On February 10, 2023, the SEC published 15 new Compliance and Disclosure Interpretations (C&DI) related to the pay versus performance (“Pay vs. Performance”) disclosure rules which were, in turn, adopted in August, 2022 (see HERE) after seven years in the process.
The rules require companies to provide a table disclosing specified executive compensation and financial performance measures for their five most recently completed fiscal years in any proxy or information statement filed under Section 14 of the Exchange Act. With respect to the measures of performance, a company will be required to report its total shareholder return (TSR), the TSR of companies in the company’s peer group, its net income, and a financial performance measure chosen by the company itself. Using the information presented in the table, companies will be required to describe the relationships between the executive compensation actually paid and each of the performance measures, as well as the relationship between the company’s TSR and the TSR of its selected peer group. A company will also be required to provide a list of three to seven financial performance measures that it determines are its most important performance measures for linking executive compensation actually paid to company performance.
The SEC administration under Gary Gensler has been actively tackling compensation and insider trading related issues, including adopting executive compensation clawback rules (see HERE); publishing new guidance on disclosures and accounting for spring-loaded compensation awards (see HERE); adopting amendments to Rule 10b5-1 insider trading plans (see HERE); and finalizing new share repurchase program disclosure rules (see HERE for the proposed rules, a blog on the final rules is coming soon.)
Section 953(a) of the Dodd-Frank Act added Section 14(i) to the Securities Exchange Act of 1934 (“Exchange Act”). Section 14(i) requires the SEC to adopt rules mandating companies to disclose a clear description of any compensation required to be disclosed Item 402 of Regulation S-K, in any proxy or consent solicitation material for an annual meeting of shareholders. Item 402 in turn sets forth the disclosure requirements related to executive compensation, including compensation disclosure and analysis (“CD&A”).
The Pay vs. Performance rules add new Item 402(v) to require a company to describe the relationship between the executive compensation actually paid and the financial performance of the company over the time horizon required by the rules. A refresher on the requirements is included at the end of this blog.
The 15 new C&DI answer common questions regarding complying with new Item 402(v).
Question 128D.01 confirms that although Item 11 of Form 10-K requires furnishing the information under Item 402 of Regulation S-K, the Pay vs. Performance disclosures required by Item 402(v) are only required to be included in a proxy or information statement. Moreover, information provided under Item 402(v) will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the company specifically incorporates it by reference.
Question 128D.02 confirms that the two-year disclosure of equity awards under Item 402(v)(2)(iii)(C)(1) would include equity awards granted to an employee while they were not a named executive officer, if those awards come within the two-year time frame. In such case, the company should disclose the change in value of such awards during the time the employee was/is a named executive officer.
Question 128D.03 provides that Item 402(v) footnote disclosure for years other than the most recent fiscal year included in the Pay vs. Performance table would be required only if it is material to an investor’s understanding of the information reported in the table for the most recent fiscal year, or of the relationship disclosure provided under Item 402(v)(5). However, the company should provide footnote disclosure for each of the periods presented in the table in the company’s first Pay vs. Performance table under the new rules.
Question 128D.04 confirms that aggregate amounts calculated for pension value adjustments will not satisfy the footnote requirements for columns (c) and (e) of the Pay vs. Performance table.
Question 128D.05 explains that for purposes of calculating peer group total shareholder return under Item 402(v)(2)(iv), a company may use any peer group that is included in its Compensation Discussion and Analysis (C&DI) even if such peer group is not used for “benchmarking” under Item 402(v)(2)(xiv).
Question 128D.06 addresses the time period for presentation of total shareholder return (TSR) and peer group TSR when the company went public during the earliest year included in the Pay vs. Performance table. In particular, the measurement point for purposes of calculating TSR and peer group TSR should begin on the registration date.
Where a company has changed its peer group in its CD&A over the past three-year period, it should use the same peer group for each year as it used in its CD&A in its Pay vs. Performance disclosure table.
In what seems obvious, Question 128D.08 confirms that a company must use net income as disclosed in its GAAP audited financial statements in column (h) of the Pay vs. Performance table (as opposed to some other net income figure).
Question 128D.09 confirms that the Company-Selected Measure can be any financial performance measure that differs from the financial performance measures otherwise required to be disclosed in the Pay vs. Performance table that meets the definition of Company-Selected Measure in Item 402(v)(2)(vi) including a measure that is derived from, a component of, or similar to those required measures (for example earnings per share, gross profit, income or loss from continuing operations, or relative total shareholder return).
