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A brief on the SEC's new rules.

Many changes for the better were made last fall when the Securities and Exchange Commission adopted its new executive compensation rules. Compensation data will now be presented in a standard, coherent fashion, and all sources of compensation will have to be disclosed. However, other significant changes to the executive compensation rules are likely to affect the process itself and may impel boards to rethink the way executives are rewarded.

The most controversial step taken by the SEC is its new requirement that a report of the board's compensation committee be included in all proxy and information statements relating to annual or special meetings at which directors are to be elected. The report must discuss the factors and criteria upon which the chief executive officer's compensation for the last fiscal year was based, including a discussion of the specific relationship of corporate performance to compensation.

The report must also address the compensation committee's policies applicable to the company's other executive officers, both in general terms and specifically as those policies relate to corporate performance.

In addressing the factors and criteria affecting compensation decisions, both qualitative and quantitative measures considered by the compensation committee must be described. Specific factors on which compensation was based - such as sales, earnings, or return on capital or assets - must be identified. However, specific benchmarks or target levels for performance do not have to be reported nor do any criteria involving confidential commercial or business information where disclosure would have an adverse effect on the company.

Over the Names

The compensation committee's report must appear over the names of each member of the compensation committee or, if the board does not have a compensation committee, over the names of each member of the board of directors. If the board materially modifies or rejects any action or recommendation of its compensation committee, the report must disclose that fact, explain the reasons for the board's actions, and appear over the names of all members of the board.

Although not a part of the compensation committee's report, the SEC has also adopted a requirement that companies present, along with the report, a "performance graph" comparing the company's five-year total return to common shareholders with the total return of a broad equity market index and either a published industry index or a company-chosen peer index. The requirement is intended to serve as a basis for shareholders to assess executive compensation decisions in the context of corporate performance.

In addition to disclosure of how compensation decisions were made, the SEC has adopted rules requiring disclosure of who made the decisions. Companies must now disclose the identity of any compensation committee member who:

(1) was an officer of the company or any of its subsidiaries during the last fiscal year;

(2) was formerly an officer of the company or any of its subsidiaries; or

(3) had any relationship required to be disclosed under Item 404 of Regulation S-K. Item 404 requires disclosure of certain "related party" relationships, such as transactions in excess of $60,000, supplier relationships, loans to or from the company or its subsidiaries, and the provision of legal, investment banking, or other professional services.

For each person identified as having a disclosable "related party" relationship, the specifics of each relationship must be discussed.

Director interlocks must also be disclosed under the new rules. A disclosable interlock exists if, during the last completed fiscal year, an executive officer of the company served on the board of another company and an executive officer of the other company served on the board of the company and either one or both of those executive officers was on the compensation committee of the other. "Related party" disclosure under Item 404 is required for any executive officer of the other company who served on the company's board and who is named under the interlock disclosure requirement.

The new rules relating to the compensation committee report, performance graph, and insider and interlock disclosure apply to all companies other than those qualifying as "small business issuers" (generally, companies with less than $25 million in revenue and public float). Proxy and information statements filed on or after January 1, 1993, are required to comply with these rules, as are those for companies whose current fiscal year ends on or after December 15, 1992, regardless of when filed.

In the one significant area discussed earlier where planning may eliminate the need for disclosure, insider membership and interlocks on compensation committees need only be disclosed as to director relationships existing on or after January 1, 1993.

The SEC has stated that these requirements do not impose new fiduciary standards on directors and are not intended to disrupt compensation committee discussions or require disclosure of each individual's reasons or motivations for supporting the committee's actions or recommendations. The new disclosure items are not intended to provide a basis for a shareholder challenge to executive compensation decisions.

Nonetheless, the new rules will bring into sharp focus the process by which executive compensation decisions are made and will affect the way thoughtful compensation committees and boards go about their business in the future.
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Author:Schwartz, Michael A.
Publication:Directors & Boards
Date:Jan 1, 1993
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