christopher mcgee washington, dc the sec’s new executive compensation rules or what is a pfo and...
TRANSCRIPT
Christopher McGeeWashington, DC
The SEC’s New Executive Compensation Rules orWhat is a PFO and Why Should I Care?
FEI Briefing
October 17, 2006
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The Process and the Substance of Compensation Disclosure Have Changed
Full disclosure means full disclosure
– Not business as usual!
– “All compensation, earned or paid, from all sources, for all services.”
Each public company must implement a coordinated information gathering and analysis effort
The Compensation Committee must participate in the effort at each stage
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The New Rules Have Made Fundamental Changes to the Substance of Compensation Disclosure
Full Disclosure Principle
Plain English
Significant Changes to Summary Compensation Table
New Disclosure Tables and Accompanying Narrative Disclosure
Compensation Discussion & Analysis
Related Person Transaction Disclosure Changes
Form 8-K Changes
What is Different?
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Named Executive Officers
Anyone who at any time during the previous fiscal year served as:
– Principal executive officer (PEO)
– Principal financial officer (PFO)
Three most highly-compensated executive officers (other than PEO and PFO) who were serving as executive officers as of the last day of the previous fiscal year
– Based on total compensation excluding pension values and NQDC earnings
– Officer is not an NEO if his or her total compensation does not exceed $100,000
Up to two additional individuals who would have been in the top three except they were no longer serving as executive officers at end of last fiscal year
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Summary Compensation Table Changes
The Summary Compensation Tables have been materially changed in both form and substance (see sample table in Appendix).
Data that has been historically included (Base, Bonus, LTI) will still be included but with changed methodologies for reporting:
– Bonuses will be split between guaranteed and performance based
– LTI will split equity grants and option (or option like) awards and the valuation of the awards is to mirror the expensed value (i.e. Black Scholes) for equity.
Definition of Perquisites reduced to $10k and will also include “all other forms of compensation”
Additional data will be required that has never been required. Includes the change in value of Pension benefits and the increase in excess of market returns, on deferred compensation.
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New Supplemental Tables
There are 6 new tables that are required for all filers. Details for each table and the associated narratives are included in the Appendix.
The 6 new tables are:
Grants of Plan-Based Awards Table
Outstanding Equity Awards at Fiscal Year-End Table
Option Exercise and Stock Vested Table
Pension Benefits Table
Nonqualified Deferred Compensation Table
Director Compensation Table
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Narratives
The rules require Narratives to accompany all tables. Details on the required narratives for each table are included in the appendix.
The key theme of the narrative requirements are that they must explain in sufficient detail:
Foundation for Salary and relative target to market
All methodologies, metrics and outcomes that drive awards of bonuses and LTI awards.
Rationale for benefits and perquisites.
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Potential Payments upon Termination of Employment or Change-in-Control Summary
.The description (no table required) must include the following detail:– Specific circumstances that would trigger payment or other benefits
– Estimated payments and benefits that would be provided in each covered circumstance, whether it would or could be in lump sum or annual, disclosing the duration and by whom it would be provided
– Factors used to determine appropriate payment and benefit levels
– Any material conditions or obligations applicable to receipt of payments or benefits
– Quantification of the benefits and payments in each covered circumstance (even if uncertainties exist), calculated by applying the following assumptions:
The triggering event took place on the last business day of the last fiscal year
The price per share of the company’s securities is the closing market price as of that date
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Compensation Disclosure and Analysis
Replaces Board Compensation Committee Report (see appendix for more detail)
– Considered “filed” with, rather than “furnished” to, the SEC
– See new Compensation Committee Report requirement
Intended to provide overview of executive compensation program
– Summary of each program element
– Context for tabular and supplemental narrative disclosure
Company presentation – of compensation committee’s views of executive compensation program
Focus in on “analysis” of compensation policies and decisions
– Less a recitation of the facts and more an explanation of what is actually going on
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New Compensation Committee Report
New Compensation Committee Report
– Presented over names of compensation committee members
– Intended to ensure committee is actively involved in preparing CD&A
– Resembles current Audit Committee Report that is required in proxy statement
Must state that committee has reviewed and discussed CD&A with management and recommended that report be included in proxy statement and annual report on Form 10-K
– Unlike CD&A, considered “furnished” to SEC, so does not carry liability implications of CD&A
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New Compensation Committee Report (continued)
Separate narrative disclosure regarding compensation committee structure and operation
– Comparable to current audit and nominating committee disclosure
Specific disclosure related to executive and director compensation:
– Scope of committee’s authority
– Extent of ability to delegate authority
– Charter (must provide website link or attach to proxy statement every three years)
– Role of any executive officers in determining or recommending executive or director compensation
– Role of consultant in determining or recommending executive or director compensation, identifying consultant, stating whether engaged by committee, and describing nature of assignment and material instructions
