Corporate Law Alert: SEC Revises Executive Compensation Disclosure Rules for Options and Stock Awards
1/8/2007

The SEC acknowledged that disclosure of the full grant date fair value of the award in the Summary Compensation and Director Compensation Tables might overstate the compensation relative to services rendered in a particular year or might not reveal the real cost to the company or the real benefit to the executive. In either case, the SEC’s stated goal of providing the investor with clearer, more comprehensive information would be undermined.

The key changes made by the SEC in December are:

Summary Compensation Table

• The Stock Awards and Option Awards columns will present the dollar amount of the compensation cost recognized for financial reporting purposes for the fiscal year in accordance with FAS 123R, that is, the cost will be spread over the "requisite service period."
• The Stock Awards and Option Awards columns will include the compensation costs of awards granted in previous fiscal years to the extent those costs are recognized during the fiscal year. The cost of pre-2006 stock-based awards that have not yet been fully recognized will be reported using the modified prospective transition method under FAS 123R even if the company has not adopted that method for financial reporting purposes.
  • "Equity" awards will be recognized over the remaining vesting schedule.
  • For stock-based "liability" awards (such as cash-settled stock appreciation rights), a company must recalibrate the value of its stock (up or down) on a mark-to-market basis for each fiscal year. If the value of the stock goes down, the amount of reported compensation will decrease as well.
• In determining the compensation cost of service-based awards, companies may not adjust for potential forfeitures, but must calculate the cost based on the assumption that the service period will be completed and the award will vest. This is contrary to FAS 123R, which typically requires estimates of forfeitures.
  • If a company discloses the compensation cost of an award that is subsequently forfeited, the cost must be deducted in the year of forfeiture. This could result in the Stock Awards and Option Awards columns containing negative numbers.
• For performance-based awards, companies will report compensation costs in the Stock Awards and Option Awards columns only to the extent that achievement of the performance goal is or becomes "probable" in the reported fiscal year. If the achievement of the performance condition is not probable at the grant date but becomes probable in a subsequent period, the proportionate amount of compensation cost based on service previously rendered will be disclosed in the Summary Compensation Table during the period in which achievement of the performance condition becomes probable. If the achievement of a performance condition was previously considered probable but in a later period is no longer considered probable, the amount of compensation cost previously disclosed in the Summary Compensation Table will be reversed during the period in which it is determined that achievement of the performance condition is no longer probable.
• The changes may affect who is a "named executive officer" included in the tables. Although the SEC did not revise the definition of named executive officer, the new rules may change the amount of "total compensation" paid to executive officers.
• Salary or bonus relinquished at an officer’s election in favor of an equity award or other non-cash compensation will be reported as salary or bonus, as applicable, not as an award.

• Disclosure of the full grant date value of stock options and stock awards is still required, but it has been moved from the Summary Compensation Table to the Grants of Plan-Based Awards Table. The full grant date value will now be reported on a grant-by-grant basis, in a new column entitled "Grant Date Fair Value of Stock and Option Awards."
• The new column will also include the incremental fair value of repriced or materially modified awards as of the date of repricing or modification.

Director Compensation Table

• Generally, all revisions applicable to the Summary Compensation Table also apply to the Director Compensation Table.
  • Director stock options and stock awards will be reported based on the compensation cost recognized for financial reporting purposes for the fiscal year.
  • If a director elects to forgo director fees in favor of an equity award or other non-cash compensation, the amount of the fees will be reported in the fees column.
• The full grant date value of stock options and stock awards granted during the fiscal year will be disclosed in a footnote to the table.

Applicability

• The new rules apply to proxy statements, information statements and registration statements filed on or after December 15, 2006 that are required to include executive compensation disclosures for fiscal years ending on or after December 15, 2006.
• The new rules also apply to Forms 10-K and 10-KSB filed for fiscal years ending on or after December 15, 2006.
• The Summary Compensation Table changes apply to small business filers, but these filers do not need to include a Grants of Plan-Based Awards Table. Therefore, the full fair value of stock-based awards will not be disclosed.

¹ The changes are adopted as interim final rules which can be found at http://www.sec.gov/rules/final/2006/33-8765.pdf.

If you have any questions about this Client Alert or if you would like our assistance in connection with these new rules, please contact a member of your Stoel Rives team or any of the following lawyers: