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On July 26, the U.S. Securities and Exchange Commission approved new disclosure rules regarding executive and director compensation, related-person transactions and certain corporate governance matters. The new rules represent the first significant changes to the SEC’s executive-compensation disclosure regime since the early 1990s. Originally proposed in January, the rules will be effective for the 2007 proxy season, and will apply to the following: Forms 10-K filed for fiscal years ending on or after Dec. 15, 2006; proxy and information statements filed on or after Dec. 15, 2006; registration statements filed on or after Dec. 15, 2006; and Forms 8-K filed in connection with triggering events that occur on or after Nov. 7, 2006. In general, the new rules call for increased disclosure regarding key compensation elements. As expected, disclosure of a total compensation dollar figure for each named executive officer will be required, as will increased disclosure regarding equity-based compensation, perquisites and the value of pension benefits and deferred compensation. The new rules require that these additional disclosures comply with the SEC’s “plain English” principles. The new rules vary somewhat from the SEC’s original proposal in a number of respects, including a requirement to provide a compensation committee report in addition to the proposed “Compensation Discussion and Analysis” (CD&A) section, and to disclose the company’s policies and practices regarding options grants, with details concerning how exercise prices and the timing of grants are determined. Although this latter requirement was not addressed in the proposed rules, it should come as no surprise in light of recent developments regarding options backdating. A key element of the new disclosure rules requires companies to describe their overall compensation objectives, policies and practices in the new CD&A section. This section is intended to provide shareholders with narrative, principles-based disclosure, including disclosure regarding options-grant policies and practices, which will need to address grant timing and option pricing practices. The CD&A disclosure is not required to include confidential information regarding specified performance targets if that disclosure would result in competitive harm to the company. The CD&A will be considered to be “filed” with (rather than “furnished” to) the SEC; consequently, CD&A disclosures will be subject to liability under the proxy rules, and, to the extent the CD&A is incorporated by reference into the company’s Form 10-K along with other compensation-related information, it will be subject to certification by the company’s chief executive officer and chief financial officer under the Sarbanes-Oxley Act. As noted in the commentary to the new rules, the chief executive officer and chief financial officer will be entitled to “look to” the compensation committee report in providing their certifications. The SEC originally had proposed replacing the compensation committee report and the company stock performance graph with the CD&A. The final rules, however, preserve both the compensation committee report and performance graph requirements. The compensation committee report will not need to be as lengthy or detailed as in the past-the primary requirement will be a statement from the committee indicating whether the committee members have discussed the CD&A with the company’s management and have recommended its inclusion in the annual report and proxy statement. The report will be considered to be “furnished” to the SEC. The performance graph will move from the compensation-related disclosures falling under Item 402 of Regulation S-K to the market price/dividends-related disclosures under Item 201 of Regulation S-K. Compensation tables The new rules continue the SEC’s emphasis on the presentation of important compensation elements in tabular format. The rules continue to require a summary compensation table with compensation information for the past three years, but now also will require additional columns, including a new column disclosing a total dollar amount of compensation for each named executive officer that will aggregate the dollar amounts included in the other seven table columns. In addition, the named executive officers to be covered by this table will be the company’s principal executive officer, the principal financial officer, the next three most highly compensated executive officers whose compensation exceeds $100,000 and up to two additional individuals with respect to whom disclosure would have been required but for the fact that the individuals stopped serving as executive officers during the last completed fiscal year. This marks a change from the old rules, which required the table to cover the company’s chief executive officer and the next four most highly compensated executive officers. In addition to the summary compensation table, companies will be required to present a new table addressing grants of plan-based awards (whether or not equity-based) during the most recent fiscal year. Disclosure will be required to show the fair value of option grants as determined under FAS 123R, the closing market price of the stock on the grant date (if higher than the exercise price) and the date that the option was approved for grant by the board or compensation committee (if different than the stated grant date). In the event the exercise price differs from the closing market price on the grant date, the company will be required to describe the method for determining the exercise price. The old requirement to disclose the potential realizable value of options based on assumed 5% and 10% increases in market value has been eliminated. Two additional tables will be required to provide information regarding deferred compensation and pension benefits. A new deferred compensation table will include disclosure of all contributions, withdrawals, earnings and year-end balances under nonqualified defined contribution and other deferred compensation arrangements with respect to the named executive officers. In addition, the disclosure rules for the pension benefits table will be expanded to require additional information regarding retirement plan and post-employment compensation, including the actuarial present value of each named executive officer’s accumulated benefits under each pension plan. Calculations of the pension benefits will be required to be based on normal retirement age (as defined in the plan), the executive’s current level of compensation and other assumptions the company uses for financial reporting purposes under generally accepted accounting principles. This approach replaces the proposed rule, which would have required estimates of