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SEC Adopts Additional Executive Compensation Disclosure Amendments

The SEC last week adopted interim final rules to conform the reporting of executive compensation to the amounts that are disclosed in companies' financial statements under FAS 123R (Rel. No. 33-8765, December 22, 2006). The SEC concluded that, by adopting the amendments as interim final rules, it could avoid the presentation of different executive compensation under the amendments adopted in July from that in later years. The SEC will seek comments on the rules for 30 days and, if necessary, will revise the interim final rule amendments to Item 402 of Regulations S-K and S-B.

The amendments revise the summary compensation table and the director compensation table with respect to stock awards and option awards to require disclosure of the compensation cost of the award over the service period, as described in FAS 123R. The requisite service period is the period in which the employee must provide service in exchange for a share-based payment.

The July executive compensation release required the disclosure of the full grant date fair value as compensation when a grant is made. Upon further consideration, the SEC decided that the disclosure would be more useful if it reflected a combination of the cost recognized in the financial statements' summary compensation table and the grant date fair value of the awards on a grant-by-grant basis in the grants of plan-based awards table.

The SEC concluded that the amended disclosure would eliminate the problem of identifying named executive officers based on a measure that reflects the full grant date value of awards. For example, a single large grant that will be earned over a number of years may change the composition of the named executive officers in the summary compensation table. 

By adding a column to the grants of plan-based award table to show the full grant date fair value of each award granted as computed in accordance with FAS 123R, investors will have a better perspective on the compensation decisions in the last completed fiscal year. The SEC amended the director compensation table in Item 402 to require footnote disclosure of the grant date fair value of each equity award computed in accordance with FAS 123R.

The amendments do not change the method a company uses to estimate forfeitures under FAS 123R. The compensation cost disclosed under Item 402 will not include an estimate of forfeitures related to service-based vesting conditions. If the named executive fails to perform the requisite service and forfeits an award, the amount of compensation cost previously disclosed in the summary compensation table will be deducted in the period in which the award is forfeited. 

The grants of plan-based awards table must include information about repriced or materially modified options, stock appreciation rights and other option-like instruments. This disclosure must be made on a grant-by-grant basis.

In adopting the interim final rules, the SEC noted that the subject matter of the amendments was subjected to extensive public comments in connection with the July executive compensation release. Companies must comply with the Item 402 amendments adopted in July for their proxy and information statements filed on or after December 15, 2006 and for Forms 10-K and 10-KSB for fiscal years ending on or after December 15, 2006.

The compliance schedule affects approximately 12,190 companies, according to the SEC. If the interim final rules were subject to notice and comment, the SEC concluded that it would generate considerable uncertainty about which standards to apply. The interim final rules will also avoid inconsistencies when comparing the compensation of named executive officers and directors.

The SEC also provided transition guidance for applying the summary compensation table and director compensation table amendments to the disclosure of awards that were granted before 2006, including equity awards that are not yet vested and liability awards that are not yet settled. Companies must use the FAS 123R modified prospective transition method for Item 402 disclosure purposes, regardless of whether they have adopted that method for their financial statement reporting.

Under the modified prospective transition method, a proportionate share of the grant date fair value determined under FAS 123 for equity awards that are outstanding on the date that FAS 123R was adopted will be recognized in the financial statements over those awards' remaining vesting periods, if any. Outstanding liability awards will be recognized in the financial statements until they are settled, based on the fair value of the awards at each financial statement reporting period under FAS 123R, as well as the portion of the awards that have vested.

The same approach will apply for the presentation of the information in the summary compensation and director compensation tables for fiscal 2006 and later years.