News
Securities
Jun. 18, 2002
Increased Disclosure for Equity Compensation Plans Is Required
Focus Column - By Jonathan Ocker and Michael Frank - In a Dec. 19, 2001 release, the Securities and Exchange Commission issued final rules requiring U.S. reporting companies (not including "foreign private issuers" with lesser reporting requirements) to provide increased disclosure of equity compensation arrangements, with particular emphasis on arrangements that have not been approved by company shareholders.
Focus Column
By Jonathan Ocker and Michael Frank
In a Dec. 19, 2001 release, the Securities and Exchange Commission issued final rules requiring U.S. reporting companies (not including "foreign private issuers" with lesser reporting requirements) to provide increased disclosure of equity compensation arrangements, with particular emphasis on arrangements that have not been approved by company shareholders.
Under the new rules, which are now effective, public companies must report annually the total number of securities available for issuance (and the weighted average exercise price of options, warrants and rights) under all plans and arrangements, distinguished by whether or not shareholders approved the plan. Companies also must describe the material features of all plans not approved by shareholders.
Finally, for the first time, companies need to file many arrangements not approved by shareholders as exhibits to the company's Form 10-Q (quarterly report) or 10-K (annual report) for the quarter in which adopted and on an ongoing basis as an exhibit to the company's Form 10-K.
Affected companies must include a table in each Form 10-K for a fiscal year ending after March 15, as well as each proxy statement related to a meeting occurring after June 15 in which the company sought shareholder action on a compensation plan. The proxy rule applies even if the compensation plan submitted for shareholder approval does not provide equity-based awards.
For example, companies submitting a "cash only" bonus plan for shareholder approval pursuant to Internal Revenue Code Section 162(m) would need to include the equity-plan disclosure in the proxy. Accordingly, companies with multiple plans may find it advantageous to consolidate shareholder-approval requests for all plans into one proxy or to consolidate plans with various features into one omnibus program, to minimize the frequency with which proxy disclosure will be required.
The prescribed table includes three columns indicating:
• Column one. The number of shares to be issued upon the exercise of options, warrants and rights.
• Column two. The weighted average exercise price of the awards listed in column one.
• Column three. The number of shares available for future issuances, excluding shares listed in column one.
The company must break out the information according to whether or not the shares relate to a plan that was adopted with shareholder approval.
Companies must provide this information for all equity compensation plans in effect at the end of the last fiscal year. A plan is considered "in effect" as long as securities remain available for future issuance or as long as options, warrants or rights previously granted under the plan remain outstanding.
Individual arrangements, such as an "outside the plan" option granted to a newly hired executive, are considered plans for this purpose. "Tax-qualified" 401(k) plans and Employee Stock Option Plans offering company stock are exempt.
Where a company requests shareholder approval of a compensation plan in its proxy and provides the disclosure there, it need not provide the disclosure in that year's 10-K but may incorporate it there by reference to the proxy.
Certain information related to the tabular disclosure may, and in some cases must, be discussed in accompanying footnotes:
• Assumed awards. The company must disclose options, warrants or rights assumed in an acquisition in a footnote providing in text form the number of shares issuable on exercise of the awards and their weighted average exercise price.
In cases where an entire option plan and its related share pool are assumed and the company may make further grants under the plan, the plan should be aggregated in the table with other plans of the same type (shareholder-approved or not shareholder-approved), rather than discussed in a footnote.
In this event, it appears that the SEC position is to treat all assumed plans as non-shareholder-approved for purposes of this disclosure unless approved separately (and not simply as a part of the general approval of the transaction) by the shareholders of the assuming company.
This adverse disclosure may make a common acquisition-related share-conservation strategy less attractive. Where applicable, companies may wish to consider explaining in a footnote (or in the description of the material features of the plan) that a plan treated for disclosure purposes as one not approved by shareholders was in fact previously approved by the acquired company's shareholders.
