Canadian Securities Law : Canadian Securities Lawyer & Attorney : Stikeman Elliott Law Firm : Montreal, Ottawa, Calgary, Vancouver, Montreal, Toronto

Specifically, the model policy states that the board will develop policies to increase engagement with shareholders on governance matters. Examples of engagement include meeting with larger shareholders and establishing methods for hearing from smaller shareholders. Boards are also to consider emerging shareholder engagement practices in other jurisdictions. Further, the model policy outlines the information to be disclosed respecting a company's approach to executive compensation. Such disclosure includes two parts. First, information required by Form 51-102F6 is to be included in the management information circular for the company's annual meeting as a report to shareholders from the issuer. Second, a committee of the board is required to include a discussion of key strategic objectives of the company and how the executive compensation plan is designed to incentivize management to meet such objectives. Under the model policy, beyond disclosure required by Form 51-102F6, the compensation discussion and analysis (CD&A) is also to describe the approach to compensation for subsequent financial years, highlighting any changes made to the prior year’s compensation plan and where and why any discretion was exercised by the board in prior years.

The suggested policy also includes a recommended form of the advisory “say on pay” resolution, which would require an affirmative vote of a majority of votes cast for approval. The policy also requires that the results of the advisory vote be disclosed along with the company’s voting results for the meeting and, while the advisory vote is not binding, that the board will take the results of the vote into account when considering future compensation policies. The policy further states that where a significant number of shareholders oppose the resolution, the board will consult with shareholders to understand their concerns and review their approach to compensation in light of such concerns.

Director compensation as a policy matter has not been addressed in the model policy, but the CCGG indicated that it may do so in the future.

3. Test pay to performance linkages

While many issuers included a detailed discussion in disclosure of the various metrics used to link pay to performance, the CCGG suggests that disclosure was inconsistent as to how the relevant metrics translated to the compensation amounts. Further, the CCGG recommends an explanation of the rationale behind the choice of the metrics, their appropriateness and how they align with the company's goals and strategy.

4. Establish share ownership guidelines

With respect to this recommendation, the CCGG suggests, among other things, prohibiting the monetization of unvested equity awards and requiring executives to hold equity in the company for a period of time after leaving the company.

5. Disclose all facets of the compensation regime

The CCGG cited the improving quality of disclosure under this criteria, but states that no company fully met this guidance. Specifically, the CCGG suggests that issuers need to "bring more clarity" to their disclosure and provided numerous examples of best practices.

The definition of excessive severance payments is also being changed in RiskMetrics' policy respecting problematic pay practices. Severance payments are currently considered excessive if they are greater than three times cash compensation, and the threshold will now be dropped to two times cash compensation. A section on risk-mitigating pay practices is also being added to the policy. In the case of problematic compensation practices, RiskMetrics will generally recommend a vote against management advisory vote proposals on say-on-pay and/or a withhold vote from compensation committee members. Equity plans considered to be vehicles for problematic compensation practices will also garner a vote against.

Further, while RiskMetrics stated that a vote is generally based on a "preponderance of problematic elements", certain practices may lead to a withhold or against vote on a stand-alone basis. Such practices may include: a general omission of timely information necessary to comprehend the rationale for compensation process and outcome, an overly generous new hire package for a new CEO, contracts containing multi-year guarantees for salary increases and bonuses, interest free or low interest loans to employees for exercising options, excessive severance or change-in-control provisions, unjustifiably large bonus payouts, excessive perks and problematic option granting practices.

RiskMetrics also released policy updates for the United States, Europe and international markets.

Such a non-binding vote would be required in any shareholders meeting occurring on of after December 15, 2009. While the draft legislation further provides that the vote is mandatory, it would not be binding on the corporation or the board, nor would it be construed as overruling a decision by the board, creating or implying any additional fiduciary duty, or as restricting the ability of shareholders to make shareholder proposals.

The proposed legislation also includes governance-related proposals that would require each member of the compensation committee to be independent. The compensation committee would have the authority, in its sole discretion, to retain and obtain independent compensation consultants and would be directly responsible for their appointment and compensation as well as the oversight of the consultants’ work. The proposal would also require that any compensation consultants, legal counsel or other adviser to the compensation committee meet independence standards to be promulgated by the SEC and that the issuer include prescribed proxy disclosure relating to retention of, and reliance upon, compensation consultants. The SEC is also given a two-year deadline to study and report back to Congress on the effects of reliance upon independent consultants.

The Treasury Department's release on the proposals is available here.

