Venable SEC Update O C T O B E R 2 0 0 6 DEADLINES FOR COMPLIANCE - - PDF document

Venable SEC Update

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DEADLINES FOR COMPLIANCE WITH NEW DISCLOSURE RULES ON EXECUTIVE AND DIRECTOR COMPENSATION RAPIDLY APPROACHING

Begin Preparing for 10-K and Proxy Statement Disclosure Now New Form 8-K Rules in Effect November 7, 2006 The new rules recently adopted by the Securities and Exchange Commission ("SEC") governing the disclosure of executive and director compensation for publicly traded companies and other issuers required to register and file reports with the SEC ("New Rules") present some of the most significant and far reaching changes in the SEC's disclosure regime in many years and the time for complying with these New Rules is rapidly approaching. Companies generally must comply with the New Rules for SEC filings for fiscal years ending on or after December 15, 2006. Additionally, the changes to Form 8-K contained in the New Rules apply to triggering events occurring on

• r after November 7, 2006.

This SEC Update lists certain action items that companies subject to the New Rules need to be taking immediately to ensure timely compliance. Before discussing these actions, however, we first want to provide a brief summary of the New Rule's most important features. Summary of the New Rules The New Rules (i) change the definition of the "named executive officers" ("NEOs") whose compensation is required to be disclosed, (ii) add a new Compensation Discussion and Analysis section, and (iii) significantly enhance the Summary Compensation Table and add more supplemental tables in an attempt to capture a more comprehensive and representative picture of executive and director compensation in annual proxy statements and other filings. Covered Individuals. Under existing rules, reporting companies must disclose compensation received by NEOs. The New Rules modify the definition of NEOs to primarily include the individuals serving as principal executive officer ("PEO") and principal financial officer ("PFO"), regardless of actual compensation, during the last fiscal year, and the three most highly compensated executive officers other than the PEO and PFO who were serving at the end of the last fiscal year and whose total compensation was $100,000 or more. Compensation Discussion and Analysis (the “CD&A"). The CD&A must discuss the material factors underlying a company's compensation policies and decisions and is intended to come before, and provide context for, the compensation tables and related narrative disclosures. In providing this context, the CD&A must address six general topics: (i) the company's compensation program objectives; (ii) what such program is designed to reward; (iii) each element of compensation; (iv) why each element of compensation is chosen; (v) the manner in which the company determines the amount (and if applicable, the formula) for each compensation element; and (vi) the manner in which each compensation element and the company's decisions regarding that element fit into the company's overall compensation objectives and affect decisions regarding other compensation elements. The CD&A must be written in "plain English" tailored to the company's individual circumstances. In addition, because the CD&A must be "filed," it will be subject to the CEO/CFO certifications filed with the Form 10-K.

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In an acknowledgement on the recent stock option back-dating controversy, the CD&A should contain a separate section discussing the company's option granting practices in the event the company has coordinated or expects to coordinate the timing of granting options with the release of material nonpublic information. A modified Compensation Committee Report must also be included, stating whether the compensation committee reviewed the CD&A with management, and if so, whether it recommended that the CD&A should be included in the company's Form 10-K and proxy statement. Unlike the CD&A, the Compensation Committee Report will be treated as "furnished." Compensation Tables. The New Rules provide that following the CD&A, a detailed disclosure, organized in the three broad categories listed below, is required in tabular format with supporting narrative discussing any material factors necessary to understanding the tables:

• Compensation with Respect to the Last Fiscal Year

Summary Compensation Table (the “SCT”). This table must identify all NEO compensation using dollar figures and now must include a "total compensation" column consisting of the sum of the other columns. The "all other compensation" column must consist of an aggregate dollar figure for all compensation not reported in any other column and requires detailed footnote disclosures of, among other items, perquisites and tax reimbursement gross-ups. Perquisites with an aggregate value of $10,000 or more must be described, and, if valued at the greater of $25,000 or 10% of total perquisites for that individual, quantified. Any single reported item, other than a perquisite or personal benefit, exceeding $10,000 must be identified and

• quantified. Finally, because the SCT will be phased in over the next three years, prior year information to

which the current rules apply will not need to be included. Grants of Plan-Based Awards Table. This table must list for each NEO the grant date of the listed awards, estimated future payouts under both non-equity and equity incentive awards, all other stock and option awards, and the exercise or base price of option awards.

• Equity and Equity-Related holdings (Outstanding Equity Awards Table and Options Exercised and Stock

Vested Table) These tables must include, respectively, outstanding stock and option awards held by NEOs at fiscal year end, and amounts realized by each NEO, in the last fiscal year, on equity awards.

