SEC Adopts Rules Regarding Pay Versus Performance

On August 25, 2022, the U.S. Securities and Exchange Commission adopted rules that require public companies to disclose the relationship between compensation “actually paid” to their executives and their financial performance, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pay Versus Performance). The new rules amend Item 402 of Regulation S-K by adding a table and requiring narrative disclosure regarding certain executive compensation and financial performance measures for a company’s five most recently completed fiscal years. The Pay Versus Performance rules will apply to proxy and information statements that include executive compensation disclosure for fiscal years ending on or after December 16, 2022. These rules do not apply to registration statements filed pursuant to the Securities Act of 1933. Below we provide a summary of key provisions of the new rules.

Background

The Pay Versus Performance rules were originally proposed in April 2015, as discussed in our Alert, in response to Section 953(a) of the Dodd-Frank Act, which added Section 14(i) to the Securities Exchange Act of 1934 (Exchange Act). Section 14(i) mandates that the SEC adopt rules requiring that annual meeting proxy statements include a clear description of what compensation is required to be disclosed under Item 402 of Regulation S-K, including information that shows the relationship between executive compensation actually paid and the financial performance of the company. The proposed rules languished for several years until the SEC reopened the comment period for them in January 2022 and indicated that it was considering certain additional disclosure requirements.

Item 402(v)

Tabular Disclosure of Specified Executive Compensation and Financial Performance Measures

The new rules add Item 402(v) of Regulation S-K. Under Item 402(v), a company will be required to disclose, for its five most recently completed fiscal years, the total compensation as reflected in the Summary Compensation Table required under Item 402 of Regulation S-K. It will also be required to disclose “executive compensation actually paid” for its principal executive officer (PEO) and, as an average, its other named executive officers (NEOs). “Executive compensation actually paid” is, to simplify what is likely to be a complicated calculation, the total compensation expressed in the Summary Compensation Table, with a complex set of adjustments made for changes in the value of equity awards and for the actuarial present value of accumulated benefits under defined benefit and actuarial pension plans, certain dividends and the impact of repricing. Note that “executive compensation actually paid” as defined in the rule may differ significantly from an executive’s realized pay, which some companies voluntarily disclose and generally only reflects sums actually received under cash programs and exercise or settlement of equity awards and does not attach notional values to outstanding awards. The table will also include the following financial performance measures for each year:

• The company’s total shareholder return (TSR), as defined in Item 201(e) of Regulation S-K
• TSR for the company’s peer group
• The company’s net income
• A financial performance measure selected by the company that represents the most important financial performance measure to link compensation actually paid to the company’s NEOs to its performance for the most recent fiscal year (the Company-Selected Measure). Companies will not need to disclose the methodology used to calculate the Company-Selected Measure

The information required by Item 402(v) must be presented in the following format:

PAY VERSUS PERFORMANCE

Disclosure of Relationships Between Financial Performance Measures and Executive Compensation, and Company and Peer Group TSRs

A company will also be required to provide (1) a clear description of the relationships between the executive compensation actually paid in columns (c) and (e) and the financial performance measures specified in columns (f), (h) and (i) of the table; and (2) a comparison of its TSR and the TSR of its peer group over the five most recently completed fiscal years. These descriptions may be provided in a narrative, graphic or combined format.

Unranked List of Most Important Financial Performance Measures

A company will also be required to provide a tabular list of three to seven of its financial performance measures that, in the company’s assessment, are the most important performance measures used by it to link compensation actually paid to the NEOs during the most recently completed fiscal year to the company’s performance (or all such measures if fewer than three were used). These performance measures may also include non-financial performance measures if the company determines that they are among its most important three to seven performance measures. The Pay Versus Performance rules allow for one tabular list that applies to all NEOs, or multiple lists with different measures for different NEOs or different measures for the PEO versus the other NEOs.

The Pay Versus Performance disclosures must be provided in the Inline XBRL format.

Smaller Reporting Companies (SRCs), Emerging Growth Companies and Foreign Private Issuers

Smaller Reporting Companies. SRCs will be subject to reduced Pay Versus Performance disclosure largely consistent with their scaled executive compensation disclosure requirements. In addition to only having to provide three years of disclosure, they will not be required to provide peer group TSR information, the Company-Selected Measure or the tabular list of financial performance measures, and they will be able to exclude certain amounts related to pensions in calculating executive compensation actually paid. Finally, an SRC will only be required to file in XBRL format beginning the third filing in which it provides Pay Versus Performance disclosure.

Emerging Growth Companies and Foreign Private Issuers. The Pay Versus Performance rules do not apply to emerging growth companies and foreign private issuers.

Effectiveness and Phase-in Period

Effectiveness. The Pay Versus Performance rules become effective 30 days after publication in the Federal Register and will apply to proxy and information statements that include executive compensation disclosure for fiscal years ending on or after December 16, 2022. Accordingly, most companies will first be required to provide disclosure in their annual proxy statements filed in 2023.

Phase-In Periods. A company must only provide information for its last three years in the first proxy or information statement that requires the Pay Versus Performance disclosure but must add another year of disclosure in the two subsequent years of its proxy or information statement filings. SRCs will be required to provide two years of disclosure initially and to add an additional year of disclosure in each subsequent annual proxy or information statement filing. A newly public company will only be required to provide Pay Versus Performance disclosure for years that it was a reporting company under the Exchange Act.