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Another Week, Another Set of SEC Guidance

On Friday, March 12, 2010, the SEC Staff again updated the Regulation S-K Compliance & Disclosure Interpretations (C&DIs).

Here is a quick summary of the three new bits of clarification that the SEC Staff offers for the revised proxy disclosure rules:

• Q. 119.25-NEIP award based on performance during 2010 granted in January 2010. After the end of the year, amounts payable are determined based on performance achieved and communicated to NEOs. After the end of the fiscal year, one executive decides not to receive any payment for the award. The SEC position is that the award would be included in both the GPBAT and SCT, even though the executive declined the award payment. Company should disclose the executive’s decision to not receive the award by either (1) adding a column next to NEIP in the SCT to report NEIP compensation declined, or (2) through a footnote to the SCT. Also, company should consider discussing in the CD&A the effect, if any, of the executive’s decision on how the company structures and implements compensation to reflect performance.
• Q. 119.26-A company has a practice of granting discretionary bonuses to executives. Before the board takes action for 2010, an executive advises the board that she will not accept a bonus for 2010. The company does not have to report anything since the bonus was declined before it was granted, and therefore, no bonus was granted.
• Q. 133.12-If a company has to disclose a consultant’s fees for “additional services” in an amount in excess of $120,000, there is no limitation on the types of services that are included in “additional services.” If a consultant also sells products to the company, then the revenues generated from such sales should be included in “aggregate fees for any additional services provided by the compensation consultant or its affiliates.”

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Heads Up: Does performance (TSR) measured on another day smell as sweet?

RiskMetrics uses the median 1- and 3-year Total Shareholder Returns (TSRs) for a company’s 4-digit GICS industry group in applying the first screen of its pay for performance test.  Only if a company’s own 1- and 3-year TSR are both below the company’s GICS industry group 1- and 3-year medians, will RiskMetrics continue on with its analysis under its pay for performance policy.

Hold onto your hats (or scarves or whatever other head wear you might have on, if any), you probably will need to re-check your company’s 1- and3-year TSRs against the GICS industry group medians.  Why? Glad you asked (and good, logical question to pose too). It seems that RiskMetrics calculated the median TSRs for the GICS industry groups using December 30, 2009 as the end date for the latest performance measurement — list of median TSRs for GICS groups.  Unfortunately, the policy is to use the last business day of the applicable quarter. In this case, that would mean December 31, 2009.

RiskMetrics has assured me that they will correct this error on their website (http://www.riskmetrics.com/policy/2010/PerformanceLists). As of 7:15 am Central on March 11, 2010, RiskMetrics had not yet corrected this.  Here is what the medians were as of December 30, 2009 (Click to open PDF FILE).

Of course, RiskMetrics will also have to update the median TSRs in its model too. The 12/30/2009 medians were input into the RiskMetrics ISSue Compass model and used for the burn rate analysis generated by the model for companies with fiscal years ending between November 15, 2009 and February 14, 2010. So, if your FYE falls within the specified range (e.g., you are a calendar year company), this will definitely impact you. You should update your pay for performance analysis as soon as the updated numbers are available to see how your company will fare.

Every company that is taking a plan to shareholders and has a FYE between November 15, 2009 and February 14, 2010, needs to compare their 1- and 3-year TSRs against the (to be) REVISED RiskMetrics’ Median TSRs for their GICS industry groups to see if the first screen of the pay for performance policy will pose any issues. From my review of a couple of individual company TSR calculations put out from the model, I think the model has calculated the individual company TSRs as of 12/31/2009. This means that this could simply be a simple exercise of comparing the amounts determined for a company’s 1- and3-year TSRs against the revised GICS industry group medians.

UPDATE – 3/11/2010, 4:45 pm Central– I’ve spoken with RiskMetrics and they indicate that the only issue was the date disclosed on their website. RiskMetrics indicates that the median TSRs disclosed yesterday and still the same today after the change of the date to December 31, 2009, were done using Standard & Poor’s database using month-end December (and not referencing a specific date).  So, it looks like this issue has been resolved.

New SEC Staff Guidance Addresses Equity Awards’ Disclosure

On March 1, 2010, the SEC Staff again updated the Regulation S-K Compliance & Disclosure Interpretations (C&DIs).

