SEC Adopts Final Rules Changing Form 8-K Reporting of Executive Compensation Matters
- United States
- 08/24/2006
- Kirkpatrick & Lockhart Preston Gates Ellis LLP - United States
On August 11, 2006, the SEC released a voluminous set of final rules encompassing broad changes to the disclosure requirements applicable to executive and director compensation and related party transactions. K&LNG has issued a detailed Alert examining these new rules, which can be accessed here: “Click Here”: http://www.klng.com/files/Publication/5f0a87f0-9ef0-49b4-9474-0004fb1413db/Presentation/PublicationAttachment/6d09ea1a-814c-4caa-9268-0248bacff552/excs0806.pdf. Also included in these final rules are significant changes to the requirements for disclosing new and modified executive and director compensation plans and arrangements under the Form 8-K reporting regime. This Alert focuses on those changes and addresses both technical and practical compliance issues with the new rules.
When do these changes to the Form 8-K rules become effective?
The changes in the Form 8-K reporting rules will be effective sixty days after the final rules are published in the Federal Register, which should occur sometime in August. Consequently, those rules will likely be effective no later than November 2006.
What changes has the SEC made to disclosure of executive compensation matters in the Form 8-K reporting rules?
In January 2006 the SEC proposed revisions to the reporting and disclosure of executive and director compensation matters under the Form 8-K reporting rules, with the intent of reducing the number of such events that companies would be required to report on Form 8-K. The final rules adopt those revisions substantially as proposed. As described in more detail below, executive and director compensation matters will no longer be reported under Items 1.01 and 1.02 of Form 8-K, but will now be reported under Item 5.02. With the exception of named executive officers (NEOs), disclosure of compensation arrangements with directors and certain specified officers only need to be reported in a Form 8-K if they relate to the appointment or departure of such individual. By contrast, material compensation matters involving NEOs will need to be disclosed in a Form 8-K even if such matters do not relate to the officer’s appointment or departure.
What are the existing rules for disclosing executive compensation matters in Form 8-K and why did the SEC decide to modify those rules?
Item 1.01 of Form 8-K requires disclosure within four business days of a reporting company’s entry into a material definitive agreement outside of the ordinary course of business, or any material amendment of such an agreement. Under the rules adopted by the SEC in 2004, whether an agreement is material and not in the ordinary course of business is determined under the standards of Item 601(b)(10) of Regulation
S-K, which regulates the agreements that must be filed as exhibits to certain securities filings. With limited exceptions, Item 601(b)(10)(iii) captures a broad array of employment and compensation arrangements, including (1) any management contract or compensatory plan or arrangement covering a director or NEO, regardless of amount or significance, (2) any other management contract or compensatory plan or arrangement covering any other executive officer unless immaterial in amount or significance, and (3) any equity-based plan or arrangement not approved by shareholders covering any employee unless immaterial in amount or significance.
The SEC initially maintained that the use of Item 601(b)(10) standards under the Form 8-K rules was not an expansion of the prior requirements regarding disclosure of compensation matters. However, the preamble to the final rules acknowledges that these standards led to more frequent and accelerated disclosure of executive compensation matters and, in many circumstances, of matters that do not qualify as “unquestionably or presumptively material” to investors.
What are the specific changes to the Form 8-K reporting rules for executive and director compensation matters?
In an effort to provide a “more balanced approach” to disclosure of compensation matters under Form 8-K, the final rules make the following amendments to the
Form 8-K requirements:
- Employment and compensation agreements or other matters covered by the Item 601(b)(10)(iii) standards will no longer be reportable under Item
- Item 5.02 of Form 8-K, which requires disclosure of the appointment or departure of directors and the principal executive officer, president, principal financial officer, principal accounting officer, principal operating officer, or any person performing similar functions (a “Specified Officer”), is expanded to include any NEO and to require disclosure of certain material compensation arrangements for directors and any Specified Officers and NEOs.
