pdf

Preparing the New Proxy Disclosures — Some Examples and Analysis

January 1, 0001

 

As companies prepare their proxy statements for their 2010 annual meetings of shareholders, they have significant new disclosure requirements to consider. The new proxy disclosure requirements adopted by the U.S. Securities and Exchange Commission (the “SEC”) on December 16, 2009 became effective on February 28, 2010 (please see our prior Client Alert for more detailed information). To assist our clients in preparing their own new disclosures, we have analyzed the disclosures made thus far in this proxy season and synthesized these disclosures into the examples set forth in this Client Alert.

Risks Arising from Compensation Policies and Practices

Amended Item 402 of Regulation S-K requires a narrative discussion of the company’s compensation policies and practices for its employees generally (not merely the company’s named executive officers) if these compensation policies create risks that are “reasonably likely to have a material adverse effect on the company.”[1]

The SEC made clear in the Adopting Release that this new disclosure requirement does not require a company “to make an affirmative statement that it has determined that the risks arising from its compensation policies and practices are not reasonably likely to have a material adverse effect on the company.” However, developments after the SEC’s adoption of the disclosure requirement have caused companies to believe that it may be necessary to make such a statement. For example, the staff of the SEC (the “Staff”) has recently indicated that, where a company does not include that disclosure, it will ask the company to explain the nature of its internal analysis that led to the determination that no disclosure was required. Additionally, Risk Metrics Group (“RMG”) has advised companies that determine that their compensation policies and practices are not likely to have a material adverse effect on their company to “at a minimum, talk about their process and any mitigating features (such as claw-backs or bonus banks) that they have adopted.” RMG stated that it viewed such disclosure as “an opportunity for communication, not simply compliance, and we expect that shareholders will be looking for a reasonably substantive discussion of the board’s process to determine whether the company’s incentive pay programs might motivate inappropriate risk-taking, and what they are doing to mitigate that.”[2]

The SEC has stated clearly that no disclosure is required if a company determines that its compensation policies and practices are not reasonably likely to have a material adverse effect on the company. Despite this clear statement, the Staff’s statements and RMG’s policy position have caused a number of companies to provide disclosure regarding such a determination. The following example is derived from those disclosures.

Sample Disclosure:

During 2009, the Company and its compensation consultant conducted a risk assessment of the Company’s compensation policies and practices and concluded that they do not motivate imprudent risk taking. In this regard, the Company notes that:
  • the Company’s annual incentive compensation is based on balanced performance metrics that promote disciplined progress towards longer-term Company goals;
  • the Company does not offer significant short-term incentives that might drive high-risk investments at the expense of long-term Company value;
  • the Company’s compensation programs are weighted towards offering long-term incentives that reward sustainable performance, especially when considering the Company’s executive share ownership and holding requirements; and
  • the Company’s compensation awards are capped at reasonable and sustainable levels, as determined by a review of the Company’s economic position and prospects, as well as the compensation offered by comparable companies;

The Company’s compensation policies and practices were evaluated to ensure that they do not foster risk taking above the level of risk associated with the Company’s business model. For this purpose, the Company and its compensation consultant considered the Company’s growth and return performance, volatility and leverage, and the time horizon of the Company’s investments; and compared them to the performance metrics, leverage, and time horizon of the Company’s compensation policies and practices. Based on this assessment, the Company concluded that it has a balanced pay and performance program that does not promote excessive risk taking.

Additional Background Regarding Directors and Director Nominees

Amended Item 401 of Regulation S-K requires expanded narrative disclosure regarding the particular experience, qualifications, attributes or skills which, in light of the company’s business and structure, led the company’s board of directors to conclude that each director and nominee should serve on the board of the company. 

Disclosure in response to this new requirement has varied widely. The most common approaches to preparation of this disclosure are:
  • a simple sentence in each director’s biography summing up each director’s professional experience and using that as the basis for the board of director’s conclusion that the individual should serve as a director;
  • a paragraph summarizing the characteristics that the company's board of directors believes each individual selected to serve as a director should possess, or
  • a combination of the two approaches above.

Sample Disclosure 1:

The Company believes that [the particular director’s] financial and business expertise, including a diversified background of managing and directing public [industry]-based companies, give him the qualifications and skills to serve as a Director.

