December 12, 2006
As part of comprehensive changes to its rules on disclosure of executive compensation and related party transactions approved in July of this year, the Securities and Exchange Commission adopted a new requirement that companies provide disclosure about their policies and procedures governing related party transactions. The requirement applies for fiscal years ending on or after December 15, 2006 and therefore, will be in effect for the 2007 proxy season.
New Item 404(b) of Regulation S-K requires disclosure of the material features of a company’s policies and procedures for the review, approval or ratification of related party transactions (referred to as "related person" transactions in Item 404). Although Item 404(b) does not mandate specific information, it provides the following examples of features that it may be appropriate for companies to address:
Companies also must identify any related party transactions since the beginning of the last fiscal year for which the policies and procedures did not require review, approval or ratification, or where the policies and procedures were not followed.
Many companies already have procedures for monitoring and reviewing related party transactions, although in some cases these procedures may not have been formalized. Indeed, Rule 4350(h) of The NASDAQ Stock Market LLC requires that the audit committee or another independent body of the board review "on an ongoing basis" and approve any related party transactions. In addition, New York Stock Exchange Rule 303A.10 and NASDAQ Rule 4350(n) require companies to have codes of conduct that address conflicts of interest. Nevertheless, companies may find it appropriate to review, and if necessary, formalize or update their procedures applicable to related party transactions in light of Item 404(b).
To assist companies in this regard, a sample annotated policy is attached. Some issues that companies should consider when implementing a policy in this area include:
1. Integrating the policy with other company policies. In addition to reviewing any existing procedures specific to related party transactions, companies should review code-of-conduct provisions and internal policies addressing conflicts of interest and consider how these will work together with a policy for approving related party transactions. Among other things, companies should look at how the policy will work with any existing procedures governing the disclosure and approval of transactions that raise potential conflicts of interest.
2. Responsibility for administering the policy. Companies should determine which board committee will be responsible for administering the policy and approving related party transactions. At many companies, the audit committee historically has been responsible for overseeing related party transactions. However, it may be appropriate, and may create efficiencies, to have the nominating/governance committee administer the policy (at least with respect to directors), because related party transactions are also likely to be relevant to the director independence assessments overseen by this committee.
3. Approval of executive officer compensation. Companies should note that under Item 404(a) of Regulation S-K, compensation paid to executive officers who are not "named executive officers" (NEOs) under Item 402 of Regulation S-K is reportable as a related party transaction unless: (a) the executive officer is not an immediate family member of a related party; (b) the compensation would have been reported under Item 402 if the executive officer were an NEO; and (c) the compensation has been approved, or recommended to the board for approval, by the compensation committee. Accordingly, in addition to applicable NYSE or NASDAQ requirements governing compensation committees and their processes for approving executive compensation, it is important that the board or compensation committee review and approve all compensation for executive officers.
4. Transition issues. Companies should finalize their policies as soon as practicable in anticipation of the disclosures required for the 2007 proxy season. In addition, Item 404(b) requires disclosure about any related party transactions during the last fiscal year that were not subject to these policies, and it does not contain an exemption or transition period for transactions that pre-date the adoption of Item 404(b). Absent further action, calendar-year companies would be required to disclose any related party transactions since the beginning of 2006 that were not approved or ratified pursuant to their policies. Accordingly, in connection with implementing or updating a policy on related party transactions, the committee responsible for the policy should review and consider whether to ratify any related party transactions dating from the beginning of 2006.
5. "Standing" pre-approvals. The attached sample annotated policy identifies categories of transactions that are deemed "pre-approved" under the policy and therefore need not be brought to the committee for approval. Some of these are transactions that the SEC has determined are not disclosable as related party transactions under Item 404(a) of Regulation S-K (such as executive and director compensation), and others are unlikely to raise the concerns underlying the Item 404(a) disclosure requirements. Companies should consider whether, due to the nature of their business activities or other particular circumstances, there are other categories of transactions that are appropriate subjects for standing pre-approval. The policy contemplates that certain transactions covered by the standing pre-approval would be reported to the committee at each regularly scheduled meeting. Regardless, it would be appropriate under Item 404(b) for the committee to review any such transactions on at least an annual basis.
We are available to answer any questions about the attached policy and to assist you in customizing it for your own use.
SAMPLE ANNOTATED POLICY
[COMPANY]
Related Party Transaction Policies and Procedures
Policy
It is the policy of the Board of Directors of [COMPANY] (the "Company") that all Interested Transactions with Related Parties, as those terms are defined in this policy, shall be subject to approval or ratification in accordance with the procedures set forth below.
Procedures
The Nominating and Corporate Governance Committee[1] shall review the material facts of all Interested Transactions that require the Committee’s approval and either approve or disapprove of the entry into the Interested Transaction, subject to the exceptions described below. If advance Committee approval of an Interested Transaction is not feasible, then the Interested Transaction shall be considered and, if the Committee determines it to be appropriate, ratified at the Committee’s next regularly scheduled meeting. In determining whether to approve or ratify an Interested Transaction, the Nominating and Corporate Governance Committee will take into account, among other factors it deems appropriate, whether the Interested Transaction is on terms no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances and the extent of the Related Person’s interest in the transaction.
