This article is reprinted with permission from the
November 29, 1994
edition of

New York Law Journal.

1994 NLP IP Company.


SEC Disclosure Requirements

By Joseph E. Bachelder


THIS COLUMNS discusses (i) SEC disclosure requirements with respect to executive severance arrangements and (ii) recent indications that the SEC may consider interests in some deferred compensation plans, previously thought not subject to registration requirements of the Securities Act of 1933. The column also provides a "status report" on the stock-based compensation project that the Financial Accounting Standards Board (FASB), the Treasury regulation project under 162(m) of the Internal Revenue Code of 1986 and the SEC project involving proposed amendments to the insider trading regulations under 16 of the Securities Exchange Act of 1934.

Executive Severance

A continuing problem for companies with senior-level executives whose employment is terminating is the uncertainty as to what is required to be disclosed in proxy statements and other documents filed with the Securities and Exchange Commission.

An ambiguity exists because of the interplay between Items 402 and 404 of the Regulation S-K under the Exchange Act. Item 402, which governs the disclosure of executive compensation and was substantially amended by the SEC in late 1992, 1 requires companies to disclose the compensation of their "named executive officers," defined as: (i) all persons serving as CEO during the last completed fiscal year; (ii) the four most highly paid executive officers (other than the CEO) at the end of the last completed fiscal year, based on "total annual salary and bonus" for that year and; (iii) "up to two additional individuals for whom disclosures would have been provided pursuant to [clause (ii) above] . . . but for the fact that the individual was not serving as an executive officer of the registrant at the end of the last completed fiscal year." 2

In addition to requiring disclosure of the compensation paid to terminated executives who are named executive officers, Item 402 requires disclosure of the terms and conditions of termination arrangements exceeding $100,000 with respect to such named executive officers:

Any compensatory plan or arrangement, including payments to be received from the registrant, with respect to a named executive officer, if such plan or arrangement results or will result from the resignation, retirement or any other termination of such executive officer's employment with the registrant and its subsidiaries or from a change-in-control of the registrant, or a change in the named executive officer's responsibilities following a change-in-control and the amount involved, including all periodic payments or installments, exceeds $100,000. 3

Under Item 404 (which was not amended by the SEC in 1992 or thereafter), an issuer must disclose certain transactions:

to which the registrant or any of its subsidiaries was or is to be a party, in which the amount involved exceeds $60,000 and in which any of the following persons had, or will have, a direct or indirect material interest, naming such person and indicating the person's relationship to the registrant, the nature of such person's interest in the transaction(s), the amount of such transaction(s) and, where practicable, the amount of such person's interest in the transaction(s):

(1) Any director or executive officer of the registrant. . . . 4

Such transactions would seem to include termination arrangements.

Taken together, do these two rules require that termination arrangements be disclosed: (i) in respect of named executive officers of such arrangements involve amounts over $100,000 and in respect of other (non-named) executive officers if they are over $60,000?; (ii) in respect of all executive terminations (whether for named or non-named executive officers) in which the arrangements involve amounts of $60,000?; or (iii) only in respect of terminations of named executive officers in which the arrangements involve amounts over $100,000 (and termination arrangements with non-named executive officers need not be disclosed)?

Members of the SEC staff have indicated that the last construction is the construction the staff will follow. 5 This conclusion appears consistent with instructions to Item 404 that provide as follows:

No information need be given in response to any paragraph of Item 404 as to any compensation or other transaction reported in response to any other paragraph of Item 404 or to Item 402 of Regulation S-K or as to any compensation or transaction with respect to which information may be omitted pursuant to any other paragraph of Item 404 or Item 402.

Named Executive Officer

A further complication is involved in determining which executives are "named executive officers." This determination, as noted above, is based on their "total salary and bonus" for the year. In order to rank the executives for purposes of disclosure in the summary compensation table, all payments made to them must be given not only as to whether the payment represents salary or bonus, but also whether as such it is attributable to the year being reported in the proxy statement.

There has been no comprehensive statement, at least officially, as to what types of severance payments are to be taken into account as salary and bonus in determining whether the termination executive is a named executive officer for the year of termination. A reasonable position would seem to be that salary continuation payments attributable to any month or months remaining in the year of termination would be includable as salary for that year.