Sample Disclosure 2:

The Company believes that its Board as a whole should encompass a range of talent, skill, diversity, and expertise enabling it to provide sound guidance with respect to the Company’s operations and interests. In addition to considering a candidate’s background and accomplishments, candidates are reviewed in the context of the current composition of the Board and the evolving needs of our businesses. The Company’s policy is to have at least a majority of Directors qualify as “independent” under the [listing requirements of an exchange or corporate governance document.] The [Nominating Committee] identifies candidates for election to the Board of Directors; reviews their skills, characteristics and experience; and recommends nominees for director to the Board for approval. [If applicable, reference to any corporate governance documents setting forth such standards.]

The [Board or Nominating Committee] seeks directors with strong reputations and experience in areas relevant to the strategy and operations of the Company’s businesses, particularly industries and growth segments that the Company serves, such as [related industries], as well as key geographic markets where it operates, such as [relevant geographic locations]. Each of the nominees for election as a Director at the Annual Meeting of Shareholders and each of the Company’s current Directors holds or has held senior executive positions in large, complex organizations and has operating experience that meets this objective, as described [below]. In these positions, they have also gained experience in core management skills, such as strategic and financial planning, public company financial reporting, corporate governance, risk management, and leadership development. Each of our directors also has experience serving on boards of directors and board committees of other public companies.

The [Board or Nominating Committee] also believes that each of the nominees and current Directors has other key attributes that are important to an effective board: integrity and demonstrated high ethical standards; sound judgment; analytical skills; the ability to engage management and each other in a constructive and collaborative fashion; diversity of origin, background, experience, and thought; and the commitment to devote significant time and energy to service on the Board and its Committees.

Diversity in Identifying Nominees for Director

Amended Item 407(c) of Regulation S-K requires a company to disclose whether, and if so how, the nominating committee or board of directors considers diversity in identifying nominees for directors. Companies may define “diversity” in the manner most appropriate to their business (including diversity as it relates to individuals' backgrounds or perspectives). If the company has a policy with regard to considering diversity in identifying director nominees, the amendments require disclosure of:
  • the manner in which the policy is implemented; and
  • the manner in which the nominating committee or board of directors assesses the effectiveness of the policy.

In response to this new disclosure requirement, most companies have disclosed that they do not have a policy for considering diversity in identifying director nominees and declined to state a specific definition of "diversity." Instead, most companies have described generally the manner in which their board of directors or nominating committee considered diversity in their director selection process. Often, as evidenced in the examples above, companies have discussed diversity as part of the amended Item 401 requirement to disclose director and nominee qualifications. Although some companies have included very brief disclosure in response to this new requirement (some disclosures are as short as a brief sentence), companies most commonly present a paragraph-long discussion of whether, and if so how, the nominating committee or board of directors considers diversity in identifying nominees for directors.

Sample Disclosure 1:

The Company does not have a formal policy with regard to the consideration of diversity in identifying Director nominees, but the [Nominating Committee or Board] strives to nominate Directors with a variety of complementary skills so that, as a group, the Board will possess the appropriate talent, skills, and expertise to oversee the Company’s businesses.

Sample Disclosure 2:

The [Nominating Committee or Board] annually reviews the individual skills and characteristics of the Directors, as well as the composition of the Board as a whole. This assessment includes a consideration of independence, diversity, age, skills, expertise, time availability, and industry backgrounds in the context of the needs of the Board and the Company. Although the Company has no policy regarding diversity, the [Nominating Committee or Board] seeks a broad range of perspectives and considers both the personal characteristics (gender, ethnicity, age) and experience (industry, professional, public service) of Directors and prospective nominees to the Board. [If applicable, reference to any statements from corporate governance documents regarding the value of diversity among Directors.]

Board Leadership Structure and the Board’s Role in Risk Oversight

New Item 407(h) of Regulation S-K requires disclosure about the company’s “leadership structure,” including disclosure regarding:
  • Whether the company has combined or separated the chief executive officer and board chair positions;
  • The basis for the board of directors’ view that the company’s particular leadership structure is appropriate for the company; and
  • Where the chief executive officer and chairman positions are combined, whether and why the company has a “lead independent director” and the specific role the lead independent director plays in the leadership of the company.

New Item 407(h) of Regulation S-K also requires disclosure regarding the manner in which the board of directors administers its risk oversight function (i.e., through the board of directors as a whole or through a committee of the board of directors). 

Disclosure of the reasons underlying a board’s decision regarding its leadership structure can be very difficult to prepare. Perhaps not surprisingly, disclosures regarding leadership structure have tended to consist of brief and conclusory statements that supported the company’s current leadership structure. Where a company has a bylaw or corporate governance principle that requires the independence of the board chair, a statement to that effect and the reasons for that provision generally are included in the disclosure.

