The SEC has proposed far-reaching changes to its disclosure rules addressing executive and director compensation, related party transactions, director independence, other corporate governance matters, and director and officer stock ownership. ¹ If adopted, the rules will represent a major overhaul of the current executive compensation reporting system, which was last updated in 1992. The proposed rules would affect compensation disclosure included in proxy statements, annual reports and registration statements, as well as a company’s obligation to report material compensation developments on Form 8-K on a real-time basis.

This memorandum provides an overview of the rule proposals and discusses the potential impact of the rule proposals on the 2006 proxy season.

How Do the Rule Proposals Impact the 2006 Proxy Season?

Definitive new rules will not be adopted in time to apply to the upcoming proxy season, and companies cannot voluntarily follow the rule proposals in place of the current rules. However, since the proposals largely respond to investor demands for increased transparency regarding compensation and related party transactions, companies should, to the extent practicable, take the rule proposals into account when drafting this year’s proxy statement. In particular:

• The SEC staff has conveyed its view that the current disclosure rules require “clear, concise and understandable disclosure of all plan and non-plan compensation awarded to, earned by, or paid to the named executive officers… and directors…, unless otherwise specified.” The SEC staff’s view is that this general requirement takes precedence over the detailed requirements of the various tables in which disclosure is required to be presented, and, therefore, that any compensatory arrangements must be disclosed, even if not specifically covered by the subsections and tables of current Item 402 of Regulation S-K. The rule proposals reinforce this view and therefore highlight the importance of making sure all compensation is identified and disclosed. To accomplish this, companies should include open-ended questions in their D&O questionnaires and convey to their officers and directors the importance of carefully and fully completing the D&O questionnaires.
  
  
• Companies are generally permitted to provide additional information corresponding to that required under the proposed rules by adding columns or supplemental tables to the existing required tabular disclosures. For example:
  
  
  
  • A company could add a column to its summary compensation table indicating the fair value of options granted (in addition to providing the number of options granted, as currently required). If a company does so, it should explain the basis on which fair value was calculated.
    
    
  • A company could also add a column to its summary compensation table reflecting a total compensation number, or alternatively it could be discussed as part of the Compensation Committee Report. In either case, extra care must be taken to ensure that the number is not misleading.
    
    
  • Given the increased popularity of restricted stock and other non-option equity awards, and the fact that the current tables focus on grants and exercises of options and SARs, companies may want to include supplemental tables that provide comparable details regarding other equity awards granted or realized during the last year.
    
    
  • A company could present director compensation information in a tabular format, as proposed, rather than in the narrative format that most companies have traditionally used.
    
    
    
• In drafting what could be its final Compensation Committee Report, the compensation committee may want to address the topics that are proposed to be required in the new Compensation Discussion and Analysis section.
  
  
• The rule proposals provide helpful interpretive guidance on what constitutes a perquisite. Companies should review this guidance in connection with decisions they make this year about what must be counted as a perk.
  
  
• One major focus of the rule proposals is enhanced disclosure about retirement and other post-employment benefits, including those payable upon the occurrence of a change in control. Many investors believe this is an area where current disclosure is too opaque and, even before the rule proposals, companies were considering ways to provide fuller and more comprehensible discussions of what executives are entitled to in various termination or retirement scenarios.
  
  
• Another major focus of the rule proposals is deferred compensation. Companies that maintain significant deferred compensation account balances should consider early compliance with the proposed new disclosure requirements about these types of arrangements.
  
  
• Several enforcement actions during the past two years have focused attention on the adequacy of disclosure regarding related party transactions, including the adequacy of disclosures regarding family member employment, reimbursement for expenses to entities affiliated with directors and officers, and other information that could inform shareholders’ evaluation of director independence. The SEC proposals, which would make the test for disclosure of related party transactions more principles-based, highlight the pressure on companies to avoid deciding against disclosure based on technical readings of the current rules.
  
  
• Even without adopting any of the proposed substantive changes in disclosure, a company can significantly improve its disclosure, and help prepare for inevitable future rule changes, by beginning to use plain English in drafting this year’s proxy statement.

Summary of SEC Rule Proposals

This summary is divided into the following sections:

Executive Compensation Disclosure
Director Compensation Disclosure
Revisions to Form 8-K
Beneficial Ownership Disclosure
Certain Relationships and Related Transactions Disclosure
Corporate Governance Disclosures
Plain English
Implications for Different Types of Filers
Transition
Overview of Proposed Changes to Compensation Tables

Executive Compensation Disclosure

Persons Covered

Currently, the executive compensation disclosure rules require disclosure regarding any person employed as CEO during the past fiscal year and the four other highest-paid executive officers employed at the end of the fiscal year, determined on the basis of salary and bonus. Under the proposal, disclosure would be required regarding a slightly different group of Named Executive Officers (“NEOs”): any Principal Executive Officer (“PEO”) during the past fiscal year, any Principal Financial Officer (“PFO”) during the past fiscal year, and the three most highly compensated executive officers employed at the end of the fiscal year other than the PEO and PFO. The most highly compensated officers would be determined on the basis of total compensation, rather than salary and bonus. Also, as currently required, up to two additional persons who would have been included but for the fact that they were not employed at the end of the fiscal year would be considered to be NEOs and covered by the required tabular and narrative disclosures.²

Compensation Discussion and Analysis (“CD&A”)

The proposal would replace the existing Compensation Committee Report and Stock Performance Chart with a new overview section that would be presented at the beginning of disclosure regarding executive compensation. The CD&A would provide narrative disclosure intended to put the tabular and related disclosure into proper perspective for investors. The new requirement is principles-based, identifying the disclosure concept and some illustrative examples, but leaving its specific application open to the unique facts and circumstances of each company and situation. Without resorting to boilerplate or merely repeating the information that follows in the required tables, the discussion should focus on the material principles underlying the company’s executive compensation policies, and the most important factors relevant to analysis of those policies. This discussion would need to address material differences in compensation policies and decisions regarding each NEO.

CD&A would explain the material elements of the company’s compensation structure by answering the following questions:

• What are the objectives of the company’s compensation programs?
  
  
• What is the compensation program designed to reward and not reward?
  
  
• What is each element of the compensation program?
  
  
• Why does the company choose to pay each element?
  
  
• How does the company determine the amount (and, where applicable, the formula) for each element?
  
  
• How do each element and the company’s decisions regarding that element fit into the company’s overall compensation objectives and affect decisions regarding other elements?

CD&A is intended to be comprehensive in its scope and would cover both in-service and post-termination compensation. Issues the SEC suggests are appropriate for examination in CD&A include:

• policies for allocating between long-term and currently paid out compensation;
  
  
• policies for allocating between cash and non-cash compensation, and among different forms of non-cash compensation;
  
  
• for long-term compensation, the basis for allocating compensation to each different form of award;
  
  
• for equity-based compensation, how the determination is made regarding timing of the grant of award;
  
  
• what specific items of corporate performance are taken into account in setting compensation policies and making compensation decisions;
  
  
• how specific elements of compensation are structured to reflect these items of the company’s performance and the executive’s individual performance;
  
  
• the factors considered in decisions to increase or decrease compensation materially;
  
  
• how compensation or amounts realizable from prior compensation are considered in setting other elements of compensation (for example, how gains from prior option or stock awards are considered in setting retirement benefits);
  
  
• the impact of accounting and tax treatments of a particular form of compensation;
  
  
• the company’s equity or other security ownership requirements or guidelines (specifying applicable amounts and forms of ownership), and any company policies regarding hedging the economic risk of such ownership;
  
  
• whether the company engaged in any benchmarking of total compensation or any material element of compensation, identifying the benchmark and, if applicable, its components; and
  
  
• the role executive officers play in the compensation process.

Unlike the current Compensation Committee Report, it is proposed that the CD&A would not be presented over the names of the Compensation Committee.

Furnished vs. Filed

Currently, the Compensation Committee Report and Stock Performance Graph, required by Item 402 of Regulation S-K, are furnished, not filed with the SEC, and are not deemed to be soliciting material. Under the proposal, the Compensation Committee Report and Stock Performance Graph would be eliminated and replaced by the CD&A. The CD&A would be deemed soliciting material, would be filed with SEC, and would be subject to Regulations 14A or 14C and to the liabilities of Section 18 of the Exchange Act. Because it would be filed as part of a company’s Form 10-K (or incorporated by reference from the company’s proxy statement), CD&A would also be covered by the CEO and CFO’s certifications of the Form 10-K.

Revised Compensation Tables

The SEC has proposed reorganizing the compensation tables and their related narrative disclosures into three broad categories:

• Total compensation received in the last fiscal year (and two preceding fiscal years) presented in a revised Summary Compensation Table setting forth compensation paid currently or deferred (including options, restricted stock and similar grants) and current earnings or awards that are part of a plan, supplemented by two tables providing back-up information for certain data in the Summary Compensation Table.
  
  
• Holdings of equity-based interests that relate to compensation or are potential sources of future compensation.
  
  
• Retirement and other post-employment compensation, including retirement and deferred compensation plans, and other post-employment benefits, such as those payable upon a change in control.

The SEC acknowledges that its proposals could, in some situations, require disclosure of the same amounts twice―once when earned (or potentially earned) and again where subsequently paid out. The SEC believes, however, that the clearer and more complete picture provided to investors under the revised format outweighs any double disclosure risk, and therefore advises companies to mitigate the impact of any double-counting by using the narrative following the tables (and where appropriate in CD&A) to explain how such disclosures relate to each other.

Summary Compensation Table

Consistent with current requirements, the revised Summary Compensation Table would remain the primary vehicle for disclosing executive compensation. As proposed, it would show each NEO’s compensation for the past three years, whether or not actually paid out. The proposal requires, for the first time, the disclosure of a figure representing total compensation paid to each NEO, as well as two supplementary tables disclosing additional information about grants of performance-based awards and all other equity awards. Narrative disclosure would follow each of the three tables, providing any additional material information necessary to an understanding of the information disclosed in the tables. The proposed format of the revised Summary Compensation Table is:

Total Compensation Column ―The proposal requires that all compensation be disclosed in dollars and that a total of all compensation be provided. The Total Compensation column would aggregate the total dollar value of each form of compensation set forth in the other columns of the Summary Compensation Table.

