SEC Proposes Pay Versus Performance Disclosure Rules
A divided Securities and Exchange Commission proposed rules on April 29, 2015 that would require U.S. public companies to disclose the relationship between executive compensation “actually paid” and the financial performance of the company (commonly referred to as the “pay versus performance disclosure” mandate).1
Highlights of Proposed Rules:
- Would apply to the 2016 proxy season if the rules are finalized in 2015
- Would apply to most public companies, including voluntary filers, but would not apply to emerging growth companies, registered investment companies (other than business development companies) or foreign private issuers
- Smaller reporting companies would be subject to scaled disclosure requirements
- Disclosure would be required in any proxy or information statement for which executive compensation disclosure (Item 402 of Regulation S-K) is required
- Would require a new disclosure item – executive compensation “actually paid” – plus a new presentation of two items that are already required to be disclosed – total executive compensation and total shareholder return (TSR)
- The new item and the two existing items would be presented in a table showing:
- total compensation and compensation “actually paid” to a company’s principal executive officer (PEO)
- average total compensation and average compensation “actually paid” to the company’s other named executive officers (NEOs) as a group
- cumulative TSR of the company and its peer group
- Additionally, the rules would require narrative or graphical disclosure of the relationship between:
- compensation "actually paid" and company TSR; and
- company TSR and peer group TSR
New Tabular Disclosure Requirement
The proposed rules would require companies to include the following new “Pay versus Performance” table in all proxy and information statements for which disclosure under Item 402 of Regulation S-K is required:
PAY VERSUS PERFORMANCE
Summary Compensation Table Total for PEO (b)
Compensation Actually Paid to PEO (c)
Average Summary Compensation Table Total for non-PEO named executive officers (d)
Average Compensation Actually Paid to non-PEO named executive officers (e)
Total Shareholder Return (f)
Peer Group total Shareholder Return (g)
The table would require disclosure of the compensation “actually paid” to the PEO and the average compensation “actually paid” to the other NEOs as a group for each of a company’s last five completed fiscal years (three years in the case of a smaller reporting company). The table would also require disclosure of the TSR of the company and, except in the case of smaller reporting companies, its peer group for each of the covered fiscal years.
All amounts disclosed in the table would have to be separately tagged using eXtensible Business Reporting Language (XBRL), and the additional disclosure described below would have to be block-text tagged. The disclosure would be considered “filed” not “furnished,” and, therefore, would be subject to liability under the Securities Act and Exchange Act. It would not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, unless the company specifically incorporates it by reference.
Compensation “Actually Paid”
The proposed rules would require making the following adjustments to an NEO’s total compensation, as disclosed in the “Summary Compensation” table, to arrive at compensation or average compensation “actually paid” during the applicable fiscal year:
- deducting the aggregate change in the actuarial present value of each NEO’s accumulated benefit under all defined benefit and actuarial plans reported in the “Summary Compensation” table;
- adding the service cost under all defined benefit and actuarial pension plans reported in the “Summary Compensation” table calculated as the actuarial present value of each NEO’s benefit under all such plans attributable to services rendered during the applicable fiscal year, consistent with “service cost” as defined in FASB ASC Topic 715; and
- deducting the amounts reported in the “Summary Compensation” table with respect to the grant of equity awards and adding in their place the fair value on the vesting date of all stock awards and all options for which the applicable vesting conditions were satisfied during the applicable fiscal year.
In addition, compensation “actually paid” during a fiscal year would include the incremental fair value attributable to adjustments or amendments to previously vested awards. If more than one person served as a company’s PEO in a single fiscal year, the compensation of all persons serving as the company’s PEO in such year must be aggregated. Total compensation for the NEOs other than the PEO and all adjustments thereto would be based on averages.
The company is required to disclose in a footnote each of the amounts deducted from and added to the “Summary Compensation” table totals in arriving at compensation “actually paid” to the PEO and average compensation “actually paid” to the other NEOs. Footnote disclosure is also required if the value of equity awards as of the applicable vesting date is determined using assumptions that differ materially from those used in determining the grant date value of such awards.
Company and Peer Group Performance Disclosure
A company’s and its peer group’s TSR is required to be calculated in the same manner as for the stock performance graph disclosure that is already required under Item 201(e) of Regulation S-K. A company is permitted to use the same peer group that it uses for purposes of its stock performance graph disclosure or it can use the peer group it uses for purposes of its Compensation Discussion and Analysis (CD&A) disclosure under Item 402(b). If the peer group is not a published industry or line-of-business index, the identity of the members of the peer group must be disclosed. The TSR of each member of the peer group must be weighted according to its stock market capitalization at the beginning of each period for which TSR is disclosed. Smaller reporting companies, which are exempt from the disclosure requirements under Item 201(e), would not be subject to the peer group disclosure requirement.
