Legal Bulletins

This legal bulletin discusses three rule releases by the U.S. Securities and Exchange Commission (the “SEC”) that affect companies, including investment companies, that file periodic reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and companies that file registration statements under the Securities Act of 1933, as amended.

The most significant rule release was issued on December 16, 2009 and imposes new disclosure requirements for proxy statements and Annual Reports on Form 10-K with respect to the risks that companies face because of their compensation policies and practices and the composition and structure of their boards of directors. The new rules apply to proxy statements and Annual Reports filed on and after February 18, 2010. The release is available at: http://www.sec.gov/rules/final/2009/33-9089fr.pdf.

On January 12, 2010, the SEC adopted a new Rule 14a-20 under the Exchange Act to clarify the requirement imposed on recipients of assistance under the U.S. Department of the Treasury’s Troubled Asset Relief Program (“TARP”), including the Capital Purchase Program, to solicit a non-binding vote from stockholders with respect to executive compensation. The release is available at: http://www.sec.gov/rules/final/2010/34-61335.pdf.

Finally, on October 13, 2009, the SEC further extended the time by which non-accelerated filers must include an attestation report of their independent auditors on internal control over financial reporting. Under the amended temporary rule, non-accelerated filers will be required to include the attestation report in annual reports for fiscal years ending on and after June 15, 2010. The release is available at: http://www.sec.gov/rules/final/2009/33-9072fr.pdf.

The material provisions of the first two rule releases are summarized below.

Proxy Disclosures Addressing Risk Exposure and Management

1. Risks associated with compensation practices and policies. If a company concludes that its compensation policies and practices create risks that are “reasonably likely” to have a material adverse effect on the company, it must include a “risk-oriented” discussion of those policies and practices. If a company determines that no discussion is required, it is not required to affirmatively state that conclusion. Smaller reporting companies are not required to include this discussion.

The analysis and discussion, which may not be included as part of the Compensation Discussion and Analysis (“CD&A”), must contemplate the policies and practices applicable to all employees, not just executive officers. The rules include a non-exclusive list of situations in which the SEC believes a discussion may be required, including practices and policies:

• for a business unit that carries a significant portion of the company’s risk profile;

• for a business unit with compensation structured significantly differently than other units;

• for a business unit where the compensation expense is a significant percentage of the unit’s revenues; and

• that vary significantly from the overall risk and reward structure of the company, such as when bonuses are awarded for completing tasks, while the income and risk to the company from that task extend over a significantly longer period of time.

If disclosure is required, the following points of discussion may be warranted:

• the general design philosophy of the company’s compensation policies and practices for employees whose behavior would be most affected by the incentives, as they relate to or affect risk taking by those employees, and the manner of their implementation;

• the company’s risk assessment or incentive considerations, if any, in structuring its compensation policies and practices or in awarding and paying compensation;

• how the company’s policies and practices relate to the realization of risks resulting from the actions of employees in both the short-term and the long-term, such as through policies requiring claw backs and/or holding periods;

• the company’s policies regarding adjustments to the policies and practices to address changes in its risk profile;

• material adjustments the company has made to its policies and practices as a result of changes in its risk profile; and
• the extent to which the company monitors its policies and practices to determine whether its risk management objectives are being met with respect to incentivizing employees.
2. Revisions to Summary Compensation Table and Director Compensation Table – Stock and Option Awards. Until now, the Summary Compensation Table and Director Compensation Table, as well as the Grants of Plan-Based Awards Table, were required to show the value of stock and option awards granted to the named executive officers and directors based on the dollar amount recognized for financial statement reporting purposes for the fiscal year. Under the new rules, companies must now show the grant date fair value of the awards computed in accordance with FASB ASC Topic 718. Importantly, where an award is a performance award, the value of the award must be based upon the probable outcome of the performance condition(s) as of the grant date, excluding the effect of forfeitures. The maximum possible payout must be disclosed in a footnote to the tables.

To facilitate year-to-year comparisons, the SEC requires that the stock and option award amounts, as well as the total compensation amounts, shown for prior fiscal years (i.e., 2008 in the case of smaller reporting companies, and 2007 and 2008 for others) be recomputed to reflect the applicable full grant date fair values of the awards.

Only those awards granted during the fiscal year should be included in the columns for that year. Companies were reminded, however, that the CD&A should discuss decisions to grant post-fiscal year end equity awards for service in a prior fiscal year, where those decisions could affect a fair understanding of a named executive officer’s compensation for the last fiscal year.

3. Enhanced disclosure about director and director nominee qualifications. The SEC has radically revised the disclosures required for directors and director nominees named in a proxy statement. Now, the proxy statement must disclose the particular experience, qualifications, attributes and/or skills that led the Board of Directors or the Nominating Committee to conclude that a particular person should serve as a director. This disclosure is required for all persons named in the proxy statement, even incumbent directors who are not standing for reelection at the annual meeting of stockholders. In addition, companies must disclose any directorships at public companies held by each director during the past five years (the current rule requires disclosure only of directorships currently held at public companies).

Similar disclosure is not required with respect to what qualifies a director to serve on a particular committee of the Board. However, the company is required to disclose whether an individual was chosen to serve on the Board because of a particular qualification, attribute or experience related to service on a specific committee.

