New
Form 8-K Executive Compensation Disclosures
On
September 8, 2006, the Securities and Exchange Commission
("SEC") released final rules regarding the disclosure of
executive and director compensation, related party
transactions, director independence, and various other
corporate governance matters in proxy statements and other SEC
filings (the "Compensation Rules"). This Client Alert is a
reminder that, because the Compensation Rules include
significant changes to the requirements of Form 8-K concerning
disclosure of executive compensation, and those changes are
effective for Form 8-K triggering events that occur on or
after November 7, 2006, reporting companies need to carefully
consider the effect of the changes on their current event
reporting obligations. This following is a brief summary of
the changes to Form 8-K made by the Compensation Rules, an
analysis of their implementation, and some practical
recommendations.
Summary
of Changes
Changes
to Items 1.01 (Entry into a Material Definitive Agreement) and
1.02 (Termination of a Material Definitive Agreement)
Item
1.01 of Form 8-K (Entry into a Material Definitive Agreement)
requires disclosure by an Exchange Act reporting company
within four days after entry into a "material definitive
agreement outside the ordinary course of business" or "any
material amendment to such an agreement." Similarly, Item 1.02
of Form 8-K (Termination of a Material Definitive Agreement)
requires disclosure concerning the termination of executive
compensation agreements or arrangements, and "material
definitive agreement" in Item 1.02 is defined by reference to
Item 1.01. Items 1.01 and 1.02 apply to "material definitive
agreements" generally, but the final sentence of Instruction 1
to Item 1.01 explicitly included executive compensation
arrangements in the definition of material definitive
agreement by its reference to Item 601(b)(10)(iii) of
Regulation S-K.
While
Item 1.01 was intended to elicit only those executive
compensation disclosures that were "unquestionably or
presumptively material," the SEC indicates in the final
release for the Compensation Rules that it had received many
executive compensation disclosures that fell below this
standard. Due to the perceived ambiguity as to which executive
compensation arrangements should be disclosed on Form 8-K, and
the resulting influx of disclosures that did not meet the
"unquestionably or presumptively material" standard, the
Compensation Rules uncouple Items 1.01 and 1.02 from Item
601(b)(10)(iii) of Regulation S-K. By so doing, employment
compensation arrangements are now removed entirely from Items
1.01 and 1.02 of Form 8-K.
Expansion
of Item 5.02 (Departure of Directors or Certain Officers;
Election of Directors; Appointment of Certain Officers;
Compensatory Arrangements for Certain Officers)
Instead
of treating executive compensation issues like other material
agreements under Items 1.01 and 1.02, Form 8-K now addresses
them in an expanded Item 5.02 (Departure of Directors or
Certain Officers; Election of Directors; Appointment of
Certain Officers; Compensatory Arrangements for Certain
Officers).
Named
Executive Officer.
Amended Item 5.02 incorporates the
concept of "named executive officer" from the proxy rules. The
term encompasses those persons for whom compensation
disclosure was required in the company's most recently filed
proxy statement, Form 10-K or registration statement.
New
Item 5.02(e) - Material Compensatory Plan, Contract or
Agreement.
New Item 5.02(e) requires a Form 8-K to be
filed whenever the principal executive officer, principal
financial officer, or any named executive officer participates
in a new "material compensatory plan, contract or arrangement"
with the company, or such a material compensatory plan,
contract or arrangement is "materially amended or modified."
The material compensatory plan, contract or arrangement being
established or materially amended does not have to take the
form of a written document.
Information
to be Disclosed.
All Item 5.02 disclosures are to be
made by a "brief description," which in the case of paragraph
(e) includes the terms, conditions and amounts payable to the
named executive officer. Disclosure is not to be made by the
fuller narrative disclosures required for executive
compensation in a proxy statement, Form 10-K or registration
statement. Additionally, subsection (e) mandates disclosure
whenever a "material grant or award" under an above-mentioned
material compensatory plan, contract or arrangement is made or
materially amended. However, Instruction 2 to subsection (e)
states that no disclosure is required if the grant or award
made or modified is "materially consistent" with the
previously disclosed terms of a material compensatory plan,
contract or arrangement.
Safe
Harbor for Item 5.02(e).
In March 2004, the SEC
provided a limited safe harbor from liability under Section
10(b) of the Exchange Act and Rule 10b-5 thereunder for
failure to timely file certain Form 8-K disclosures. The safe
harbor protects a company from liability for violations of the
Rule 10b-5 antifraud provisions so long as the required
disclosure is made by or on the company's filing due date for
the quarterly or annual report for the period in question. The
disclosure must be made in the 10-Q or 10-K covering the
period in which the disclosure should have occurred or in a
separate Form 8-K. The Compensation Rules extend this safe
harbor to disclosures made in accordance with Form 8-K Item
5.02(e).
Additionally,
a company can forfeit its eligibility to use the Form S-3 if
it fails to timely file all reports required under the
Exchange Act during the 12 months prior to the filing of the
registration statement. Under the Compensation Rules, a safe
harbor for Form S-3 eligibility also applies to Item 5.02(e)
so long as the disclosure is made by or on the company's
filing due date for the quarterly or annual report for the
relevant period.
Safe
Harbors Apply to Item 5.02(e) Only.
The safe harbors
for antifraud liability and Form S-3 eligibility apply only to
Item 5.02(e) and not to any of the other disclosures required
by new Item 5.02.
Revised
Item 5.02(b) - Resignation, Retirement or
Termination.
The Compensation Rules amend Item 5.02(b)
to require Form 8-K disclosure upon the retirement,
resignation or termination of a company's (1) principal
executive officer, (2) president, (3) principal financial
officer, (4) principal accounting officer, (5) principal
operating officer, (6) any other person performing similar
functions, or (7) a named executive officer. The disclosure
need only be a brief description of the fact that the event
occurred and the date of the event.
