the sec’s new executive compensation rules or what is a pfo and why should i care? fei briefing

Christopher McGeeWashington, DC

The SEC’s New Executive Compensation Rules orWhat is a PFO and Why Should I Care?

FEI Briefing

October 17, 2006

Mercer Human Resource Consulting 2

The Process and the Substance of Compensation Disclosure Have Changed

Full disclosure means full disclosure

– Not business as usual!

– “All compensation, earned or paid, from all sources, for all services.”

Each public company must implement a coordinated information gathering and analysis effort

The Compensation Committee must participate in the effort at each stage


The New Rules Have Made Fundamental Changes to the Substance of Compensation Disclosure

Full Disclosure Principle

Plain English

Significant Changes to Summary Compensation Table

New Disclosure Tables and Accompanying Narrative Disclosure

Compensation Discussion & Analysis

Related Person Transaction Disclosure Changes

Form 8-K Changes

What is Different?


Named Executive Officers

Anyone who at any time during the previous fiscal year served as:

– Principal executive officer (PEO)

– Principal financial officer (PFO)

Three most highly-compensated executive officers (other than PEO and PFO) who were serving as executive officers as of the last day of the previous fiscal year

– Based on total compensation excluding pension values and NQDC earnings

– Officer is not an NEO if his or her total compensation does not exceed $100,000

Up to two additional individuals who would have been in the top three except they were no longer serving as executive officers at end of last fiscal year


Summary Compensation Table Changes

The Summary Compensation Tables have been materially changed in both form and substance (see sample table in Appendix).

Data that has been historically included (Base, Bonus, LTI) will still be included but with changed methodologies for reporting:

– Bonuses will be split between guaranteed and performance based

– LTI will split equity grants and option (or option like) awards and the valuation of the awards is to mirror the expensed value (i.e. Black Scholes) for equity.

Definition of Perquisites reduced to $10k and will also include “all other forms of compensation”

Additional data will be required that has never been required. Includes the change in value of Pension benefits and the increase in excess of market returns, on deferred compensation.


New Supplemental Tables

There are 6 new tables that are required for all filers. Details for each table and the associated narratives are included in the Appendix.

The 6 new tables are:

Grants of Plan-Based Awards Table

Outstanding Equity Awards at Fiscal Year-End Table

Option Exercise and Stock Vested Table

Pension Benefits Table

Nonqualified Deferred Compensation Table

Director Compensation Table


Narratives

The rules require Narratives to accompany all tables. Details on the required narratives for each table are included in the appendix.

The key theme of the narrative requirements are that they must explain in sufficient detail:

Foundation for Salary and relative target to market

All methodologies, metrics and outcomes that drive awards of bonuses and LTI awards.

Rationale for benefits and perquisites.


Potential Payments upon Termination of Employment or Change-in-Control Summary

.The description (no table required) must include the following detail:– Specific circumstances that would trigger payment or other benefits

– Estimated payments and benefits that would be provided in each covered circumstance, whether it would or could be in lump sum or annual, disclosing the duration and by whom it would be provided

– Factors used to determine appropriate payment and benefit levels

– Any material conditions or obligations applicable to receipt of payments or benefits

– Quantification of the benefits and payments in each covered circumstance (even if uncertainties exist), calculated by applying the following assumptions:

The triggering event took place on the last business day of the last fiscal year

The price per share of the company’s securities is the closing market price as of that date


Compensation Disclosure and Analysis

Replaces Board Compensation Committee Report (see appendix for more detail)

– Considered “filed” with, rather than “furnished” to, the SEC

– See new Compensation Committee Report requirement

Intended to provide overview of executive compensation program

– Summary of each program element

– Context for tabular and supplemental narrative disclosure

Company presentation – of compensation committee’s views of executive compensation program

Focus in on “analysis” of compensation policies and decisions

– Less a recitation of the facts and more an explanation of what is actually going on


New Compensation Committee Report

New Compensation Committee Report

– Presented over names of compensation committee members

– Intended to ensure committee is actively involved in preparing CD&A

– Resembles current Audit Committee Report that is required in proxy statement

Must state that committee has reviewed and discussed CD&A with management and recommended that report be included in proxy statement and annual report on Form 10-K

– Unlike CD&A, considered “furnished” to SEC, so does not carry liability implications of CD&A


New Compensation Committee Report (continued)

Separate narrative disclosure regarding compensation committee structure and operation

– Comparable to current audit and nominating committee disclosure

Specific disclosure related to executive and director compensation:

– Scope of committee’s authority

– Extent of ability to delegate authority

– Charter (must provide website link or attach to proxy statement every three years)

– Role of any executive officers in determining or recommending executive or director compensation

– Role of consultant in determining or recommending executive or director compensation, identifying consultant, stating whether engaged by committee, and describing nature of assignment and material instructions

Appendix


Changes to Summary Compensation Table

Name & Principal Position

YearSalary

($)Bonus

($)

Stock Awards

($)

Option Awards

($)

