On April 29, the Securities and Exchange Commission (SEC) proposed new “pay-versus-performance” disclosure rules to implement one of the last two remaining executive compensation requirements mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act). The SEC has now proposed (but not finalized) rules implementing the principal executive officer (PEO) pay-ratio rule, hedging-policy rule and pay-versus-performance disclosure rule under the Act, which leaves only the rules concerning clawback policies still to be proposed.
The proposed rules would require the following table to be included in the executive compensation section (Regulation S-K, Item 402) of all annual and special proxy statements and consent solicitations where executive compensation disclosure is otherwise required:
PAY VERSUS PERFORMANCE
| Summary Compensation Table Total for PEO
| Compensation Actually Paid to PEO
| Average Summary Compensation Table Total for non-PEO named executive officers
| Average Compensation Actually Paid to non-PEO named executive officers
| Total Shareholder
|Peer Group Total Shareholder Return
Fiscal Years Covered
The table would cover the five most recently completed fiscal years, except for smaller reporting companies, for which only three years of disclosure would be required. In addition, there would be a transition rule under which non-smaller reporting companies initially would report only three years of data for the first year in which the requirement was in effect, which would increase by one year each subsequent year until all five years were being reported. In addition, newer public companies are required to report data only for the years in which they have been subject to the SEC’s reporting requirements.
Only the PEO and other named executive officers (NEOs) would be listed in the table. This is good news, as there had been some concern that disclosure as to executives who are not NEOs could be required under the statutory language.
Disclosure is presented separately for the PEO and the other NEOs as a group. If more than one person serves as PEO during a year, then the PEO compensation is presented on a combined basis as if a single PEO served.
Compensation “Actually Paid”
Compensation “actually paid” would be defined to include annual “total compensation” as reported in the summary compensation table, minus (i) the portion, if any, of the aggregate change in actuarial present value of pension benefits for the year that is unrelated to the executive’s service during the year; minus (ii) the grant-date fair value of option and stock awards for the year; plus (iii) the aggregate vesting-date value of option and stock awards that vested during the year (with footnote disclosure of how each added and subtracted amount was calculated). This calculation addresses the concern over potential distortions caused by interest rates and other actuarial factors on pension values as well as the timing of equity awards, but would require additional specialized calculations to be performed each year − in particular for the fair value of option awards at the vesting date, which is not otherwise a calculation that issuers would ever have to make. Issuers would be able to provide disclosure of additional compensation measures (such as “realized pay” or “realizable pay”) as long as the additional disclosure is not misleading and not more prominent than the required disclosure.
Total Shareholder Return
As expected, total shareholder return (TSR) would be the performance measure (the statute had left this open). TSR would be calculated in the same way as required for purposes of the “performance graph” required by Regulation S-K, Item 201. This calculation is as follows:
TSR = (cumulative amount of dividends for the period assuming reinvestment
+ difference between share price at end and beginning of the period)
÷ share price at the beginning of the period
TSR for both the issuer and peer group would be reported cumulatively as of the end of each year in the five-year period.
Although not required by statute, the proposed rules would require disclosure of the TSR of a company’s peers in addition to the company’s own TSR. For purposes of calculating peer-group TSR, issuers would be allowed to use either the peer group or the index used for purposes of the performance graph disclosure required by Regulation S-K, Item 201, or the self-selected peer group that the issuer uses for purposes of setting and comparing executive compensation. The Item 201 peer group may include (i) a broad equity market index; (ii) a published industry or line-of-business index; (iii) peer issuers selected in good faith; or (iv) other issuers with similar market capitalizations if the issuer cannot reasonably identify a peer group.
Additional Narrative or Graphic Description
In addition to the table above, the proposed rules also would require an additional narrative or graphic description (or both) of the relationship between executive compensation actually paid and the issuer’s TSR, as well as the relationship between the issuer’s TSR and the peer-group TSR, using the values in the table. The preamble to the proposed rules provides that an example of potential graphic disclosure could include a “graph providing executive compensation actually paid and change in TSR on parallel axes and plotting compensation and TSR over the required time period.” Graphic presentation would not be required under the proposed rules, although there is a decent possibility it will be required in the final rules, and we would expect most issuers to begin using a graphic presentation once the rules become effective, regardless of whether it is required.
The preamble notes that the pay-versus-performance disclosure does not need to be included in the compensation discussion and analysis (CD&A). Nevertheless, because this disclosure would be part of Regulation S-K, Item 402, it would be subject to the “say-on-pay” vote. If not included in the CD&A, it would not be covered by the compensation committee report.
Smaller Reporting Companies
Smaller reporting companies would be allowed to: (i) present only three years of disclosure instead of five (only two years for the first year for which the disclosure is required); (ii) exclude pension-related data; and (iii) exclude the disclosure of peer-group TSR.
The proposed rules would exempt emerging-growth companies and foreign private issuers.
Incorporation by Reference
Even though the pay-versus-performance requirement in the proposed rules would be included in Regulation S-K, Item 402, it would not be required to be disclosed in filings (such as registration statements and annual reports) other than annual or special proxy statements, and would not be deemed to be incorporated in such other filings unless specifically provided for. Issuers would need to be careful to avoid inadvertently incorporating the pay-versus-performance disclosure in their registration statements and annual reports along with the other Item 402 executive compensation disclosure from the proxy.