in a given fiscal year must compare its return with that on both the old and new index in the graph appearing in that years proxy or information statement.
In another change from the proposal, this provision requires that the total return figures be presented on a dividend reinvested basis. Commenters have pointed out that only in this manner will inter-company comparability be assured. Companies that have elected to pass excess cash flow through to investors otherwise would appear to have provided a significantly lower return than in reality would be the case.
Under the proposal, issuers were free to set the base year at any point in time, so long as a minimum five-year period was depicted. A number of commenters noted that such an approach could lead to the selection of a base year beyond five years for the sole purpose of casting performance in an unduly favorable light. The rule as adopted thus establishes a mandatory measurement point fixed at the close of trading on the last trading day preceding the first day of the fifth preceding fiscal year, with disclosure mandated from that time through and including the registrants last completed fiscal year. 114 A shorter period may be used if the class of registrant equity forming the basis for the comparison has been registered under the Exchange Act for a shorter time. Adopting a mandatory measurement point not only will reduce the potential for manipulation, but also will enhance inter-company comparability.
The proposed rules also would have required registrants to compare their total return against a group of peer companies, using either return on a nationally recognized industry index or a registrant-constructed peer group index. In response to commenter questions about the definition of a nationally recognized index, the term published index has been substituted in the final rule to make clear that the Commission is not limiting the indices that may be used. 115 The rules also have been revised to clarify that the registrant has broad discretion in determining its peer comparison. The comparison may be made to one or a number of other companies, including foreign issuers. Moreover, the registrant may use bases other than its industry or line of business for determining its peer comparison, so long as such bases are disclosed.
Several commenters expressed concern regarding difficulties likely to be encountered in presenting the requisite peer comparison, particularly by registrants whose peers are privately-held companies, or subsidiaries or divisions of larger publicly-held companies. To address this concern, the rule now gives registrants that do not believe it feasible to provide a peer comparison to disclose this belief, and to compare their shareholder return to one or more companies selected on the basis of similar market capitalization.
To the extent feasible, the registrant should use comparable methods of presentation and assumptions for the total cumulative return calculations necessary for the requisite broad market and peer index comparisons with the registrants return. Where the registrant elects to construct its own peer group index, the same methodology must be used in calculating both the registrants total return and that on the registrant-constructed peer index.
To illustrate:
Commenters also expressed concern over the possibility of increased exposure to liability in connection with identifying peer companies and constructing an appropriate index. As noted above, the Performance Graph, as adopted, will receive the same treatment as the annual report to security holders, and will appear only in registrant proxy or information statements relating to annual meetings of security holders (or special meetings or written consents in lieu of such meetings) at which directors are to be elected. This disclosure will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference into any such filing. 116
Registrants may provide, in their discretion, additional presentations using other measures of performance for comparable periods.
J. Option/SAR Repricing Report
The proposed requirement for a report by a registrants compensation committee (or other board committee performing equivalent functions, or in the absence of any such committee, the entire board of directors) triggered by a repricing or equivalent amendment or replacement of an outstanding option or SAR has been adopted, as modified to reflect commenters views. 117 Triggering events under this provision have been narrowed to include only repricing of options or SARs held by a named executive officer, or equivalent amendment or replacement of options or SARs, effected in the last completed fiscal year and after the effective date of these rules. Further, the requirement does not extend to any repricing transactions that occurred before a registrant became subject to the reporting provisions of Section 13(a) or 15(d) under the Exchange Act.
As adopted, the report requirement is triggered by any action taken in the last completed fiscal year to lower the exercise price of an option or SAR held by a named executive officer, whether through amendment, cancellation or replacement grants or any other means. 118 The rule does not cover post-grant strike price changes resulting from: a formula-based repricing mechanism in existence at the time of grant, which is characteristic of some indexed and premium priced options; the operation of a plan antidilution provision; or a recapitalization or similar transaction affecting equally all holders of securities of the same class. 119
If a triggering event within the scope of the rule occurs, a report must be provided over the names of the members of the appropriate registrant committee discussing the reasons for the repricing of the named executives options and SARs during the last completed fiscal year. 120 In addition, the registrant must provide tabular information with respect to the repricing of options/SARs held by any executive officer over the shorter of the last ten completed fiscal years or the period in which the registrant has been subject to the reporting requirements of Section 13(a) or 15(d) of the Exchange Act. This 10-year disclosure period was selected to reflect the typical 10-year term of a compensatory stock option.
Except as narrowed to focus solely on repricing, the repricing table is unchanged from the proposal:
The 10-year repricing table need not be provided by a small business issuer eligible to use Regulation S-B. 121
K. Additional Information with Respect to Compensation Committee Interlocks and Insider Participation in Compensation Decisions
Revised Item 402(j) requires disclosure of specified information regarding the relationships of members of the registrants board of directors under circumstances in which shareholders may have greater concerns regarding the independence of board compensation decision making. This provision has been substantially revised from that proposed. As noted above, small business issuers eligible to use Regulation S-B are not subject to the Compensation Committee Interlocks and Insider Participation disclosure requirement. 122
The relationships provisions have been substantially reformatted, and no longer require disclosure in the event of option or SAR repricing. The revised provisions require disclosure under a specified caption--Compensation Committee Interlocks and Insider Participation. The provision requires that the registrant identify the members of its compensation committee (or other committee performing comparable functions), specifying any member who:
(a) was, at any time during the last completed fiscal year, an officer or employee of the registrant or any of its subsidiaries;
(b) was formerly an officer of the registrant or any of its subsidiaries; or
(c) had any relationship requiring disclosure by the registrant under Item 404 of Regulation S-K.
If any relationship requiring Item 404 disclosure existed, the information required by Item 404 with respect to that person must be set forth.
In the event the registrant does not have a compensation committee (or committee with comparable responsibilities), the item requires disclosure of the participation in its Board of Directors deliberations on executive compensation by any officer or employee, or former officer, of the registrant or any of its subsidiaries.
Disclosure of specified executive officer-director interlocks continues to be required. The interlocks requiring disclosure have been revised to include those situations where an executive officer of one company serves on the compensation committee of another company that has an executive officer serving on the first companys board of directors. In response to the proposing releases inquiry, several commenters responded that the potential conflict of interest in this circumstance was sufficiently great to require the interlock disclosure. 123 Interlocks involving not-for-profit entities have been excluded in response to public comment that such relationships do not raise the same level of concern with respect to the independence of the compensation-setting process. 124
Where a specified interlock existed, the proposal would have required disclosure of all financial interests in excess of $60,000 between the registrant and the director of the registrant who served as an executive officer of the other entity (and his or her affiliates). The proposal also called for disclosure of any means by which that interlocking director could benefit from actions of the registrant or its executive officers, and all discussions relating to compensation matters between the interlocking director and members of the compensation committee. These disclosures have been reduced substantially; in particular, the requirements with respect to benefits from actions of the registrant and discussions relating to compensation have been deleted. Instead, the provision as adopted requires that the relationship disclosure mandated under Item 404 of Regulation S-K accompany disclosure of the int