Lawyer Article

In late December 2006, the Securities and Exchange Commission announced that it had amended its new executive compensation and director disclosure rules to more closely conform the disclosure of stock and option awards to applicable accounting standards for financial statement reporting.¹ The amendments (the "Amendments") are intended to provide investors with a better view of the compensation earned by an executive officer or director during a particular reporting period (i.e., the requisite service period, as opposed to the full grant date fair value), and thus to be more aligned with the disclosure required for other forms of compensation in the Summary Compensation Table and the principles underlying financial statement disclosures. The Amendments, which were adopted in the form of interim final rules, are effective for the upcoming 2007 proxy season, so public companies should immediately begin considering their effect on required disclosures.

In July 2006, the SEC adopted enhanced executive and director compensation, corporate governance and related person transaction disclosure requirements for proxy statements, registration statements and annual reports filed by public companies (the "July 2006 Rules").² Under the July 2006 Rules, a dollar value for all equity awards is required to be disclosed in the Summary Compensation Table, with the valuation based on the aggregate grant date fair value of the awards computed in accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment ("FAS 123R"), without regard to the effect of any service or vesting requirements. As a result of the Amendments, however, the Summary Compensation Table and Director Compensation Table will now be required to disclose the compensation cost of equity awards over the requisite service period (generally, the vesting period), as required under FAS 123R.³

The Amendments also modify the Grant of Plan-Based Awards Table to (i) add a new column showing, on a grant-by-grant basis, the full grant date fair value of awards computed in accordance with FAS 123R (thus retaining -- albeit in a different table -- the aggregate grant date fair value disclosure requirement from the July 2006 Rules), and (ii) require disclosure regarding any options, stock appreciation rights or similar option-like instruments that are repriced or materially modified, including disclosure regarding the incremental fair value computed as of the repricing or modification date as determined in accordance with FAS 123R. Finally, the Director Compensation Table has also been revised to (i) require footnote disclosure of the grant date fair value of each equity award, as computed in accordance with FAS 123R, and (ii) include footnote information regarding any repriced or materially modified options, SARs or similar option-like instruments (including disclosure of the incremental fair value of the award).

The compensation cost disclosed in the Summary Compensation Table for stock awards will not include an estimate of forfeitures related to service-based vesting, but, if the named executive officer (or "NEO") forfeits the award, the amount of compensation cost previously disclosed in the table will be deducted in the period during which the award is forfeited. Similar adjustments will be required for performance-based vesting conditions, if, for instance, achievement of the performance goal was probable at the grant date, but ceases to be probable at a later date. These adjustments could, in some cases, result in a negative figure for the column, which would, in turn, affect the NEO's total compensation tally. Companies will need to implement appropriate recordkeeping procedures to reflect these adjustments.

Companies also will need to assess the impact of the Amendments on identification of NEOs. For instance, an executive who was granted a large equity award with vesting components may currently be identified as an NEO based on the aggregate grant date fair value of the award (applying the July 2006 Rules). However, under the Amendments, the executive may not rise to the NEO level based on the fact that the dollar value of his equity award would be reduced to only include the proportionate amount of the award’s total fair value that will be recognized in the company’s financial statements for the fiscal year. Companies also will need to consider the effect of the Amendments not only on disclosures in the Summary Compensation Table, Grant of Plan-Based Awards Table and Director Compensation Table, but also in the Compensation Discussion and Analysis.

The Amendments were effective as of December 29, 2006. However, the SEC did establish a 30-day comment period for the Amendments, so it is possible that additional modifications to the Amendments may be made. Nonetheless, the Amendments are effective for proxy statements, registration statements and annual reports on Form 10-K that relate to Regulation S-K Item 402 and Item 404 disclosures for fiscal years ending on or after December 15, 2006. As a result, public companies should take action now to analyze the impact of the Amendments on their reporting and disclosure obligations.

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¹ The SEC press release regarding the amendments may be found at http://www.sec.gov/news/press/2006/2006-219.htm. The SEC’s interim final rules, Executive Compensation Disclosure, Release No. 33-8765 (December 22, 2006), may be found at http://www.sec.gov/rules/final/2006/33-8765.pdf.

² See Executive Compensation and Related Person Disclosure, Release No. 33-8732A (August 29, 2006), which can be found at http://www.sec.gov/rules/final/2006/33-8732a.pdf. Our client alert regarding the July 2006 Rules can be found at http://www.wcsr.com/resources/pdfs/cs083006.pdf.

³ FAS 123R defines a requisite service period as the period or periods over which an employee is required to provide service in exchange for a share-based payment. Under FAS 123R, although compensation cost is initially measured based on the award’s grant date fair value, it is generally recognized for financial reporting purposes over the requisite service period.