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Executive Compensation Rules Provide Guidance on Stock Option Grant Disclosure

The SEC's 436-page final rule adopting new executive compensation and related person disclosure includes guidance on the types of information that must be disclosed about stock option grants and invites additional comments on whether companies should disclose the compensation of up to three additional highly compensated employees besides the principal executive and financial officers (Rel. No.33-8732, August 11, 2006). The stock option guidance was included in the final rulemaking in light of recent revelations about companies that had failed to disclose the back-dating of stock option grants. The SEC is seeking additional comments on the disclosure of three additional highly paid employees based on the extensive comments it received in response to the proposal. 

The SEC's existing rules regarding the disclosure of executive stock option grants did not contain a line item requirement for information on issuers' programs, plans or practices for the selection of stock option grant dates or exercise prices. The new rules include tabular disclosure on the full grant date fair value computed in accordance with FAS 123R. The grant date is generally considered the day the decision is made to award an option as long as the recipients are promptly notified, according to the SEC. In addition to the tabular disclosure, companies will have to discuss options-related compensation in the new Compensation Disclosure and Analysis section, particularly as it relates to the timing and pricing of stock option grants.

The SEC reiterated in the adopting release that it does not express a view on whether a company has a valid or sufficient reason for the timing of option grants. Some commenters said that certain timing practices may unfairly benefit executives and employees. The SEC concluded that, regardless of the reason, if a company has a program, plan or practice to time the grant of stock options to executives in coordination with material nonpublic information, it should be fully disclosed to investors. Companies should also consider how the board or the compensation committee considers material nonpublic information when determining whether and in what amount to make stock option grants.

The SEC said that companies should pay particular attention when drafting their disclosure in a number of circumstances, including the role of the compensation committee and the role of any executive officers. If a company has a program, plan or practice relating to the timing of stock option grants that has not previously been disclosed, it should disclose that information

In the company's CD&A, it should discuss the objectives of its compensation program and what the program is designed to award. Each element of compensation should be disclosed along with the reasons the company chooses to pay each element, and how the amount of each element is determined. Companies should explain how these elements fit into their overall compensation objectives. Companies should also disclose the impact of accounting and tax treatments of particular forms of compensation. Due to the significance of decisions to waive or modify performance goals, the SEC said those decisions should be disclosed in the CD&A.

The SEC's intent with respect to disclosing the compensation for three additional highly compensated employees is to provide investors with information about those who may influence significant policy decisions. Significant policy decisions may include the exercise of strategic, technical, editorial, creative, managerial or similar responsibilities. The SEC provided examples of employees who may not be executive officers but who may participate in significant policy decisions, including the director of a news division of a major network, the principal creative leader of a media conglomerate's entertainment unit or the head of a principal business unit that develops technological innovations.

The SEC said it was convinced by commenters that the disclosure should not include sales persons, entertainment personalities, actors, singers or professional athletes who are highly compensated but have no significant responsibilities for policy decisions. The reproposal of this piece of the executive compensation disclosure rules is part of the SEC's consideration of whether some level of narrative disclosure should be provided about nonexecutive but highly compensated employees and what the appropriate level of compensation might be in light of their roles.

The SEC has asked for additional comments on whether the proposal should apply only to large accelerated filers. The SEC is also seeking information on the role of the compensation committee in determining or approving the compensation of the additional employees if they are not executive officers. The SEC asked whether the three additional employees should be named and whether it should define what it means by the "responsibility for significant policy decisions."

Commenters are encouraged to provide information about the costs involved in collecting the information. The SEC noted that no one provided cost estimates in response to its earlier request for comments. The SEC has provided its own estimates and assumptions and asked for commenters' views on those figures. The comment period will be open for 45 days.