The disclosure regarding risk oversight has tended to be more robust than the disclosure regarding leadership structure. Although disclosure patterns may vary from industry to industry, many disclosures have demonstrated a company's careful examination of the risk oversight function and the risks attendant to a particular business and industry.

Sample Disclosure Regarding Leadership Structure 1:

The Board has determined that the positions of Chairman of the Board and Chief Executive Officer should be held by different persons. In addition, the Board believes that the Chairman should never be an employee. Since [date], the Board has been led by an independent Non-Executive Chairman. Under our Corporate Governance Principles, the Chairman of the Board is responsible for coordinating the Board’s activities, including the scheduling of meetings of the full Board, scheduling executive sessions of the non-employee directors and setting relevant items on the agenda (in consultation with the Chief Executive Officer as necessary or appropriate). The Board believes this leadership structure has enhanced the Board’s oversight of, and independence from, Company management, the ability of the Board to carry out its roles and responsibilities on behalf of our stockholders, and our overall corporate governance compared to our prior combined Chairman/Chief Executive Officer leadership structure.

Sample Disclosure Regarding Leadership Structure 2:

The Board does not have a policy regarding the separation of the roles of Chief Executive Officer and Chairman of the Board as the Board believes it is in the best interests of the Company to make that determination based on the position and direction of the Company and the membership of the Board. The Board has determined that having an independent director serve as Chairman is in the best interest of the Company’s shareholders at this time. This structure ensures a greater role for the independent Directors in the oversight of the Company and active participation of the independent Directors in setting agendas and establishing Board priorities and procedures. Further, this structure permits the Chief Executive Officer to focus on the management of the company’s day-to-day operations.

Sample Disclosure Regarding Leadership Structure 3:

The Board does not have a policy regarding the separation of the roles of Chief Executive Officer and Chairman of the Board as the Board believes it is in the best interests of the Company to make that determination based on the position and direction of the Company and the membership of the Board. The Board has determined that having the Company’s Chief Executive Officer serve as Chairman is in the best interest of the Company’s shareholders at this time. This structure makes the best use of the Chief Executive Officer’s extensive knowledge of the Company and its industry, as well as fostering greater communication between the Company’s management and the Board.

Sample Disclosure Regarding Risk Oversight 1:

Companies face a variety of risks, including credit risk, liquidity risk, and operational risk. The Board believes an effective risk management system will (1) timely identify the material risks that the Company faces, (2) communicate necessary information with respect to material risks to senior executives and, as appropriate, to the Board or relevant Board Committee, (3) implement appropriate and responsive risk management strategies consistent with Company’s risk profile, and (4) integrate risk management into Company decision-making.

The Board has designated the Audit Committee to take the lead in overseeing risk management and the Audit Committee makes periodic reports to the Board regarding briefings provided by management and advisors as well as the Committee’s own analysis and conclusions regarding the adequacy of the Company’s risk management processes.

In addition to the formal compliance program, the Board encourages management to promote a corporate culture that incorporates risk management into the Company’s corporate strategy and day-to-day business operations. The Board also continually works, with the input of the Company’s executive officers, to assess and analyze the most likely areas of future risk for the Company.

Sample Disclosure Regarding Risk Oversight 2:

The Company has a risk management program overseen by [executive officer], who reports directly to the Chief Executive Officer. Material risks are identified and prioritized by management, and each prioritized risk is referred to a Board Committee or the full Board for oversight. For example, strategic risks are referred to the full Board while financial risks are referred to the audit or finance Committees. The Board regularly reviews information regarding the Company's credit, liquidity, and operations, as well as the risks associated with each, and annually reviews the Company's risk management program as a whole. Also, the Compensation Committee periodically reviews the most important risks to the Company to ensure that compensation programs do not encourage excessive risk-taking.

* * *

If you have any questions regarding compliance with the SEC’s new proxy disclosure requirements, please contact the authors or your O’Melveny & Myers adviser.





[1] The SEC stated in the release adopting this disclosure requirement (Rel. No. 33-9089, the “Adopting Release”) that this disclosure should be included in the discussion of the company’s compensation, but not in the company’s “Compensation Discussion and Analysis. With regard to named executive officers, however, the SEC noted that “to the extent that risk considerations are a material aspect of the company’s compensation policies or decisions for named executive officers, the company is required to discuss them as part of its CD&A under the current rules.”

[2] RMG FAQ regarding U.S. Proxy Disclosure Requirements for 2010.