According to the SEC, it selected TSR as the measure of a company’s performance because (i) TSR is objectively determinable from the share price of the company and not open to subjective determinations of performance, (ii) companies (other than small reporting companies, which are not subject to Item 201(e) of Regulation S-K) are already required to determine and disclose TSR and (iii) using a consistently calculated measure, such as TSR, should increase the comparability of pay-versus-performance disclosure across companies. The SEC observed that, as with other mandated disclosures, companies would be permitted to provide supplemental measures of financial performance so long as any additional disclosure is clearly identified, not misleading and not presented with greater prominence than the required disclosure.
Additional Narrative Disclosure
In addition to the tabular disclosure described above, the proposed rules would require companies to include a clear description of the relationship between (i) the compensation “actually paid” to the PEO and the average compensation “actually paid” to the other NEOs and (ii) the company’s cumulative TSR for each of the company’s last five completed fiscal years (three years for smaller reporting companies). The description is also required to include a comparison of the cumulative TSR of the company and its peer group over the same period. Such disclosure can be included as a narrative, graphically or as a combination of the two. As examples, the SEC suggested that such disclosure can take the form of a graph providing executive compensation “actually paid” and change in TSR on parallel axes and plotting compensation and TSR over the required time period. Alternatively, such disclosure could include showing the percentage change over each year of the required time period in both executive compensation “actually paid” and TSR together with a brief description of the relationship.
The proposed rules would require the new disclosure in all proxy and information statements for which executive compensation disclosure (Item 402 of Regulation S-K) is required. The disclosure would not be required in annual reports on Form 10-K or other reports under the Exchange Act or in registration statements under the Securities Act or Exchange Act.
Location of Disclosure
The SEC proposed implementing the rules by adding section (v) to Item 402 of Regulation S-K, but the proposed rules do not mandate any particular location for the new disclosure within the proxy or information statement. It would be logical to include the new disclosure in close proximity to other Item 402 disclosure. However, unless the information is considered by the compensation committee in making its pay decisions, the disclosure should probably not be included within the CD&A and covered by the Compensation Committee Report. Note that as an Item 402 disclosure, it is subject to the say-on-pay advisory vote provisions of Exchange Act Rule 14a-21(a).
The proposed rules include a transitional period over which the pay-versus-performance disclosure requirements would be phased-in. Companies that are not smaller reporting companies would be required to provide disclosure for their last three completed fiscal years in the year in which the proposed rules first become effective, for the last four fiscal years in the next year and for five fiscal years in each following year. Smaller reporting companies would be required to provide disclosure for their last two completed fiscal years in the year in which the proposed rules become effective and for their last three completed fiscal years in each following year. In addition, smaller reporting companies would not be required to electronically format their pay versus performance disclosure using XBRL until the third filing in which they are required to provide such disclosure. Companies would not be required to provide disclosure for any prior years during which, at any time, they were not subject to the reporting requirements of Sections 13(a) or 15(d) of the Exchange Act.
Comment Period and Next Steps
The proposed rules will be subject to a 60-day public comment period commencing on their publication in the Federal Register. The proposed rules were approved by a 3-2 vote and a second vote will be required following the conclusion of the comment period before the proposed rules (in their current form or as modified in response to the comments) can become effective. So far, many observers have agreed with the dissenting Commissioners’ concern that the proposed rules took a more prescriptive approach than was required by the Dodd-Frank Act and give too much attention to short-term company performance through the use of the TSR metric. On the other hand, some have also noted that standardizing the calculations may assist investors in comparing companies and may make it easier for companies to determine what to disclose.
Companies will be required to comply with the rules in their first proxy or information statement filed after the rules become effective, which could be as early as the 2016 proxy season. Companies should be able to take a wait and see approach for now because most of the required disclosure is not new. However, companies may wish to confirm the historical data is available and begin preparing the new compensation “actually paid” calculation.
If you would like to discuss any aspect of the Proposed Pay Versus Performance Disclosure Rules or would like any additional information, please contact one of the Dechert attorneys listed below or any Dechert attorney with whom you regularly work.
1) The SEC proposed the rules to implement Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The proposed rules are available here. Previously, we have discussed the SEC's pay ratio proposal under Section 953(b) of the Dodd-Frank Act in Dechert's OnPoint SEC Proposes Rules for CEO Pay Ratio Disclosure.