The SEC has yet to address some overdue rulemaking mandated by the corporate governance and executive compensation provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank”), although final rule making action on one area may occur in early 2015.
Proposed Pay Ratio Rules
On September 18, 2013, the SEC proposed amendments to Item 402 of Regulation S-K to implement Section 953(b) of Dodd Frank, which directed the SEC to amend its executive compensation disclosure rules to require public companies to disclose:
- The median of the annual total compensation of all its employees except the company’s principal or chief executive officer (CEO);
- The annual total compensation of its CEO; and
- The ratio of the two amounts.
The SEC refers to this disclosure, which would be required in new paragraph (u) of Regulation S-K Item 402, as “pay ratio” disclosure. As proposed, smaller reporting companies, emerging growth companies and foreign private issuers would not be subject to the pay ratio disclosure requirement.
Not Required For 2015 Proxy Season. The good news is that this pay ratio disclosure is not be required for the 2015 proxy season. Assuming no changes are made to the transition period set forth in the proposed rules, should the SEC adopt the final pay ratio rules in 2015, the earliest that the disclosure is likely to be required would be the 2017 proxy season for calendar-year companies (with respect to 2016 compensation). On the other hand, there seems to be growing speculation over the utility of this information versus the costs incurred to compile the data, particularly in light of the new Republican-led Congress.
Pay for Performance
Under Section 953(a) of Dodd Frank, the SEC must amend its executive compensation rules to require disclosure by each public company of “information that shows the relationship between executive compensation actually paid and… financial performance, taking into account” the company’s stock price performance. Many commentators have noted the ambiguities in the Dodd Frank requirement and the significant technical issues it raises. Key among these is an absence of guidance about the period over which performance is to be measured, when pay is required to be taken into account, which executives’ pay is required to be taken into account, and how to measure performance.
Not Required For 2015 Proxy Season. Although the SEC has yet to propose rules on this topic, most companies are paying closer attention to pay for performance alignment. For example, U.S. companies continue to shift more of the long-term incentive mix toward grants with explicit performance conditions and increasingly use total shareholder return as a performance measure. These trends reflect an appropriate emphasis on “pay for performance” in designing executive compensation programs. According to Towers Watson, while 60 percent of U.S. public companies conducted analyses to assess how closely their executive pay levels align with company performance, fewer than half of those companies disclosed the results of their pay-for-performance analyses in their 2014 proxy statements. Companies should consider expanding the analysis of pay-for-performance in the compensation discussion and analysis section of their proxy statements as a means of supporting their say-on-pay proposals and demonstrating responsible compensation practices by their boards of directors.
Most companies are looking to and waiting for the SEC to define the key components of the Dodd Frank pay-for performance disclosure (e.g., definition of pay and performance), while giving companies flexibility as to how the information is presented so that each company can tell its unique pay-for performance story.
Clawback and Hedging Policies
The final two areas of mandated rulemaking under Dodd Frank’s corporate governance and executive compensation provisions include mandatory policies and disclosure regarding clawbacks of executive compensation and disclosure of hedging by employees and directors. The SEC’s regulatory agenda published late last year suggested that the SEC expected to propose rules by the end of 2014 to address these issues, but these proposals remain unpublished as of late January 2015.