Appendix
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Changes to Summary Compensation Table
Name & Principal Position
YearSalary
($)Bonus
($)
Stock Awards
($)
Option Awards
($)
Non-Equity Incentive Plan
Compen-sation
($)
Change in Pension
Value and NQDC
Earnings($)
All Other Compen-
sation($)
Total($)
PEO
PFO
A
B
C
Summary Compensation Table(values in 000s)
• Represents total of all other columns in table• Total excluding pension values and NQDC
earnings determines officers to include
• All compensation disclosed in dollars ($)
• Stock-related awards in year grant made that derive value from equity value, without option-like features
• Valuation based on grant date fair value (FAS 123R)• Include awards with performance-based conditions• Earnings not disclosable if factored into fair value
• Stock-related awards with option-like features
• Valuation based on grant date fair value (FAS 123R)
• Value of all other incentive awards earned in fiscal year (includes most annual incentives)
• Awards where performance measure(s) not share price and not settled in equity
• Grant details covered in supplemental table
• Annual change in actuarial present value of accumulated defined benefit pension plans (including unvested benefits)
• Above-market or preferential earnings on nonqualified deferred compensation
• Only includes discretionary and guaranteed amounts
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SCT – All Other Compensation
“All Other Compensation” column will include:– Perquisites and other personal benefits– Tax “gross-ups” and reimbursements– Discount stock purchases (unless arrangement is broadly
available)– Amounts paid or accrued under severance and change-in-control
arrangements– Company contributions to defined contribution plans (but not
earnings)– Value of insurance premiums paid by company for NEO life
insurance– Dollar value of dividends or earnings not factored into award fair
value
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SCT – All Other Compensation – Perquisites
Perquisite disclosure requirements
– If aggregate value is $10,000 or more, must disclose/identify each perquisite
– If individual perquisite has value in excess of greater of $25,000 or 10% of total perquisites, must quantify and disclose value
“Perquisites” not defined - instead apply two-step analytical framework:
– An item is not a perquisite if it is “integrally and directly related to the performance of the executive’s duties”
– Doesn’t cover items that merely facilitate job performance
– An item is a perquisite if it confers a “direct or indirect benefit that has a personal aspect,” without regard to whether it may be provided for some business reason or for the convenience of the company
– Item not covered if generally available on a non-discriminatory basis to all employees
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SCT – Narrative Disclosure
Following the tabular disclosure, a company must provide a narrative description of any material factors necessary to understand the information disclosed in the table, for example:
– A description of the material terms in the NEOs’ employment agreements
– Disclosure of repricings or other material modifications of outstanding awards
– An explanation of the amount of salary and bonus in proportion to total compensation
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Grants of Plan-Based Awards Table
Name Grant Date
Estimated Future Payouts Under Non-Equity Incentive Plan Awards
Estimated Future Payouts Under Equity Incentive Plan Awards All Other
Stock Awards:
Number of Shares of
Stock or Units (#)
All Other Option Awards: Number
of Securities Underlying
Options (#)
Exercise or Base Price of
Option Awards ($/Sh)Threshold
($)Target
($)Maximum
($)Threshold
(#)Target
(#)Maximum
(#)
PEO
PFO
A
B
C
Grants of Plan-Based Awards
• Grants made during last completed fiscal year• Estimated future payouts for both equity and non-equity
incentive plans• Separate disclosure for each award
• If the award provides only for a single estimated payout, that amount should be reported as target
• If the per-share exercise price of options is less than closing market price on grant date, additional column required showing closing market price on grant date; must also add footnote explaining pricing methodology
• Additional “Approval Date” column required if differs from grant date
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Plan – Based Awards Narrative
The narrative disclosure following this table must describe the terms of the disclosed awards, for example:
– a general description of the formula or criteria to be applied in determining the amounts payable
– Vesting schedule
– Performance-based conditions
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Name
Option Awards Stock Awards
Number of Securities Underlying
Unexercised Options(# Exer)
Number of Securities Underlying
Unexercised Options
(# Unexer)
Equity Incentive Plan Awards:
Number of Securities Underlying
Unexercised Unearned Options
(#)
Option Exercise Price
($)
Option Expiration
Date
Number of Shares or Units of
Stock That Have Not Vested
(#)
Market Value of
Shares or Units of
Stock That Have Not Vested
($)
Equity Incentive Plan Awards:
Number of Unearned Shares,
Units or Other Rights That Have
Not Vested(#)
Equity Incentive Plan Awards: Market or
Payout Value of Unearned Shares, Units
or Other Rights That Have Not Vested
($)
PEO
PFO
A
B
C
Outstanding Equity Awards at Fiscal Year-End
Outstanding Equity Awards at Fiscal Year-End Table
• All outstanding grants at fiscal year end• Grant-by grant disclosure for each option• Unrealized option gain no longer disclosed
• Based on achieving threshold performance unless prior year’s performance was higher
• Vesting dates disclosed in footnote• Individual exercise price and
expiration dates must be provided for each award
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Option Exercise and Stock Vested Table
Name & Principal Position
Option Awards Stock Awards
Number of Shares Acquired on Exercise
(#)
Value Realized on Exercise
($)
Number of Shares Acquired on Vesting
(#)
Value Realized on Vesting($)
PEO
PFO
A
B
C
Option Exercises and Stock Vested
• Number of shares acquired through exercise (options) or vesting (stock)
• Value realized at time of exercise (spread) or vesting (share price)