Non-Equity Incentive Plan

Compen-sation

($)

Change in Pension

Value and NQDC

Earnings($)

All Other Compen-

sation($)

Total($)

PEO

PFO

A

B

C

Summary Compensation Table(values in 000s)

• Represents total of all other columns in table• Total excluding pension values and NQDC

earnings determines officers to include

• All compensation disclosed in dollars ($)

• Stock-related awards in year grant made that derive value from equity value, without option-like features

• Valuation based on grant date fair value (FAS 123R)• Include awards with performance-based conditions• Earnings not disclosable if factored into fair value

• Stock-related awards with option-like features

• Valuation based on grant date fair value (FAS 123R)

• Value of all other incentive awards earned in fiscal year (includes most annual incentives)

• Awards where performance measure(s) not share price and not settled in equity

• Grant details covered in supplemental table

• Annual change in actuarial present value of accumulated defined benefit pension plans (including unvested benefits)

• Above-market or preferential earnings on nonqualified deferred compensation

• Only includes discretionary and guaranteed amounts


SCT – All Other Compensation

“All Other Compensation” column will include:– Perquisites and other personal benefits– Tax “gross-ups” and reimbursements– Discount stock purchases (unless arrangement is broadly

available)– Amounts paid or accrued under severance and change-in-control

arrangements– Company contributions to defined contribution plans (but not

earnings)– Value of insurance premiums paid by company for NEO life

insurance– Dollar value of dividends or earnings not factored into award fair

value


SCT – All Other Compensation – Perquisites

Perquisite disclosure requirements

– If aggregate value is $10,000 or more, must disclose/identify each perquisite

– If individual perquisite has value in excess of greater of $25,000 or 10% of total perquisites, must quantify and disclose value

“Perquisites” not defined - instead apply two-step analytical framework:

– An item is not a perquisite if it is “integrally and directly related to the performance of the executive’s duties”

– Doesn’t cover items that merely facilitate job performance

– An item is a perquisite if it confers a “direct or indirect benefit that has a personal aspect,” without regard to whether it may be provided for some business reason or for the convenience of the company

– Item not covered if generally available on a non-discriminatory basis to all employees


SCT – Narrative Disclosure

Following the tabular disclosure, a company must provide a narrative description of any material factors necessary to understand the information disclosed in the table, for example:

– A description of the material terms in the NEOs’ employment agreements

– Disclosure of repricings or other material modifications of outstanding awards

– An explanation of the amount of salary and bonus in proportion to total compensation


Grants of Plan-Based Awards Table

Name Grant Date

Estimated Future Payouts Under Non-Equity Incentive Plan Awards

Estimated Future Payouts Under Equity Incentive Plan Awards All Other

Stock Awards:

Number of Shares of

Stock or Units (#)

All Other Option Awards: Number

of Securities Underlying

Options (#)

Exercise or Base Price of

Option Awards ($/Sh)Threshold

($)Target

($)Maximum

($)Threshold

(#)Target

(#)Maximum

(#)

PEO

PFO

A

B

C

Grants of Plan-Based Awards

• Grants made during last completed fiscal year• Estimated future payouts for both equity and non-equity

incentive plans• Separate disclosure for each award

• If the award provides only for a single estimated payout, that amount should be reported as target

• If the per-share exercise price of options is less than closing market price on grant date, additional column required showing closing market price on grant date; must also add footnote explaining pricing methodology

• Additional “Approval Date” column required if differs from grant date


Plan – Based Awards Narrative

The narrative disclosure following this table must describe the terms of the disclosed awards, for example:

– a general description of the formula or criteria to be applied in determining the amounts payable

– Vesting schedule

– Performance-based conditions


Name

Option Awards Stock Awards

Number of Securities Underlying

Unexercised Options(# Exer)


Unexercised Options

(# Unexer)

Equity Incentive Plan Awards:


Unexercised Unearned Options

(#)

Option Exercise Price

($)

Option Expiration

Date

Number of Shares or Units of

Stock That Have Not Vested

(#)

Market Value of

Shares or Units of

Stock That Have Not Vested

($)

Equity Incentive Plan Awards:

Number of Unearned Shares,

Units or Other Rights That Have

Not Vested(#)

Equity Incentive Plan Awards: Market or

Payout Value of Unearned Shares, Units

or Other Rights That Have Not Vested

($)

PEO

PFO

A

B

C

Outstanding Equity Awards at Fiscal Year-End

Outstanding Equity Awards at Fiscal Year-End Table

• All outstanding grants at fiscal year end• Grant-by grant disclosure for each option• Unrealized option gain no longer disclosed

• Based on achieving threshold performance unless prior year’s performance was higher

• Vesting dates disclosed in footnote• Individual exercise price and

expiration dates must be provided for each award


Option Exercise and Stock Vested Table

Name & Principal Position

Option Awards Stock Awards

Number of Shares Acquired on Exercise

(#)

Value Realized on Exercise

($)

Number of Shares Acquired on Vesting

(#)

Value Realized on Vesting($)