• Awards other than options. Footnotes should disclose the maximum number of shares that may be issued pursuant to awards other than options, e.g., as restricted stock or pursuant to a stock appreciation right. For example, many plans contain an internal limit on restricted stock that is less than the total number of shares reserved for issuance.
• 'Evergreen' features. Evergreen features (features that automatically increase the number of shares available under a plan) and other formulas for determining the number of shares available for issuance under a plan must be disclosed in a footnote.
• Stock purchase plans. Even though not required, it may be desirable to indicate in a footnote the number of shares available for future issuance pursuant to a broad-based employee stock purchase plan, because institutional investors tend to view such plans more favorably.
• Plan descriptions. In addition to the table, the Form 10-K or proxy must describe all non-shareholder-approved plans and arrangements that may issue stock. The description must include all material features of the plan. Companies may satisfy the narrative description requirement by reference to the footnotes to the Form 10-K financial statements, provided the footnote disclosure includes all "material features" of the plan.
• Non-shareholder-approved plans as exhibits. The new rules also amend Item 601 of Securities Regulation S-K to require that companies file most non-shareholder-approved equity compensation arrangements in which employees may participate as an exhibit to the quarterly report for the quarter in which established and on the Form 10-K on an ongoing basis.
This requirement applies unless the arrangement is "immaterial in amount or significance." The rule also applies whether or not executive officers may participate and applies to assumed plans under which future awards may be made.
• Further tightening of shareholder-approval rules. The new rules clearly subject affected companies, particularly those with significant non-shareholder-approved plans, to substantially increased administrative and reporting burdens. Moreover, even as companies begin to comply with the new rules now and into the 2003 proxy season, the shareholder-approval landscape is likely to continue to change.
Recent New York Stock Exchange and Nasdaq proposals may be just the beginning. The NYSE has repeatedly, most recently until June 30, extended its "pilot program" allowing "broadly based" plans with significant rank-and-file participation to avoid shareholder approval.
Under the pilot program, plans have been exempt from shareholder approval if at least a majority of the company's full time, exempt U.S. employees are eligible to participate under the plan and at least a majority of the shares awarded under the plan during the first three years of the plan (or the plan's full term, if shorter) are awarded to employees who are not directors or "Section 16" officers, with decisionmaking authority for the company.
On June 6, the NYSE Corporate Accountability and Listing Standards Committee appeared to abandon the pilot program. The committee released a report to the NYSE Board proposing that, apparently without exception, all equity compensation plans be subject to shareholder approval. The proposal also would deny brokers their current ability to vote shares held in "street name" in favor of equity plan proposals in many cases where the broker receives no instructions from the beneficial owner.
Nasdaq has long had a similar rule to that of the pilot program: Nasdaq has exempted from shareholder approval plans under which, during their first three years and during each subsequent year, the majority of eligible participants are not directors or Section 16 officers and the majority of shares underlying awards are granted to this non-officer and non-director group.
On May 24, Nasdaq Chairman Simmons announced a new rule (subject to SEC approval) requiring that all equity plans benefiting directors or officers be shareholder-approved.
At this time, it is not known to what extent plans that previously received a Nasdaq "comfort letter" or complied with the NYSE pilot program would be "grandfathered" under the new rules.
It appears that the Nasdaq proposal would allow companies to continue to offer initial executive officer inducement grants and rank-and-file-only option plans without shareholder approval, although inducement grants will require the approval of an outside compensation committee or the majority of the company's independent directors. The NYSE does not appear to contain similar exceptions.
Time will tell whether the new Nasdaq and NYSE rules both will survive in their current form or whether the bodies will move to adopt the same rule.
Of course, aside from the exchange rules, companies seek shareholder approval of equity plans for other reasons. For example, shareholder approval is necessary for plans that grant tax advantaged "incentive stock options" under Internal Revenue Code Section 422.
Similarly, shareholder approval is required for companies seeking to preserve the deductibility by the company of compensation recognized upon exercise of options by officers subject to the $1 million cap under Internal Revenue Code Section 162(m).
