On Friday afternoon, Corp Fin posted a slew of new CDIs—15 in total—regarding the new pay-versus-performance rule. You may recall that, in August last year, the SEC finally adopted a new rule that will require disclosure of information reflecting the relationship between executive compensation actually paid by a company and the company’s financial performance—a new rule that was originally mandated by Dodd-Frank in 2010. Lots of questions have arisen about implementation of the rule, and SEC representatives let it be known that CDIs on the topic would be forthcoming. (See this post from thecorporatecounsel.net blog.) Not surprisingly, most of the CDIs are about the complicated Pay Versus Performance table and are just as thorny as the rule, so get your Advil ready.
Summary of the rule. As a reminder, new Item 402(v) of Reg S-K will require companies to describe the relationship between executive comp actually paid and the financial performance of the company for the five most recently completed fiscal years in proxy or information statements in which executive compensation disclosure is required.
Under the new rule, companies will be required to provide a table disclosing specified executive comp and financial performance measures for the principal executive officer and, as a “mean” average, for the other named executive officers (as defined in Item 402 for all companies and for smaller reporting companies, respectively). To allow investors to assess whether changes in the composition of the NEO group led to changes in the average compensation reported from year to year, companies will also need to identify in a footnote the individual NEOs whose compensation is included in the average for each year. The table will include a measure of total comp (taken from the Summary Comp Table), as well as a measure reflecting “executive compensation actually paid,” a complex calculation prescribed by the rule. In addition, the table will include as financial performance measures “total shareholder return” for both the company and for its peer group, as well as the company’s net income and a financial performance measure selected by, and specific to, the company that the company believes “represents the most important financial performance measure,” not otherwise required in the table, that the company uses to link compensation actually paid to its NEOs to company performance for the most recently completed fiscal year (referred to as the “Company-Selected Measure”). In years when a company has multiple PEOs, the company would need to include separate SCT total comp and comp actually paid columns for each PEO.
The company will also be required to “clearly describe,” using the information presented in the table, the relationships between compensation actually paid to the PEO and the mean average paid to the remaining NEOs and three measures of the company’s financial performance: cumulative TSR; net income; and the Company-Selected Measure, again over the five most recently completed fiscal years. The company will also need to describe the relationship between the company’s TSR and the weighted TSR of its peer group over the same period. SRCs can take advantage of scaled disclosure, describing only the measures they are required to include in the table and for their three, rather than five, most recently completed fiscal years.
Finally, the company (other than an SRC) will also be required to provide an unranked “Tabular List” of three to seven of the most important financial performance measures—which must include the Company-Selected Measure—used by the company to link executive comp actually paid to the NEOs during the last fiscal year to company performance. At their option, companies may also include non-financial performance measures in this list if they considered those measures to be among their “most important” measures and the company has disclosed at least three financial performance measures. Companies may also voluntarily provide supplemental measures of compensation or financial performance or other supplemental disclosures, so long as they are “clearly identified as supplemental, not misleading, and not presented with greater prominence than the required disclosure.”
In the first applicable filing after effectiveness of the rules, companies will need to provide the disclosure for the last three fiscal years and to provide disclosure for an additional year in each of the two subsequent annual proxy filings where disclosure is required; however, SRCs will be required to provide disclosure only for the last two fiscal years in the first applicable filing. For newly public companies, information for fiscal years prior to the last completed fiscal year will not be required if the company was not a reporting company under Section 13(a) or 15(d) of the Exchange Act at any time during that year.(See this PubCo post.)
CDIs. The new CDIs can all be found under the caption for Reg S-K, Item 402(v). Summaries are below, but each CDI number below is linked to the actual CDI on the SEC website, so you can easily read the version in full.
Section 128D. Item 402(v)—Pay Versus Performance
128D.01 The pay-for-performance information required under Item 402(v) is not required to be included in Form 10-K, notwithstanding the requirement in Item 11 of Form 10-K that the company provide all the information required under Item 402. Rather, Item 402(v) specifically provides that the information required “must be provided in connection with any proxy or information statement for which the rules of the Commission require executive compensation disclosure pursuant to Item 402 of Regulation S-K, and Instruction 3 to Item 402(v) specifies that the information provided under Item 402(v) of Regulation S-K will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.”
128D.02 As you probably recall, the Pay Versus Performance table required under the new rules includes a number of complex calculations for “compensation actually paid,” particularly the formula to be applied to reflect changes in fair value of equity awards. Item 402(v)(2)(iii)(C)(1) requires a number of adjustments under subparagraphs (ii), (iv) or (v) relating to prior fiscal year equity awards. According to Corp Fin, in calculating the required equity award adjustments, equity awards granted to a first-time NEO in a year prior to the NEO’s appointment are still required to be included, even if they were not reported in the Summary Comp Table. The illustrative example provided in the question describes a non-NEO employee who is granted a stock option in year 1 and appointed as an NEO in year 2. Must that NEO’s “compensation actually paid” in year 2 reflect the adjustments required by subparagraphs (ii), (iv) or (v) with respect to the stock option granted in year 1? Corp Fin said “Yes[,] the change in value of such awards during the executive’s tenure as a NEO should be included in the calculation of compensation actually paid.”