The Nominating and Corporate Governance Committee has reviewed the Interested Transactions described below in "Standing Pre-Approval for Certain Interested Transactions" and determined that each of the Interested Transactions described therein shall be deemed to be pre-approved or ratified (as applicable) by the Nominating and Corporate Governance Committee under the terms of this policy. In addition, the Board of Directors has delegated to the Chair of the Nominating and Corporate Governance Committee the authority to pre-approve or ratify (as applicable) any Interested Transaction with a Related Party in which the aggregate amount involved is expected to be less than [$1 million]. In connection with each regularly scheduled meeting of the Nominating and Corporate Governance Committee, a summary of each new Interested Transaction deemed pre-approved pursuant to paragraph (3) or (4) under "Standing Pre-Approval for Certain Interested Transactions" below and each new Interested Transaction pre-approved by the Chair in accordance with this paragraph shall be provided to the Committee for its review.
No director shall participate in any discussion or approval of an Interested Transaction for which he or she is a Related Party, except that the director shall provide all material information concerning the Interested Transaction to the Nominating and Corporate Governance Committee.
If an Interested Transaction will be ongoing, the Nominating and Corporate Governance Committee may establish guidelines for the Company’s management to follow in its ongoing dealings with the Related Party. Thereafter, the Nominating and Corporate Governance Committee, on at least an annual basis, shall review and assess ongoing relationships with the Related Party to see that they are in compliance with the Committee’s guidelines and that the Interested Transaction remains appropriate.
Definitions
An "Interested Transaction" is any transaction, arrangement or relationship or series of similar transactions, arrangements or relationships (including any indebtedness or guarantee of indebtedness) in which (1) the aggregate amount involved will or may be expected to exceed $100,000 [2] in any calendar year, (2) the Company is a participant, and (3) any Related Party has or will have a direct or indirect interest [3] (other than solely as a result of being a director or a less than 10 percent beneficial owner of another entity).
A "Related Party" is any (a) person who is or was (since the beginning of the last fiscal year for which the Company has filed a Form 10-K and proxy statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director, (b) greater than 5 percent beneficial owner of the Company’s common stock, or (c) immediate family member of any of the foregoing. Immediate family member includes a person’s spouse, parents, stepparents, children, stepchildren, siblings, mothers- and fathers-in-law, sons- and daughters-in-law, and brothers- and sisters-in-law and anyone residing in such person’s home (other than a tenant or employee).
Standing Pre-Approval for Certain Interested Transactions
The Nominating and Corporate Governance Committee has reviewed the types of Interested Transactions described below and determined that each of the following Interested Transactions shall be deemed to be pre-approved by the Committee, even if the aggregate amount involved will exceed $100,000.
1. Employment of executive officers. Any employment by the Company of an executive officer of the Company if:
a. the related compensation is required to be reported in the Company’s proxy statement under Item 402 of the Securities and Exchange Commission’s ("SEC’s") compensation disclosure requirements (generally applicable to "named executive officers"); or
b. the executive officer is not an immediate family member of another executive officer or director of the Company, the related compensation would be reported in the Company’s proxy statement under Item 402 of the SEC’s compensation disclosure requirements if the executive officer was a "named executive officer", and the Company’s Compensation Committee approved (or recommended that the Board approve) such compensation.
2. Director compensation. Any compensation paid to a director if the compensation is required to be reported in the Company’s proxy statement under Item 402 of the SEC’s compensation disclosure requirements;
3. Certain transactions with other companies. Any transaction with another company at which a Related Person’s only relationship is as an employee (other than an executive officer), director or beneficial owner of less than 10% of that company’s shares, if the aggregate amount involved does not exceed the greater of $1,000,000, or 2 percent of that company’s total annual revenues;
4. Certain Company charitable contributions. Any charitable contribution, grant or endowment by the Company to a charitable organization, foundation or university at which a Related Person’s only relationship is as an employee (other than an executive officer) or a director, if the aggregate amount involved does not exceed the lesser of $1,000,000 [4], or 2 percent of the charitable organization’s total annual receipts;
5. Transactions where all shareholders receive proportional benefits. Any transaction where the Related Person’s interest arises solely from the ownership of the Company’s common stock and all holders of the Company’s common stock received the same benefit on a pro rata basis (e.g. dividends).
6. Transactions involving competitive bids. [5] Any transaction involving a Related Party where the rates or charges involved are determined by competitive bids.
7. Regulated transactions. Any transaction with a Related Party involving the rendering of services as a common or contract carrier, or public utility, at rates or charges fixed in conformity with law or governmental authority.
8. Certain banking-related services. Any transaction with a Related Party involving services as a bank depositary of funds, transfer agent, registrar, trustee under a trust indenture, or similar services.
[1] At many companies, the Audit Committee historically has taken responsibility for monitoring related party transactions. However, companies should determine whether their Nominating and Corporate Governance Committees should administer this policy (at least with respect to directors) since these matters are relevant to the independence determinations that the Committees must conduct.
[2] Note that this is lower than the $120,000 threshold set forth in Item 404(a) of Regulation S-K. This lower threshold is a rounder number and involves the Committee in advance in case a transaction unexpectedly crosses the $120,000 threshold.
[3] Note that the word "material" is omitted in this definition in order to permit the Committee, rather than the individuals involved, to assess the materiality of the Related Party’s interest in the transaction.
[4] A company should consider whether a lower threshold would be appropriate in light of its director independence standards, the amounts it contributes to various charitable organizations, and the size of the charitable organizations to which it contributes.
[5] A company should assess whether any of the transactions covered by ## 6-7 above are applicable given the industry in which it operates.
© 2006 Gibson, Dunn & Crutcher LLP
The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.