On January 27, 2006, the Securities and Exchange Commission proposed extensive new disclosure rules for executive and director compensation and other corporate governance matters. While the vast majority of the changes impact proxy statement disclosure, the SEC also adopted complementary revisions to Form 8-K addressing the disclosure of compensatory plans, contracts and arrangements with certain executive officers. The 8-K changes form an important part of the compensation disclosure puzzle, as they reflect the SEC's desire for current disclosure of the key compensatory arrangements that are discussed in much greater detail in the annual proxy statement. The SEC's first attempts to address this concern in the initial wave of rule-making following the adoption of the Sarbanes-Oxley Act in 2002 resulted in substantial confusion concerning the required 8-K disclosure of executive and director compensation. As a result, the SEC has adopted these new revisions, which went into effect on November 7, 2006.1
The New Rules
The new 8-K requirements have three primary impacts:
1. They remove plans, contracts and arrangements with officers and directors from the scope of Item 1.01, and remove the termination of any such plans, contracts and arrangements from the scope of Item 1.02.
2. They expand the universe of individuals for whom disclosure of appointment to or departure from certain positions is required under Item 5.02.
3. They move disclosure of compensatory plans, contracts and arrangements to Item 5.02 and define the universe of individuals for whom these disclosures must be made.
Furthermore, the limited safe harbor regarding Section 10(b) and Rule 10b-5 liability and Form S-3 eligibility in the event that the company fails to timely file certain 8-K reports is extended to include disclosure of material plans, contracts or arrangements under Item 5.02(e) (but the safe harbor is NOT extended to disclosure under the other sub-sections of Item 5.02).2
Covered Officers: The new 8-K requirements in Section 5.02 require disclosure with respect to a defined universe of individuals, generally referred to as the "Covered Officers." Specifically, these Covered Officers are:
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the principal executive officer,
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the president,
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the principal financial officer,
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the principal accounting officer,
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the principal operating officer,
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any person performing similar functions to any of the above positions, and
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any named executive officer.
The named executive officers are defined under Item 402(a) as the principal executive officer, the principal financial officer, the next three most highly compensated executive officers, and up to two additional officers for whom disclosure would have been provided but for the fact that the individual was not an executive officer at year end.
Required Disclosure: In addition to the disclosure required with respect to the election or departure of a director, which does not change under the new requirements, revised Item 5.02 requires the following:
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Disclosure of the appointment of or the retirement, resignation or termination of any of the Covered Officers, including the name of the individual, his or her position and the date of appointment, retirement, resignation or termination.
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For all new appointments of Covered Officers, a description of any material plan, contract or arrangement (whether or not written) to which the Covered Officer is a party, or in which he or she participates, that is entered into in connection with the appointment, or any material amendment of any such material plan, contract or arrangement in connection with the appointment. In addition, any grant or award to a Covered Officer, or modification thereof, under any such material plan, contract or arrangement in connection with the appointment must also be disclosed. There is NO exception for the disclosure of a grant or award made in connection with appointment, even if the plan or award agreement describing the terms of the grant or award has already been disclosed and is already on file with the SEC.
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For elections of directors other than by a vote of security holders at a meeting called for that purpose, a description of any material plan, contract or arrangement (whether or not written) to which the director is a party, or in which he or she participates, that is entered into in connection with the election, or any material amendment of any such material plan, contract or arrangement in connection with the election. In addition, any grant or award to a director, or modification of such a grant or award, under any such material plan, contract or arrangement in connection with the election must also be disclosed. As with the similar requirement for Covered Officers, there is no exception for this disclosure of grants or awards made in connection with elections outside of an annual or special meeting.
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A brief description of any material new compensatory plan, contract or arrangement, material amendment to such plan, contract or arrangement or any new material grant under such plan, contract or arrangement, with respect to the principal executive officer, the principal financial officer or any other named executive officer3 , any time the company enters into, adopts or materially amends such a plan, contract or arrangement. In this circumstance, description of a new grant is limited by "materiality" and is NOT required if the grant is materially consistent with the terms of the plan, contract or arrangement previously disclosed and filed, and the grant itself is disclosed the next time the company makes disclosures under Item 402 of Regulation S-K (generally, in the next proxy statement). Disclosure of a plan, contract or arrangement is NOT required if the plan, contract or arrangement does not discriminate in scope, terms or operation in favor of executive officers or directors and is available generally to all salaried employees. Note that "director-only" plans will not trigger this 8-K disclosure requirement, since it only applies with respect to the principal executive officer, the principal financial officer or any other named executive officer.4
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If the salary or bonus for a named executive officer for the most recent fiscal year could not be calculated at the time of the last proxy statement (or other filing including S-K Item 402 disclosures) and therefore was omitted from the Summary Compensation Table, disclosure of this salary and bonus when calculable, along with a new calculation of the "Total Compensation" figure from the Summary Compensation Table.
