New SEC Disclosure Rules Regarding Executive Compensation and Governance Issues

The SEC has adopted new disclosure rules relating primarily to executive compensation. Many of the changes, such as an expanded compensation table, will, in our view, be best learned in the process of implementation. Therefore, we have confined this letter to areas of major change, particularly those for which advanced planning can be useful.

These amendments are effective for Form 10-Ks for fiscal years ending after December 14, 2006 and registration statements and proxy statements filed after December 14, 2006 which include information for years ending after December 14, 2006. The rules apply prospectively in that there will be no need to reformulate the tables and information for prior fiscal years. New Form 8-K requirements, generally concerned with the reporting of management contracts, are effective for filing events that arise after November 6, 2006 and also apply prospectively.

The amendments also impose the SEC’s plain English requirements on these disclosures.

1. Compensation Discussion and Analysis Section.
The proxy statement disclosure of compensation will now begin with a new section captioned “Compensation Discussion and Analysis.” This section will discuss the company’s policies with respect to compensation for the named executive officers. The discussion must describe the objectives of the program, what the program is designed to reward, each element of compensation, why the company pays each element, how the amount of each element is determined and how these practices fit into the overall compensation objectives of the company. These discussions then would involve allocations between long-term and current compensation, allocations between cash and non-cash compensation, specific items of performance taken into account, the role of executive officers in making compensation decisions and similar matters. Since this section will provide discussion and analysis through management's perspective, Sarbanes-Oxley Section 302 certifications cover this new section. The SEC has stated that CEOs and CFOs may “look to” the Compensation Committee Report in providing their certifications on CD&A.

Specific performance targets must be disclosed unless they involve trade secrets or information that would cause competitive harm if disclosed. The same standard is used as when requesting confidential treatment in filings relying upon exemptions from the Freedom of Information Act. The language of the release indicates that it will be more difficult than in the past for issuers to omit compensation-related disclosures based on confidentiality concerns.

A discussion of the company’s policies and practices in granting options to employees will be required. In particular, policies must describe why particular grant dates, for example, quarterly or annually, are selected and why. Additionally, if any program, plan or practice is designed to time the grant of options or equity awards to executives in coordination with the release of material non-public information, it must be fully disclosed.

If the exercise price of grants does not equal the closing price on the date of grant, further explanation is required including the insertion of additional tabular columns. The date of grant is as determined by FAS 123R. Consider changing your plan documents and practices now to avoid the additional disclosure. This rule applies even if a perfectly reasonable alternative is used, for example, the mean between the high and low sales prices on the date of grant. The date of grant is now set as the date the Committee or Board takes action.

2. Compensation Committee Report.
Proxy statements will still contain a Compensation Committee Report. The amendments require the Committee to state whether it has reviewed and discussed the new Compensation Discussion and Analysis section with management and recommended that it be included in the Form 10-K and proxy statement.

3. Integration of Compensation Sections.
The Compensation Committee Report and other additional corporate governance disclosures described below will focus on the corporate governance structure utilized by the company in the determination of compensation, such as the scope and authority of the Committee and others in making those determinations. The Compensation Discussion and Analysis will focus on the policies and objectives of the company.

The Compensation Discussion and Analysis should tie in to the information shown in the compensation table. The report can also speak prospectively. One technique we use in preparing such reports is to describe almost chronologically the actions actually taken by the Committee since the last proxy statement. This, in most cases, will involve the setting of compensation for next year. In any case, the Compensation Discussion and Analysis section would include the items discussed above and must address the information shown in the compensation tables.

4. Executive Compensation Tables.
There are several changes to the Summary Compensation Table, most notably the adding of a total compensation column; instructions that in setting the dollar value of equity grants, the grant date fair value must be utilized; and a new column reporting changes in actuarial present value of accumulation pension benefits and similar matters. Expanded disclosure regarding retirement plans and other post-effective payments will also be required. Disclosure of benefits payable upon a change in control or similar action calculated as if the event occurred at the end of the preceding fiscal year will be included.

A description of factors necessary to understand the information presented in the table will also be required. This would include, for example, the material terms of employment agreements, options, and restricted stock awards.

The first presentation in the new rules will only include the prior fiscal year. Eventually, this will grow into three full fiscal years.

The new Summary Compensation and related tables are attached as Annex A.

5. Perquisites.
Perquisites and other benefits in excess of $10,000 must now be disclosed in detail. Previously disclosure was only required if the aggregate amount of perquisites was the lesser of either $50,000 or 10% of salary and bonus. Each perquisite valued at more than $25,000 or 10% of total perquisites and other personal benefits must be quantified and disclosed in a footnote.