Jonathan Ocker is chair and a partner of Orrick Herrington & Sutcliffe's compensation and benefits group in San Francisco. Michael Frank practices in the firm's Menlo Park office.
By Jonathan Ocker and Michael Frank
In a Dec. 19, 2001 release, the Securities and Exchange Commission issued final rules requiring U.S. reporting companies (not including "foreign private issuers" with lesser reporting requirements) to provide increased disclosure of equity compensation arrangements, with particular emphasis on arrangements that have not been approved by company shareholders.
Under the new rules, which are now effective, public companies must report annually the total number of securities available for issuance (and the weighted average exercise price of options, warrants and rights) under all plans and arrangements, distinguished by whether or not shareholders approved the plan. Companies also must describe the material features of all plans not approved by shareholders.
Finally, for the first time, companies need to file many arrangements not approved by shareholders as exhibits to the company's Form 10-Q (quarterly report) or 10-K (annual report) for the quarter in which adopted and on an ongoing basis as an exhibit to the company's Form 10-K.
Affected companies must include a table in each Form 10-K for a fiscal year ending after March 15, as well as each proxy statement related to a meeting occurring after June 15 in which the company sought shareholder action on a compensation plan. The proxy rule applies even if the compensation plan submitted for shareholder approval does not provide equity-based awards.
For example, companies submitting a "cash only" bonus plan for shareholder approval pursuant to Internal Revenue Code Section 162(m) would need to include the equity-plan disclosure in the proxy. Accordingly, companies with multiple plans may find it advantageous to consolidate shareholder-approval requests for all plans into one proxy or to consolidate plans with various features into one omnibus program, to minimize the frequency with which proxy disclosure will be required.
The prescribed table includes three columns indicating:
• Column one. The number of shares to be issued upon the exercise of options, warrants and rights.
• Column two. The weighted average exercise price of the awards listed in column one.
• Column three. The number of shares available for future issuances, excluding shares listed in column one.
The company must break out the information according to whether or not the shares relate to a plan that was adopted with shareholder approval.
Companies must provide this information for all equity compensation plans in effect at the end of the last fiscal year. A plan is considered "in effect" as long as securities remain available for future issuance or as long as options, warrants or rights previously granted under the plan remain outstanding.
Individual arrangements, such as an "outside the plan" option granted to a newly hired executive, are considered plans for this purpose. "Tax-qualified" 401(k) plans and Employee Stock Option Plans offering company stock are exempt.
Where a company requests shareholder approval of a compensation plan in its proxy and provides the disclosure there, it need not provide the disclosure in that year's 10-K but may incorporate it there by reference to the proxy.
Certain information related to the tabular disclosure may, and in some cases must, be discussed in accompanying footnotes:
• Assumed awards. The company must disclose options, warrants or rights assumed in an acquisition in a footnote providing in text form the number of shares issuable on exercise of the awards and their weighted average exercise price.
In cases where an entire option plan and its related share pool are assumed and the company may make further grants under the plan, the plan should be aggregated in the table with other plans of the same type (shareholder-approved or not shareholder-approved), rather than discussed in a footnote.
In this event, it appears that the SEC position is to treat all assumed plans as non-shareholder-approved for purposes of this disclosure unless approved separately (and not simply as a part of the general approval of the transaction) by the shareholders of the assuming company.
This adverse disclosure may make a common acquisition-related share-conservation strategy less attractive. Where applicable, companies may wish to consider explaining in a footnote (or in the description of the material features of the plan) that a plan treated for disclosure purposes as one not approved by shareholders was in fact previously approved by the acquired company's shareholders.
• Awards other than options. Footnotes should disclose the maximum number of shares that may be issued pursuant to awards other than options, e.g., as restricted stock or pursuant to a stock appreciation right. For example, many plans contain an internal limit on restricted stock that is less than the total number of shares reserved for issuance.
