By John Stuart and Kenneth Moore, Reitner, Stuart & Moore            

As we warned you in the last edition of the Directors’ Digest, the SEC has turned on the pressure for the compensation committee for 2007 and following.

On August 11, 2006, the SEC adopted in final form the first major revamp of executive and director compensation and related party transactions since 1992. The adopting release weighs in at a back-straining 436 pages. The SEC reported that it received more than 20,000 comments on the preliminary proposal which we discussed in the last edition of the Digest. You can get the final rule off the SEC website for free (assuming you don’t burn out your printer trying).

The revised disclosure will apply to your 2006 10-K (assuming that you have a calendar year-end) and for all proxy statements or registration statements requiring such disclosure that are filed with the SEC after December 15, 2006. 

For those of you who are not on the board of a “reporting company,” you have dodged a major bullet for now. However, it seems increasingly that the Federal examiners have a way of turning these corporate governance pronouncements into “best practices” whether or not you are actually subject to the rule.

There are plenty of “gems” here for all directors, not just those that sit on the compensation committee, including new disclosures on director compensation and benefits, expanded disclosure of related party transactions and director independence.  However, the major onus will fall on the compensation committee who will likely be charged with creating (from whole cloth) a new narrative overview to begin the executive and director compensation disclosure. This new discussion and analysis section should cover the material factors underlying compensation policies and decisions reflected in the data presented in the tables later in the disclosure. The SEC states that this new overview should be considered similar to the overview recommended as an introduction to management’s discussion and analysis of financial condition (except, unlike the MD&A, directors are not going to be able to pass off easily the drafting to the accountants, the lawyers or the CFO). Like the MD&A, you are to include a discussion of current and forward-looking data and exclude boiler-plate and a mere recitation of the data in the included tables.  Plus, you have to write it in plain English.

For those who have writer’s block, the SEC did include a non-exclusive list of examples of the issues that would potentially be “appropriate” for a company to address, including:

• policies for allocating between long-term and currently paid out compensation;

• policies  for allocating between cash and non-cash compensation, and among different forms of non-cash compensation;

• for long-term compensation, the basis for allocating compensation to each different form of award;

• how the determination is made as to when awards are granted, including awards of equity-based compensation such as options;

• what specific items of corporate performance are taken into account in setting compensation policies and making compensation decisions;

• how specific elements of compensation are structured and implemented to reflect these items of the company’s performance and the executive’s individual performance;

• the factors considered in decisions to increase or decrease compensation materially;

• how compensation or amounts realizable from prior compensation are considered in setting other elements of compensation (e.g., how gains from prior option or stock awards are considered in setting retirement benefits);

• the impact of accounting and tax treatments of a particular form of compensation;

• the company’s equity or other security ownership requirements or guidelines and any company policies regarding hedging the economic risk of such ownership;

• whether the company engaged in any benchmarking of total compensation or any material element of compensation, identifying the benchmark and, if applicable, its components (including component companies); and

• the role of executive officers in the compensation process.

Even if the Committee is somehow able to duck the drafting duty, it won’t be able to avoid the potential liability associated with the compensation discussion and analysis. The Committee must issue a signed report (strikingly similar to the now familiar audit committee report) indicating that it has reviewed the compensation discussion and analysis with management and recommends that it be included in the applicable company report.

Obviously, if you are on the compensation committee of a reporting company, you will have plenty to keep you busy (and be responsible for) during the first quarter of 2007 as the due dates for proxy statements and 10-Ks roll around. Our advice is to (i) get briefed and up to speed on this “monster,” (ii) put the project on a timeline starting in the 4th quarter and (iii) divide up the drafting responsibilities. You don’t want to wait until March to start this one.

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