Salary and Bonus Columns―These columns are retained substantially in their present form.³ If any salary or bonus compensation is payable, but is deferred, the amount deferred must be disclosed in a footnote to the applicable column.

Stock Awards Column―The Stock Awards column would disclose any awards that derive their value from the company’s equity securities or permit settlement in such securities. Some examples of stock awards are restricted stock, restricted stock units, and phantom stock and units that do not have option-like features.

Valuation would be based on the grant date fair value of the award determined pursuant to Financial Accounting Standards Board Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (FAS 123R). Under the proposal and FAS 123R, compensation cost is measured based on the grant date fair value of the award. However, unlike FAS 123R, which allows recognition for financial reporting purposes over the vesting period of the award, the proposal would require disclosure as compensation of the entire fair value of the award in the year in which the grant is made.

Stock awards subject to performance-based conditions would also be included in this column.⁴

Option Awards Column―Awards of options, SARs and similar stock-based compensation instruments that have option-like features would be disclosed in a manner similar to the proposed treatment of stock awards.

Rather than the current requirement to disclose the number of securities underlying the awards, this column would require the disclosure of the grant date fair value of the award as determined pursuant to FAS 123R, regardless of the form of settlement of the award.

If the award has performance conditions, details on the estimated future payouts would be disclosed in one of the newly required supplemental tables that are discussed below.

If the award has no performance conditions, but instead vests with the passage of time and continued employment, the number of shares underlying the award and other details regarding the award would be disclosed in a second supplemental table.

Companies would no longer be required to show the potential realizable value of options under assumed 5% and 10% increases in stock price.

Non-Stock Incentive Plan Compensation Column―This column would report the dollar value of all amounts earned during the fiscal year pursuant to incentive plans where the award does not contain performance measures based solely on the price of the company’s securities and is not settleable in the company’s securities.

Because of the lack of a clearly accepted standard for measuring the value at grant date of these non-stock awards, disclosure in the Summary Compensation Table would continue to be required when earned (which means the year when the relevant performance criteria are met, whether or not payment is actually made in that year), rather than in the year of grant. However, the grant would be disclosed in the supplemental Grants of Performance-Based Awards Table in the year of grant.

All Other Compensation Column―This column would require disclosure of all other compensation not required to be included in any other column. The only exception would be perquisites and personal benefits if they aggregated less than $10,000 for an NEO. Perquisites and personal benefits are discussed in more detail in the next two sections of this summary.

It is proposed that each item of compensation included in this column that exceeds $10,000 would be separately identified and quantified in footnotes. Each item of compensation less than $10,000 (other than aggregate perquisites and personal benefits) would be included in the column, but would not be required to be identified by type and amount.

Examples of items that would be reported in this column in addition to perquisites, include, without limitation:

• All earnings on compensation deferred on a basis that is not tax-qualified, including non-qualified defined contribution retirement plans. Currently, disclosure is only required to the extent such earnings are “above-market or preferential.”
  
  
• Aggregate increase in actuarial value to the executive officer of defined benefit and actuarial plans accrued during the year. (The retirement section, discussed below, would provide additional information regarding these plans.)
  
  
• Severance or change in control payments.
  
  
• Company contributions or other allocations to defined contribution plans.
  
  
• Dollar value of any insurance premiums paid by the company with respect to life insurance for the benefit of an NEO.
  
  
• “Gross ups” or other amounts reimbursed for the payment of taxes.
  
  
• Compensation cost (calculated in accordance with FAS 123R) associated with any discounted purchases of company securities by the executive unless the discount is available generally to all security holders or all salaried employees of the company.

The proposed rules would eliminate the sometimes-confusing current distinction between the “Other Annual Compensation” and “All Other Compensation” columns.

Perquisites and Other Personal Benefits―The All Other Compensation column would also include all perquisites and personal benefits unless the aggregate amount for a particular NEO is less than $10,000. This is a significant change from the current rules, which permit omission of perquisites if the aggregate is the lesser of $50,000 or 10% of total annual salary and bonus.

In addition, currently only perquisites that are 25% of the total amount for each officer must be identified and quantified. Under the proposal, footnote disclosure would be required identifying perks and other personal benefits unless the aggregate amount is less than $10,000, and if a perquisite or personal benefit is valued at the greater of $25,000 or 10% of total perquisites and other personal benefits, its value must be disclosed.

Interpretive Guidance as to Perquisites

Without providing any bright-lines, the proposal indicates that the concept of perquisites and personal benefits should be broadly construed.

The release does, however, provide interpretive guidance that among the factors to be considered in determining whether an item is a perquisite or personal benefit are the following:

• An item is not a perquisite if it is integrally and directly related to the performance of the executive’s duties.
  
