Section 953(a) of the Dodd-Frank Act added Section 14(i) of the Securities Exchange Act of 1934 (Exchange Act), directing the SEC to adopt rules requiring registrants to disclose in any proxy or consent solicitation, a clear description of the relationship between executive compensation actually paid and the financial performance of the company. While several existing form requirements and items of Regulation S-K already require disclosures regarding the financial performance of a registrant, as well as about executive compensation and policies, no current disclosure requirements link the two elements. On April 29, 2015, the SEC published its proposed rule requiring certain additional disclosures regarding the relationship between the two. The SEC stated in its accompany release that it believes that this new proposed disclosure may help shareholders to evaluate directors' oversight of executive compensation and its relationship to financial performance.
The SEC's proposal contemplates the adoption of a new Item 402(v) of Regulation S-K. Item 402(v) would require a registrant to:
- Present the calculation of total compensation for specified executive officers as the total currently presented in the Summary Compensation Table but excluding changes in the present value of certain benefits on defined benefit and pension plans that are not attributable to the applicable year of service and including the value of equity awards at vesting, rather than the Summary Compensation Table's presentation of such equity awards at the time of grant;
- Require registrants to measure financial performance using cumulative total shareholder return (TSR) as currently defined under Item 201(e) of Regulation S-K and to compare it to TSR of a peer group, in the same way TSR is presently compared to a broad equity market index under Item 201 of Regulation S-K;
- Require registrants to include a new table including executive compensation actually paid, the total compensation as disclosed in the Summary Compensation Table, TSR, and peer group TSR;
- Require the new disclosures to be presented for the principal executive officer and as an average for the remaining named executive officers (NEOs) identified in the Summary Compensation Table during the years covered; and
- Provide a clear description of (1) the relationship between executive compensation actually paid to the registrant's NEOs and the TSR of the registrant, and (2) the relationship between the registrant's TSR and the TSR of a peer group chosen by the registrant, over each of the registrant's five most recently completed fiscal years.
The SEC is accepting comments on the proposed rules through July 6, 2015, 60 days from the date the proposed rules are published in the federal register.
Filings Requiring Item 402(v) Disclosures
As proposed, the new disclosures called for under Item 402(v) of Regulation S-K would be required in any proxy or information statement for which disclosure under the general Item 402 of Regulation S-K is required. Such Item 402 information is required in a typical proxy statement for election of directors at a registrant's annual meeting, as well as if action is to be taken with regard to any bonus, profit sharing, or other contract or arrangement in which any director, nominee, or executive officer of the registrant will participate, any pension or retirement plan in which they will participate, or the granting or extension to them of options, warrants, or rights to purchase securities. Such information will also be required in any proxy statement seeking an advisory "say on pay" vote under Section 951 of the Dodd-Frank Act.
Under the current proposal, the new Item 402(v) disclosures would not be required in a registration statement under the Securities Act of 1933, as amended (Securities Act), which does otherwise require the general Item 402 of Regulation S-K disclosures.1 The release also notes that, as proposed, the new Item 402(v) disclosures would not be deemed to be incorporated by reference into any Securities Act or Exchange Act filing, except to the extent that the registrant specifically incorporates it by reference. This nuance is notable because, generally for an issuer who elects to incorporate the Part III information required by Form 10-K by reference to its proxy statement, the Item 402 disclosures contained in such
proxy statement are incorporated by reference. Here, the new Item 402(v) disclosures would be excluded from that incorporation by reference. Similarly, the new disclosures would not be incorporated by reference into any filing that forward incorporates by reference, such as a shelf registration statement on Form S-3.
Calculation of Compensation "Actually Paid"
A key element of Exchange Act Section 14(i), as directed by Dodd-Frank, is that the new disclosures present "executive compensation actually paid," in contrast to the total amount presented in the Summary Compensation Table.
Section 14(i) of the Dodd-Frank Act, however, did not define "executive compensation actually paid." Proposed Item 402(v) represents a trend recognized by the Staff to present "realizable pay" and "realized pay." As proposed, the determination of compensation "actually paid" similarly will start with the total amount from the Summary Compensation Table for an NEO and adjust for certain items that were not realized in the time period covered by the disclosure.
The initial proposal includes three adjustments to the total from the Summary Compensation Table: changes in actuarial pension value; earnings on non-qualified deferred compensation; and equity awards. The Staff is seeking feedback on each of those three adjustments, discussed in more detail below, and more generally on other suggested adjustments.