Revised
Item 5.02(c) - Appointment of Officers.
Under the old
rules, Item 5.02(c) required disclosure by way of a brief
description of the material terms of any employment agreement
between the company and the (1) principal executive officer,
(2) president, (3) principal financial officer, (4) principal
accounting officer, (5) principal operating officer, or (6)
any other person performing similar functions. Under amended
Item 5.02(c), the disclosure must now include, similar to Item
5.02(e), a brief description of any "grant or award,"
"material plan, contract or arrangement," or any modification
thereto, to which any of the above parties is a participant.
However, the new Item 5.02(c) does not contain an instruction,
such as with Item 5.02(e), removing the disclosure requirement
for grants or awards "materially consistent" with previously
disclosed terms.
Revised
Item 5.02(d) - Appointment of Directors.
Under the old
rules, Item 5.02(d) required certain disclosures whenever the
company appointed a director other than by a vote of security
holders at an annual meeting or special meeting convened for
that purpose. Under the new amended Item 5.02(d), the company
must briefly describe any "grant or award," "material plan,
contract or arrangement," or any modification thereto, to
which the director is a participant. As with Item 5.02(c),
Item 5.02(d) does not contain an instruction removing the
disclosure requirement for grants or awards "materially
consistent" with previously disclosed terms.
New
Item 5.02(f) - Previously Omitted Salary and Bonus
Disclosures.
New Item 5.02(f) requires disclosure of a
named executive officer's salary or bonus, which was omitted
from the Summary Compensation Table because it was not
available when the company filed its last proxy or annual
report, when the salary or bonus becomes calculable. The Form
8-K disclosure must also include the named executive officer's
newly calculated total compensation figure. There is no
distinction between cash or equity based plans when
considering the need for disclosure.
General
Instruction D.
Under the old rules, General
Instruction D allowed a company to file a single Form 8-K to
satisfy one or more disclosure items so long as the company
identified by item number and heading all of the applicable
items being satisfied and provided all of the substantive
disclosures required by each of the items. The Compensation
Rules liberalize General Instruction D to provide that a Form
8-K filing may omit the Item 1.01 heading if multiple items in
addition to 1.01 are applicable, assuming all of the
substantive disclosures required under Item 1.01 are satisfied
under another heading.
Analysis
The
Compensation Rules intend to improve upon the disclosure
requirements under Form 8-K Items 1.01 and 1.02 by
concentrating the executive compensation provisions in Item
5.02 and clarifying which agreements satisfy the standard of
"unquestionably or presumptively material." However, the
Compensation Rules simply seem to have perpetuated some
ambiguity under the new formulation of "material compensatory
plan, contract or arrangement." While this formulation
improves on the old one by removing the "outside the ordinary
course of business" concept, it does little to address the
uncertainty of what satisfies the "unquestionably or
presumptively material" standard. As a result, companies must
still evaluate the materiality of a compensation plan,
contract or agreement on a case-by-case basis.
Similarly,
the Compensation Rules provide little guidance as to which
awards or grants will escape the disclosure requirements of
5.02(e) because they are "materially consistent" with
previously disclosed terms and therefore exempted by
Instruction 2. Apparently, Instruction 2 intends to limit the
application of 5.02(e) to only those awards or grants that are
new or significantly different than those previously
disclosed. While the Instruction aims to alleviate the burden
on companies by eliminating disclosure for slight
modifications in awards or grants, the ambiguity of the
"materially consistent" standard removes the burden only for
truly de minimis modifications.
Practical
Recommendations
In
order to comply with the Compensation Rules for executive
compensation disclosures under Form 8-K, public company
management may wish to consider some or all of the following
actions:
- Review
existing executive compensation arrangements with your
directors and named executive officers to determine if any
aspects not yet disclosed are subject to the amended Form
8-K.
- Prior
to filing any quarterly or annual report, specifically
consider whether any Item 5.02(e) disclosures should have
been made during the preceding quarter. Failure to make any
such disclosures could endanger the safe harbors for
antifraud liability and Form S-3 eligibility that could
otherwise have been preserved.
- Modify
the design of your disclosure controls and procedures so
that the trigger events for Item 5.02(b), (c) or (d), such
as the hiring, promotion, termination, resignation, or
retirement of any employee that has been or may be
considered a named executive officer or director, will
immediately elicit consideration of whether a Form 8-K
disclosure is required. The 4-day window is short and could
lapse unless the disclosure inquiry receives immediate
attention.
- When
a triggering event for Item 5.02(b), (c) or (d) disclosure
occurs and it is unclear whether a modification to an award
or grant is materially consistent with a prior disclosure,
establish a policy of protecting your interests by filing a
Form 8-K disclosure within 4 days of the triggering event.
- Modify
your disclosure controls and procedures to provide that the
appropriate company officer has an updated list of those
officers and directors for whom any compensation change
could potentially necessitate a Form 8-K disclosure.
The
text of the final rules is available at http://www.sec.gov/rules/final/2006/33-8732afr.pdf.
The
DGS Corporate Finance & Acquisitions Group has worked
extensively with boards and audit committees to work through
difficult disclosure and financial reporting issues, and would
be happy to consult with you on your needs in this
particularly uncertain regulatory environment.
This
article has been prepared for informational purposes on
matters of public interest, and it is not to be construed as
legal advice or opinion. Davis Graham & Stubbs LLP
provides such advice or opinion only after being engaged to do
so with respect to particular facts and circumstances. Receipt
of this article should not be considered to create an
attorney-client privilege relationship. Readers should consult
counsel regarding any course of action in connection with the
subject of this article. | 
