Back in 2015, the U.S. Securities and Exchange Commission (“SEC”) issued proposed rules on the pay-for-performance disclosure required under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”). While that proposal generated much commentary at the time, the rules were never finalized. Seemingly to refresh the debate and move things forward, the SEC recently reopened the 30-day comment period for those 2015 proposed rules.
Dodd-Frank was enacted to address financial stability after the 2008 financial crisis by requiring accountability and transparency of SEC registrants.¹ Certain Dodd-Frank provisions required rulemaking by the SEC in order to be implemented. In particular, Section 953(a) of Dodd-Frank (which added Section 14(i) to the Securities Exchange Act of 1934) requires the SEC to adopt rules for requiring registrants’ proxy statements to describe the relationship between the executive compensation actually paid and the financial performance of the company.
The reopened comment period relates specifically to the portion of the 2015 proposal related to new disclosure rule Item 402(v) of Regulation S-K. This “2015 Proposal” would require a registrant to describe how the executive compensation actually paid by the registrant relates to the registrant’s financial performance. The 2015 Proposal would require a proxy table providing:
- the “total compensation” actually paid to the company’s principal executive officer (“PEO”) and, on average, to the company the company’s other named executive officers (“NEO”), as reflected in the Summary Compensation Table;
- the “compensation actually paid” to the PEO and other NEOs, which is based on the amounts reported as “total compensation,” adjusted to (i) exclude changes in actuarial present value of pension benefits and (ii) take into account the fair value of equity awards at vesting, rather than their grant date fair value;
- the company’s total shareholder return (“TSR”) over the three most recently completed fiscal years as a measure of its financial performance; and
- the TSR of the company’s peer group over the three most recently completed fiscal years.
Smaller reporting companies are required to disclose the relationship between executive compensation actually paid and TSR over the registrant’s three most recently completed fiscal years but are not required to disclose the peer group TSR.
The SEC’s stated objective in reopening the comment period to the 2015 Proposal is to determine whether the disclosure of additional performance metrics would provide investors with useful information to evaluate the relationship of executive compensation to a company’s financial performance while preserving comparability. The press release accompanying the Reopening of Comment Period for Pay Versus Performance (the “2022 Release”) includes a statement from SEC Chairman Gensler that “commenters expressed concerns that total shareholder return would provide an incomplete picture of performance.” Accordingly, the SEC is also considering requiring registrants to disclose the following measures of performance to clarify for investors the relationship between executive compensation and financial performance:
- Disclosures in tabular form of the registrant’s pre-tax net income, net income and a measure chosen by the company to measure its financial performance;
- In a format of the registrant’s choice (e.g., a graph or narrative text), a clear description of the relationship among the measures provided in tabular form (e.g., the three new measures proposed); and/or
- A list of the registrant’s five most important measures used to link compensation actually paid during the fiscal year to company performance, in order of importance.
In connection with reopening the comment period, the SEC Commissioners stated that “financial incentives are a key motivator to drive performance of executives in their role as fiduciaries to companies and shareholders,” and “understanding what those incentives are and whether they are working and how they link to the company’s performance is important to investors in evaluating the company’s compensation practices.” In addition, one Commissioner specifically noted that companies are increasingly linking executive pay to environmental, social and governance (“ESG”) measures to advance their ESG goals and improve performance, including through ESG-related performance measures. (See Seyfarth’s thought piece on this topic here.) More broadly, citing to the growing gap between pay for executives and for everyday workers, one Commissioner stressed that “investors need to know if the growth in executive compensation has also resulted in value creation.” The Commissioners requested feedback from commenters on how flexibility in the rule could provide companies and investors with better information to evaluate these types of customized incentive pay arrangements with the performance of the company.
While the 2022 Release would add content requirements to proposed disclosures that certain commenters have already characterized as onerous, it would also provide companies with greater ability to document how value is created for its shareholders with effective incentive policies. Specifically, the 2022 Release would allow companies to use a customized alternative performance metric to demonstrate how their uniquely designed incentive programs contribute to the company’s financial performance. Customized performance measures could be designed with industry specific variations in mind including addressing sustainability or other ESG features. For example, progress towards certain industry-specific ESG standards (e.g., as identified by the Sustainable Accounting Standards Board) could be incorporated into a company’s performance metric.
Finally, note that the SEC does not appear to be unified in the quest to issue a final rule under Dodd-Frank Section 953(a). One SEC Commissioner stated his disagreement with the need for additional disclosure requirements, opining that such disclosure would be burdensome to public companies, questioning its utility to investors, and suggesting that the 2022 Release exceeded the statutory mandate of Section 953(a).
The new 30-day comment period ended on March 4, 2022. We are hopeful that this means that a final rule will be issued some time in 2022.