The more common use of benchmarking is the use of peer group analysis to determine the appropriate elements of compensation and the levels at which they should be paid out. Under the New Disclosure Requirements, CD&A requires disclosure of any benchmarks used for compensation purposes, explaining the different elements of the benchmark relied upon and identifying both the companies included in the benchmark group and the selection criteria.¹ Boards and compensation committees should keep this in mind when undertaking their benchmarking exercises. This may be a good opportunity to revisit the rationale behind past practices and to consider alternatives that may be appropriate, including internal pay equity benchmarking as well as analysis based on both short term and long term comparisons. While benchmarking is useful and common in compensation analysis, some experts are of the view that benchmarks should be viewed as a basis for determining compensation levels and not as the final targets themselves. Factors unique to the business enterprise need to be carefully considered in adjusting and evaluating benchmarks, especially given that current economic conditions and market responses to those conditions represent different challenges for different industries and participants within an industry. The CD&A imposes an increased requirement to make disclosure, but also provides an opportunity to explain how a company has considered factors specific to it in tailoring the benchmark appropriately.

¹       Form 51-102F6, Item 2.

Preparing for this disclosure provides an opportunity to determine whether the compensation package is adequately tied to the type of performance that is meant to be or should be rewarded. Pay-for-performance essentially refers to the correlation of the different elements of executive remuneration with the achievement of desirable corporate goals. As described in RiskMetrics’ 2009 Canadian Policy Updates, the principle of pay-for-performance, aligned with an emphasis on long term shareholder value, takes into consideration the linkage between pay and performance, the mix between fixed and variable pay, performance goals and equity-based plan costs.²

To assess whether pay is properly tied to performance, a company first needs to determine what performance it wants to reward. This involves a focus on the key success factors of the business and a determination of the metrics that best measure those factors, taking into consideration all appropriate factors, both quantitative and qualitative. Quantitative factors include, among others, revenue and profit growth, net income, cash flow and cash flow management, return on equity, margins, cost containment and market share. Assessment of qualitative achievements requires a more tailored approach as these may vary significantly from one enterprise to another and include measures such as leadership, customer satisfaction, product or service quality, fostering of compliance, ethics green initiatives or similar desirable outcomes.³ The questions raised by this analysis are “what drives the business” and “how do we measure it?”

The New Disclosure Requirements also specifically target pay-for-performance by requiring companies to disclose any performance goals or similar conditions that are used for determining compensation payments. The only exemption from this disclosure is where disclosure of specific quantitative or qualitative factors would be seriously prejudicial to the company’s interests (and even then, if the company wishes to rely on this exemption, it must state what percentage of the executive’s total compensation relates to this undisclosed information and how difficult it could be for the executive, or how likely it will be for the company, to achieve the undisclosed performance goal or similar condition). If a company discloses performance goals or similar conditions that are non-GAAP financial measures, it must explain how the company calculates these goals from its financial statements. CD&A also contains new requirements to discuss, under the five-year shareholder return graph, how the trend shown by the graph compares to the trend in the company’s compensation to executive officers over the same period.⁴ This type of greater transparency is similar to executive compensation disclosure requirements adopted by the U.S. Securities and Exchange Commission (the SEC) in 2006.⁵ Subsequent to the implementation of these rules, the SEC has on numerous occasions highlighted that boilerplate or legalese will not suffice.⁶ The CSA will no doubt be of a similar view.

One of the challenges represented by the new level of disclosure required for performance targets is that it has the potential to encourage companies to lean towards more short term and concrete targets that are easier to identify and that it is more comfortable disclosing, as opposed to more long term measures that may be considered competitively sensitive.⁷ Boards and compensation committees facing these challenges should keep in mind the underlying goals that are the basis for their compensation policies, notwithstanding these may represent sensitive disclosure matters.

¹         Form 51-102F6, Item 2.
²         RiskMetrics also notes in its 2009 Canadian Policy Updates that poor pay practices include large bonus payouts without justifiable performance linkages, performance metrics that are changed, cancelled or replaced during the performance period without adequate explanations or links to performance and the payment of dividends on performance award grants prior to the achievement of required performance criteria or goals. 
³         “A Think Piece for Directors and Consultants: The Challenges of Relative Financial Measures: What Measure(s) to Use?” Kesner, M. (Compensation Standards: Summer 2008). See also the Canadian Coalition for Good Governance’s “Guidelines for Principled Executive Compensation” dated June 2006 at Appendix Four.
⁴         Form 51-102F6, Item 2.
⁵        “Executive Compensation Disclosure: Observations on Year Two and a Look Forward to the Changing Landscape for 2009,” speech by John W. White, Director, Division of Corporate Finance of the SEC, October 21, 2008.
⁶         “SEC on Pay Disclosure: Less Conversation, More Analysis,” Johnson, S. (CFO.com: October 9, 2007.
⁷         “Executive Pay: A Special Report : A Brighter Spotlight, Yet Pay Rises,” Deutch, C.H. (The New York Times: April 6, 2008).

