On August 25, 2022, the U.S. Securities and Exchange Commission (SEC) approved final rules on the correlation between executive pay and company performance (pay-for-performance). As discussed in our previous client alert, pay-for-performance rules were originally proposed in 2015 but not adopted and were reopened for public comment in January 2022 (the reopening release). The final rules fulfill rulemaking requirements mandated by Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act). Companies must comply with the new rules in proxy or information statements for fiscal years ending on or after December 16, 2022. Calendar year companies will first need to include this information in their proxy or information statements filed in 2023.
This client alert summarizes the final rules and highlights significant differences between the proposed rules (as modified by the reopening release) and the final rules.
New Item 402(v) of Regulation S-K
The final rules add a new Item 402(v) to Regulation S-K that requires a company's proxy or information statement to include:
These provisions are each further discussed below.
Pay-for-Performance Table
The table mandated by new Item 402(v) must include:
Total Compensation for PEO and NEOs
The total compensation to be shown in the table is the total executive compensation reported in the summary compensation table (SCT) for the PEO and an average of the total compensation amount for the remaining NEOs. If there is more than one PEO in a year, there must be separate disclosure for each PEO.
Actual Compensation for PEO and NEOs
As contemplated by the original proposal and reopening release, the final rules provide that the amount to be shown as "actually" paid to executives is the amount in the total compensation column of the SCT adjusted for certain equity and pension amounts. However, in response to significant public comments, the final rules modify the required equity and pension adjustments as follows:
Company Total Shareholder Return
As in the proposal, the pay-for-performance table must include the company's TSR, determined substantially the same as determined for the stock performance graph (Item 201(e) of Regulation S-K). The final rules clarify that both company TSR and peer group TSR (discussed below) should be calculated based on a fixed investment of one hundred dollars at the measurement point. The final rules also clarify that the measurement period is from the market close on the last trading day before the company's earliest year shown in the table through and including the end of the year for which TSR is being calculated. Accordingly, the TSR for the first year in the table will be the TSR over that first year, the TSR for the second year will be the cumulative TSR over the first and the second years, and so on.
Peer Group Total Shareholder Return
As proposed, the pay-for-performance table must include the TSR of the company's peers (weighted based on starting stock market capitalization for the measurement period), comprising either the peer group in the company's stock performance graph or the peer group for purposes of the company's compensation discussion and analysis. Smaller reporting companies would be exempt from this peer return requirement.
Company Net Income and Company-Selected Measure
The inclusion in the table of company net income and a company-selected measure was suggested for consideration in the reopening release. Both are included in the final rules. A third measure suggested for consideration in the reopening release, pre-tax net income, was not included in the final rules.
Net income must be calculated according to GAAP. The company-selected measure (which will not be required for smaller reporting companies) is a measure chosen by the company as its most important financial performance measure for compensation actually paid for the most recently completed year and not already included in the table. If the company-selected measure is a non-GAAP measure, it will not be subject to the normal non-GAAP rules (similar to the treatment of performance targets in a compensation discussion and analysis); however, information must be provided as to how the number is calculated from the company's audited financial statements.
The company may, but is not required to, include additional columns to the table for other performance measures it considers important. These measures need not be financial but must not be misleading or given greater prominence than the required disclosure and must be labelled as supplemental.
Pay-for-Performance Description
In addition to the pay-for-performance table required under new Item 402(v), the final rules require a pay-for-performance description to accompany the table. Using the information in the table, companies must discuss the relationship of actual executive compensation during the past five years (or three years, for smaller reporting companies) to the company's TSR and the relationship of the company's TSR to that of its peer group, all as originally proposed. In view of the additional two company financial measures added to the table in the final rules (net income and a company-selected measure), companies must also describe the relationship between the executives' actual pay and these company financial performance measures as set forth in the table. This disclosure could be in a narrative, a graphic, or a combination of the two.
If the company has added any additional performance measures to the table, the relationship of actual executive compensation to those measures must be discussed as well.
Tabular List of Most Important Financial Performance Measures
The new rules also require companies to list three to seven of the most important financial performance measures used to link executive compensation actually paid to company performance (the tabular list). The tabular list will not be required to be ranked, which is a departure from the reopening release suggestion that they be listed in order of importance. The final rules include flexibility in the number of performance measures (three to seven), rather than the five measures contemplated in the reopening release. With respect to the determination of which measures are the most important, the final rules provide that the company should look to the most recent fiscal year (rather than over the timeline of all past years included in the table). The final rules do not require companies to provide the methodology used to calculate the measures included in the tabular list.
Although the company-selected measure in the table must be financial and included in the tabular list of most important financial performance measures, the company may also include non-financial measures as among its most important performance measures in the tabular list, as long as it includes at least three financial measures.
The tabular list may be presented in one of three different ways: one list for all NEOs, including the PEO; one list for the PEO and one for the remaining NEOs; or one list for the PEO and one for each NEO. If separate lists are provided, each must contain the requisite three to seven financial performance measures.
Smaller reporting companies are not required to provide a tabular list.
Inline XBRL
The final rules require companies to separately tag each number in the Item 402(v) pay-for-performance table, block-text tag the footnote disclosure and relationship description, and tag quantitative or other specific data points in the footnotes, all in Inline XBRL (iXBRL). For additional information on iXBRL, see the SEC's published C&DIs.
Smaller reporting companies are only required to provide the required iXBRL data beginning in the third filing in which it provides pay-for-performance disclosure, instead of the first.
Applicability
Foreign private issuers, registered investment companies, and emerging growth companies are not subject to the new pay-for-performance requirement. As discussed above, smaller reporting companies are subject to scaled disclosure.
The pay-for-performance disclosures are not required in filings other than proxy or information statements that include executive compensation information, even if Item 402 disclosure is otherwise required in a filing (e.g., a Form S-1). As proposed, the final rules provide that information would not be deemed to be incorporated by reference into any other filing, unless the company does so specifically. In addition, the SEC will not mandate the location of this disclosure within a proxy or information statement in which it is included.
Compliance Timetable
The new rules are effective 30 days after publication in the Federal Register. Companies will need to comply with the new rules in proxy or information statements for fiscal years ending on or after December 16, 2022. Accordingly, calendar year companies will need to include the pay-for-performance table and accompanying disclosure in their proxy or information statements filed in 2023.
In the first proxy or information statement that includes the disclosure, companies will be required to provide the information for three years only, with an additional year of information in each of the two subsequent proxy or information statements that require this disclosure. Smaller reporting companies may provide two years of information in their first filing, with an additional year in subsequent proxy or information statements.
Next Steps
Companies should begin now to prepare for inclusion of the pay-for-performance requirements in proxy statements in 2023. In particular, affected companies should:
For more information on these final rules or any related matter, please contact any member of the firm's public company representation or employee benefits and compensation practices.