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In July 2006, amid national attention to the ever-growing salaries earned by corporate executives, the Securities and Exchange Commission (SEC) adopted extensive substantive changes to the disclosure requirements for executive compensation found in public company proxy statements and annual reports.

The SEC designed the new disclosure requirements with two goals in mind. First, the new disclosure requirements were intended to close reporting loopholes that had previously allowed large amounts of compensation to go undetected. Second, the new disclosure requirements were aimed at improving the quality and usefulness of information investors received. The SEC’s dissatisfaction with boilerplate language in many companies’ prior disclosures resulted in changes aimed at providing a clearer understanding of how corporate boards and board compensation committees make compensation decisions.

The overhaul of compensation disclosure requirements was designed to give investors better information regarding compensation earned by corporate executives. The SEC believes that providing a clear, succinct and understandable description of compensation paid to the most highly compensated officers at a given company helps investors make better-informed investment decisions.

To make executive compensation more transparent, a significant change to the disclosure requirements is the addition of the Compensation Discussion and Analysis (CD&A). While the majority of information a company must disclose is presented in tabular form, the CD&A is a narrative that precedes the tables discussing the company’s compensation policies and practices that are not readily apparent from the tables themselves. The narrative provides context for understanding the principles that guide executive compensation decisions, the company’s method of calculating total compensation and the elements of compensation.

Along with the addition of the CD&A, the SEC amended existing compensation tables and added new tables, all of which was aimed at making compensation decisions and forms of compensation more transparent. The amended and new compensation tables require detailed disclosure of executive compensation for the named executive officers (NEOs) in three broad categories: compensation over the last three fiscal years; exercises and holdings of previously awarded equity compensation; and post-employment compensation.

Disclosure of executive compensation over the last three years is reported in the Summary Compensation Table (SCT), which consists of the following information:

• The name and principal position of executive officers;
• The year;
• Salary;
• Bonus;
• Stock awards;
• Option awards;
• Non-equity incentive plan compensation;
• Change in pension value and non-qualified deferred compensation earnings;
• All other compensation; and
• The total compensation.

Under the new disclosure requirements, NEOs consist of a company’s principal executive officer and principal financial officer during the most recent fiscal year, and the three most highly compensated executive officers based on total compensation as opposed to simply the aggregate of an executive’s base salary plus any annual bonus. This is a significant change under the new rules. Bonuses disclosed in the amended SCT only include nonperformance based bonuses such as guaranteed bonuses, stay bonuses or discretionary bonuses. Non-equity incentive compensation awards are now reported separately. Non-equity incentive compensation includes compensation that is based on a performance target for the company that is communicated to the NEO.

The amended SCT mandates reporting compensation related to stock and option awards based on the “fair value” of such awards computed in accordance with the Financial Accounting Standard (FAS) 123R. Under the new rules, the amount of compensation for stock and option awards that is required to be reported in the SCT for any fiscal year is aligned with the compensation expense the company recognizes in its financial statements for the fiscal year under FAS 123R. Further, the amended SCT requires an accounting for changes in pension value and non-qualified deferred compensation. This new item requires disclosure of increases in the actuarial value of accumulated pension benefits and earnings on nonqualified deferred compensation. This item is not considered when determining an NEO. All Other Compensation now includes any and all perquisites executives receive and which have an aggregate value of $10,000 or more in a reported fiscal year, instead of the previous threshold of $25,000. All information disclosed in the SCT must now be listed in dollars, which allows for easy computation of Total Compensation. Requiring disclosure of Total Compensation as one aggregate number was intended to make it easier for investors to compare executive compensation packages across companies.

Supplementing the information in the SCT are the following tables: Grants of Plan-Based Awards, Option Exercises and Stock Vested, and Outstanding Equity Awards at Fiscal Year-End. The Grant of Plan-Based Awards table provides investors with detailed information regarding equity grants — both performance and nonperformance based — and nonequity performance based awards, including an estimate of future payouts. The Option Exercises and Stock Vested table replaces a previous table, which was limited to disclosure of stock option exercises, and requires disclosure of amounts realized by the NEOs as a result of options thaty they exercised or stock awards that vested in the last fiscal year, according to the market price as of the exercise or vesting date. The Outstanding Equity Awards at Fiscal Year-End table specifically requires disclosure of the number of shares that are subject to outstanding equity awards and the number of securities that are exercisable and unexercisable. The table also includes a schedule of vesting and expiration dates for these awards.

Finally, the new disclosure requirements increase the amount of post-employment compensation information that must be reported to investors. Companies must disclose the actuarial present value of an NEO’s accumulated benefit under any pension benefit plan in which the NEO is a participant and the number of years of credited service the NEO received under each plan. Companies must also disclose the contributions, earnings and balances under all nonqualified defined contribution plans, and any other plan that provides for deferral of compensation that is not tax-qualified.

Despite the SEC’s goal of shedding light on compensation practices and providing investors with a clear understanding of executive compensation packages, it appears that the re-designed disclosure rules may have slightly missed the mark based on the initial filings since the new disclosure requirements took it effect. While the new requirements were aimed at producing numerous benefits for investors in public companies, it has been suggested that investors are simply getting more voluminous and complex information about compensation without any greater insight into the reasoning behind a company’s executive compensation policies. Despite initial criticisms regarding the excessive length and lack of clarity of disclosures, the new disclosure requirements may be viewed as successful in other respects.

As a result of the new disclosures,

companies are now re-evaluating both the awards top executives receive each year and the public’s perception of this compensation. This additional scrutiny of executive compensation has lead to decreases in perks, as well as consideration of exactly how much compensation is necessary for chief executives. This type of self-scrutiny and re-evaluation should be beneficial to investors. It may be necessary for the SEC to make additional changes to the disclosure requirements to increase the clarity and efficiency of the information investors receive.

Kristyn Byrnes, a summer associate with the firm and a law student at Rutgers University School of Law, contributed to this article.

This article is only a brief overview highlighting aspects of the new disclosure rules. The information is general and should not be considered as advice. Readers should consult professional counsel for specific legal, ethical, or clinical questions and more general information.


KATAYUN I. JAFFARI is a partner in Saul Ewing’s business department and a member of the corporate governance and securities transactions practice groups. She has counseled companies in acquisitions, sales, securities offerings, public reporting documents, internal investigations, federal and state governance issues, and exchange listing matters. Jaffari represents public and private companies in a variety of industries, including biotechnology and emerging businesses. She frequently writes and speaks about issues relating to corporate governance and securities law.

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