• 'Evergreen' features. Evergreen features (features that automatically increase the number of shares available under a plan) and other formulas for determining the number of shares available for issuance under a plan must be disclosed in a footnote.
• Stock purchase plans. Even though not required, it may be desirable to indicate in a footnote the number of shares available for future issuance pursuant to a broad-based employee stock purchase plan, because institutional investors tend to view such plans more favorably.
• Plan descriptions. In addition to the table, the Form 10-K or proxy must describe all non-shareholder-approved plans and arrangements that may issue stock. The description must include all material features of the plan. Companies may satisfy the narrative description requirement by reference to the footnotes to the Form 10-K financial statements, provided the footnote disclosure includes all "material features" of the plan.
• Non-shareholder-approved plans as exhibits. The new rules also amend Item 601 of Securities Regulation S-K to require that companies file most non-shareholder-approved equity compensation arrangements in which employees may participate as an exhibit to the quarterly report for the quarter in which established and on the Form 10-K on an ongoing basis.
This requirement applies unless the arrangement is "immaterial in amount or significance." The rule also applies whether or not executive officers may participate and applies to assumed plans under which future awards may be made.
• Further tightening of shareholder-approval rules. The new rules clearly subject affected companies, particularly those with significant non-shareholder-approved plans, to substantially increased administrative and reporting burdens. Moreover, even as companies begin to comply with the new rules now and into the 2003 proxy season, the shareholder-approval landscape is likely to continue to change.
Recent New York Stock Exchange and Nasdaq proposals may be just the beginning. The NYSE has repeatedly, most recently until June 30, extended its "pilot program" allowing "broadly based" plans with significant rank-and-file participation to avoid shareholder approval.
Under the pilot program, plans have been exempt from shareholder approval if at least a majority of the company's full time, exempt U.S. employees are eligible to participate under the plan and at least a majority of the shares awarded under the plan during the first three years of the plan (or the plan's full term, if shorter) are awarded to employees who are not directors or "Section 16" officers, with decisionmaking authority for the company.
On June 6, the NYSE Corporate Accountability and Listing Standards Committee appeared to abandon the pilot program. The committee released a report to the NYSE Board proposing that, apparently without exception, all equity compensation plans be subject to shareholder approval. The proposal also would deny brokers their current ability to vote shares held in "street name" in favor of equity plan proposals in many cases where the broker receives no instructions from the beneficial owner.
Nasdaq has long had a similar rule to that of the pilot program: Nasdaq has exempted from shareholder approval plans under which, during their first three years and during each subsequent year, the majority of eligible participants are not directors or Section 16 officers and the majority of shares underlying awards are granted to this non-officer and non-director group.
On May 24, Nasdaq Chairman Simmons announced a new rule (subject to SEC approval) requiring that all equity plans benefiting directors or officers be shareholder-approved.
At this time, it is not known to what extent plans that previously received a Nasdaq "comfort letter" or complied with the NYSE pilot program would be "grandfathered" under the new rules.
It appears that the Nasdaq proposal would allow companies to continue to offer initial executive officer inducement grants and rank-and-file-only option plans without shareholder approval, although inducement grants will require the approval of an outside compensation committee or the majority of the company's independent directors. The NYSE does not appear to contain similar exceptions.
Time will tell whether the new Nasdaq and NYSE rules both will survive in their current form or whether the bodies will move to adopt the same rule.
Of course, aside from the exchange rules, companies seek shareholder approval of equity plans for other reasons. For example, shareholder approval is necessary for plans that grant tax advantaged "incentive stock options" under Internal Revenue Code Section 422.
Similarly, shareholder approval is required for companies seeking to preserve the deductibility by the company of compensation recognized upon exercise of options by officers subject to the $1 million cap under Internal Revenue Code Section 162(m).
Jonathan Ocker is chair and a partner of Orrick Herrington & Sutcliffe's compensation and benefits group in San Francisco. Michael Frank practices in the firm's Menlo Park office.
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