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Pension Benefits Table
Name Plan NameNumber of Years Credited
Service(#)
Present Value of Accumulated Benefit
($)
Payments During Last Fiscal Year
($)
PEO
PFO
A
B
C
Pension Benefits
• Separate disclosure for each plan• Plans include: tax qualified defined benefit plans, SERPs, cash
balance plans• Excludes defined contribution plans (next table)
• Replaces current Pension Plan Table
• Actuarial present value of accumulated benefit under the plan
• Retirement age assumed to be “normal” age as defined in the plan, or earliest unreduced age if none
• Must add footnote if credited service and actual years of service differ, and quantify difference and resulting benefit augmentation
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Name
Executive Contributions in
Last FY($)
Registrant Contributions in
Last FY($)
Aggregate Earnings in
Last FY($)
Aggregate Withdrawals / Distributions
($)
Aggregate Balance at Last FYE
($)
PEO
PFO
A
B
C
Nonqualified Deferred Compensation
• Disclosure of all earnings (vs. only when earned and above market) on deferred compensation, that is not tax-qualified
• Must disclose in footnote contributions, earnings, and balance amounts previously disclosed in Summary Compensation Table
Nonqualified Deferred Compensation Table
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Deferred Compensation Narrative
The company must disclose all material factors necessary to understand table, including:
– types of compensation permitted to be deferred and any deferral limitations
– the measures of calculating interest or other plan earnings
– material terms with respect to payouts, withdrawals and other distributions
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Director Compensation Table
NameFees Earned or Paid in Cash
($)
Stock Awards
($)
Option Awards
($)
Non-Equity Incentive Plan Compensation
($)
Change in Pension Value
and NQDC Earnings
($)
All Other Compensation
($)Total
($)
A
B
C
D
E
Director Compensation
• Grouping of multiple directors in a single row permitted, as long as all of their elements and amounts of compensation are identical
• Formatted tabular disclosure now required, in light of growing complexity of director compensation programs
• Pension values and nonqualified deferred compensation earnings disclosed in separate column
• All other, including:- Perquisites and
personal benefits
- Consulting fees- Director legacy
programs
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Director Compensation Narrative
Additional material information necessary to understand tabular information
Perquisite disclosure required only if value of benefits is $10,000 or more
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Principles-based disclosure
– CD&A must discuss six specific items: Program objectives Behaviors that program is designed to reward Each element of compensation Rationale for each element Methodology (including formula) used to determine amount for each
element How each element and decisions regarding that element fit into overall
compensation objectives and affect decisions regarding other elements
– Must also discuss any other material information that is necessary to an investor’s understanding of the executive compensation program
Rules include examples of other potentially material matters to be discussed
Compensation Disclosure and Analysis
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Compensation Disclosure and Analysis
CD&A will be considered “filed” with, rather than “furnished” to, the SEC
– Subject to full liability under the federal securities laws May be included in Securities Act registration statements Will be included in annual report on Form 10-K and possibly
other Exchange Act reports
– Also subject to CEO/CFO certification requirements when included in annual report on Form 10-K
CEO and CFO must formally attest to report’s accuracy and completeness
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Compensation Disclosure and Analysis
Discussion of performance-based compensation
– Must address specifics of performance-based compensation Specific items of corporate performance used in program How specific forms of pay are structured to reflect corporate
and/or individual performance
– Need not disclose target measures/levels if: Involves trade secrets Involves confidential commercial or financial information, the
disclosure of which would cause competitive harm for company Standard for determining competitive harm is whether company
could receive confidential treatment of information from SEC
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Compensation Disclosure and Analysis
New discussion of stock option grant practices– Responds to stock option backdating controversy– Must address how determination is made as to when awards are granted,
including equity-based compensation such as options– Must also address option compensation, particularly timing and pricing of
option grants, including Why the company selects particular dates for granting awards How option terms and conditions are established, such as how
exercise prices are determined Whether company has program or practice to coordinate timing of
grants with release of material, nonpublic information and, if so, scope and nature of arrangement
– Disclosure is in addition to new Grants of Plan-Based Awards Table that includes information about grant dates, grant date share prices and exercise prices
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Compensation Disclosure and Analysis
Other issues
– Explaining the compensation-setting process Should address in manner that emphasizes rationale for each
pay element in context of total compensation Use of compensation tools Peer groups and benchmarking Time period covered
– Discussing compensation of each named executive officer
– Integration with existing disclosure controls and procedures
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Compensation Disclosure and Analysis
Preparing the CD&A:
– Management will prepare draft report A multi-disciplinary exercise involving executives, directors, HR, legal,
others
– Compensation committee will review draft report and provide input
– CEO and CFO must certify contents of report as included in annual report on Form 10-K
– New Compensation Committee Report will comprise part of due diligence process
– Need to coordinate with filing of annual report on Form 10-K