New SEC Guidance: Pay-Versus-Performance Disclosures in Upcoming Proxy Statement Filings

Background

On Aug. 25, 2022, the SEC released its final regulations implementing Dodd Frank Section 953(a) Pay for Performance rules (see McGuireWoods’ Aug. 30, 2022, legal alert). These regulations require companies to disclose (in tabular and narrative format) the relationship between compensation actually paid to the company’s named executive officers and certain performance measures.

Newly Released Guidance

On Feb. 10, 2023, the U.S. Securities and Exchange Commission (SEC) released compliance and disclosure interpretations (C&DIs) providing further guidance on the Pay versus Performance rules described above. These C&DIs respond to specific questions related to the Pay versus Performance disclosures and are effective immediately. Therefore, companies will need to incorporate this guidance, as applicable, into their Pay versus Performance disclosures included in upcoming proxy statements addressing 2022 fiscal year compensation. Below is a summary of the guidance found in the new C&DIs.

Peer Group Clarifications

• CD&A Peer Group: Companies may use a peer group disclosed in the compensation discussion and analysis when calculating peer group total shareholder return (TSR) for the Pay versus Performance table even if such group is not used for “formal benchmarking” purposes (i.e., fixing pay to a specified percentage of peer group pay).  However, the selected peer group must have been used to help determine executive pay.

• Peer Group TSR Calculated for Relevant Year’s Peer Group: If peer group make up differed during any of the relevant lookback years, the TSR reported for each year should correlate to the TSR for that applicable year’s peer group.

Performance Measures

• GAAP Net Income Required: Net income disclosures in the Pay versus Performance table must correspond to generally accepted accounting principles disclosures (GAAP). For example, companies may not use net income attributable to consolidated subsidiaries.

• Can Only Use Stock Price if Used as Award Measure: While technically a financial performance measure for other purposes, stock price cannot be used as the company-selected performance measure in the Pay versus Performance table unless it is actually used to link pay and performance (i.e., is used to determine bonus pool size or is a market condition directly applicable to an incentive award). Stock price cannot be the company-selected measure if its only impact is through the inherent changes in the value of equity-based awards.

• Measures Must Apply to the Most Recently Completed Fiscal Year: The company-selected measure cannot be measured over a multi-year period that includes the applicable fiscal year as the final year (e.g., three-year aggregate revenue), similar to the multi-year measurement periods for calculating cumulative TSR, even if such performance period were to be used consistently for all years in the table.

• Measures Derived From TSR or Net Income Are Permissible: The company-selected measure in the Pay versus Performance table may be derived from TSR or net income — e.g., earnings per share, gross profit, income or loss from continuing operations, or relative TSR. These measures also may be included as performance measures in the tabular list.

• Must Consider Bonus Pool Financial Measures: If a company utilizes a bonus “pool” plan in which an aggregate bonus pool is created based on a single financial measure, and that is the only financial measure utilized in executive compensation, such company may not omit disclosures concerning its most important financial performance measure.  The bonus pool creation is based on a financial performance measure that must be disclosed.

Compensation Actually Paid Adjustments

• Aggregate Adjustments Prohibited: Companies must provide footnote disclosure of each adjustment made for pension plans and equity awards when calculating compensation actually paid (i.e., columns (c) and (e) in the Pay versus Performance table). Aggregate disclosure of such adjustments is not permissible.

• Footnote Disclosure of Calculations for Prior Years: Companies must include footnote disclosure of adjustments for all three fiscal years covered in this year’s Pay versus Performance disclosures (i.e., in the first year of disclosure). Going forward, footnote disclosure is only required for the most recent fiscal year, unless footnote disclosure of prior year’s adjustments is material to an investor’s understanding of the information presented.

Named Executive Officers

• Equity Awards to First-Time Named Executive Officers (NEOs): Equity awards granted to a new NEO prior to such individual becoming an NEO are included when calculating compensation actually paid, despite not being included in the summary compensation table. For example, if a non-NEO is granted a restricted stock unit award in year one and is appointed as an NEO in year two, that NEO’s compensation actually paid calculation for year two must reflect the applicable adjustments (i.e., change in value) with respect to the restricted stock unit award granted in year one.

• Aggregation of Multiple Principal Executive Officers (PEOs): Although a company must provide separate columns in the Pay versus Performance table for multiple PEOs in a fiscal year, it may aggregate the compensation of such PEOs in a given year for purposes of the narrative, graphical or combined comparison between compensation actually paid and TSR, net income and the company-selected measure, so long as the presentation of such aggregated compensation will not be misleading to investors.

Other Information

• Companies That Recently Went Public: If a company went public during the applicable lookback period for initial Pay versus Performance disclosures (i.e., within the past three fiscal years), the company’s TSR disclosure period for the tabular disclosure begins with its registration date.

• Form 10-K Impact: Companies including traditional proxy disclosures on Form 10-K do not have to include the Pay versus Performance disclosures in their proxy statements so long as the proxy statement specifically incorporates by reference the Form 10-K disclosure. Notably, this rule applies only to companies filing Form 10-K prior to the proxy statement.