  
• Otherwise, an item is a perquisite if it confers a direct or indirect benefit that has a personal aspect, even if provided for some business reason or for the convenience of the company, unless it is generally available on a non-discriminatory basis to all employees.

The SEC cautions that the concept of a benefit that is “integrally and directly related” to job performance is to be construed narrowly, and also provides a number of examples of benefits that generally will be considered perquisites, and those that will not. The examples provided of items that are perquisites or personal benefits include:

• club memberships not used exclusively for business entertainment;
  
  
• personal finance, tax advice or investment management services;
  
  
• personal travel financed by the company or using vehicles owned or leased by the company;
  
  
• personal use of other company property, housing or living expenses, including relocation assistance;
  
  
• security provided at a personal residence or during personal travel;
  
  
• commuting expenses;
  
  
• additional clerical or secretarial services devoted to personal matters; and
  
  
• discounts on company products or services that are not generally available to all employees.

The release makes clear that determinations by the company regarding the appropriateness or business purpose of an item are not relevant to the inquiry of whether it confers a personal benefit to the executive. For example, the release specifically states that a company policy that executives must use company aircraft for security reasons during personal travel does not affect the conclusion that the item provided is a perquisite.

Examples of items that are not considered perquisites or personal benefits include:

• travel to and from business meetings;
  
  
• other business travel;
  
  
• business entertainment;
  
  
• security provided during business travel;
  
  
• itemized expense accounts used for business purposes only;
  
  
• office space at a company business location, even if larger than that of other employees;
  
  
• a reserved parking space that is closer to business facilities but not otherwise preferential; and
  
  
• clerical or secretarial services devoted to company matters, even if at a higher level than those provided to other employees.

Beyond these examples, companies and their advisors are expected to assess particular arrangements to determine whether they require disclosure as perquisites or personal benefits.

The release also reiterates previous guidance that the aggregate incremental cost to the company is the proper measure of value of perquisites, not the amount attributed to such benefits for tax purposes.

Supplemental Annual Compensation Tables

These two tables are intended to help explain information in the Summary Compensation Table.

Grants of Performance-Based Awards Table―This table would include information regarding non-stock grants of incentive plan awards, stock-based incentive plan awards and awards of options, restricted stock, and similar instruments under plans that are performance-based. Awards would be considered performance-based if subject to either a performance condition, or a market condition, as those terms are defined in FAS 123R. The table would show the terms of grants made during the last fiscal year, with separate disclosure for each grant. The proposed format of this table, which is based in part on the current LTIP table, is:

Grants of All Other Equity Awards Table―This table would show equity-based compensation awards granted in the last fiscal year that are not performance-based (for example, awards that vest based only on the passage of time and continued employment or awards where the payout is tied to the company’s stock price, and not to other performance criteria). Options and SARs granted in connection with a repricing would be included in the table. The table would require footnote description of any material terms of a grant. The proposed format of this table is:

Narrative Disclosure to Summary Compensation and Supplemental Tables

The proposal calls for narrative disclosure in addition to CD&A to give context to the tabular disclosure in the Summary Compensation Table, Grants of Performance-Based Awards Table and Grants of All Other Equity Awards Table.

The disclosure would focus on any additional material factors necessary to an understanding of the information disclosed in the tables, and might include, for example:

• Material terms of executive employment agreements that are relevant to the reported tabular disclosure.
  
  
• Material terms of repricing, extension of exercise period, change in vesting or other material modifications of outstanding option or other stock-based awards (the existing ten-year option repricing table would be eliminated).
  
  
• Material assumptions underlying calculations of amounts reflected in the tables.
  
  
• Material award terms relating to performance-based awards, such as the formula or criteria to be applied in determining the amounts payable, the vesting schedule, the performance-based conditions, and material modifications or waivers to any performance criteria, among others.

As is currently the case, companies would not be required to disclose any specific factor, criteria, or performance-related or other condition that involves confidential commercial or business information, disclosure of which would adversely affect the company’s competitive position.

The proposal would also require narrative disclosure regarding up to three employees who were not executive officers during the last fiscal year whose compensation was greater than that of any of the NEOs. The item would require disclosure of such employee’s total compensation and a description of his or her job position, but would not require individuals to be named. This proposal, if adopted, would require companies to track total compensation of non-executive employees.

Holdings and Exercises/Vestings of Previously Awarded Equity

The proposal would require two tables detailing equity compensation. The first table would show the amounts of prior awards outstanding and the second would show the exercise or vesting of equity awards during the fiscal year.

Outstanding Equity Awards at Fiscal Year-End―This table would disclose information regarding outstanding equity awards and the market-based values of the awards as of the fiscal year end, using the following format:

Consistent with the current rules, options, SARs, and similar instruments would be considered “in the money” if the market price of the underlying security exceeds the exercise price of the instrument. “In the money” instruments would be valued by calculating the difference at fiscal year end between the market price and the exercise price.

The market value of stock and incentive plan holdings would be calculated based on year-end market price of the unvested holdings.