• Retirement and other post-employment compensation (Pension Benefits Table, Nonqualified Deferred

Compensation Table and Potential Termination and Change-in-Control Narrative) The two tables must include among other items, the actuarial present value of each NEO's accumulated benefit under each pension plan, and all executive and employer contributions (plus earnings for the year), withdrawals/distributions and year-end balance for each nonqualified deferred compensation plan. The Potential Termination and Change in Control Payment Narrative must describe and quantify any arrangement that provides for payments following or in connection with an NEO's termination of employment or change in responsibilities, or the company's change in control. Director Compensation. The current narrative disclosure requirement is being replaced by a comprehensive table similar to the SCT, but for the most recent fiscal year only. Guidance on Perquisite Disclosure. The new rules provide interpretive guidance stating that an item of compensation is a perquisite if it is not "integrally and directly related to the performance of the executive's duties," and also "confers a direct or indirect benefit that has a personal aspect, without regard to whether it may be provided for some

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business reason or for the convenience of the company, unless it is generally available on a non-discriminatory basis to all employees." Other Items. The new rules also contain changes to the Form 8-K requirements and clarify what events trigger Form 8-K filings. Finally, the new rules update and somewhat expand the related person transaction disclosure requirements. Action Items for Complying with New Rules Given the scope and magnitude of the changes in disclosure of executive and director compensation under the New Rules and the rapidly approaching deadlines for complying with the new disclosures, your company should take the following actions immediately, if it has not begun to do so already:

• Educate the Necessary Parties: The appropriate persons need to become educated about the New

Rules and the requirements they impose. This education process should consist of the following steps:

• Identify the individuals in the company who need to be responsible for understanding and

complying with the New Rules.

• Coordinate with in house and/or outside counsel to determine the process and program for

educating the persons identified above.

• Determine a program for educating the members of the compensation committee and other

directors—Directors will need to be actively involved in analyzing and articulating the company's compensation policies to be discussed in the CD&A. Board meetings to educate the directors on the New Rules and the obligations of the Board thereunder should be scheduled as soon as possible.

• Update Disclosure Policies and Procedures: The New Rules require your company to update its

policies and procedures for gathering the information necessary to prepare executive and director compensation disclosures. Following is a list of actions that need to be taken in connection with this process:

• Compliance with Form 8-K Requirements: the changes to Form 8-K will require updating

procedures for identifying triggering events that require disclosure on Form 8-K. The changes to Form 8-K are effective November 7, 2006.

• Update Tally Sheets and other Internal Mechanisms for Gathering Compensation

Information: The company must ensure that its mechanisms for tracking, accumulating and calculating the required information under the New Rules are effective.

• Update D&O Questionnaires: The New Rules significantly alter and expand the information

required to be disclosed. D&O Questionnaires will need to be updated accordingly.

• Disclosure Table Mock-Ups: Preliminary mock tabular and narrative disclosures under the

New Rules should be prepared for review by management and the compensation committee.

• Update PEO/PFO Certification Procedures: As discussed above, the CD&A will be covered

by the PEO/PFO certifications.

• Update Compensation Committee Charter: The charter should be reviewed and, if necessary,

updated to reflect the New Rules.

• Review and Analyze Compensation Policies and Decisions: As discussed above, one of the

central elements of the New Rules is the CD&A, which is intended to be a principle based discussion of the policies underlying the company's compensation decisions, rather than a narrative recitation of the information that follows in the compensation tables or a generic boilerplate

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• disclosure. Accordingly, your company will need to understand and analyze its past and current

compensation decisions and the policies underlying those decisions. In connection with preparing the CD&A, you should consider the following actions:

• Articulate Compensation Objectives: Identify and articulate the company's objectives in

making compensation decisions.

• Review and Analyze Past and Current Compensation Decisions: Examine past and current

compensation decisions and analyze the intent and effectiveness of these decisions in furthering the company's compensation objectives.

• Consider Changes to Compensation Policies: In connection with reviewing past and current

compensation practices, consider whether changes to any existing practices are desirable. In particular, consider whether changes in option granting practices and executive perquisites are desirable given the expanded disclosure requirements with respect to these items.

• Involve the Board in this Process: Because the CD&A is a statement of the company's
• verall compensation philosophy, the directors should be actively involved in shaping the
• disclosure. Additionally, as discussed above, the compensation committee will need to

recommend whether to include the CD&A in the Form 10-K and proxy statement. Accordingly, directors should be engaged in the process of preparing the CD&A as soon as possible.

• Act Now: Given the scope of the changes in disclosure imposed by the New Rules, companies need

to accelerate the timeline for preparing next year's 10-K and proxy statement. Accordingly, if you have not done so already, you should immediately develop your company's plan and timeline for implementing the actions outlined above.

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For more information about the matters discussed in this SEC Update, please contact Beth Hughes at (703) 760-1649, Tuck Washburne at (410) 244-7744, Alan Yarbro at (410) 244-7622, Wallace Christner at (202) 344-4988, Ariel Vannier at (202) 344-4867, Thomas France at (703) 760-1657, Andrea O'Brien at (301) 217-5655, Barbara Schlaff at (410) 244-7494 or John Wilhelm at (703) 760-1917. This SEC Update is published by the Corporate Finance and Securities Group and the Employee Benefits and Executive Compensation Group of Venable LLP. It is not intended to provide legal advice or opinion. Such advice may only be given when related to specific fact situations.