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For the 2005 proxy season, the Securities and Exchange Commission ("SEC") has increased its focus on what it views as an historical departure from generally required standards of disclosure of executive compensation among public companies. In August 2004, the SEC adopted new Form 8-K rules that significantly affect how and when public companies report material definitive agreements, including agreements related to compensation. The SEC executive compensation disclosure rules require the clear disclosure of all plan and non-plan compensation paid to the company’s executive officers and directors. This disclosure must be included in the annual proxy statement or in periodic reports pursuant to the Securities Exchange Act of 1934, or in both places. In addition, certain compensation arrangements must be disclosed on Form 8‑K. In addition to disclosure of specific line items required by the SEC’s rules, the company must disclose all payments and other compensation information, the omission of which would make the overall disclosures "materially misleading."
On November 23, 2004, the SEC’s Division of Corporation Finance published Frequently Asked Questions ("FAQs") interpreting the new Form 8-K rules. In addition, in various speeches during 2004 and January 2005, Alan Beller, the Director of the Division of Corporation Finance at the SEC, asserted that current SEC rules, as written, already require "clear, concise and understandable disclosure of all plan and non-plan compensation awarded to, earned by, or paid to the named executive officers … and directors … by any person for all services rendered in all capacities to the registrant and its subsidiaries, unless otherwise specified…."
In light of the FAQs, informal commentary by the SEC staff (the "Staff"), the public positions recently taken by Mr. Beller, as well as the general trend of heightened scrutiny regarding executive compensation disclosure, public companies should closely examine and adjust (if necessary) their executive compensation disclosure practices. This is a rapidly changing and uncertain area. Described below are the best practices that should be followed in taking a conservative approach to what SEC policy currently requires in this area.
Form 8-K Disclosure Obligations Relating to Executive Compensation
Executive Employment Agreements. Item 1.01 of the new Form 8-K requires disclosure of the company’s entry into material definitive agreements or material amendments to existing material agreements within four business days thereof. A "material definitive agreement" for purposes of Form 8-K includes any agreement which is required to be filed as an exhibit to the registrant’s reports on Form 10-Q or Form 10-K pursuant to Item 601(b)(10) of Regulation S-K.
Bonuses and Bonus Plans. Bonus arrangements and bonus plans constitute "compensatory plans" for purposes of the new Form 8-K rules, and must be disclosed on Form 8-K within four business days of the establishment of the plan, or if there is no formal "plan," the establishment of the criteria upon which a company will determine bonuses for its executives. If a bonus arrangement or plan contains fixed criteria (such as a formula based on certain performance metrics), and bonuses are paid out in accordance with such pre-determined criteria, the actual payment of bonuses will not trigger another Form 8-K filing. If, however, the registrant (through its compensation committee or the board of directors) exercises discretion in determining bonuses notwithstanding formally articulated criteria, then the payment of such discretionary bonuses will trigger a new Form 8-K filing.
Accordingly, when a company’s compensation committee establishes bonus criteria and determines material bonuses, a Form 8-K should be filed within four business days after the meeting at which the material bonuses were determined and criteria established. If at a later date the actual payout of material bonuses is not in accordance with the established criteria (and made at the discretion of the board or compensation committee), the material payout would also trigger a new Form 8-K filing.
Consequences of Failure to File. In the past, a registrant’s failure to file a required Form 8-K resulted in loss of the registrant’s eligibility to use Form S-3 for follow-on financings, loss of eligibility to rely on Rule 144 for resale of securities, and actual or potential securities fraud liability under Section 10(b) and Rule 10b-5. Under the new Form 8-K rules, which have substantially increased the number and scope of events reportable on Form 8-K, as an accommodation, the SEC also instituted a safe harbor for registrants with respect to certain items on Form 8-K (the "Safe Harbor").
Safe Harbor Covers Item 1.01. The Safe Harbor provides that registrants will not lose S-3 eligibility, Rule 144 eligibility, or incur securities fraud liability under Section 10(b) or Rule 10b-5 solely because of a failure to timely file a Form 8-K to report certain categories of events, provided that the information that should have been disclosed on Form 8-K is reported in the Form 10-Q or Form 10-K periodic report relating to the period in which the event occurred. For instance, the Safe Harbor does not cover a failure to timely file a Form 8-K to report the departure or appointment of a new officer under Item 5.02. However, the Safe Harbor does cover a failure to timely file a Form 8-K to report entry into a material definitive agreement (including bonus plans and establishment of bonus criteria) or a material amendment of a material agreement (including executive salary increases).
