To Our Clients and Friends:
On April 29, 2015, the Securities and Exchange Commission ("SEC" or "Commission") voted, 3-2, to issue proposed rules implementing the pay-versus-performance disclosure requirement in Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"). In summary, the proposed rules would require proxy statements or information statements setting forth executive compensation disclosure to include (1) a new compensation table setting forth for each of the five most recently completed fiscal years, the "executive compensation actually paid" (as defined in the proposed rules), total compensation as disclosed in the Summary Compensation Table, total shareholder return (TSR), and peer group TSR, and (2) based on the information set forth in the new table, a clear description of the relationship between executive compensation actually paid to the company’s named executive officers and the company’s TSR, and a comparison of the company’s TSR and the TSR of a peer group chosen by the company.
Statements made by the SEC Commissioners during the open meeting regarding the proposed rules are available here, and the SEC’s proposing release is available here. The comment period for the proposed rules will expire 60 days after the proposed rules are published in the Federal Register. Set forth below is a summary of the proposed rules, highlights from the Commissioners’ statements, and considerations for companies.
Summary of the Proposed Rules
New Tabular Disclosure under Item 402(v) of Regulation S-K. Section 953(a) of the Dodd-Frank Act instructs the Commission to adopt rules requiring companies to provide "a clear description of … information that shows the relationship between executive compensation actually paid and the financial performance of the issuer." To address this mandate, proposed Item 402(v) would require companies to include a new table (in the format set forth below) in any proxy statement or information statement setting forth executive compensation disclosure, reporting:
- The "executive compensation actually paid" to the principal executive officer ("PEO") and the total compensation reported in the Summary Compensation Table for the PEO. If more than one person served as the PEO during the covered fiscal year, then the compensation for all PEOs during that year would be aggregated and disclosed.
- An average of the "executive compensation actually paid" to the remaining named executive officers and an average of the total compensation reported in the Summary Compensation Table for the remaining named executive officers.
- The company’s cumulative annual TSR calculated in accordance with Item 201(e) of Regulation S-K (i.e., in the same manner as in the Stock Price Performance Graph required in annual reports to shareholders).
- The cumulative annual TSR of the companies in a peer group chosen by the company (which may be the peer group used for the purposes of Item 201(e) or the peer group used in the Compensation Discussion and Analysis).
PAY VERSUS PERFORMANCE
|
Year (a) |
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) |
As proposed, the table would set forth this information for each of the five most recently completed fiscal years, subject to a transition rule and certain exceptions described below.
In addition, the proposed rules would require companies to accompany the new table with disclosure that "use[s] the information provided in the table … to provide a clear description of the relationship" between executive compensation actually paid and the company’s TSR, and the company’s TSR and the TSR of its peer group. These descriptions could include narrative or graphic disclosure (or a combination of the two).
Companies would also be required to tag the disclosure in interactive data format using eXtensible Business Reporting Language, or XBRL. This would be the first time that the SEC has required companies to tag proxy statement disclosure.
"Executive Compensation Actually Paid." Under the proposed rules, "executive compensation actually paid" would equal the total compensation reported in the Summary Compensation Table with adjustments made to the amounts reported for pension values and equity awards.
- With respect to pension values, the changes in actuarial present value of benefits under defined benefit and actuarial pension plans would be deducted from the reported total compensation, and the actuarially determined service cost for services rendered by the executive would be added. Thus, executive compensation "actually paid" would exclude the portion of the total change in actuarial pension value reported in the Summary Compensation Table that results solely from changes in interest rates, mortality assumptions, age, and other actuarial inputs and assumptions regarding benefits accrued.
- Equity awards would be considered "actually paid" on the date of vesting (even if, in the case of stock options, they have yet to be exercised) and valued at their fair value on the vesting date, as computed under accounting rules, in contrast to the Summary Compensation Table where equity awards are reported at fair value on the grant date.
Footnote disclosure would be required about the amount of all adjustments, as well as valuation assumptions used in determining any equity award adjustments that are materially different from those disclosed in the company’s financial statements. The SEC acknowledges in the proposing release that a number of companies have used the concepts of "realizable pay" and "realized pay" in their proxy statements as a means of comparing pay and performance, and states that companies could supplement the Item 402(v) disclosure with these concepts, so long as the supplemental disclosure is not misleading or presented more prominently than the required disclosure.