Overview

The New Form has been organized into a number of new sections, as discussed in detail below. While a number of requirements found in the Current Form are carried forward, the New Form contains many new disclosure requirements. The New Form introduces, among other things, a requirement for a narrative discussion in the form of a "compensation discussion and analysis" and a revised format for the summary compensation table, which includes a column that sets out the dollar value of total compensation as a single number. A new disclosure section for compensation paid to directors is also included. Disclosure of compensation paid under incentive plans has also been consolidated into one section, which contains significantly revised requirements for the format of the various tables and explanatory disclosure. This includes the requirement to disclose equity-based compensation based on grant date fair value of the grant or award. Other significant changes include expanded pension disclosure and more detailed disclosure on termination or change of control payments. The instructions contained in the New Form state that the objective of the disclosure is to "communicate the compensation the board of directors intended the company to pay, make payable, award, grant, give or otherwise provide to each named executive officer (NEO) and director for the financial year" and that a company's disclosure under the form must satisfy this objective.

Summary compensation table

The New Form introduces a revised format and additional content for the summary compensation table (the SCT) for the Company's NEOs.

Under the New Form, identifying the three most highly compensated executive officers is not just based on salary and bonus, but on total compensation (excluding pension value and certain incremental payments as well as some other prescribed exclusions). This effectively means that, in order to make this determination, the company will need to calculate the value of total compensation under the last column of the SCT for its highest paid executives, including the value of equity and non-equity incentive plan awards.

Another significant change in the New Form is the overhaul of the SCT. Under the New Form, the SCT requires disclosure of each NEO's salary, share-based awards, option-based awards, non-equity incentive plan compensation (separated between annual and long-term plans), pension value (as discussed below), all other compensation and total compensation for the three most recently completed financial years (recognizing, that a three year history in compliance with the new requirements cannot be presented until 2010).  Some of these columns are not only new, but also represent significant changes to what is, or is not, to be included.

For example, the salary column requires the disclosure of the dollar value of cash and non-cash based salary that was earned by an NEO during the relevant financial year. As well, for both share-based awards and option-based awards, the value disclosed must be the grant date fair value. If the grant date fair value is different from the accounting fair value as determined in accordance with section 3870 of the CICA Handbook, footnote disclosure is required disclosing the amount, and an explanation, of the difference. The non-equity incentive plan compensation column requires disclosure of all amounts earned for services performed during the relevant year that are related to awards under non-equity incentive plans and all earnings on any such outstanding awards. This column is to include any discretionary cash awards, earnings, payments, or payables that were not based on pre-determined performance goals as well as performance-based plan awards. This category is divided into two subcategories, (i) annual incentive plans (AIPs) and (ii) long-term incentive plans (LTIPs).

The Pension Value column requires disclosure of all compensation relating to defined benefit or defined contribution plans, including disclosure relating to service costs and other compensatory items.

Under the column entitled "All Other Compensation", disclosure is required of all other compensation that is not reported in any other column in the SCT. This includes, but is not limited to, perks, such as property or other personal benefits that are provided to an NEO and that are not generally available to all employees, as well as amounts relating, to among others, incremental payments relating to termination or change of control benefits that occur before the end of the relevant financial year and the dollar value of insurance premiums paid or payable by, or on behalf of, the company for personal insurance for an NEO (if the estate of the NEO is the beneficiary). The threshold for requiring disclosure of perks is an aggregate amount that is equal to or greater than the lesser of $50,000 or 10% of an NEO's total salary for the financial year. The commentary to this column also clarifies that, generally, an item will not be a perk if it is necessary for a person to do his or her job, even if it provides some personal benefit. If an item is not necessary for a person to do his or her job and provides some direct or indirect personal benefit, it is a perk, regardless of the reason that it is provided, unless it is also available on a non-discriminatory basis to all employees.

The last column of the SCT is a new column and requires disclosure of the aggregate dollar value of all of the other columns on the SCT for each NEO, representing another change from the current table, which does not require disclosure in dollar amounts for certain categories.