The SEC also expanded the disclosure required for directors and director nominees that have been involved in certain legal proceedings. Under the revised disclosure requirements, a 10-year history is now required (a five-year history was previously required), and the SEC added the following additional types of actions that must be disclosed:

• any judicial or administrative proceedings resulting from involvement in mail or wire fraud or fraud in connection with any business activity;

• any judicial or administrative proceedings based on violations of federal or state securities, commodities, banking or insurance laws and regulations, or any settlement to such actions; and

• any disciplinary sanctions or orders imposed by a stock, commodities or derivatives exchange or other self-regulatory organization.

Finally, the proxy statement must now disclose whether, and, if so, how, a Nominating Committee considers diversity in identifying director nominees. Additionally, if the Nominating Committee has a diversity policy, the proxy statement must disclose how this policy is implemented and how the Nominating Committee assesses the effectiveness of the policy. The SEC did not define “diversity” because it believes that each company should be free to determine the meaning of that concept. For some companies, diversity might include differing viewpoints, professional experience, education, skills, and other individual qualities, while other companies may consider such concepts as race, gender and national origin.

4. Disclosure about Board leadership structure and risk oversight. Under the rule amendments, a company must now disclose whether and why it has chosen to combine or separate the principal executive officer and the board chairman positions, and the reasons why the company believes that this board leadership structure is the most appropriate structure given the specific characteristics or circumstances of the company. Where these two positions are combined and the Board has appointed a lead independent director, the company must also disclose whether and why the company has a lead independent director and the specific role he or she plays in the leadership of the company.
In addition to the foregoing, a company is now required to describe the Board’s role in the oversight of the company’s risk management process. The SEC’s rule is intended to give investors an understanding of how the company perceives the role of its Board and the relationship between the Board and senior management in managing the material risks facing the company. Companies have been given flexibility to describe who administers the risk oversight function, such as through the entire Board or through a committee, such as the Audit Committee. Where relevant, the SEC believes that the discussion should address whether the persons who supervise the day-to-day management responsibilities report directly to the Board as a whole or to a committee, or how the Board or committee otherwise receives information from such persons.

5. Enhanced disclosure about fees paid to compensation consultants. Current rules require companies to disclose the role that compensation consultants play in setting director and executive compensation. Under the amended rules, companies will also have to disclose the aggregate amount of all fees paid to consultants and their affiliates who provide non-executive compensation consulting services to the company, if the fees charged for the non-executive compensation consulting services exceeded $120,000 for the fiscal year. If the Board appointed the consultant, the company must also disclose whether the decision to use the consultant for non-executive compensation consulting services was made or recommended by management and whether the Board has approved these services. Where management uses its own consultant for compensation and non-compensation advice, the company need not include fee and related information for that consultant so long as the Board has its own consultant.

The SEC clarified that consulting services involving only broad-based non-discriminatory plans or the provision of information, such as surveys, that are not customized for the company, or are customized based on parameters that are not developed by the consultant, are not treated as executive compensation consulting services for purposes of the disclosure rules. For example, information regarding the form and amount of compensation typically paid to officers and directors within a particular industry would be excluded, so long as the consultant does not also provide advice or recommendations in connection with that information.

6. Mandatory Form 8-K reporting of stockholder voting results. Currently, the voting results of proposals submitted to stockholders are required to be reported in the Quarterly Report on Form 10-Q for the quarter in which the meeting was held. Under the amended rules, companies are now required to disclose these results in a new Item 5.07 of a Current Report on Form 8-K within four business days of the vote.

Proxy Disclosures for TARP Assistance Recipients

The Emergency Economic Stabilization Act of 2008 (“EESA”) requires any company that has received financial assistance under TARP to permit a separate stockholder advisory vote to approve the compensation of executive officers, as disclosed in the company’s proxy statement for its annual meeting of stockholders (or a special meeting in lieu of an annual meeting). To implement this requirement, the SEC has amended Regulation 14A under the Exchange Act by adding Rule 14a-20 and also added a new Item 20 to Schedule 14A. Pursuant to the amendment, these companies will be required to disclose in their proxy statements that they are providing a separate stockholder vote on executive compensation pursuant to the requirements of EESA, and to briefly explain that the vote is non-binding.

The SEC chose not to require any additional disclosure requirements with respect to TARP assistance, but it did remind these companies (other than smaller reporting companies, which are not subject to the CD&A requirement) that they have an obligation to consider whether the impact of TARP participation on compensation is required to be discussed in the CD&A in order to provide investors with material information that is necessary to an understanding of executive compensation.

Importantly, the SEC also amended Exchange Act Rule 14a-6 to specify that this non-binding vote is not within the class of items that triggers the need to file a preliminary proxy statement, as was the case last year.

If you have any questions about any of these changes, please call or e-mail one of the following members of the Firm’s Securities Law Practice Group:

Abba David Poliakoff, 410-576-4067, apoliakoff@gfrlaw.com

Michele L. Bresnick, 410-576-4216, mbresnick@gfrlaw.com

Andrew D. Bulgin, 410-576-4280, abulgin@gfrlaw.com