On April 29, 2015, the Securities and Exchange Commission (the “SEC”) proposed rules to implement Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) requiring each public company to disclose information about the relationship between executive compensation actually paid by the company and its financial performance. The proposed rules would implement these provisions by adding a new Item 402(v) to Regulation S-K. The rule proposal is available here. Comments to the proposed rules are due 60 days after the publication of the proposal in the Federal Register. At this point, it is not clear whether the final rules will be adopted and effective prior to the 2016 proxy season.
New Item 402(v)
Item 402(v) would require a company to include a new “Pay Versus Performance” table in any proxy or information statement for which disclosure under Item 402 of Regulation S-K is required.
The new table would contain the following entries for each of the previous fivefiscal years:
- The total compensation of the company’s principal executive officer (“PEO”) as disclosed in the Summary Compensation Table under Rule 402(c) and theaverage of the total compensation of the company’s other named executive officers (as identified under Item 402(a)(3) of regulation S-K (“NEOs”)) as disclosed in the Summary Compensation Table;
- The executive compensation actually paid to the PEO in that fiscal year and theaverage of the executive compensation actually paid to the other NEOs in that fiscal year, calculated as the total compensation number adjusted in two ways:
- for defined benefit and actuarial pension plans, the company would deduct the executive’s accumulated benefit under such plans and then add back the service cost for all such plans calculated as the actuarial present value of the executive’s benefit attributable to services rendered during the covered fiscal year; and
- for all stock and option awards, the company would deduct from total compensation the aggregate grant date fair value included in the Summary Compensation Table; and then add back the fair value on the vesting date for all such awards for which all applicable vesting conditions were satisfied during the covered fiscal year.
- The cumulative total shareholder return of the company and its ‘peer group,” each calculated in the same manner and over the same measurement period as the performance graph currently required under Item 201(e) of Regulation S-K. The peer group would be the same as used for the purposes of Item 201(e) disclosure or, if applicable, the peer group that the issuer uses for purposes of Item 402(b).
In addition to the Pay Versus Performance table, Item 402(v) requires the company to provide a description of the relationships between compensation and the cumulative total shareholder return of the company and its peer group as shown on the table. The proposing release notes that this description could be provided by the company in graphic or narrative form (or both).
The disclosure required by 402(v) is to be electronically formatted using the eXtensible Business Reporting Language (XBRL) with each amount required to be disclosed in the Pay Versus Performance table tagged separately.
Foreign Private Issuers, Registered Investment Companies, Emerging Growth Companies and Smaller Reporting Companies
Foreign private issuers as defined in Exchange Act Rule 3b-4 and registered investment companies would not be required to provide Item 402(v) disclosure as proposed. Companies that qualify as emerging growth companies under Section 3(a) of the Exchange Act also are exempt from needing to comply with Item 402(v).
Companies that qualify as a “smaller reporting company” pursuant to Item 10(f) of Regulation S-K would only be required to provide the information required by Item 402(v) for three years, instead of five years. Since smaller reporting companies are generally not required to disclose pension arrangements in executive compensation, they would not be required to make the pension related adjustments to disclose the actual amount of executive compensation. Smaller reporting companies would also not be required to disclose a peer group total shareholder return. Smaller reporting companies would only be required to provide the Pay Versus Performance table in XBRL format starting with the third filing in which it provides such disclosure.
The proposed rules provide that the first time a company provides the 402(v) disclosure, it need only provide the disclosure for a three year period, and it would then be required to provide disclosure for an additional year in each of the two subsequent annual filings in which this disclosure is required. Smaller reporting companies are only required to provide the information for two years in their first such filing.
Calculating the Actual Compensation paid to the PEO and the NEOs
As noted above, the actual compensation entries on the Pay Versus Performance table make two adjustments to the amounts currently disclosed in a company’s Summary Compensation Table:
Defined Benefit Plans and Actuarial Pension Plans. The proposal notes that the adjustments for defined benefit plans and actuarial pension plans are made to exclude the portion of the total change in actuarial pension value that results solely from changes in interest rates, age and other actuarial inputs and assumptions regarding benefits for services rendered by the executive during the applicable year. However, the proposal notes it is appropriate to include in the table the value deemed to be set aside in the applicable year for the pension benefits payable upon retirement due to the executive’s service during that applicable year. This is the “service cost” consistent with the definition in FASB ASC Topic 715.
Equity Awards. The proposal provides that equity awards should be considered actually paid and valued at fair value on the date vesting occurs, rather than fair value on the date of grant as is currently required by the Summary Compensation Table. Fair value amounts are to be computed in a manner consistent with fair value measurement guidance in FASB ASC Topic 718. Proposed Item 402(v) further provides that if a company adjusts, replaces, modifies or amends the exercise price of a previously vested option or stock appreciation right then the company should include in the calculation of actual compensation paid the incremental fair value, computed as the excess fair value of the modified award over the fair value of the original award upon vesting of the modified award.
Footnote Disclosure. Item 402(v) requires the company to disclose in footnotes to the Pay Versus Performance table each of the amounts deducted and added as adjustments for defined benefit plans, pensions funds and equity. In addition, the footnotes to the table should include any assumptions made in the calculation of fair value of the equity awards to the extent those assumptions differ materially from the assumptions disclosed pursuant to the instructions to Item 402(c) (or Item 402(n) for smaller reporting companies).
Change of the PEO. If more than one person serves as PEO during a given year, then the information in the Pay Versus Performance table would be disclosed on an aggregated basis.
Practice Considerations -- What is new here?
Most of the disclosure required by proposed Item 402(v) is already required to be disclosed elsewhere in a company’s proxy or information statement. Item 402(v) merely collects and tabulates such information in a manner that the SEC has determined would be more beneficial to investors. However, companies should be aware of the following information which is being disclosed either in a new format or is not currently disclosed to investors:
- The format of the Pay Versus Performance table will highlight the trend of the compensation levels paid to the PEO and, on average, the other NEOs as compared to the growth of the company’s shareholder return and its peer group’s shareholder return;
- The Pay Versus Performance table would be required to be provided in XBRL format and the data on the table will be subject to electronic searches;
- Item 402(v) also requires additional narrative or graphic disclosure describing these relationships and companies may want to utilize this opportunity to address any issues such disclosure may raise with investors;
- Once the transition period ends, the compensation information reported in the Pay Versus Performance table (including the compensation information that is carried over from the Summary Compensation Table) will be reported for the past five years, whereas currently the Summary Compensation Table only reports compensation data for the past three years;
- Item 402(v) requires the disclosure of the annual service cost under defined benefit plans and pension plans for the PEO and the other NEOs which is not currently required to be disclosed (although investors currently should be able to calculate it based on information reported in the Pension Benefits Table and its footnotes); and
- Item 402(v) requires the disclosure of the fair value of option awards as of the vesting date, which is not otherwise currently required to be disclosed by Regulation S-K (although the value of stock awards as of vesting are currently required to be disclosed).