Changes in Actuarial Pension Value
The proposed determination of executive compensation actually paid would reduce the total amount included in the Summary Compensation Table by the change in actuarial present value of all defined benefit and pension plans. However, the actuarially determined service cost attributable to services provided by the NEO in that particular year would be added back to the "actually paid" total. The Staff believes that any change in these actuarial present values, beyond the service cost from the most recent year, are generally previously accrued based on changes interest rates, executive age, and other actuarial inputs and assumptions which may limit the comparability of the measure.
Earnings on Non-Qualified Deferred Compensation
In contrast to changes in pension value, the proposed "actually paid" determination would include the amount of any above-market or preferential earnings on deferred compensation that is not tax-qualified because those amounts represent compensation accrued during the year covered by the disclosure. The Staff notes that excluding this item would result in the amounts not being disclosed until the executive in question elected to take a withdrawal or distribution from their deferred compensation.
In contrast to the Summary Compensation Table, in which equity awards are presented based on the aggregate fair value on the grant date, proposed Item 402(v) disclosure would include as executive compensation actually paid, the fair value of any equity award on its vesting date. The Staff believes that the fair value of any such equity awards should not be considered "actually paid" until any conditions on the NEO's right to receive the shares underlying the awards are satisfied. The release also specifies that the fair value of the award on the date it vests is the relevant measure, as opposed to on the date of exercise, because once the award vests any value derived by the NEO by deciding when to exercise the award is not value provided by the registrant. As elsewhere in Item 402 disclosure, the fair value on a respective vesting date would be calculated in accordance with FASB ASC Topic 718.
Executives Covered by Item 402(v)
In contrast to the Summary Compensation Table, proposed Item 402(v) contemplates disclosure for the principal executive officer (PEO) and then an average of the remaining NEOs included in the Summary Compensation Table.2 The SEC suggests that, by requiring registrant's to present this new disclosure for the NEOs, any additional administrative burden should be minimized since the registrant is already tracking compensation data for the NEOs for other purposes.
The release notes that the basis for presentation of the PEO's compensation information separately is because shareholders have a particular interest in PEO pay. In light of this, the Staff specifically seeks comment on whether the proposed disclosures should only be included for the PEO. For the remaining
NEOs, because the identity of the NEOs and the number of NEOs presented in the table may fluctuate on a year-to-year basis, the SEC offers that providing the new disclosures as an average for the remaining NEOs offers the most empirically comparative data over time.
The SEC specifically seeks comment on the presentation noted above, and whether the new Item 402(v) disclosures should be presented as an average, as proposed, on an individual basis by NEO, or as an aggregate total. The Staff also seeks feedback on how practitioners believe changes to the group of other NEOs on a yearly basis would impact usefulness and comparability of the averaged data.
Relationship to CD&A
The SEC Staff noted specifically that it proposed the pay-versus-performance rules as part of a new Item 402(v) to supplement the Compensation Discussion and Analysis (CD&A) required under Item 402(b) of Regulation S-K, rather than as a new component of CD&A. However, the SEC is seeking feedback on this structure and whether there would advantages to requiring the new disclosures as part of CD&A.
Smaller Reporting Companies, Emerging Growth Companies, and Foreign Private Issuers
The SEC proposes that the new rules would have scaled requirements for Smaller Reporting Companies, such as measuring pay-versus-performance only over the registrant's three most recently completed fiscal years and a phase-in period, in which registrants may provide pay-for-performance disclosure for the three most recently completed fiscal years in the first year of compliance. Additionally, the proposed disclosure would not be required for any year in which the registrant was not a reporting company, or for emerging growth companies or foreign private issuers.
As proposed, the new disclosures required by Item 402(v) do not appear to be overly burdensome. In most cases, they require presentation of data already gathered by registrants, with respect to the NEOs, in a different manner than currently presented under Item 402 of Regulation S-K. However, given the SEC's interest in balancing the value of the new disclosures to investors with minimizing the burdens on registrants, SEC reporting companies are encouraged to evaluate what would be required to comply with the proposed disclosure and to provide feedback if any elements of the proposal seem more burdensome to comply with and less beneficial to investors.
Gregory D. Hughes contributed to this advisory. He is a Columbia University School of Law graduate employed at Arnold & Porter LLP. Mr. Hughes is not admitted to the bar.