PEO

PFO

A

B

C

Option Exercises and Stock Vested

• Number of shares acquired through exercise (options) or vesting (stock)

• Value realized at time of exercise (spread) or vesting (share price)


Pension Benefits Table

Name Plan NameNumber of Years Credited

Service(#)

Present Value of Accumulated Benefit

($)

Payments During Last Fiscal Year

($)

PEO

PFO

A

B

C

Pension Benefits

• Separate disclosure for each plan• Plans include: tax qualified defined benefit plans, SERPs, cash

balance plans• Excludes defined contribution plans (next table)

• Replaces current Pension Plan Table

• Actuarial present value of accumulated benefit under the plan

• Retirement age assumed to be “normal” age as defined in the plan, or earliest unreduced age if none

• Must add footnote if credited service and actual years of service differ, and quantify difference and resulting benefit augmentation


Name

Executive Contributions in

Last FY($)

Registrant Contributions in

Last FY($)

Aggregate Earnings in

Last FY($)

Aggregate Withdrawals / Distributions

($)

Aggregate Balance at Last FYE

($)

PEO

PFO

A

B

C

Nonqualified Deferred Compensation

• Disclosure of all earnings (vs. only when earned and above market) on deferred compensation, that is not tax-qualified

• Must disclose in footnote contributions, earnings, and balance amounts previously disclosed in Summary Compensation Table

Nonqualified Deferred Compensation Table


Deferred Compensation Narrative

The company must disclose all material factors necessary to understand table, including:

– types of compensation permitted to be deferred and any deferral limitations

– the measures of calculating interest or other plan earnings

– material terms with respect to payouts, withdrawals and other distributions


Director Compensation Table

NameFees Earned or Paid in Cash

($)

Stock Awards

($)

Option Awards

($)

Non-Equity Incentive Plan Compensation

($)

Change in Pension Value

and NQDC Earnings

($)

All Other Compensation

($)Total

($)

A

B

C

D

E

Director Compensation

• Grouping of multiple directors in a single row permitted, as long as all of their elements and amounts of compensation are identical

• Formatted tabular disclosure now required, in light of growing complexity of director compensation programs

• Pension values and nonqualified deferred compensation earnings disclosed in separate column

• All other, including:- Perquisites and

personal benefits

- Consulting fees- Director legacy

programs


Director Compensation Narrative

Additional material information necessary to understand tabular information

Perquisite disclosure required only if value of benefits is $10,000 or more


Principles-based disclosure

– CD&A must discuss six specific items: Program objectives Behaviors that program is designed to reward Each element of compensation Rationale for each element Methodology (including formula) used to determine amount for each

element How each element and decisions regarding that element fit into overall

compensation objectives and affect decisions regarding other elements

– Must also discuss any other material information that is necessary to an investor’s understanding of the executive compensation program

Rules include examples of other potentially material matters to be discussed




CD&A will be considered “filed” with, rather than “furnished” to, the SEC

– Subject to full liability under the federal securities laws May be included in Securities Act registration statements Will be included in annual report on Form 10-K and possibly

other Exchange Act reports

– Also subject to CEO/CFO certification requirements when included in annual report on Form 10-K

CEO and CFO must formally attest to report’s accuracy and completeness



Discussion of performance-based compensation

– Must address specifics of performance-based compensation Specific items of corporate performance used in program How specific forms of pay are structured to reflect corporate

and/or individual performance

– Need not disclose target measures/levels if: Involves trade secrets Involves confidential commercial or financial information, the

disclosure of which would cause competitive harm for company Standard for determining competitive harm is whether company

could receive confidential treatment of information from SEC



New discussion of stock option grant practices– Responds to stock option backdating controversy– Must address how determination is made as to when awards are granted,

including equity-based compensation such as options– Must also address option compensation, particularly timing and pricing of

option grants, including Why the company selects particular dates for granting awards How option terms and conditions are established, such as how

exercise prices are determined Whether company has program or practice to coordinate timing of

grants with release of material, nonpublic information and, if so, scope and nature of arrangement

– Disclosure is in addition to new Grants of Plan-Based Awards Table that includes information about grant dates, grant date share prices and exercise prices



Other issues

– Explaining the compensation-setting process Should address in manner that emphasizes rationale for each

pay element in context of total compensation Use of compensation tools Peer groups and benchmarking Time period covered

– Discussing compensation of each named executive officer

– Integration with existing disclosure controls and procedures



Preparing the CD&A:

– Management will prepare draft report A multi-disciplinary exercise involving executives, directors, HR, legal,

others

– Compensation committee will review draft report and provide input

– CEO and CFO must certify contents of report as included in annual report on Form 10-K

– New Compensation Committee Report will comprise part of due diligence process

– Need to coordinate with filing of annual report on Form 10-K

the sec’s new executive compensation rules or what is a pfo and why should i care? fei briefing

Documents

total compensation

new tables

awards of bonuses

required narratives

compensated executive

changedfull disclosure

equity grants

sample table