A company may not use stock price as its Company-Selected Measure under Item 402(v)(2)(vi) if the company does not use it to link compensation actually paid to its named executive officers to company performance, even if it has a significant impact on the amounts reported in the Pay vs. Performance table. That is, if the only impact of stock price on a named executive officer’s compensation is through changes in the value of share-based awards (which would be evident from the company’s Summary Compensation Table disclosure), the company could not include its stock price as the Company-Selected measure. However, if, for example, the company’s stock price is a market condition applicable to an incentive plan award or is used to determine the size of a bonus pool, it may be included as a company’s Company-Selected Measure.
The Company-Selected Measure included in the Pay vs. Performance table may not be measured over a multi-year period that includes the applicable fiscal year as the final year. It must be the most recently completed fiscal year.
Question 128D.12 confirms that a company may not avoid the Pay vs. Performance table by using a pool plan for annual bonuses, where such plan has any tie to financial performance.
If a company has multiple principal executive officers (“PEOs”) in a fiscal year, Item 402(v) requires the registrant to provide separate columns for each PEO in the Pay vs. Performance table required by Item 402(v)(1). The SEC confirms, that to the extent it would not be misleading, the company can aggregate the PEO’s compensation for purposes of the narrative, graphical, or combined comparison between compensation actually paid and TSR, net income, and the Company-Selected Measure.
If a company changes its fiscal year during the time period covered by the Item 402(v) Pay vs. Performance table, it should provide the disclosure required by Item 402(v) for the “stub period,” and do not annualize or restate compensation. For example, in late 2022, a company that is not a Smaller Reporting Company changed its fiscal year end from June 30 to December 31. In the company’s first Pay vs. Performance table, it should provide disclosure for each of the following four periods: July 1, 2022 to December 31, 2022; July 1, 2021 to June 30, 2022; July 1, 2020 to June 30, 2021; and July 1, 2019 to June 30, 2020. The company should also continue providing such disclosure including the stub period until there is disclosure for five full fiscal years after the stub period.
A company emerged from bankruptcy, and a new class of stock that was issued under the bankruptcy plan started trading in September 2020. The company is preparing its first Pay Versus Performance disclosure for inclusion in its 2023 proxy statement. The company will be presenting less than five full years of data in its stock performance graph under Item 201(e) using a measurement period for the graph from September 2020 through December 2022. For purposes of the requirement in Item 402(v)(2)(iv), the company may provide its cumulative total shareholder return and peer group cumulative total shareholder return in the same manner. The company should provide footnote disclosure to explain the approach and its effect on the Pay vs Performance table.
Refresher on Pay vs. Performance Rules
The Pay vs. Performance rules require a company to include a new table disclosing compensation “actually paid” to the principal executive offer or CEO and to the other named executive officers and the corresponding “total compensation” amounts for the prior five fiscal years or three fiscal years for smaller reporting companies. The five- or three-year look-back, as applicable, is subject to a phase-in period for the new rules. The disclosure must be included in any proxy or information statement for which Item 402 disclosure is required.
With respect to the measures of performance, a company is required to report its total shareholder return (TSR), the TSR of companies in the company’s peer group, its net income, and a financial performance measure chosen by the company itself. Using the information presented in the table, companies are required to describe the relationships between the executive compensation actually paid and each of the performance measures, as well as the relationship between the company’s TSR and the TSR of its selected peer group. A company is also required to provide a list of three to seven financial performance measures that it determines are its most important performance measures for linking executive compensation actually paid to company performance.
The table must include:
- The total executive compensation of the principal executive officer (“PEO”) and the average of the total compensation of other named executive officers (“NEO”) as reported in the summary compensation table (note the summary compensation table is already a required Item 402 disclosure in proxy and information statements);
- The executive compensation “actually paid” to the PEO and the average of the executive compensation actually paid to the other NEO. The new proposed rules delineate the required elements and calculation for this disclosure;
- The cumulative total shareholder return (TSR), calculated in the same manner as the performance graph already required by current SEC rules.
The table should be set up as follows. Smaller reporting companies are exempt for the items with asterisks.