Background and Definition of Perquisites. The SEC has historically been disinclined to provide guidance to registrants as to what constitutes a "perquisite." Recent enforcement actions by the SEC toward the end of 2004, however, indicate that perquisite disclosure is now under increased regulatory scrutiny.[fn3] In speeches delivered in October 2004 and January 2005, Alan Beller suggested that many items that companies up to now have viewed as business expenses (e.g., housing, security systems, cars, etc.) may be perquisites for SEC disclosure purposes (depending, among other things, on whether an expense is available to employees on a non-discretionary basis, or whether it is a benefit for which only a chosen few are eligible). In addition, as noted in the overview above, Mr. Beller stated that companies must disclose all forms of compensation even if they are not specifically required by the rules to do so. The non-material elements of compensation would, therefore, be made part of proxy statement disclosures but not rise to the level of a material exhibit for periodic filings.
Valuation of Perquisites. Once a company has decided that an item is a perquisite, the value of the perquisite must be determined for disclosure purposes. SEC rules provide that perquisites should be valued at their "aggregate incremental cost" to the company. Although there is little guidance on what constitutes an "aggregate incremental cost," commentators, experts and registrants have considered it to mean the additional cost that the company incurs as a result of providing the perquisite, rather than its value to the recipient.
De Minimis Rule. Under the current rules, not all perquisites must be reported. Only if the aggregate value of perquisites in any given year to an NEO exceed the lesser of $50,000 or 10% of an NEO’s annual salary, must they be included as "other annual compensation" in the summary compensation table of the registrant’s proxy statement. If this threshold is not met, no further disclosure is required. In addition, if perquisites exceed this threshold, and if the value of any one perquisite among all perquisites given, exceeds 25% of the aggregate value of the NEO’s perquisites, the perquisite must be identified by type and amount in a footnote to the executive compensation table, or in accompanying narrative.
Compensation Committee Reports
The Staff has indicated that it will be reviewing Compensation Committee Reports more closely to determine if companies are adhering to them and to discern if committee members participated in drafting and/or reviewing the reports.
This is a rapidly changing and uncertain area. The SEC could require additional or different disclosures from those described in this memorandum in the future or could issue guidance that eliminates the need to make some of the disclosures described above. However, until further guidance from the SEC, we recommend that public companies take heed of, and follow, these best practices in taking a more conservative approach to executive compensation disclosures than they may have done in the past.
 A "named executive officer" includes all individuals serving as the registrant’s chief executive officer or acting in a similar capacity during the last fiscal year regardless of compensation level, the registrant’s four next most highly compensated executive officers other than the CEO who were serving as executive officers at the end of the last completed fiscal year, and up to two additional individuals who would have been included as the "four most highly compensated executive officers" but for the fact that such individuals were not serving as an executive officer at the end of the last completed fiscal year (Item 402(a)(3) of Regulation S-K).
 This Staff position is consistent with the SEC Corporation Finance Division’s Manual of Telephone Interpretations (July 1997), which notes that where a registrant is a party to an oral agreement that would be required to be filed as an exhibit to Form 10-Q or Form 10-K if it were written (including an employment agreement), the registrant is required to file a written description of that agreement as an exhibit to the applicable Form 10-Q or Form 10-K. Notwithstanding this telephone interpretation, until recently most registrants have not filed summaries of oral employment agreements (such as "at will" employment agreements and annual amendments to increase salaries), and in the past have apparently taken the position that such agreements need not be filed as exhibits to periodic reports.
 In August 2004 the SEC alleged that Tyson Foods failed to comply with SEC regulations regarding the disclosure and description of perquisites, resulting in civil penalties of $1.7 million and administrative cease-and-desist orders against Tyson and its founder. On September 23, 2004, the SEC issued a cease-and-desist order against General Electric Company alleging that it violated the proxy solicitation and periodic reporting requirements of the Exchange Act by filing with the SEC annual reports and proxy statements that failed to fully and accurately disclose perquisites to its former chief executive Jack Welch.
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