Blogs

SEC Revisits Pay Versus Performance Rules

The Securities and Exchange Commission (SEC), in its recent move on January 27, 2022, revived discussions on previously proposed rules under the Dodd-Frank Act, focusing on the disclosure of data illustrating the correlation between a company's financial performance and the compensation it pays to executives. Originating in April 2015, these rules remained largely unaddressed until now, also having their scope widened to encompass additional performance metrics.

The current SEC leadership, headed by Gary Gensler, has been resolutely addressing issues related to compensation and insider trading. Their focus areas have included re-evaluating executive compensation clawback rules, updating guidelines on disclosures and accounting for spring-loaded compensation awards, proposing changes to Rule 10b5-1 insider trading plans, and suggesting new share repurchase program disclosure rules.

The Background

Introduced by the Dodd-Frank Act, Section 953(a) led to the incorporation of Section 14(i) into the Securities Exchange Act of 1934 ("Exchange Act"). This section mandates that issuers disclose a clear breakdown of any compensation stated in Item 402 of Regulation S-K, in any proxy or consent solicitation material for an annual meeting of shareholders. This includes details of the relationship between executive compensation and the company's financial performance, considering changes in the value of the company's stock, dividends, and any distributions. Moreover, it offers the possibility of including a graphical representation of the information.

Despite current rules demanding comprehensive metrics and details on executive compensation, none have previously necessitated a specific disclosure detailing the link between pay and performance. The new disclosure requirements aim to complement the Compensation Discussion and Analysis (CD&A) by providing a factual depiction of how the compensation paid relates to the company's financial performance.

The New Proposal

The new proposal requires companies to disclose compensation "actually paid" to the CEO and other named executive officers, along with the corresponding "total compensation" amounts for the previous five fiscal years (or three for smaller reporting companies). This table must include details on total executive compensation, compensation "actually paid", and the cumulative total shareholder return (TSR).

The new disclosure requirements won't apply to emerging growth companies or foreign private issuers. Smaller public companies will have a more limited disclosure requirement.

Calculating "Actually Paid" Compensation

For smaller reporting companies, the compensation "actually paid" is the executive compensation reported in the Summary Compensation Table, already a required disclosure. Other companies must modify the disclosed amount to exclude changes in actuarial present value of benefits under certain pension plans not attributable to the applicable year of service, and to include the fair value of equity awards at vesting rather than when granted.

Aligning with Total Shareholder Return (TSR)

The proposed rules mandate companies to measure financial performance using TSR, as defined in Item 201(e) of Regulation S-K. They should then compare it with the compensation "actually paid" to the CEO and other named executive officers. This comparison can be disclosed in either narrative or graphical form or a combination of both, with the placement of the discussion being flexible.

In addition to TSR, the SEC is mulling over the need for a tabular disclosure of pre-tax income, net income, and a company-specific measure. A clear explanation of the relationship among these measures would be required, though the company can choose its format of presentation.

Additional and Supplemental Disclosure

The reporting company can provide additional disclosure if it aids in understanding the pay vs. performance discussion, as long as it is not misleading and does not overshadow the basic disclosure requirements.

Inline XBRL Tagging

The new disclosure must be tagged using Inline XBRL.

Phase-In Period

A phase-in period is allowed under the new rule. In the first filing after the proposed rule takes effect, companies will only be required to provide two years of disclosure. With each subsequent year's filing, they will need to add an extra year of disclosure until they reach the required years (3 years for smaller reporting companies and 5 years for others).