Small Public Company Forum

The SEC recently issued a new set of Compliance & Disclosure Interpretations (C&DIs) covering the new proxy disclosure enhancement rules passed in December 2009 and effective as of February 28, 2010.  One C&DI touches on the material we presented on at our January 14, 2010 Small Public Company Forum event hosted by Baker Tilly Virchow Krause – the new director qualifications disclosures.  Below are excerpts from the C&DIs and our commentary on complying with the new director qualifications disclosure.  In addition, we thought this would be a good opportunity to close the loop on a question that arose during the January Forum event on the subject of how to reflect performance shares on the revised Summary Compensation Table.

C&DI

Regulation S-K, new Item 401(e)

Question:  For each director and nominee, Item 401(e)(1) requires disclosure of such person’s “specific experience, qualifications, attributes or skills” that led the board to conclude that such person should serve as a director at the time that a filing containing the disclosure is made.  May a company provide these disclosures on a group basis if the directors or nominees share similar characteristics, such as all of them are audit committee financial experts or all of them are current or former CEOs of major companies?

Answer:  No.  The disclosure of each director or nominee’s experience, qualifications, attributes or skills must be provided on an individual basis.  For each person, a company must disclose why the person’s particular and specific experience, qualifications, attributes or skills led the board to conclude that such person should serve as a director of the company, in light of the company’s business and structure, at the time that a filing containing the disclosure is made.  For example, it would not be sufficient to disclose simply that a person should serve as a director because he or she is an audit committee financial expert.  Instead, a company should describe the particular and specific experience, qualifications, attributes or skills that led the board to conclude that this particular person should serve as a director at the time that a filing containing the disclosure is made.

Our Commentary:  This does not alter our advice on best practices delivered at our January Forum event.  To recap, there is no prescribed format for complying with new Item 401(e).  Nevertheless, we believe that companies should consider adding a new paragraph (immediately following or preceding the paragraphs containing the director biographies) that would provide the newly required disclosures.  In this paragraph, companies would adopt a group-oriented disclosure that would begin by identifying the board’s conclusion on qualifications shared among different directors, and then go on to identify the particular experiences, skills and attributes of each director that substantiate those qualifications.  After that, more particular qualifications (not shared by or among directors) would be disclosed.  The key to complying with the C&DI is the inclusion of the particular information for each individual director.  A fine example of this approach appears in the Definitive Proxy Statement filed by Hovnanian Enterprises, Inc. on February 1, 2010 (page 5).

Another approach that would seem to work well would be to include a short summary of the particular experiences, qualifications, skills and attributes in each individual director’s biography.  The only potential difficulty with this approach is separating the facts of the director’s biographical background with the analysis sought by the new disclosure item.  This may not be as difficult as it would first seem.  A fine example of this approach appears in the Preliminary Proxy Statement filed by Fortune Brands, Inc. on February 5, 2010, where the disclosure is set off beneath each biography to make the analysis stand separately from the biographical data.

Although every company’s situation is different, we do not generally recommend that companies use charts or matrices to identify particular experiences, qualifications, skills and attributes of their directors since that kind of presentation could present “political problems” with or among board members.

Performance Shares on the Summary Compensation Table

At our January Forum event, a question arose about how to properly reflect performance shares under the new Summary Compensation Table rules.  “Performance shares” are equity or equity-related grants that have market-, performance- or service-related conditions attached to the vesting or size of the grants. These conditions affect the grant date fair market value of grants for financial reporting purposes.  Under the new rules, the “probable outcome,” as determined under ASC FASB Topic 718 (the successor to FAS 123(R)), is the proper method for determining the “grant date fair market value” for performance shares.

As we discussed at the Forum event, this could lead to some strange numbers in the table. Theoretically, if it is highly improbable that the performance shares would ever vest, then the grant date value could be very low (or even zero). In this case, it would be advisable to provide additional description of the award in the footnotes or narrative disclosure accompanying the table, to help the reader understand why the value in the table is so small.