128D.03 Item 402(v)(3) requires, for each amount disclosed in columns (c) (compensation actually paid to the PEO) and (e) (average comp actually paid to the other NEOs) of the Pay Versus Performance table, footnote disclosure of each of the amounts deducted and added pursuant to Item 402(v)(2)(iii)— generally, adjustments for pension benefits and equity awards. In the company’s first table under the new rules, the staff advises that the company should provide footnote disclosure for each of the periods presented in the table. Thereafter, footnote disclosure is required only for the most recent fiscal year included in the table, but will be required for other years included in the table “if it is material to an investor’s understanding of the information reported in the Pay Versus Performance table for the most recent fiscal year, or of the relationship disclosure provided under Item 402(v)(5)” (which requires a description of several relationships, such as between comp actually paid and TSR).
128D.04 Item 402(v)(3) requires, for each amount disclosed in columns (c) (comp actually paid to the PEO) and (e) (average comp actually paid to the other NEOs), footnote disclosure of each of the amounts deducted and added pursuant to Item 402(v)(2)(iii). The company may not satisfy this requirement by providing the aggregate amounts calculated for pension value adjustments under Item 402(v)(2)(iii)(B)(1) and equity award adjustments under Item 402(v)(2)(iii)(C)(1). Corp Fin advises that the company should provide footnote disclosure of each of the amounts deducted and added under Items 402(v)(2)(iii)(B)(1)(i) – (ii) and Items 402(v)(2)(iii)(C)(1)(i) – (vi).
128D.05 Under Item 402(v)(2)(iv), the company is required to calculate peer group total shareholder return, using the the same index or issuers used by it for purposes of its performance graph or the companies it uses as a peer group for purposes of its CD&A. As discussed in this post from thecorporatecounsel.net, there has been some question as to whether the CD&A peer group needed to be a peer group used to for “benchmarking.” This CDI confirms that the peer group does not have to be a peer group formally used for “benchmarking.” To perform the TSR calculation, the company may use a peer group that is disclosed in its CD&A as a peer group “actually used” to help determine executive pay, even if the peer group is not used for “benchmarking” under Item 402(b)(2)(xiv), as that term is explained in CDI 118.05. (That CDI provides that “benchmarking generally entails using compensation data about other companies as a reference point on which—either wholly or in part—to base, justify or provide a framework for a compensation decision. It would not include a situation in which a company reviews or considers a broad-based third-party survey for a more general purpose, such as to obtain a general understanding of current compensation practices,” such as simply a market check.)
128D.06 If the company went public during the earliest year included in the Pay Versus Performance table, for purposes of determining the time period required to be presented for cumulative TSR and peer group TSR, the “measurement point” for the calculations should begin on the Exchange Act registration date, consistent with the calculation of TSR under Item 201(e) of Reg S-K.
128D.07 For purposes of peer group TSR, if a company used different peer groups in its CD&A in different years over the disclosure period, for the first filing, the company should present the peer group TSR for each year in the table using those different peer groups; that is, for each year, the company should use the same peer group disclosed in its CD&A for that year. The company cannot simply choose the most recent peer group used for each of the three years.
128D.08 Item 402(v)(2)(v) requires “net income” to be included in column (h) of the Pay Versus Performance table, which means that the company is required to provide its “net income or loss” as required by Reg S-X to be disclosed in its audited GAAP financial statements. Accordingly, the company may not use other net income amounts presented in the audited financial statements, such as income or loss from continuing operations or, where the company consolidates subsidiaries that are not wholly-owned, net income attributable to the controlling interest.
128D.09 Item 402(v)(2)(vi) requires the company to include in the table as financial performance measures TSR for both the company and for its peer group, as well as the company’s net income. That Item also requires the company to include a “Company-Selected Measure,” that is, “an additional financial performance measure included in the Tabular List….designated as the Company-Selected Measure, which in the registrant’s assessment represents the most important financial performance measure (that is not otherwise required to be disclosed in the table) used by the registrant to link compensation actually paid to the registrant’s named executive officers, for the most recently completed fiscal year, to company performance.” Although net income and cumulative TSR are already included in the table, the company may use a financial performance measure that is derived from, a component of, or similar to these required measures, such as earnings per share, gross profit, income or loss from continuing operations, or relative TSR. The measure must, however, meet the definition of Company-Selected Measure in Item 402(v)(2)(vi). The staff notes that these types of measures could also be included as financial performance measures in the Tabular List required by Item 402(v)(6). (How does the SEC define “financial performance measures”? Under Item 402(v)(2)(vi), “financial performance measures” are defined as “measures that are determined and presented in accordance with the accounting principles used in preparing the issuer’s financial statements, any measures that are derived wholly or in part from such measures, and stock price and TSR. A financial performance measure need not be presented within the registrant’s financial statements or otherwise included in a filing with the Commission to be a Company-Selected Measure. Disclosure of any Company-Selected Measure, or any additional measure that the registrant elects to provide, that is not a financial measure under generally accepted accounting principles will not be subject to [various non-GAAP requirements]; however, disclosure must be provided as to how the number is calculated from the registrant’s audited financial statements.”)