If a company chooses to report the grant date fair value assumptions for equity awards in relation to the Grants of Plan-Based Awards Table, it can satisfy the Summary Compensation Table disclosure requirements for such information by referencing the Grants of Plan-Based Awards Table. See Question 119.16

The guidance addresses how to report the exercise of a “reload” stock option. Basically, any additional options received must be reported as an option grant in the Grants of Plan-Based Awards Table. Also, the grant date fair value of the stock options granted gets included in the Summary Compensation Table, as a Company would for any other stock option grant. See Section 220.01

The most significant new C&DI that was added was  Question 119.24, which addresses the proxy reporting for equity incentive plan awards that have multi-year performance periods, and where the Compensation Committee retains the right to exercise negative discretion in accordance with Internal Revenue Code Section 162(m) to reduce the amount of the award ultimately earned. In particular, this C&DI addresses such awards when the accounting rules (FASB ASC Topic 718 to be precise) indicate that the grant date won’t occur until the end of the performance period after the Committee has made its determination with respect to the awards earned, i.e., after the exercise of its negative discretion. The rules on that are a bit technical, but suffice it to say, it can happen.  In such a case, an employee could start providing service counted towards the earn before then (and most likely would do so).  The date at which the employee starts providing such service is called the “service inception date” under the accounting rules.

For purposes of the proxy disclosure of such an award, the SEC staff indicated that a company would include the award for the year in which the service inception date occurs.  The grant date fair value would be included in the Summary Compensation Table and Grants of Plan-Based Awards Table based on the the probable outcome of the performance conditions as of the service inception date. This amount also would be used in determining whether an executive officer is a named executive officer for the year in which the service inception date occurs.

Here’s the full guidance on this:

Question: In 2010, a company grants an executive officer an equity incentive plan award with a three-year performance period that begins in 2010. The equity incentive plan allows the compensation committee to exercise its discretion to reduce the amount earned pursuant to the award, consistent with Section 162(m) of the Internal Revenue Code. Under FASB ASC Topic 718, the fact that the compensation committee has the right to exercise “negative” discretion may cause, in certain circumstances, the grant date of the award to be deferred until the end of the three-year performance period, after the compensation committee has determined whether to exercise its negative discretion. If so, when and how should this award be reported in the Summary Compensation Table and Grants of Plan-Based Awards Table? In what year should this award be included in total compensation for purposes of determining if the executive officer is a named executive officer?

Answer: Use of grant date fair value reporting in Item 402 generally assumes that, as stated in FASB ASC Topic 718, “[t]he service inception date usually is the grant date.” The service inception date may precede the grant date, however, if the equity incentive plan award is authorized but service begins before a mutual understanding of the key terms and conditions is reached. In a situation in which the compensation committee’s right to exercise “negative” discretion may preclude, in certain circumstances, a grant date for the award during the year in which the compensation committee communicated the terms of the award and performance targets to the executive officer and in which the service inception date begins, the award should be reported in the Summary Compensation Table and Grants of Plan-Based Awards Table as compensation for the year in which the service inception date begins. Notwithstanding the accounting treatment for the award, reporting the award in this manner better reflects the compensation committee’s decisions with respect to the award. The amount reported in both tables should be the fair value of the award at the service inception date, based upon the then-probable outcome of the performance conditions. This same amount should be included in total compensation for purposes of determining whether the executive officer is a named executive officer for the year in which the service inception date occurs. [Mar. 1, 2010]

Finally, due to the February 28, 2010 effective date for the revised proxy disclosure rules, the revised C&DIs withdraw a number of interpretations which are no longer needed.  The following questions have been withdrawn:

• Question 119.04
• Question 119.05
• Question 119.11
• Question 119.12
• Question 119.15, and
• Question 120.05.

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More SEC Guidance on Revised Proxy Disclosure Rules

On February 16, 2010, the SEC Staff updated the C&DIs for Regulation S-K with a few additional questions and answers, as follows:

Question 116.07

Question: Instruction 3 to Item 401(a) provides that if the information called for by paragraph (a) is being presented in a proxy or information statement, no information need be given respecting any director whose term of office as a director will not continue after the meeting to which the statement relates. Is Item 401(e) disclosure required with respect to any director to whom this Instruction applies?

Answer: No. Item 401(e) disclosure is not required for any director for whom the company is not required to provide Item 401(a) disclosure.

Question 117.05

Question: A registrant with a calendar fiscal year end has filed a Securities Act registration statement (or post-effective amendment) for which it seeks effectiveness after December 31, 2009 but before its 2009 Form 10-K is due. Must it include Item 402 disclosure for 2009 in the registration statement before it can be declared effective?

Answer: If the registration statement is on Form S-1, then it must include Item 402 disclosure for 2009 before it can be declared effective. This is because 2009 is the last completed fiscal year. Part I, Item 11(l) of Form S-1 specifically requires Item 402 information in the registration statement, which includes Summary Compensation Table disclosure for each of the registrant’s last three completed fiscal years and other disclosures for the last completed fiscal year. General Instruction VII of Form S-1, which permits a registrant meeting certain requirements to incorporate by reference the Item 11 information, does not change this result because the registrant has not yet filed its Form 10-K for the most recently completed fiscal year.