Summary Compensation Table Total
Compensation Actually Paid
|Average Summary Compensation Table Total for Non-PEO
Average Compensation Actually Paid to Non-PEO
|Value of Initial Fixed $100
Investment Based On:
Peer Group Total Shareholder
Item 402 defines the NEOs for whom disclosure is required as: (i) all individuals serving as the registrant’s principal executive officer (“PEO”) or acting in a similar capacity during the last completed fiscal year, regardless of compensation level, (ii) all individuals serving as the registrant’s principal financial officer (“PFO”) or acting in a similar capacity during the last completed fiscal year, regardless of compensation level, (iii) the registrant’s three most highly compensated executive officers other than the PEO and PFO who were serving as executive officers at the end of the last completed fiscal year, and (iv) up to two additional individuals for whom Item 402 of Regulation S-K disclosure would have been provided but for the fact that the individual was not serving as an executive officer of the registrant at the end of the last completed fiscal year.
Companies are required to use the information in the table to provide clear descriptions of the relationships between compensation actually paid and three measures of financial performance. That is, the company must describe the relationship between (i) the executive compensation actually paid to the company’s PEO and (ii) the average of the executive compensation actually paid to the company’s remaining NEOs to (a) the cumulative TSR of the company, (b) the net income of the company, and (c) the company’s Company-Selected Measure, over the three- or five-year period. Companies are also required to provide a clear description of the relationship between its TSR and the TSR of a peer group chosen by it, for the same time period. Companies have flexibility as to the format in which to present the descriptions of these relationships, whether graphical, narrative, or a combination of the two. Companies will also have the flexibility to decide whether to group any of these relationship disclosures together, but any combined description of multiple relationships must be “clear.”
A company must also provide an unranked list of the most important financial performance measures used by it to link executive compensation actually paid to the company’s NEOs during the last fiscal year, to company performance. Although companies may include non-financial performance measures in this list, they must select the Company-Selected Measure for the table from the financial performance measures included in this list. Also, the Company-Selected Measure must be the financial performance measure that in the company’s assessment represents the most important performance measure (that is not otherwise required to be disclosed in the table) used by the company to link compensation actually paid to its NEOs, for the most recently completed fiscal year, to company performance
The new disclosure requirements do not apply to emerging growth companies or foreign private issuers. Smaller reporting companies are only required to present such descriptions with respect to the measures they are required to include in the table and for their three, rather than five, most recently completed fiscal years.
Disclosure of compensation “actually paid”
The Pay vs. Performance rules delineate the elements of and calculation for the required compensation “actually paid” disclosure. For smaller reporting companies, the compensation “actually paid” is the executive compensation reported in the Summary Compensation Table disclosure already required to be disclosed in the proxy and information statements in accordance with existing Item 402. All companies other than smaller reporting companies must then modify the disclosed amount to exclude changes in actuarial present value of benefits under defined benefit and actuarial pension plans that are not attributable to the applicable year of service, and to include the fair value of equity awards at vesting rather than when granted.
Relationship with Total Shareholder Return (TSR)
As touched on above, the rules require companies to measure financial performance using TSR as defined in Item 201(e) of Regulation S-K and to make a comparison with the TSR of the company and the compensation actually paid for both the CEO and an average of all the other named executive officers. Using the values disclosed in the table, the company must disclose the relationship between the executive compensation actually paid and the company’s TSR. The company can make the disclosure either using a narrative discussion, a graph or a combination of both. Interestingly, the company has flexibility as to the location of the discussion and it is not required to be included in the CD&A section. Companies that are not smaller reporting companies must also provide disclosure on the relationship between the company’s TSR and the TSR of a peer group as chosen by the reporting company.
Additional and Supplemental Disclosure
A company may provide additional and supplemental disclosure to the extent that such additional disclosure is useful to an understanding of the pay vs. performance discussion. As with any information, the additional information cannot be misleading or detract from the basic disclosure elements required by the new proposed rules.
Inline XBRL Tagging
The disclosure must be tagged using Inline XBRL.
The rule allows for a phase-in period. In the first filing following the effectiveness of the rule, companies are only required to provide two years of disclosure and will need to add an additional year of disclosure for each subsequent year’s filing until the required number of years of disclosure has been achieved (3 years for smaller reporting companies and 5 years for all others).
Laura Anthony, Esq.
Anthony L.G., PLLC
A Corporate Law Firm
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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