Following the SCT, the company is required to provide a narrative discussion explaining any significant factors necessary to understand information contained in the SCT. These include the significant terms of an NEO's employment agreement or arrangement, any repricing or other significant changes to the terms of any share-based or option-based award programs, and the significant terms of any award reported in the SCT, including a description of the formula or criteria to be applied in determining the amounts payable and the vesting schedule.

Compensation discussion and analysis

The New Form also requires a new narrative form of discussion and analysis of the executive compensation provided to NEOs, referred to as compensation discussion and analysis (CD&A). Under the CD&A, the company is required to provide a description and explanation of all significant elements of compensation awarded to, earned by, paid to, or payable to NEOs during the most recently completed financial year. Specifically, the CD&A is to include a discussion of the following:

1. the objectives of the compensation program;
2. what the compensation program is designed to reward;
3. each element of compensation;
4. why the issuer chooses to pay each element;
5. how the issuer determines the amount and formula for each element; and
6. how each element of compensation and the issuer's decisions about that element fit into the issuer's overall compensation objectives and affect decisions about other elements.

In addition to the disclosure set out above, the CD&A also requires the issuer to include disclosure of the following items, to the extent they are applicable: (i) any new actions, decisions or policies that were made after year-end that could affect an understanding of an NEO's compensation for the most recently completed financial year; (ii) a statement of the benchmark used for compensation purposes and an explanation of its components, including companies included in the benchmark group and the selection criteria; and (iii) any performance goals or similar conditions based on objective, identifiable measures, such as share price or earnings per share, unless a reasonable person would consider that disclosure of the specific quantitative or qualitative factors would be seriously prejudicial to the company's interest. If the company discloses performance goals or similar conditions that are non-GAAP financial measures, it must also explain how the company calculates these goals from its financial statements.

The CD&A also includes a requirement to set out a performance graph showing the company's cumulative total shareholder return over the five most recently completed financial years. A new requirement has been added to discuss, under the graph, how the trend shown by the graph compares to the trend in the company's compensation to executive officers reporting under the form over the same period.

Also under the CD&A, the company is required to describe the process used to grant option-based awards to executive officers, including a description of the role of the compensation committee and executive officers in setting or amending any equity incentive plan under which an option-based award is granted.

Incentive plan awards

Item 4 of the New Form requires disclosure of outstanding share-based and option-based awards in the form of two separate tables. The first table requires disclosure of all outstanding awards at year-end and the second table requires disclosure of the value vested or earned on each option-based, share-based and non-equity-based incentive plan during the most recently completed financial year. These tables are to be followed by a narrative discussion that describes and explains the significant terms of all plan-based awards, including non-equity incentive plan awards, but only in respect of awards that were issued, vested or were exercised during the year, or that were outstanding at year-end.

Deferred compensation plans and defined benefit and defined contribution pension plans

Item 5 requires disclosure in tabular form for all defined benefit plans and defined contribution plans. Following the tabular disclosure, the company is required to include a narrative discussion of any significant factors necessary to understand the information disclosed in the tables. Also required is a description of the significant terms of any deferred compensation plan, including the types of compensation that can be deferred, the significant terms of payouts, withdrawals and other distributions, and measures for calculating interest or other earnings, how and when such measures can be changed and at whose election. These measures must also be quantified where possible.

Termination and change of control benefits

The New Form abandons the $100,000 benchmark for disclosure of change of control or termination benefits for an NEO, requiring disclosure of all amounts, and more detailed disclosure of the compensatory arrangements with NEOs relating to retirement, resignation, termination and change of control. The New Form requires that for each contract, agreement, plan or arrangement that provides for payments to an NEO at, following, or in connection with any termination, resignation, retirement, a change in control of the company or a change in an NEO's responsibilities, the company is required to describe and explain, and where possible quantify, the following:

• circumstances that trigger payments or provision of other benefits;
• the estimated incremental payments that are triggered, including timing, duration and who they are provided by;
• how the payment and benefit levels are determined;
• any significant conditions or obligations that apply to receipt of payments, including but not limited to non-compete, non-solicitation, non-disparagement or confidentiality agreements (including the terms of these agreements and any provisions contained therein regarding waiver or breach); and
• any other significant factors for each written contract, agreement, plan or arrangement.

Director compensation

The New Form also includes a new table that requires disclosure of director compensation, which is similar in form to the SCT for NEOs. This table requires tabular disclosure for each director of the fees earned, share-based awards, option-based awards, non-equity incentive plan compensation, pension value, all other compensation and total compensation provided for the relevant year. Following the table, the New Form also requires the company to include a narrative discussion of any factors necessary to understand director compensation. Tabular and narrative disclosure relating to share-based, option-based and non-equity incentive plan compensation is also required for directors similar to that required for NEOs under Item 4 of the New Form.