Filings under Item 5.02 as revised must still be made within four business days of the triggering event. Companies making these disclosures need not provide the level of detail required under the proxy disclosure rules, but rather must provide only a brief description of the applicable plan, program or arrangement.
Practical Implications of the Revised Requirements: The new requirements have several practical implications. First, the universe of covered individuals for 8-K disclosure purposes is much clearer - directors and the officers listed above under "Covered Officers," including the named executive officers. For 8-K purposes, companies no longer need to worry about individuals outside of this list.5 And unlike under the old disclosure requirements, revised Form 8-K clarifies when to make the determination of who qualifies as a named executive officer - look to the last SEC filing that included the disclosure required under Item 402(c) of Regulation S-K (usually the annual proxy statement), and the named executive officers from that filing are the named executive officers for 8-K purposes.
Second, a plan, contract or arrangement with respect to a Covered Officer is not "deemed" material under the new rules, as opposed to the old 8-K requirements6 ; therefore, disclosure is subject to a materiality determination. The SEC has not clarified what is "material," relying on the standard definition of information that impacts an investor's decision to buy, sell or hold the company's securities. Consequently, the company must make a materiality determination with respect to disclosure of these plans, contracts and arrangements. Companies should follow many of the lessons learned since the expansion of the 8-K disclosure requirements following Sarbanes-Oxley, noting the SEC's comments in its releases that it believes that "much of the disclosure regarding employment compensation matters required in real-time under the Form 8-K requirements is viewed by investors as material." Remember that not only written arrangements, but also oral ones, must be evaluated for materiality and disclosure. The SEC has also confirmed informally that offer letters to Covered Officers, even if they do not rise to the level of an "agreement," generally fall under the term "arrangement" and should be evaluated for 8-K disclosure purposes (as well as exhibit filing purposes).
Third, when an individual is appointed to a "Covered Officer" position, or elected as a director other than at a shareholder meeting, 8-K disclosures will generally be more extensive than in the past. Companies need to include descriptions of any material plan, contract or arrangement entered into (or amended) in connection with the appointment (not just any employment agreement, as was required under the old form). Note that the requirement is NOT limited to compensatory plans, contracts or arrangements - any material plan, contract or arrangement must be disclosed, although the 8-K can reference a description of the plan, contract or arrangement in the company's most recent Form 10-K or proxy statement rather than repeating the description. In addition, any grants or awards under such plan, contract or arrangement, or modifications to a grant or award previously made, must now be disclosed, even if the terms of the plan, contract or arrangement have been previously disclosed.
Finally, 8-K disclosure of material plans, contracts or arrangements adopted, entered into, or modified separately from the appointment of a Covered Officer will now only need to be disclosed with respect to an even more limited universe of individuals - the principal executive officer, the principal financial officer or any other named executive officer.7 Furthermore, material grants or awards to these individuals under these plans, contracts or arrangements do not need to be disclosed if they are consistent with terms previously disclosed.
Actions Companies Can Take Now
A company may take the following steps to ease the incorporation of the new Form 8-K disclosure requirements into its disclosure regime:
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Determine who the Covered Officers are. This is the first step to ensuring the appropriate disclosures are made in a timely fashion.
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Update disclosure controls and procedures to capture necessary information about Covered Officers. This includes educating the appropriate individuals, whether they are in Human Resources, Legal, Finance or other departments, regarding the new universe of Covered Officers and the scope of information about these individuals that must be disclosed.
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Alert and educate the compensation committee about the new requirements. Actions taken by the compensation committee will directly impact the disclosure required on Form 8-K under the new requirements, and in some cases (such as actions taken in executive session), the committee may be the first to know of an event triggering disclosure.
1On December 22, 2006, the SEC adopted additional revisions to the new disclosure rules; however, these revisions did not affect the new 8-K requirements .
2In addition, the revised requirements delete the requirement to include the Item 1.01 heading in a Form 8-K if the information required to be disclosed under Item 1.01 is included under another Item.
3Note that this requirement applies only to the named executive officers, not the Covered Officers (although practically these two groups will overlap).
4Note, however, that for purposes of required exhibits to a company's periodic reports, contracts, plans and arrangements with directors are still deemed material pursuant to Item 601(b)(10) of Regulation S-K and must be filed.
5Because the test for 8-K disclosure will differ from the test under Item 601 of Regulation S-K for filing material agreements as exhibits to periodic reports, however, companies will still need to evaluate any management contract and any compensatory plan, contract or arrangement with any executive officer to determine whether filing is required with the next periodic report.
6Under the old 8-K requirements, Item 601(b)(10) of Regulation S-K provided the definition of "material agreement," which deems "any management contract or compensatory plan, contract or arrangement" with a named executive officer or director to be material, and also includes such contracts, plans or arrangements with other executive officers "unless immaterial in amount or significance."
7But see notes 3 and 4 above.
Published February 1, 2007.