the annual benefit payable upon retirement. Finally, three-year compensation information regarding the company’s outside directors will be required to be presented in a new director compensation table, which will be similar in format to the summary compensation table. The new rules also require narrative disclosure regarding director compensation, including a description of standard director compensation arrangements and whether any director has a different compensation arrangement. The new rules require disclosure of agreements or arrangements, whether or not written, to provide payments to named executive officers in connection with changes-of-control, changes in an executive’s responsibilities and termination of an executive’s employment. In quantifying these arrangements, the new rules clarify that companies must assume that the event triggering the benefit occurred on the last business day of the most recently completed fiscal year, and that the stock price used in calculating the value of the benefit would be the price on that date. Given that many change-of-control or termination agreements contain provisions that pay out different benefit amounts depending on the reason for termination, companies will need to give careful thought to compliance with this disclosure requirement, and should consider the various benefit amounts that could be paid out to a named executive officer for each possible termination event. The new rules amend Item 403(b) of Regulation S-K to require disclosure of the number of shares pledged as security by each executive officer, not just named executive officers, and each director. Accordingly, companies should make sure that their director and executive officer questionnaires request this information from all questionnaire recipients. The disclosure requirements in Item 404 of Regulation S-K, regarding related-person transactions, also have been amended. Pursuant to the new rules, a company will be required to disclose transactions since the beginning of its fiscal year, or any currently proposed transactions, in which it was or is to be a participant where the amount exceeds $120,000, and in which any related person has, or will have, a direct or indirect material interest. Additional disclosures concerning the company’s internal policies and procedures for reviewing, approving and ratifying related-person transactions will be required under the new rules, as well as the identification of any related-person transaction that did not require a review under such policies and procedures. Companies must state whether their policies are written and, if not, how they are memorialized. The final rules add a new Item 407 of Regulation S-K, which consolidates existing disclosure requirements regarding director independence and related corporate governance matters, in most cases without any substantive changes. New Item 407 also updates disclosure requirements regarding director independence to reflect the SEC’s current requirements and exchange listing standards. New disclosures also are required with respect to the compensation committee, which are similar to current disclosure requirements for audit and nominating committees. Companies will be required to describe, separately from the CD&A, their processes for considering and determining executive officer and director compensation, including any role played by executive officers or compensation consultants in determining the amount or form of executive officer or director compensation. Form 8-K revisions The new rules also provide several revisions to Form 8-K with respect to the disclosure of employment and compensatory arrangements. These arrangements will no longer be covered by items 1.01 (Entry into a Material Definitive Agreement) or 1.02 (Termination of a Material Definitive Agreement) of Form 8-K, but now will be made under an expanded Item 5.02 (Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers). In order to address concerns raised about Form 8-K filing requirements, the new rules clarify that certain employment contracts and arrangements, including material amendments, will be required to be disclosed on Form 8-K only if they involve named executive officers. For purposes of Item 5.02, the SEC has clarified that the named executive officers are those individuals for whom compensation disclosure was required in the company’s most recent filing under the Securities Act of 1933 or the Securities Exchange Act of 1934. The new executive compensation disclosure regime will require much greater detailed disclosures and, in most cases, significant redrafting of previously incorporated language. Companies need to assess the effects that changes to this regime will have on disclosure processes. While companies that have robust processes in place should not find the changes difficult to implement, planning now will make the 2007 proxy and Form 10-K drafting go more smoothly. The team responsible for coordinating the preparation of the Form 10-K and proxy statement should revise questionnaires used to gather background information for those filings to ensure that all disclosure items under the new rules are covered. The compensation committee charter and checklist of committee tasks also should be reviewed and revised to reflect the new CD&A requirement, and the disclosure team should map out the process for drafting, management review and sign-off, and compensation committee review and sign-off regarding the CD&A. The disclosure team should ensure that additional quantitative information required to be disclosed can be extracted from the company’s databases, and that the sources of qualitative information regarding compensation (including senior management, the compensation committee and outside consultants) understand their roles as information providers and are available at appropriate times during the process. The company’s disclosure team also should assess the effects of the changes to Form 8-K reporting requirements on disclosure practices. While the new rules should reduce the number of Form 8-K filings relating to compensation matters, the focus shift from Item 1.01 to Item 5.02 will require planning to ensure that the new requirements are met, and that compensation-related information that no longer needs to be included in Form 8-K but is still required in the proxy statement does not get overlooked. Thomas L. Hanley is a partner in the Washington office of Philadelphia-based Pepper Hamilton. He advises public companies and privately held businesses on corporate and securities law issues. Jack R. Garfinkle is a partner in the firm’s Philadelphia office. He concentrates his practice on mergers and acquisitions, securities offerings, venture capital and corporate representation.

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