Footnote disclosure would detail information such as expiration and vesting dates.

Option Exercises and Stock Vested―This table would show amounts received upon exercise of options and similar instruments or the vesting of stock, using the following format:

The grant date fair value of the instruments would have been shown in the Summary Compensation Table for the grant year, so column (d) would show the previously reported value to mitigate double-counting issues.

Post-Employment Compensation

The proposal would replace the current pension plan table and alternative plan disclosure with two new tables and enhanced narrative disclosure. The proposal also calls for new disclosure regarding compensation arrangements triggered upon termination or changes in control.

Retirement Plan Potential Annual Payments and Benefits Table―The proposal would require tabular disclosure of estimated retirement benefits to be payable at normal retirement and, if available, early retirement. A separate line of tabular disclosure would be required for each plan in which an NEO participates that provides for retirement benefits. The proposed format of the table is:

If an NEO is not yet eligible to retire, dollar amounts of annual benefits would be calculated assuming that the NEO continued to earn the same amount of compensation as reported for the last fiscal year.

The table would be followed by narrative disclosure of material factors necessary to an understanding of each plan disclosed in the table, including, for example:

• The material terms and conditions of benefits available under the plans, including formulas, eligibility standards and early retirement arrangements.
  
  
• If a lump sum distribution option is available, the amount that would be available upon election at the end of the last fiscal year, disclosing valuation methods and material assumptions involved.
  
  
• The specific elements of compensation included in applying the benefit formula, identifying each element.
  
  
• Company policies regarding matters such as granting extra years of credited service.

Nonqualified Defined Contribution and Other Deferred Compensation Plans Table―In contrast to current rules, which only require disclosure of above-market earnings on nonqualified deferred compensation, the proposal would require disclosure of all contributions, earnings and balances under all nonqualified defined contribution and deferred compensation plans. The proposed format of the new tabular disclosure is:

In order to mitigate potential “double-counting” issues, footnote disclosure would quantify the extent to which amounts were already reported in the Summary Compensation Table. As noted above, the Summary Compensation Table would also require footnote disclosure regarding deferred compensation.

As with the other tables, narrative disclosure would follow describing the material factors necessary to an understanding of the information disclosed in the table. Such factors might include:

• The type(s) of compensation permitted to be deferred, including any limitations thereon.
  
  
• Measures of calculating interest and/or plan earnings.
  
  
• Material terms regarding payouts, withdrawals and other distributions.

Other Potential Post-Employment Payments―Narrative disclosure would be required regarding any written or unwritten arrangement providing termination or change in control compensation, including the following:

• Specific circumstances that would trigger payment(s) or the provision of other benefits.
  
  
• Estimated payments and benefits to be provided in each circumstance, including terms of payment (such as lump-sum payment or payment over time).
  
  
• Specific factors used to determine payment and benefit levels.
  
  
• Any material conditions or obligations applicable to the receipt of payments or benefits, such as non-competition, non-solicitation, or confidentiality agreements.
  
  
• Any other material factors necessary for understanding the provisions.

Quantitative disclosure would be required. Where the amounts payable are uncertain, the company would have to make reasonable estimates and disclose the assumptions underlying the estimates.

Director Compensation Disclosure

The proposal would also require tabular disclosure for director compensation and narrative disclosure of additional material information. The table would be similar to the Summary Compensation Table, but would only include information for the last fiscal year.

The “All Other Compensation” column of the Director Compensation Table would include, but not be limited to:

• all perquisites and other personal benefits if the total is $10,000 or greater (which has the effect of reducing the company’s disclosure obligation since directors’ perks are currently required to be disclosed, no matter how de minimis they are);
  
  
• all earnings on non-qualified deferred compensation;
  
  
• all tax reimbursements;
  
  
• annual company contributions or other allocations to defined contribution plans;
  
  
• compensation cost (calculated in accordance with FAS 123R) associated with any discount purchases of company securities, unless available to all security holders or salaried employees generally;
  
  
• aggregate annual increase in actuarial value of all defined benefit and pension plans;
  
  
• annual company contributions to defined contribution and other deferred compensation plans;
  
  
• all consulting fees;
  
  
• awards under director legacy or charitable awards programs; and
  
  
• the dollar value of any insurance premiums paid by or on behalf of the company for life insurance for the director’s benefit.

In addition, footnote disclosure would be required regarding outstanding equity awards at fiscal year end, similar to the disclosure required by the Outstanding Equity Awards at Fiscal Year-End table for NEOs.

Interpretive guidance regarding executive compensation would cover analogous director compensation issues.

Narrative disclosure would be required following the table describing any additional material factors necessary for an understanding of the information disclosed in the table. No supplemental tables for director compensation are proposed.

Revisions to Form 8-K

Proposed Revisions to Items 1.01 and 5.02 of Form 8-K

In the proposing release, the SEC acknowledges that the substantial increase in executive compensation disclosure that has followed the adoption of new 8-K rules does not always provide investors with information that is unquestionably or presumptively material. The SEC indicates its view that much of the executive compensation information disclosed under the new 8-K requirements is material to investors, but acknowledged a desire to restore a more balanced approach that elicits unquestionably material information, but limits disclosure of immaterial information. Members of the SEC staff have indicated that the changes are intended only to eliminate immaterial items from the scope of 8-K.

The proposal would accomplish this by eliminating employment compensation arrangements from the scope of Items 1.01 and 1.02 of Form 8-K and instead covering such arrangements in an expanded Item 5.02.

Currently, Item 5.02 requires disclosure of the appointment or departure of directors and specified officers. The expanded Item 5.02 would maintain the current focus as well as require additional disclosure regarding material employment compensation arrangements involving NEOs that currently fall under Item 1.01.

Specifically, the proposal would:

• Expand the requirement to disclose information regarding retirement, resignation or termination to include all persons falling within the definition of NEO for the company’s previous fiscal year, whether or not included in the list of principal officers currently set forth in Item 5.02.
  
  
• Expand the currently required disclosure when a new principal officer is named beyond employment agreements to require a brief description of any material plan, contract or arrangement to which a covered officer or director is a party.
  
  
• Require the filing of a Form 8-K with respect to any material new compensation plan, contract or arrangement, or any new grant or award thereunder, and any material amendment to such an agreement for any NEO.⁵
  
  
• Require the filing of a Form 8-K for disclosure of salary and bonus information for the most recent fiscal year that was not included in the company’s most recent Item 402 disclosure because it was not determinable at the time that disclosure was made (for example, a bonus for the prior year determined after the proxy statement was finalized). A new total compensation figure, including that salary or bonus amount, is also to be included. The determination of the amount, or the payment, of such salary or bonus would trigger the Form 8-K filing requirement.

By refocusing ongoing 8-K disclosure on NEOs, the rule proposal would eliminate the need to file Form 8-Ks reporting new and amended compensatory arrangements for executive officers who are not NEOs and directors.

General Instruction D to Form 8-K

The proposal would revise the instructions to Form 8-K to permit companies to omit the Item 1.01 heading in a Form 8-K also disclosing any other Item, so long as the included disclosure meets the substantive requirements of Item 1.01.

Extension of Safe Harbor

The proposal would extend the safe harbors regarding Section 10(b) and Rule 10b-5 and Form S-3 eligibility in the event that the company fails to timely file reports under the new portions of Item 5.02 that are in effect being transferred from Item 1.01. As is currently the case, the existing provisions of Item 5.02, as amended, would not be covered by the safe harbor.

Beneficial Ownership Disclosure

The proposal would amend Item 403(b) of Regulation S-K, which provides for tabular disclosure of security ownership of management, to require footnote disclosure of the number of shares pledged as security by NEOs, directors and nominees. The SEC believes the risk of loss of shares owned by these persons has the potential to influence management’s decisions and, therefore, the existence of such security pledges could be material to investors.

The proposal would also require disclosure of beneficial ownership of directors’ qualifying shares.

Certain Relationships and Related Transactions Disclosure

The proposal would significantly modify the disclosure requirements regarding transactions and relationships between the company and related persons. The purpose of this disclosure would, however, remain the same―to elicit disclosure regarding transactions and relationships, including indebtedness, involving the company and related persons, the independence of directors and nominees, and the interests of management.

Transactions with Related Persons

The proposal would significantly alter the instructions to Item 404(a) to better articulate broad disclosure principles and refocus the disclosure analysis on general principles of materiality. Specifically, disclosure would be required regarding:

• any transaction since the beginning of the last fiscal year, or any currently proposed transaction;
  
  
• in which the company was or is to be a participant;
  
  
• in which the amount involved exceeds $120,000; and
  
  
• in which any related person had, or will have, a direct or indirect material interest.

“Transaction” would be defined broadly to include any financial transaction, arrangement or relationship or any series of similar transactions, arrangements or relationships, specifically including indebtedness and guarantees of indebtedness.⁶

“Related person” would be defined to mean any person who was at any time during the specified time period, in any of the following categories:

• any director or executive officer of the registrant and his or her immediate family members; and
  
  
• if the disclosure is being provided in any proxy statement involving the election of directors, any nominee for directors and the immediate family members of any nominee.

In addition, a 5% holder of the company’s voting securities or any member of such person’s immediate family, would be a “related person” with respect to transactions that occur when they are a 5% holder or family member of a 5% holder.

“Immediate family member” of a related person would mean any child, stepchild, parent, stepparent, spouse, sibling, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, sister-in-law, and any person (other than a tenant or employee) sharing the related person’s household.

“Amount involved” would mean the dollar value of the transaction, including:

• in the case of any lease or other transaction providing for periodic payments or installments, the aggregate amount of all periodic payments or installments due on or after the beginning of the company’s last fiscal year; and
  
  
• in the case of indebtedness, the largest aggregate principal amount outstanding since the beginning of the last fiscal year and all amounts of interest payable during the last fiscal year.