In the adopting release, the SEC provided interpretive guidance concerning factors to be considered in determining whether an item is a perquisite or another personal benefit. An item is not a perquisite or personal benefit if it is integrally and directly related to performance of the executive’s duties. Otherwise, it is a perquisite or personal benefit even if it also involves a business reason or is established for the convenience of the company. For example, the furnishing of a Blackberry would not be a perquisite but a requirement to use a company aircraft for security reasons would also involve a personal benefit and, therefore, be viewed as a perquisite or personal benefit. Perquisites are valued based on aggregate incremental cost.

6. Named Executive Officers.
Previously salary and bonus were the only items taken into account in determining the five highest paid officers who then would form the named executive officer group listed in the Compensation Table. Now, the CEO and CFO are automatically included as named executive officers along with the three highest paid executives with total compensation in excess of $100,000. Also, items that are earned but not paid under non-equity incentive plans, perquisites, matching contributions and similar items will be involved in determining the named executive officers. However, changes in value of pension benefits and earnings on non qualified deferred compensation earnings will not be included for purposes of determining named executive officers.

7. Related Party Transactions.
The related party transactions section of the proxy statement will now require an explanation of the policies and procedures followed by companies in approving such transactions. Some companies will adopt written policies in response to this requirement. Nasdaq rules have for several years required approval of related party transactions by Audit Committees. The threshold for disclosure has been raised from $60,000 to $120,000.

8. Director Independence and Compensation.
A table for the last fiscal year only showing director compensation will now be required along with a disclosure of option grant practices followed for directors and policies and procedures for determining director compensation.

9. Security Ownership Disclosures.
Disclosure of shares owned by directors and officers will now require disclosure of the number of shares that have been pledged including standard brokerage account arrangements.

10. Performance Graph.
The graph will no longer be required in the proxy statement but must be presented in the annual report to shareholders.

11. Corporate Governance Disclosure.
Companies must now disclose in proxy statements and similar filings the identity of their independent directors and the definition of independence used in making that determination. These will generally conform to requirements of Nasdaq or the NYSE, as the case may be. The definition must be posted on the company’s website with appropriate disclosure of that posting. If not posted, they must be included as an appendix to the proxy statement at least once every three years. Any transactions, relationships or other arrangements not previously disclosed in the proxy statement which were considered by the Board of Directors in making its independence determinations must also be disclosed. These provisions will require boards to review at least annually the independence standards and their application to directors as well as to review any other information that would bear upon independence determinations.
In addition, a separate section on the compensation committee processes and procedures must be provided. This separate section must state whether the compensation committee has a charter and if so, whether it is posted on the company's website or included with the proxy materials at least once every three years. This section must also address the role of compensation consultants and executives in the compensation process. The compensation committee's scope of authority and ability to delegate must also be disclosed.

12. Form 8-K Changes
Changes to Form 8-K will reduce the reporting of compensation agreements and plans for executive officers by only requiring the reporting of matters that, in the words of the SEC release, are “unquestionably or presumptively material.” Plans and agreements will now be limited to those covering the principal executive officer, principal financial officer and any one of the other executive officers named in the compensation table in the most recent proxy statement.

13. Other
The SEC is continuing to consider its proposal to require disclosure of compensation paid to the three highest paid non-executive officers. As it now stands, the proposal is to require disclosure by companies with market capitalizations in excess of $700 million of the compensation of three employees whose compensation is greater than any of the named executive officers without naming those employees. No information will be required regarding employees without responsibility for significant policy decisions.

We urge you to start the process of determining which parts of these new rules will require the most time and resources of your company. Specifically, we believe that companies will spend significant time in developing drafts of the Compensation Discussion and Analysis section and gathering information required for the awards and pension tables. As items disclosed in one table may have to be disclosed in others, it may take time for some companies to provide consistent and accurate disclosure. Your company's reliance on tally sheets will increase as a result of these new rules and annual director and officer questionnaires will have to be overhauled.

The following are our attorneys specializing in securities matters who may be of assistance to you in these matters:

Gary P. Kreider
(513) 579-6411
gkreider@kmklaw.com 

Mark A. Weiss
(513) 579-6599
mweiss@kmklaw.com 

F. Mark Reuter
(513) 579-6469
freuter@kmklaw.com 

Michael J. Moeddel
(513) 639-3962
mmoeddel@kmklaw.com