Final Pay Versus Performance Rules: Teaching Old Disclosure New Tricks

• Jurisdiction: United States,Federal
• Citation: Vol. 1 No. 1
• Publication year: 2023

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Julia L. Petty, Michael J. Albano, Audry X. Casusol, Helena K. Grannis, and Katherine Baker ^*

In this article, the authors discuss final rules adopted by the Securities and Exchange Commission requiring certain U.S. public companies to disclose information regarding the relationship between the compensation they pay to their executives and their own financial performance.

The Securities and Exchange Commission ("SEC") has adopted final rules (the so-called "pay versus performance" rules) ¹ that will require U.S. public companies (including smaller reporting companies ("SRCs") but excluding emerging growth companies, foreign private issuers, and registered investment companies) to disclose information reflecting the relationship between executive compensation "actually paid" and company financial performance for the five most recently completed fiscal years (three years for SRCs).

The disclosure will be required pursuant to a new subsection (v) to Item 402 of Regulation S-K ("Item 402") and is effective for a company's proxy or information statement covering a fiscal year ending on or after December 16, 2022.

The final rules went into effect on October 8, 2022, which means that most companies ² must comply with the disclosure for the fast-approaching 2023 proxy season.

Given the complexity of the final rules, extensive calculations and disclosures, and compressed timeline, companies should begin the process of gathering necessary information and discussing the best way to present the disclosure with their advisors and internal constituents.

Background

In response to the 2008 financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the

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"Dodd-Frank Act") was enacted, adding Section 14(i) to the Securities Exchange Act of 1934 (the "Exchange Act"), which directed the SEC to adopt rules requiring companies to disclose the relationship between the compensation actually paid to its named executive officers ("NEOs") and the financial performance of the company.

In April 2015 the SEC published proposed rules to implement Section 14(i) by adding a new subparagraph (v) to Item 402. The proposed rules would have required companies to include new tabular disclosure showing an SEC-prescribed method of calculating executive compensation "actually paid" and provide a clear description of the relationship between such compensation and the cumulative company total shareholder return ("TSR") and the relationship between the company's TSR and the TSR of a peer group chosen by the company, over each of the company's five most recently completed fiscal years.

The SEC reopened the comment period to the proposed rules earlier this year, which SEC Chair Gary Gensler stated was done to "[consider] whether additional performance metrics would better reflect Congress' intention in the Dodd-Frank Act and would provide shareholders with information they need to evaluate a company's executive compensation policies." ³ After 12 languishing years, the SEC, without an open meeting, adopted the final rules.

Required Disclosure

The final rules will require companies to provide:

1. A "Pay Versus Performance" table, reflecting compensation "actually paid" to the company's Principle Executive Officer ("PEO") and its other NEOs;
2. A clear description of the relationship between compensation actually paid to its PEO and other NEOs and company performance; and
3. A tabular list of three to seven of the most important financial performance measures that the company uses to link executive compensation and company performance.

The final rules permit companies to voluntarily provide supplemental measures of financial performance and other supplemental disclosure, so long as any additional disclosure is clearly identified as supplemental, not misleading, and not presented with greater prominence than the required disclosures. ⁴

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Pay Versus Performance Tabular Disclosure

The new Item 402(v) will require tabular disclosure as shown in the accompanying table (the "Pay Versus Performance Table"; see the next page) of the following information for each of the past five fiscal years (three for SRCs) (see the Compliance Dates section below for initial phase-in periods):

■ Total compensation as reported in the Summary Compensation Table ("Total Compensation") for the PEO and compensation "actually paid" to the PEO;
■ Average of Total Compensation and the average of compensation "actually paid" to all of the NEOs other than the PEO;
■ The company's cumulative TSR presented as the current dollar value of an initial investment of $100; ⁵
■ TSR for the company's self-selected peer group (SRCs are not required to provide this disclosure); ⁶
■ The company's net income for the fiscal year calculated in accordance with U.S. GAAP; and
■ A measure selected by the company as the most important financial performance measure used to link compensation actually paid to the company's PEO and other NEOs for the most

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