RiskMetrics Weighs In on Compensation Risk Disclosures

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The new proxy disclosure rules (Item 402(s) to be precise) require public companies to include a narrative disclosure discussing the company’s compensation policies and practices as they relate to the company’s risk management if risks arising from the company’s compensation policies and practices for its employees are “reasonably likely to have a material adverse effect on the company.” The new rule does not require a company to provide a negative disclosure, e.g., “We reviewed our compensation policies and practices and found no material adverse risks.”

Speculation is that the SEC Staff likely will focus on this Item 402(s) disclosure as part of its review of proxies filed during the 2010 proxy season. However, it is unclear whether these comments will be primarily filed this proxy season as it is the first in which this disclosure will be in place, and will then be somewhat dropped going forward.

Companies considering how and where to address this disclosure item in their proxies need to also consider a FAQ issued yesterday by RiskMetrics Group (along with 2 others I’ll deal with in another post):

What will RiskMetrics be looking for in the new disclosure requirement on risks raised by compensation programs? In particular, how will RMG react to non-disclosure?

RMG understands that issuers typically do not like to provide negative disclosures (e.g., “we found no material adverse risks caused by compensation”) due to concerns over liability, and the SEC generally does not require them to make such statements. As a result, some companies may choose to say nothing in their proxy statement this season with regard to searches for material adverse effects from pay which conclude there are no such risks. While RMG does not have a policy regarding non-disclosure, we advise issuers to, at a minimum, talk about their process and any mitigating features (such as claw-backs or bonus banks) that they have adopted. We view this disclosure as an opportunity for communication, not simply compliance, and we expect that shareholders will be looking for a reasonably substantive discussion of the board’s process to determine whether the company’s incentive pay programs might motivate inappropriate risk-taking, and what they are doing to mitigate that.

RMG’s view may spur a few companies to address the risks associated with their compensation policies and practices and any risk assessment that was conducted.  However, note that this is not an RMG policy. As such, it is not required that companies follow this guidance from RMG or risk a negative vote recommendation against directors or an equity compensation plan proposal. That being said, companies may be better off coming up with a paragraph of disclosure that walks through the steps they have in place that mitigate any risks that exist, i.e. clawback provisions, stock ownership guidelines, stock retention guidelines, a particular balance of compensation, the performance goals utilized, mechanisms like bonus banks to keep a portion of previously “earned” compensation at risk, etc.  Doing so would be far more instructive to shareholders about what is currently in place to help mitigate risks than any statement that says, we found no risks to exist.  As such, this type of statement is likely to be well received by RMG and would not necessarily require a company to include a dreaded negative disclosure (“We determined after a careful review and assessment that Company does not have any risks  from its compensation policies and practices for its employees that are reasonably likely to have a material adverse effect on the Company”).

Of course, the next question is where to place this disclosure? I think most folks realize that it does not have to (and in the vast majority of cases should not) be included in the Compensation Discussion & Analysis (CD&A) section. However, the SEC Staff has issued guidance (C&DIs, Regulation S-K, Q. 128A.01) to the effect that it expects the Item 402(s) disclosure to be with the other Item 402 disclosures on compensation and would not expect it to be hidden, obscured, or difficult to locate. So, perhaps this should go somewhere in the narrative section following the Summary Compensation and the Grants of Plan-Based Awards Tables.

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SEC Issues Final Proxy Disclosure Rule Amendments

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The U.S. Securities and Exchange Commission met this morning and voted 4 to 1 in favor of approving the amendments to the proxy disclosure rules that were issued over the summer with some changes.  I’ll review the final amended rules and blog in the coming days about the changes that will impact equity compensation.  In the meantime, I wanted to make sure folks knew the final rules were posted to the SEC’s website this afternoon and can be accessed at:



Where’s Waldo? Where can you put the Equity Compensation Plan Information Table?

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Generally, the Equity Compensation Plan Information table is included in a company’s Form 10-K, unless a company is putting a compensation-related matter to shareholders on its proxy.

However, this could lead to confusing your shareholders as the table would then bounce back and forth between the Form 10-K and the proxy, simply depending on whether a company is putting a compensation matter to shareholders.  Some companies have wondered if they could simply just put the table into their proxy all the time and simply reference it in the Form 10-K.  The short answer: yes, companies can do that.

The rules governing the Equity Compensation Plan Information Table,Item 201(d) under Regulation S-K, can be found at: http://www.law.uc.edu/CCL/regS-K/SK201.html

 Helpfully, the SEC has issued a Compliance & Disclosure Interpretation which specifically addresses this issue and indicates that it is permissible to incorporate by reference the table if it is included in a proxy, even if no compensation plan is put to shareholders for a vote:

Question 106.01

Question: Is the Item 201(d) disclosure required in Part II of Form 10-K, given that Item 5 of Form 10-K indicates that the registrant is required to furnish the information required under Item 201, or should the Item 201(d) disclosure be included (or incorporated by reference) in Part III of Form 10-K given that Item 12 indicates that the registrant is required to furnish the information required under Item 201(d)?

Answer: The Item 201(d) disclosure should be included in Part III, Item 12 of Form 10-K. An issuer may rely on General Instruction G.3 to Form 10-K to incorporate by reference the Item 201(d) disclosure from its proxy statement or information statement, even if the issuer did not submit a compensation plan for security holder action at its annual meeting of security holders. See American Bar Association (Jan. 30, 2004). [Mar. 13, 2007]

Link to the SEC’s C&DIs: http://www.sec.gov/divisions/corpfin/guidance/regs-kinterp.htm