- Item 5.02 will now require a brief description of any employment agreement and any material plan, contract or arrangement applicable to a Specified Officer, NEO or director that is entered into or materially amended, as well as any grant, award or modification of an existing grant or award to a covered officer or director under such an arrangement, in connection with such individual’s appointment or departure.
- In addition, Item 5.02 will require a brief description of any material new compensatory plan or arrangement, or any new grant or award under such an arrangement (whether cash or equity-based), and any material amendment to such an arrangement or modification of an existing grant or award, that applies to the principal executive officer, principal financial officer and any NEO, regardless of whether such event is in connection with the individual’s appointment or departure.
- A grant or award, or a modification, will not need to be disclosed if it is consistent with the terms of previously-disclosed plans, agreements or arrangements and it is disclosed in the company’s next proxy statement.
- Item 5.02 also is expanded to require disclosure of salary or bonus of an NEO for the most recent fiscal year if those amounts were not available or determinable when the company issued its proxy statement for that year, and thus were not disclosed in the proxy statement. This will require an update of the applicable total compensation figure as well.
- Plans and arrangements that do not discriminate in scope, terms or operation in favor of executive officers or directors and that are generally available to all salaried employees are not required to be disclosed under Form 8-K.
- The instructions to Item 5.02 clarify that for purposes of disclosure, NEOs are those officers for whom disclosure was required in the company’s most recent proxy statement or other filing containing executive compensation disclosure pursuant to Item 402 of Regulation S-K.
- General Instruction D to Form 8-K is revised to provide that, where an event would be reportable under Item 1.01 and any other item of Form 8-K, if the event is reported under the other item, the Item 1.01 heading can be omitted as long as the substantive disclosure that would be required under Item 1.01 is included under the other item.
Do we need to update all executive compensation disclosures every time we are required to report a compensation matter in a Form 8-K?
No. The preamble to the final rules emphasizes that the Form 8-K rules only require a brief description of the particular matter being reported. Consequently, a Form 8-K reporting an executive compensation matter should not include an update of all executive and director compensation information relating to the company since the last proxy statement. Disclosure should be limited to and focused on material information regarding the specific event or development that is required to be reported.
Are there any changes in the existing safe harbor exceptions where a company fails to file a Form 8-K within the four-day deadline?
Yes. The existing Form 8-K rules contain a limited safe harbor if a company fails to timely report certain events required under Form 8-K, including events subject to Items 1.01 and 1.02. The safe harbor permits such events to be reported no later than the due date of the company’s quarterly or annual report for the applicable period without affecting the company’s liability under Section 10(b) or Rule 10b- 5 of the Securities Exchange Act, as well as its eligibility to use Form S-3 registration statements. The final rules extend that safe harbor to events required to be reported under Item 5.02(e) of Form 8-K. Item 5.02(e) is described in the fourth bullet point above and covers new compensatory arrangements or awards under such arrangements, and amendments to such arrangements or awards, that apply to the principal executive officer, principal financial officer and any NEO. Accordingly, the safe harbor extension of time to file does not apply to disclosure of a compensation matter relating to the appointment or departure of a director or specified
officer.
What are the practical implications of these changes?
The new requirements for disclosing executive and director compensation matters under Form 8-K should have the intended effect of reducing the overall number of such filings by focusing primarily on NEO arrangements and matters relating to the appointment or departure of other executives and directors. A company’s Form 8-K compliance procedures should be updated to focus on compensation arrangements involving Specified Officers, as well as NEOs and directors, instead of the potentially broader category of “any executive officer” that applied under the Item 601(b)(10)(iii) standards. In addition, the new rules do not change the exhibit filing standards of Item 601(b)(10)(iii) which require filing of all material compensation plans, agreements and arrangements with NEOs, other executive officers and directors (including written descriptions of oral arrangements). Because many of those arrangements will no longer be reported in (and in most cases filed with) a Form 8-K, companies will need to adopt procedures to identify such plans, agreements and arrangements for filing in the company’s next annual or quarterly report.
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