The SEC noted that some companies may have been “operating under a misconception” as to the application of the threshold “amount involved.” The proposal states that the current $60,000 threshold and the proposed $120,000 threshold should not be considered a bright-line materiality standard. Rather, Item 404(a) of Regulation S-K calls for a materiality analysis of transactions above the threshold to determine whether the related person has a direct or indirect material interest in the transaction. The materiality of any interest is to continue to be determined on the basis of the significance of the interest to investors in light of all the circumstances and the significance of the interest to the related person. The relationship of the related persons to the transaction, and with each other, and the amount involved would be among the factors to be considered in determining the materiality of the information to investors.

One area that will require more frequent materiality judgments relates to business relationships involving directors and nominees. Current Item 404(b) of Regulation S-K, which is proposed to be deleted, contains several bright-line standards requiring disclosure when a director or nominee is an executive officer or over 10% owner of an entity doing business with the company or has certain specified relationships with a law firm or investment bank that provides services to the company. In reliance on an existing SEC staff telephone interpretation, many companies have concluded that transactions that are within the scope of current Item 404(b), but that are not required to be disclosed under Item 404(b) because they fall below the applicable dollar threshold, also do not require disclosure under Item 404(a) even if they exceed $60,000, so long as the transaction is solely a business relationship that does not afford the director or nominee any special benefits. The elimination of current Item 404(b) means all such business relationships will need to be tested under Item 404(a)’s general standard of materiality.

The rules would provide very few bright-line exceptions from the related party transactions disclosure requirements. Most importantly:

• Disclosure of compensation to an executive officer would not be required if:
  
  
  • the compensation is reported pursuant to Item 402 of Regulation S-K; or
    
    
  • the executive officer is not an immediate family member of a related person and such compensation would have been reported under Item 402 if the executive officer was an NEO and such compensation had been approved by a committee of independent directors.
    
    
• Disclosure of compensation to a director (or nominee for director) would not be required if the compensation is reported under Item 402 of Regulation S-K.

In addition, a person associated with an entity that engages in a transaction with the registrant will not be deemed to have an indirect material interest in the transaction if the interest only arises as a result of the person’s position as a director and/or less than 10% security holder or limited partner (in each case, when aggregated with all other related persons) of the other entity.

When disclosure of a related party transaction is required, that disclosure must include:

• the name of the related person;
  
  
• why the person is a related person;
  
  
• the related person’s interest in the transaction;
  
  
• the amount of the transaction and of the related person’s interest;
  
  
• in the case of indebtedness, the largest aggregate amount outstanding, the current amount outstanding, the amount of principal and interest paid during the last year and the rate of interest; and
  
  
• any other information that is material to investors in light of the circumstances of the transaction.

Procedures for Approval of Related Person Transactions

The proposal would add a new Item 404(b), which is unrelated to current Item 404(b). Proposed Item 404(b) would require a description of the company’s policies and procedures for review, approval and ratification of Item 404(a) reportable transactions. The required disclosure would include all material features required to understand the policies and procedures, including, among other things:

• the types of transactions covered, and the standards to be applied;
  
  
• the persons or groups of persons on the company’s board of directors responsible for applying the policies and procedures; and
  
  
• whether such policies and procedures are in writing and, if not, how such policies and procedures are evidenced.

The proposal would also require identification of any transactions required to be reported by Item 404(a) where the policies and procedures did not require review, approval or ratification, or were not followed.

Promoters

Disclosure would be required in Form S-1 registration statements and other initial filings under the Securities Act regarding the identity and nature of any transactions with promoters during the last five fiscal years.

Corporate Governance Disclosures

Under the proposals, various disclosure requirements regarding director independence and corporate governance would be consolidated in a single disclosure item and those related to compensation committees would be expanded.

Disclosure would be required identifying each independent director of the company. The company would have to identify the definition of independence used (generally, at a minimum, the applicable listing standard definition). The same definition would be applied to all directors and nominees. The company would be required to disclose whether its definition of independence is posted on its Web site, or include the definition as an exhibit to its proxy at least once every three years.

The proposal would also require disclosure of:

• any members of the compensation, nominating and audit committee not identified as independent; and
  
  
• any transaction or relationships not otherwise disclosed as a related party transaction under Item 404(a) of Regulation S-K that were considered by the board in determining that a director and director nominee is independent.

These independence disclosures would be required with respect to anyone who served as a director during the past year.

Disclosure similar to the current requirements for audit and nominating committees would be required for the compensation committee, specifically:

• the scope and authority of the compensation committee;
  
  
• the extent to which the compensation committee may delegate any authority to any other persons;
  
  
• whether the compensation committee’s authority is set forth in a charter, and, if so, the Web site address where the charter is available (if not available, the charter would have to be attached as an exhibit to the proxy at least once every three years);
  
  
• any role of any executive officers in determining or recommending executive officer and director compensation; and
  
  
• any role of compensation consultants in determining or recommending the amount of form of compensation, identifying the consultants and whether the consultants were engaged by the committee or some other person and specifying the scope of the engagement.