On the other hand, Form S-3’s information requirements are satisfied by incorporating by reference filed and subsequently filed Exchange Act documents; for example, there is no specific line item requirement in Form S-3 for Item 402 information. Accordingly, a non-automatic shelf registration statement on Form S-3 can be declared effective before the Form 10-K is due. Securities Act Forms C&DI 123.01 addresses the situation in which a company requests effectiveness for a non-automatic shelf registration statement on Form S-3 during the period between the filing of the Form 10-K and the definitive proxy statement.

Question 119.21

Question: In April 2010, a company grants an equity award to an executive officer, and the terms of the award do not provide for acceleration of vesting if the executive officer leaves the company. The grant date fair value of the award is $1,000. In November 2010, the executive officer will leave the company, and the company modifies the officer’s same equity award to provide for acceleration of vesting upon departure. The fair value of the modified award, computed under FASB ASC Topic 718, is $800, reflecting a decline in the company’s stock price. What dollar amount is included in 2010 total compensation for purposes of identifying 2010 named executive officers and reported in the executive officer’s 2010 stock column with respect to this award if he will be a named executive officer? How would the company report the equity award if the award modification and executive’s departure occur in 2011?

Answer: Consistent with Instruction 2 to Item 402(c)(2)(v) and (vi), the incremental fair value of the modified award, computed as of the modification date in accordance with FASB ASC Topic 718, as well as the grant date fair value of the original award must be reported in the 2010 stock column. Applying the guidance in paragraph 55-116 of FASB ASC Section 718-20-55, incremental fair value is computed as follows: the fair value of the modified award at the date of modification minus the fair value of the original award at the date of modification equals the incremental fair value of the modified award. In this fact pattern, the fair value of the original award at the date of modification is zero, because the executive officer left the company in November and the original award would not have vested. Therefore, the incremental fair value of the modified award is $800. As a result, the total amount reported is $1,800, which reflects the two compensation decisions the company made for this award in 2010. The same amount is included in 2010 total compensation for purposes of identifying the company’s 2010 named executive officers pursuant to Items 402(a)(3)(iii) and (iv).

If the award modification and executive’s departure occur in 2011, the company would report $1,000 in the 2010 stock column for the grant date fair value of the original award. In the 2011 stock column, the company would report $800 for the incremental fair value of the modified award.

Question 119.22

Question: During 2010, a company grants an annual incentive plan award to a named executive officer. Because no right to stock settlement is embedded in the terms of the award, the award is not within the scope of FASB ASC Topic 718. Therefore, it is a non-equity incentive plan award as defined in Rule 402(a)(6)(iii). The named executive officer elects to receive the award in stock. Instruction 2 to Item 402(c)(2)(iii) and (iv) does not apply because the award is an incentive plan award rather than a bonus. Should the company report the award in the stock awards column (column (e)) or in the non-equity incentive plan award column (column (g)) in its 2010 Summary Compensation Table? How should the award be reported in the Grants of Plan-Based Awards Table?

Answer: The company should report the award in the non-equity incentive plan award column (column (g)) of the Summary Compensation Table, reflecting the compensation the company awarded, with footnote disclosure of the stock settlement. Similarly, in the Grants of Plan-Based Awards Table, the company should report the award in the estimated future payouts under non-equity incentive plan awards columns (columns (c)-(e)). The stock received upon settlement should not also be reported in the Grants of Plan-Based Awards Table because that would double count the award.

Question 119.23

Question: During 2010, a company grants annual incentive plan awards to its named executive officers. The awards permit the named executive officers to elect payment of the award for 2010 performance in company stock rather than cash, with the election to be made during the first 90 days of 2010. Such company stock will have a grant date fair value equal to 110% of the award that would be paid in cash. One named executive officer elects stock payment, and the others do not. How is the award reported for the named executive officer who elects stock payment? How is the award reported for the named executive officers who receive cash payment?

Answer: For the named executive officer who elects stock payment, the award is reported in the 2010 Summary Compensation Table and Grants of Plan-Based Awards Table as an equity incentive award. This is the case even if the amount of the award is not determined until early 2011 because all company decisions necessary to determine the value of the award are made in 2010. For the named executive officers who receive cash payment, the award is reported in the 2010 Summary Compensation Table and Grants of Plan-Based Awards Table as a non-equity incentive plan award.

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