Companies reporting in the United States

The New Form carries forward the existing exemption for SEC issuers who provide information required by Item 402 of Regulation S-K under the Securities Exchange Act of 1934. As is the case under the Current Form, this exemption does not apply to a foreign private issuer that satisfies Item 402 by providing information required by Items 6.B and 6.E.2 of Form 20-F under the Securities Exchange Act of 1934. This effectively means that issuers that fully comply with SEC requirements will be exempt from complying with the New Form, however, those that rely on exemptions available to foreign private issuers will not.

Mandatory annual disclosure for certain issuers

Together with the revisions to Form 51-102F6, the final proposal also adds a new section under Part 11 of National Instrument 51-102 Continuous Disclosure Obligations. This new section requires reporting issuers that do not send an information circular to securityholders that includes executive compensation disclosure as required by Item 8 of Form 51-102F5, or an annual information form that includes information required by Item 18 of Form 51-102F2 (such as debt-only reporting issuers), to provide the disclosure required by the New Form within 140 days of their year-end. Item 8 of Form 51-102F5 (which is the form of information circular) requires executive compensation disclosure to be provided if an information circular is sent in connection with an annual general meeting or a meeting at which a company's directors are to be elected or where the securityholders will be asked to vote on a matter relating to executive compensation. This new requirement effectively means that if an issuer does not have such a meeting in any particular year, and does not file an annual information form, it will have to now comply with these new executive compensation disclosure requirements on an annual basis.  These new provisions do not apply to certain foreign issuers, however, that comply with information circular and proxy requirements under National Instrument 71-102 Continuous Disclosure and Other Exemptions Relating to Foreign Issuers.

Preparing for compliance

To prepare for compliance, issuers may need to make substantial changes to the manner in which they gather and disclose executive compensation. A few suggestions to prepare for compliance include:

• tracking each component of compensation of a larger group of executives to determine which are the most highly compensated under the New Form;
• analysing all equity-based compensation arrangements to determine appropriate valuation methodologies and comparing valuations with accounting fair value under Section 3870 of the CICA Handbook;
• tracking the information necessary to categorize and calculate the aggregate incremental costs of perks;
• tracking data necessary to comply with the new pension disclosure requirements;
• reviewing the New Form with the compensation committee to determine whether changes to executive compensation practices are required in light of the new disclosure requirements and to prepare for CD&A disclosure (in respect of which disclosure made by issuers under U.S. CD&A requirements may be a helpful reference); and
• preparing executive compensation disclosure sufficiently in advance of the 2009 proxy season.
   

Significant Changes to Disclosure Requirements

The following is a list of significant differences between the current disclosure form, and the proposed form:
 

• The summary compensation table will include a new column showing the total compensation, expressed in dollars, provided to each named executive officer (NEO). This amount will represent the total of the figures disclosed in the other columns in the table.  Other aspects of the table have been revised and a narrative description of any material factors that are necessary to understand the information in the table must also be included.
• All equity compensation in the summary compensation table is required to be disclosed on the basis of the compensation cost of these awards over the requisite service period (as per the Canadian Institute of Chartered Accountants’ handbook requirements), as reflected in a company's financial statements. This deviates from the current form, which discloses items such as stock and options according to the number of shares or other securities granted.
• A new narrative compensation discussion and analysis section will be required to explain the rationale for specific compensation programs for executives.  The CSA has identified six key principles that reporting issuers must discuss, including examples of the types of issues that could be addressed when explaining the principles.
• There is more specific disclosure of potential payments to NEOs upon termination of their position at the company, including more required details on retirement benefits.
• The proposed executive compensation form will require expanded disclosure of director compensation, including a summary table and equity disclosure similar to what is required for NEOs.

Implementation and transition

As stated above, the proposed executive compensation form is intended to replace the current form.  The new form was originally proposed to apply to financial years ending on or after December 31, 2007.  It was also proposed that venture issuers that do not send a management information circular be required to file a completed Form 51-102F6 within 140 days of the company’s financial year-end.  The proposal was open for comments until June 30, 2007 and the Notice and Request for Comment stated that the intention was to have the proposed in effect at the end of 2007.  However, according to CSA Notice 51-325, published on August 31, 2007, given the comments received on their original proposals, the CSA will be publishing further proposals for comment prior to implementing these changes.