The current requirement to report on compensation committee interlocks would be retained. The current requirement to include a copy of the Audit Committee charter in the proxy statement at least once every three years would be eliminated for companies that post the charter on their Web site.

Plain English

The proposal would require information disclosed pursuant to Items 402 (Executive compensation), 403 (Security ownership of certain beneficial owners and management), 404 (Transactions with related persons and promoters) and 407 (Corporate governance) of Regulation S-K to be in plain English.

Implications for Different Types of Filers

Implications for Small Business Issuers

The proposing release addresses the SEC staff’s recognition that the executive compensation arrangements of small business issuers are generally less complex than those of larger public companies. To reflect this, and also to avoid imposing unwarranted burdens on small business issuers, the proposals would require such issuers to provide, along with related narrative disclosure:

• the Summary Compensation Table (only for the last two fiscal years);
  
  
• the Outstanding Awards at Fiscal Year-End Table; and
  
  
• the Director Compensation Table.

Small business issuers would be required to provide information for only the PEO and the two most highly compensated officers other than the PEO. In addition, narrative disclosure of a number of items would be provided in place of certain tabular or footnote disclosure, and small business issuers would not be required to provide the CD&A.

Small business issuers would not be required to provide the new Item 404(b) description of policies and procedures for reviewing related party transactions and the applicable disclosure threshold for related party transactions would be the lesser of $120,000 or 1% of average total assets for the last three years.

Implications for Foreign Private Issuers

Consistent with existing requirements, a foreign private issuer under the proposals will be deemed to comply with Item 402 of Regulation S-K if it provides the information required by specific items of Form 20-F, plus additional information if otherwise made publicly available.

A proposed amendment to the exhibit instructions to Form 20-F would clarify the exhibit requirements applicable to foreign private issuers for compensatory agreements so that the exhibit rules do not appear to require the filing as an exhibit of information that is not otherwise required to be disclosed.

With respect to related party transactions, the proposed rules would require foreign private issuers to provide any more detailed information being disclosed by the issuer’s home or trading market.

Implications for Business Development Companies

Under the proposals, business development companies would be subject to the same executive compensation disclosure requirements described in this memorandum for operating companies. This marks a change from the current requirements, which are based in part on the requirements that apply to operating companies and in part on the requirements that apply to investment companies registered under the Investment Company Act.

In order to provide investors with a clear and complete picture of executive compensation, the proposals would require business development companies to include all of the disclosures required by Item 402 of Regulation S-K, for all of the persons covered by such item⁷ in their registration statements, in their proxy and information statements if certain actions are to be taken, and in their annual reports on Form 10-K.

Transition

The SEC has proposed that the new rules, when adopted, would not require companies to retroactively “restate” compensation or related transaction disclosure for prior fiscal years. Instead, the proposed Summary Compensation Table and disclosure required by proposed Item 404(a) would be required only for the most recent fiscal year. This would result in phased-in implementation of the proposed Summary Compensation Table amendments and proposed Item 404(a) disclosure over a three-year period for Regulation S-K companies, and a two-year period for Regulation S-B companies.

Overview of Proposed Changes to Compensation Tables

This bulletin was prepared by Sean Mulcahy, Jonathan Wolfman and Jennifer Zepralka.

For more information about this issue or WilmerHale’s Corporate Department please contact:

Mark Borden

¹ The rule proposals are contained in a proposing release titled “Executive Compensation and Related Party Disclosure,” Rel. Nos. 33-8655; 34-53185; IC-27218. The comment period is scheduled to end on April 10, 2006.

² As discussed below under “Narrative Disclosure to Summary Compensation and Supplemental Tables,” in certain circumstances the company would be required to provide additional narrative disclosure regarding up to three other employees who were not executive officers but who earned more in total compensation than any of the NEOs. These additional persons would not, however, be considered to be NEOs.

³ As discussed below under “Revisions to Form 8-K and Periodic Report Exhibit Requirements,” if salary and bonus cannot be calculated as of the most recent practicable date prior to when Item 402 disclosure is provided, a current report under Item 5.02 of Form 8-K would be triggered by a payment, decision or other occurrence, as a result of which such amounts become calculable in whole or in part.

⁴ Currently, Instruction 1 to Item 402(b)(2)(iv) allows reporting of performance-based stock awards as long-term incentive plan awards. The proposal would eliminate this option.

⁵ Grants or awards would not be disclosable on Form 8-K if they are consistent with the terms of previously disclosed plans or arrangements and they are disclosed the next time the company reports under Item 402 of Regulation S-K (i.e., generally the next year’s proxy statement).

⁶ The proposals would eliminate the current distinction (found in Item 404(c) and Item 404(a) of Regulation S-K) between indebtedness and other types of related person transactions. As a result, the proposals would require disclosure of indebtedness transactions and material indirect interests in indebtedness transactions for a broader category of person than currently required, including significant shareholders.

⁷ The compensation disclosure required by the proposals would cover the same officers as for operating companies. This is a departure from the current rules for business development companies, which apply to the three highest paid officers of the company that have aggregate compensation from the company for the most recently completed fiscal year in excess of $60,000.