Also, a post-termination annual bonus payment attributable to the year of termination likewise would seem includable as a bonus for that year. Other payments, such as salary continuation payments attributable to periods beyond the year of termination and other payments that are not attributable to that year, should excludable in determining salary and bonus for such year of termination. It must be emphasized, however, that discussions with the SEC staff have been inconclusive in this regard.

Finally, many severance arrangements with individual senior-level executives are required to be filed with the SEC as exhibits (usually to the Form 10-K annual report). Item 601(b)(10)(iii)(A) of Regulation S-K provides:

Any management contract or any compensatory . . . contract or arrangement . . . in which any director or any of the named executive officers of the registrant, as defined by Item 402(a)(3), participates shall be deemed material and shall be filed; and any other management contract or any other compensatory . . . contract, or arrangement in which any other executive officer of the registrant participates shall be filed unless immaterial in amount of significance.

Because of the broad language of Item 601 in respect of named executive officers, one might expect most, if not all, severance arrangement with such individuals would be filed as exhibits with the SEC. Relatively few severance arrangements with such individuals, however, appear as exhibits to the 10-K. 6 As to non-named executive officers, most companies presumably conclude that their arrangements are immaterial.

Deferred Compensation

A number of public corporations have been engaged in discussions with the SEC regarding the issue of whether deferred compensation plans may, in some cases, represent securities that require registration under the Securities Act.

Historically, U.S. public corporations with deferred compensation plans have not been concerned with the issue of whether to register such a plan. Among the reasons are the assumption that no securities are involved and the assumption that no investment decision is involved.

Of course, even if the assumptions are incorrect, in many cases the limited number, the sophistication and the compensation or net worth of the individuals involved would afford exemption pursuant to Regulation D under the Securities Act. Thus, the concern primarily is with deferred compensation plans covering a large number of executives who do not meet the compensation or net worth criteria for the Regulation D exemption: specifically, over 35 executives who do not meet such criteria. (These observations may not apply to a situation in which the issue is whether the Investment Company Act of 1940 is applicable.)

For many years, U.S. corporations have been able to rely on no-action letters from the SEC staff to the effect that particular deferred compensation plans do not require registration. 7

It has been generally assumed that entitlements under a deferred compensation plan are not "securities" within the meaning of 2(1) of the Securities Act, which provides that, unless the context otherwise requires, the term security means:

any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, . . . or, in general, any interest or instrument commonly known as a "security," . . . .

In issuing the no-action letters referred to above, the SEC staff stated that it was not necessarily adopting the legal analysis of those seeking the no-action letters, who have generally argued that interests in the deferred compensation plans are not securities.

The SEC staff has therefore left open the possibility that it might regard an interest in a deferred compensation plan as a security, perhaps because it would be deemed to be an "evidence of indebtedness" or an "investment contract." It is noteworthy that the Internal Revenue Service is seeking to establish that a deferred compensation plan is not a debt obligation but rather is compensation and that interest on the deferred amounts is not deductible as interest. 8

Since 1990 it appears that the SEC staff has ceased issuing no-action letters of the sort described above. It is understood that, in light of this, some issuers have registered their deferred compensation plans.

Investment Decision

As noted above, in order for the transaction between employer and employee to require registration, there must be an "investment decision" by the employee. If there is no choice for the executive to make, there would appear to be no transaction involved that requires registration.

There are many forms of deferred compensation that automatically defer compensation, including non-qualified supplemental executive retirement plans (so-called SERPs).

On the other hand, many deferred compensation plans provide the executive with an election to receive a payment currently (or relatively so) or to defer it. Is an "investment decision" involved in such a case?

Even is no election is involved as to the original deferral, some deferred compensation plans provide the opportunity to direct the "investments" representing the deferred amounts. "Investment" alternatives may include: interest on the deferred amounts, phantom shares of the employer of other investment choices such as government securities and mutual funds.

Again, there is a question as to whether an investment decision is involved.

There is no indication when or if the SEC will publish guidelines as to circumstances in which it considers registration may be required in connection with non-qualified deferred compensation programs. In the meantime, many public corporations may need to give attention to this subject.

This column has been following the developments of the stock-based compensation project at FASB since the issuance of an Exposure Draft in 1993 proposing that stock option grants be valued and charged against a company's earnings. 9

A FASB Task Force meeting, originally scheduled for Oct. 25, has been rescheduled for Dec. 2. During the fall. FASB has been holding meetings at which various stock option valuation methods have been further explored.