Filings and Timing of Disclosure. Companies would need to include the proposed disclosure in the first applicable filing after the final rules become effective. It is not clear whether final rules will become effective in time for the disclosure to be required in 2016 proxy statements. Companies eventually would be required to include disclosure for the most recent five years, but would be allowed to provide disclosure for only three years in the first proxy or information statement in which they provide the disclosure, adding one additional year in each of the two subsequent years. The Item 402(v) disclosure would be treated as "filed" for the purposes of the Exchange Act and would be subject to the say-on-pay advisory vote under Exchange Act Rule 14a-21(a).
Issuers Subject to the Proposed New Rules. The proposed rules would require pay-versus-performance disclosure for all companies other than emerging growth companies (which are statutorily exempt from the requirements pursuant to the Jumpstart Our Business Startups Act), foreign private issuers, and registered investment companies.
Smaller reporting companies would be subject to scaled disclosure. Specifically, they would not be required to provide peer group TSR, would only have to provide disclosure for the most recent three years, and would be allowed initially to provide disclosure for two years, adding one additional year in the next year. Smaller reporting companies also would be afforded a transition period with respect to XBRL requirements.
Open Meeting Comments
In her opening remarks, Chair Mary Jo White specifically asked for comments on the use of TSR as a measure of financial performance and input on how investors will use the disclosure. Commissioners Luis Aguilar and Kara Stein, each of whom voted for the proposed rules, remarked that the proposed rules would increase accountability with respect to executive compensation by providing investors with performance data that will be comparable across companies. Commissioners Daniel Gallagher and Michael Piwowar, each of whom voted against the proposed rules, emphasized the prescriptive nature of the proposed rules and questioned the utility of TSR as a performance metric. Commissioner Gallagher stated that it was "dubious" whether the proposed rules’ definition of executive compensation actually paid is the "most meaningful definition for every company across the board," and noted that Institutional Shareholder Services (ISS) recently changed its TSR-based screening approach over concerns that its focus on TSR failed to account for nuances among companies.
Considerations for Companies and Commenters
The proposed rules reflect the Commission’s Congressionally mandated foray into the controversy of how best to demonstrate a connection between executive compensation and company performance, an issue that companies, shareholders and proxy advisory firms, among others, have wrestled with for years. The proposed rules reflect a number of important policy considerations in implementing the mandate in Section 953(a). The Commission chose, for example, to propose a prescriptive format applicable to all issuers, although the Commission noted that based on comments it had received to date, commenters were divided on whether the Commission should provide specific rules on how the proposed disclosure must be prepared or allow companies flexibility in determining how to disclose the relationship between pay and performance. In addition, the Commission chose to calculate compensation "actually paid" based on the accounting fair value of equity awards at their vest date, instead of the "intrinsic value"; thus, for example, the value of stock options will exceed the "spread" that would have been realized by an executive if she had exercised an option on the day it vested. As well, the Commission determined to use TSR as the measure of "financial performance of the issuer", to provide for TSR disclosure on an annual basis, and to require TSR disclosure for a peer group of companies.
Companies should evaluate whether to comment on the proposed rules and, if they do plan to comment, what topics to address. In this respect, companies may wish to prepare a mock-up of the proposed table and consider what issues would be presented under the proposed rules. The Commission has asked for input on whether it has struck the right balance between satisfying the mandate of Section 953(a) and providing companies with flexibility, and whether there are alternatives to the current proposals that the Commission should consider. The Commission also has requested comment on various implementation alternatives identified in the "Economic Analysis" section of the proposing release, which includes a discussion of the implications of taking a more principles-based approach to the requirements, and a discussion of alternatives for the definition of "executive compensation actually paid." In this regard, given the progress that many companies have made in their pay-for-performance disclosures over the past several years and increasing concerns among both companies and shareholders over proxy statement information overload, companies and shareholders may wish to consider commenting on whether the Commission’s proposals are likely to result in clearer disclosure or instead will add to the disclosure burden by requiring greater explanations of factors that make the disclosures mandated under the proposed rules not appropriate or not representative for individual companies.
Several other items on which the Commission specifically has requested comment include:
- Whether the proposed tabular disclosure will enhance comparability across companies;
- Whether requiring the use of TSR could emphasize short-term stock price improvement over the creation of long-term shareholder value; and
- Whether there will be any significant transition costs imposed on companies.
The 60-day comment period should provide companies with adequate time to consider alternatives and assemble input. However, it will be particularly important for companies to spend time now gathering and analyzing data on the costs of compiling the information and burdens of drafting the additional disclosures if they intend to provide the Commission with insight into the cost/benefit implications of the proposed rules.