SEC Releases New C&DIs on Proxy Disclosure Enhancement Rules

Earlier this week, the Staff of the Division of Corporation Finance of the SEC released six new Compliance and Disclosure Interpretations (C&DIs) providing guidance on issues raised by the new proxy disclosure enhancement rules adopted on December 16, 2009.

Three of the new C&DIs relating to executive compensation are particularly notable:

Question 119.21 addresses the calculation and disclosure in the Summary Compensation Table of the grant date fair value of equity awards that, at grant, do not provide for accelerated vesting on a termination of employment but are later modified to provide for accelerated vesting upon an executive officer’s departure. The basic facts outlined in Question 119.21 are the following:

• In April 2010, a company grants an executive officer an equity award that has a grant date fair value of $1,000 and does not provide for accelerated vesting upon a termination of employment.
• In connection with the executive officer’s termination of employment in November 2010, the company modifies the award to provide for acceleration of vesting on departure.
• The fair value of the modified award, computed under FASB ASC Topic 718 at the time of the modification, is $800. his reflects a decline in the company’s stock price from date of grant to the date of modification.

Question 119.21 concludes that the company would be required to report an aggregate grant date fair value of $1,800 for this award in the stock column of its 2010 Summary Compensation Table, reflecting the two compensation decisions the company made for the award in 2010. This amount would also be included in 2010 total compensation for purposes of identifying the company’s 2010 named executive officers. Question 119.21 concludes that if the modification occurred in 2011, the company would report $1,000 in the stock column of its 2010 Summary Compensation Table for the grant date fair value of the original award, and would report the incremental fair value of the modified award in the stock column of its 2011 Summary Compensation Table. The incremental fair value would be $800, which is the value of the modified award at the time of modification in excess of the zero fair value of the original award at the time of modification (because at the time of termination the original award would have been forfeited had it not been modified).

This interpretation follows applicable accounting principles and is generally consistent with prior interpretive positions of the Staff, but has important consequences. First, the inclusion of the incremental fair value of the award in the year it is modified, which typically coincides with the year of termination, could affect the identification of the “up to two additional executive officers” to be included in the Summary Compensation Table who are no longer serving as executive officers at year-end. Companies must have a process going forward to consider the impact of this type of modification in determining their named executive officers.

Second, forfeiture conditions are not taken into account in determining grant date fair value of performance or time-vested equity awards. This means that the original grant date fair value of the award for reporting purposes was not discounted to take into account the possibility that it would not vest or would be forfeited. This can lead to a confusing result. For example, in the facts outlined in the C&DI, an equity award that never had a value in excess of $1,000 would be reported in the Summary Compensation Table as having had a value of $1,800. In these circumstances, companies should consider footnote disclosure explaining the derivation of the numbers and that multiple values were included for one equity award.

Finally, from a disclosure perspective this interpretation arguably advantages companies that provide for automatic vesting of equity awards on termination of employment since awards with that feature would only be reflected in the Summary Compensation Table at grant.

Questions 119.22 and 119.23 both address the disclosure of incentive awards for which a named executive officer may receive payment in either cash or stock, at the officer’s election, but reach different conclusions regarding the appropriate method of disclosure.

In Question 119.22, a company grants an annual incentive plan award to a named executive officer during 2010. The named executive officer elects to receive the award in stock; the timing of the election is not clear from the question, but there is a suggestion that the right to so elect was not built into the terms of the award. In Question 119.23, a company grants annual incentive plan awards to its named executive officers during 2010. The awards permit the executive officers to elect during the first 90 days of 2010 to receive payment in settlement of the awards in company stock rather than cash. If a stock election is made, the stock will have a grant date fair value equal to 110% of the cash award. One named executive officer elects stock payment, while the others do not.

Question 119.22 concludes that the award should be reported in the non-equity incentive plan award column of the Summary Compensation Table, with footnote disclosure of the stock settlement. Similarly, in the Grants of Plan-Based Awards Table, the company would report the award in the estimated future payouts under non-equity incentive plan awards columns. The stock received upon settlement of the award would not be reported in the Grants of Plan-Based Awards Table, to avoid double-counting the award.

By contrast, Question 119.23 concludes that the named executive officer who elected to be paid his annual incentive award in stock will have his award reported in the 2010 Summary Compensation Table and Grants of Plan-Based Awards Table as an equity incentive award, even if the amount of the award is not determined until 2011. Named executive officers who do not make the stock election will have their awards reported in the 2010 Summary Compensation Table and Grants of Plan-Based Awards Table as non-equity incentive plan awards.

The basis of the distinction appears to turn on the question of whether the particular award would be accounted for under FASB ASC Topic 718. Question 119.22 specifically states that the award is not within the scope of FASB ASC Topic 718 because no right to stock settlement is embedded in the terms of the award (even though the executive officer apparently was able to request and receive stock settlement of his award). Question 119.23 does not specifically address the treatment of the awards covered in its hypothetical by reference to the accounting rules. In the hypothetical presented in Question 119.23 the right to stock settlement was embedded in the terms of the award, presumably as determined under FASB ASC Topic 718. If that is the case, it is worth noting that the manner of disclosure of the award turns on the election of the executive officer.

The other new C&DIs clarify that:

• Disclosure of director experience and qualifications is not required for a director whose term of office will not continue after the meeting to which the statement relates (Question 116.07);
• Item 402 disclosure by a registrant with a calendar fiscal year end is required in any Securities Act registration statement (or post-effective amendment) filed after the end of the calendar year but before its Form 10-K in respect of such year is due (Question 117.05); and
• The first day of the four-business day filing period for an Item 5.07 Form 8-K is the day after the date of the relevant shareholder meeting (Question 121A.01).

Please feel free to contact any of your regular contacts at the firm or any of the partners and counsel listed under Executive Compensation and Employee Benefits or Corporate Governance if you have any questions.