On April 29, the SEC proposed rules to require each SEC registrant (other than an emerging growth company, registered investment company or foreign private issuer) to disclose the relationship between executive compensation actually paid by the company and the company’s financial performance. The proposed rules would implement Section 14(i) of the Exchange Act, which was added by Section 953(a) of the Dodd-Frank Act. Under the proposal, a company would be required to disclose in a new table executive pay and performance information for itself and companies in a peer group and to tag the information in an interactive data format.  The company would have to include the new information in a proxy or information statement in which executive compensation disclosure is required by Item 402 of Regulation S-K, but not in an annual report on Form 10-K or in a Securities Act registration statement that requires Item 402 disclosure.

A copy of the SEC’s release proposing the rules (No. 34-74835) is available on the SEC’s website. Comments on the proposed rules are due within 60 days after publication of the release in the Federal Register.

Item 402(v) of Regulation S-K

The rules would add a new Item 402(v) to Regulation S-K. The company would be required by Item 402(v) to provide the following information in its proxy or information statement:

  • Tabular disclosure for the last five fiscal years (subject to a phase-in period, described below) of:
    • Total compensation and compensation actually paid to the company’s principal executive officer (PEO)
    • Average compensation actually paid to the company’s named executive officers (NEOs) other than the PEO
    • Total shareholder return (TSR) of the company
    • Total shareholder return of a peer group chosen by the company
  • A clear description of:
  • The relationship between executive compensation actually paid to the company’s NEOs and the company’s cumulative total shareholder return
  • The relationship between the company’s total shareholder return and the total shareholder return of a peer group chosen by the company, over each of the company’s five most recently completed fiscal years (or three fiscal years, in the case of smaller reporting companies) 

Tabular disclosure. Under the proposed rules, the company would be required to include pay-for-performance information in a new table presented in the following format:

Click here to view table.

  • Summary Compensation Table Total for PEO would reflect the PEO’s “total” compensation as reported in the summary compensation table.
  • Compensation Actually Paid to PEO would show the PEO’s total compensation as disclosed in the summary compensation table, with the following adjustments:
    • Equity awards would be valued at the fair market value of the award on the vesting date during the applicable year and not at the fair value on the grant date
    • The change in pension value reflected in the summary compensation table would be adjusted to add back the actuarially determined service cost for services rendered by the executive during the applicable year
  • Average Summary Compensation Table Total for Non-PEO Named Executive Officers would be calculated based on the total compensation reported in the summary compensation table for the non-PEO named executive officers. The covered NEOs would include the company’s principal financial officer and its three most highly compensated executive officers, as well as up to two additional individuals for whom disclosure would have been provided but for the fact that any such individual was not serving as an executive officer at the end of the last completed fiscal year.
  • Average Compensation Actually Paid to non-PEO Named Executive Officers would be calculated in the same manner as compensation actually paid to the PEO.
  • Total Shareholder Return would be calculated using the methodology prescribed by Item 201(e) of Regulation S-K, which is the methodology used to prepare the performance graph included in the annual report to shareholders.
  • Peer Group Total Shareholder Return would be based on the total shareholder return of a peer group chosen by the company for use in its performance graph or in the Compensation Discussion and Analysis (CD&A) presented in the proxy or information statement.

Disclosure of relationship between executive compensation and company performance. The company would be required to use the values presented in the new table to (1) describe the relationship between the executive compensation actually paid and the company’s total shareholder return and (2) the relationship between the company’s total shareholder return and the peer group’s total shareholder return. The description would appear after the new table and could be presented in narrative form, graphically, or in a combination of the two formats.

Interactive data tagging (XBRL). Each column of the new table, including any footnote disclosure, and disclosure of the relationship between executive compensation and company performance would have to be provided in interactive data format using XBRL. The company would be required to file the XBRL exhibit with its definitive proxy or information statement.

Location of new disclosure. The proposed rules do not specify where in the proxy or information statement the new disclosure must be located, but the expectation is that the disclosure would appear with the Item 402 executive compensation disclosure. The SEC noted in the proposing release that the pay-for-performance disclosure should not appear as part of the CD&A unless the company considered the pay-for-performance relationship in its compensation decisions.

Phase-in periods

The proposed rules include phase-in periods for the new disclosure. A company that is not a smaller reporting company would have to provide Item 402(v) disclosure for three years, instead of five years, in the first filing for which the disclosure is required. Disclosure would be required for a four-year period in the subsequent year’s filing and for the five-year period in the third filing that requires the Item 402(v) disclosure.

For smaller reporting companies, the proposed rules would allow Item 402(v) disclosure for two years instead of three years in the first filing and require the disclosure for the three-year period in the company’s second filing. Smaller reporting companies would not be required to include XBRL data tagging of the pay-for-performance disclosure until their third filing under the new rules.

Effective date

The timing of adoption of the final rules will depend in large measure on the volume of comments the SEC receives on its proposal. It is possible the SEC could adopt final rules in the Fall of 2015, which would make the disclosure requirement effective for the 2016 proxy season.

Open questions

The SEC’s proposal raises a number of questions that we expect will be addressed in the final rules and adopting release:

  • Whether, as proposed, the final rules will require disclosure of the average compensation actually paid to non-PEO named executive officers in addition to the PEO, or whether the SEC ultimately will determine that preparation of such disclosure is unnecessarily burdensome to registrants and not helpful to investors
  • Whether, as proposed, company performance will be measured by total shareholder return, which may be affected by factors other than company performance and which might result in an overemphasis on short-term performance over long-term performance, or instead will be measured by some other standard, the determination of which might be left to the company’s discretion
  • Whether the final rules will adopt a more principles-based approach and afford companies more flexibility to determine how best to communicate their compensation strategy to investors
  • Whether the final rules will provide any additional relief for smaller reporting companies or other types of registrants

Looking ahead

In addition to considering whether to comment on the proposal, companies would be well served to brief the compensation committee on the proposed new disclosure and its possible impact on the discussion of executive compensation in the proxy statement. In this connection, it would be helpful to consider what the tabular and narrative disclosures would look like if the rules are adopted as proposed.