Coming to Grips With the New SEC Compensation and Governance Rules – What Management, Directors and Compensation Committees Should Be Doing Now

In late July, the SEC re-wrote the rule book for public companies in the areas of executive compensation and related party transactions and made significant changes relating to corporate governance. Next year's proxy statement will look very different from the last.

This alert summarizes the key steps we believe that management, directors, and compensation committee members should focus on while there is still an opportunity to take actions that could make the transition to the new rules less difficult. A summary of the new rules will be provided separately to clients. In addition, we will be sending a separate alert focusing on the SEC's changes to the disclosure requirements on Form 8-K.

What Management Should Be Doing

• Dedicate sufficient resources for the next annual disclosure cycle. The process this year will be more expensive and require significant input from third parties - compensation consultants, actuaries, outside counsel and others. (Section 404 of Sarbanes-Oxley (internal controls) is a legitimate point of comparison.) Hopefully, a significant portion of this expense will be on a one-time basis.
• Identify all members of the internal working group who should participate. The next proxy statement is likely to require active participation from finance and human resource personnel and disclosure committee members who may not have been involved last year as well as accounting (include your FAS123(R) expert) and senior management.
• Identify the executives who are likely to be Named Executive Officers (NEOs) using the new criteria for "total compensation."
• Determine whether you may have a highly paid non-executive officer who makes significant business decisions so you can respond quickly if the SEC adopts the latest version of the "Katie Couric rule."
• Prepare mock-ups of key tables using last year's data as soon as possible. This is the single best means of seeing what you need but don't have at present.
• Review and revise your disclosure controls and procedures and, if separate, Form 8-K reporting policies.
• Prepare a timeline for the board of directors showing the process in some detail with specific responsibilities assigned to specific plans and persons.
• If you haven't done so already, conduct an internal review of your option grant practices and be prepared to explain them in the proxy statement next year. Don't take the risk that the auditors will raise an issue about this before delivering their opinion.
• Understand what types of benefits, for both executives and directors, may be considered "perquisites" and put a system in place to track all such benefits.The SEC provided more specific guidance on what constitutes a perk and companies will need to reconsider various perks in light of such guidance and public perception.

What Directors Should Be Doing

• Be prepared to spend significantly more time this year in answering the company's requests for information. The directors and officers questionnaire will be more extensive, and the company will need greater detail regarding related person transactions and your stock ownership.
• Review the charters of all standing Board committees, corporate governance guidelines and codes of business conduct for appropriate revision.
• Consider beefing up your current, or adopting a new, related party transactions policy. Although virtually all public companies have a procedure for conflict of interest transactions, that policy should be reviewed in view of the changes in this area, including the need to make detailed disclosure of those policies and how the company applied them.
• Consider revising or adopting new categorical standards of independence for board members.
• Hold management to their timeline.

What Compensation Committees Should Be Doing

• Understand and evaluate the committee's use of compensation consultants and relationships with the company or management.
• Review the table mock-ups as soon as they are available, paying particular attention to new disclosures regarding pension benefits, non-qualified deferred compensation and estimated payments for change in control scenarios. If necessary, consider changing these arrangements before year end.
• Review all employment agreements with NEOs and plans for consistency – consider amending them to employ identical definitions for key terms such as "cause" or "good reason" and the mechanics of termination. This should greatly simplify the tabular presentation and narrative description of severance arrangements.
• Consider having a member of the company's disclosure committee or outside disclosure advisor participate in key compensation committee meetings for the purpose of making certain that justifications of compensation decisions are agreed upon and disclosed appropriately.
• Approve all compensation arrangements for all executive officers, not just NEOs.
• Coordinate the drafting and review of the compensation discussion and analysis (CD&A) with management. The CEO and CFO will have to certify the accuracy of the CD&A at the time of filing the annual report on Form 10-K (even though CD&A will be contained in the proxy statement that has not yet been filed).
• Examine all components of the NEOs' compensation. Each component and amount of such compensation will need to be justified in the proxy statement. Just because a certain type or level of compensation fit with the company's executive compensation objectives five years, or even one year, ago or was necessary to attract an executive does not mean that it is still justifiable.
• Eliminate or amend any compensation arrangements or perquisites that could create the perception of over-reaching or greed. One example is ending dividend accruals on unvested shares of restricted stock or restricted stock units.
• Evaluate and possibly amend all retirement arrangements with NEOs on an executive-by-executive basis, taking into account accumulated wealth opportunities and expected corporate benefits from such arrangements.
• When setting new performance targets for bonus and incentive plans, understand that the specific targets may need to be disclosed unless the company can meet the SEC's strict standard for confidential treatment. Even if the standard can be met and the specific targets are not disclosed, the company will still need to disclose how difficult it will be for the undisclosed target levels to be satisfied.