There are indications that FASB may withdraw its original proposal and issue a new one. 10 If that occurs, a new comment period would begin and new public hearings presumably would be held.

If a new proposal is released, there is a possibility that FASB's timetable for the new rules to take effect would be changed. That schedule now requires companies to recognize options granted after Dec. 31, 1996 as compensation expense.

A requirement that financial statements for years commencing in 1994 and thereafter disclose information concerning options granted after Dec. 31, 1993 already has been postponed until years commencing in 1995, although disclosure of information concerning 1994 grants may still be required beginning in the 1995 financial statements.

Following the Congressional elections in early November, a number of persons in Washington, D.C., both in and out of Congress, suggested the possibility of further legislation regarding the FASB stock-based compensation project. Last May, the Senate voted 88-9 in favor of a sense-of-the Senate resolution calling on FASB to drop the proposal. Last month, Senator Joseph Lieberman (D-Conn.) introduced the Accounting Standards Reform Act of 1994, which would require the SEC to approve any new or amended financial accounting standard adopted by FASB. 11 Senator Lieberman also had introduced the Equity Expansion Act of 1993 at the time the Exposure Draft was issued, which included a provision effectively overruling the FASB proposal. 12

Code 162(m)

Section 162(m) precludes companies from deducting certain executive compensation exceeding $1 million. Performance-based compensation that meets certain criteria under Section 162(m) is exempted. There are a number of unsettled issues, however, as to how these criteria are to be applied in various circumstances.

Officials at the Treasury Department have indicated that additional guidance will be released soon. 13 It appears possible that the guidance, in the form of amendments to the proposed regulations that were issued in December 1993, will be issued before the end of the year. It is expected that the new proposed regulations will cover the definition of "outside directors" and will provide guidance as to companies involved in initial public offerings.

In August, the SEC issued proposed amendments to the rule promulgated under 16 of the Exchange Act. 14 These amendments generally would broaden the exemption under certain broad-based employee benefit plans for "insiders" who are subject to short-swing profit liability. The required public comment period ended on Nov. 1 and the SEC is now studying the approximately 85 comments received. The SEC apparently hopes to have a response ready in early 1995.


1 See this column, New York Law Journal, Nov. 30, 1992.

2 Item, 402(a)(3) under Regulation S-K.

3 Item 402(h)(2) under Regulation S-K.

4 Item 404(a) under Regulation S-K..

5 As reported in The Corporate Counsel (Executive Press, Inc., San Francisco, California), September-October 1994, at 1. This position has also been confirmed in a telephone conversation with a member of the SEC staff.

6 The observation made in the text is not based on an extensive survey, but rather on the experience of the author in reviewing 10-Ks over the years. In many cases severance arrangements are embodied in employment agreements previously filed as exhibits to the 10-Ks.

7 E.g., McKesson Corporation (January 9, 1990); Diversified Energies, Inc. (October 28, 1988); and Shearson Lehman Hutton Inc. (June 20, 1988).

8 See Albertson's, Inc. v. Commissioner, 12 F.3d 1529 (9th Cir. 1993), rev'g 95 T.C. 415 (1990), reh'g granted. Nos. 91-70380, 91-70381 (march 31, 1994). The opinion of the Ninth Circuit was withdrawn upon the granting of the rehearing. It is understood that the rehearing was held on June 29, 1994. As of the date of this column, no decision on the rehearing has been published.

9 For recent developments see this column, New York Law Journal, June 30, 1994 and Aug. 31, 1994. This column also discussed the FASB proposals at the time the Exposure Draft was issued. June 30, 1993.

10 Lee Berton, "FASB May Alter Option Plan to Ease Impact on Profits," The Wall Street Journal, November 16, 1994, at A2, A20. See also 26 Sec. Reg. & L. Rep. (BNA) 1245 (September 16, 1994).

11 S.2525, 103d Cong., 2d Sess. (1994).

12 S. 1175, 103d Cong., 1st Sess. (1993).

13 217 Daily Tax Report (BNA) G-3 (November 14, 1994); 212 Daily TAx Report (BNA) G-4 (November 4, 1994).

14 See this column, Aug. 31, 1994.