128D.10 A financial performance measure may be used as a Company-Selected Measure only if the company actually uses that measure to link NEO compensation to company performance. Accordingly, even though “stock price” is considered a “financial performance measure,” and even if the company does not otherwise use any financial measures to link pay and performance, it would not be appropriate for a company to disclose stock price as its Company-Selected Measure if the company does not use it to link pay and financial performance, even if stock price “has a significant impact on the amounts reported in the Pay Versus Performance table.” For example, if the only impact of stock price on a NEO’s compensation is through changes in the value of share-based awards (which value is largely tied to stock price and which would be evident from the company’s SCT disclosure), the company could not include its stock price as the Company-Selected Measure. However, if the company’s “stock price is a market condition applicable to an incentive plan award, or is used to determine the size of a bonus pool, it may be included as a registrant’s Company-Selected Measure.”
128D.11 The definition of a Company-Selected Measure expressly ties the measure to “the most recently complete fiscal year.” As a result, it cannot be measured over a multi-year period that includes the applicable fiscal year as the final year (similar to the use of multi-year measurement periods for calculating TSR under Item 402(v)(2)(iv)), even if that performance period is used consistently for all years in the table. Under the definition of Company-Selected Measure, the measure represents, in the company’s assessment, the most important financial performance measure (not otherwise required to be disclosed in the table) used “to link compensation actually paid to the registrant’s named executive officers, for the most recently completed fiscal year, to company performance.” [Emphasis added.]
128D.12 Assume a “pool plan,“ where payouts from a bonus pool are made only upon achievement of a financial performance measure or where the size of the pool is determined based on the level of achievement of the performance measure; once that financial performance measure is achieved, the comp committee, in its discretion, allocates bonus payouts. The staff advised that the pool plan uses a financial performance measure to link comp to company performance, even though the comp committee allocates bonus payouts in its discretion, based on criteria independent of the financial performance measure. As a result, even if the company does not use any other financial performance measures in determining executive comp, the company may not omit the Tabular List required under Item 402(v)(6) or the Company-Selected Measure and related relationship disclosure. “Because the size of the bonuses paid from the ‘bonus pool’ is determined based wholly or in part on satisfying the financial performance measure,“ the staff said, “the registrant is using the financial performance measure to link the executive compensation actually paid to company performance within the meaning of Item 402(v)(2)(vi) and Item 402(v)(6).”
128D.13 If the company has multiple PEOs in a fiscal year, the rule requires that it provide separate columns in the Pay Versus Performance table for each PEO. However, the staff will not object if a company aggregates the PEOs’ compensation for purposes of the narrative, graphical or combined comparison between compensation actually paid and TSR, net income, and the Company-Selected Measure, so long as the presentation is not misleading to investors.
Section 228D Item 402(v) — Pay Versus Performance
228D.01 What time periods are shown in the Pay Versus Performance table if a company changes its fiscal year during the covered time period? The staff advises that the company should “provide the disclosure required by Item 402(v) for the ‘stub period,’ and… not annualize or restate compensation. For example, in late 2022, a company that is not a Smaller Reporting Company changed its fiscal year end from June 30 to December 31. In the registrant’s first Pay Versus Performance table, provide disclosure for each of the following four periods: July 1, 2022 to December 31, 2022; July 1, 2021 to June 30, 2022; July 1, 2020 to June 30, 2021; and July 1, 2019 to June 30, 2020. Continue providing such disclosure including the stub period until there is disclosure for five full fiscal years after the stub period.” The staff considers this approach to be consistent with the approach taken in Question 217.05 applicable to the SCT.
228D.02 What time periods are shown in the company’s first Pay Versus Performance table if a company emerges from bankruptcy with a new class of stock issued under the bankruptcy plan that started trading in September 2020? Under the treatment prescribed in Question 206.14, the company will present less than five full years of data in its stock performance graph under Item 201(e) using a measurement period for the graph from September 2020 through December 2022. The staff advises that, for the Pay Versus Performance table, the company may provide its cumulative TSR and peer group cumulative TSR in the same manner, but should provide footnote disclosure to explain the approach and its effect on the table.
