"Pay Versus Performance" Rule Proposed by Securities and Exchange Commission
On April 29, 2015, the U.S. Securities and Exchange Commission (SEC) issued another proposed rule under the Dodd-Frank Act, this time with respect to the pay versus performance requirements of Section 953(a) of the Act. Section 953(a) added Section 14(i) to the Securities Exchange Act and directed the SEC to issue rules requiring each issuer, other than an emerging growth company, to disclose in any proxy statement or consent solicitation material for an annual meeting information that shows the relationship between executive compensation actually paid and the financial performance of the issuer. The SEC's proposed rule would add a new Item 402(v) to Regulation S-K, which would require the following be included in any proxy or information statement for which disclosure under Item 402 is required:
- A prescribed table describing:
(1) compensation actually paid to the principal executive officer (PEO);
(2) total compensation for the PEO as described in the Summary Compensation Table currently required by Item 402(c) of Regulation S-K;
(3) average compensation actually paid to the non-PEO named executive officers;
(4) average total compensation for the non-PEO named executive officers as described in the Summary Compensation Table currently required by Item 402(c) of Regulation S-K;
(5) the registrant total shareholder return as described in Item 201(e) of Regulation S-K (TSR); and
(6) the TSR for a peer group of the registrant; and
- A disclosure of the relationship between: executive compensation actually paid and registrant TSR; and registrant TSR and the peer group TSR.
This alert outlines the details of the requirements that would be imposed by the proposed rule. The SEC is accepting comments with respect to the proposed rule until July 6, 2015. The requirements of the rule would apply to the first proxy statement or information statement filed after the rule becomes effective, which could happen in time for the disclosure requirements to applicable during the 2016 proxy season.
When the Proposed Rule's Requirements would be Triggered
The SEC has proposed that the disclosures be included in any proxy or information statement for which disclosure under Item 402 is required. Item 402 disclosure is required if the action is to be taken with regard to:
- election of directors;
- 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 on a pro rata basis.
The proposed rule would require the disclosures in materials other than those which appear to be required by the plain language of the statute, as disclosures under Item 402 are required in circumstances other than annual meeting disclosures while Section 953(a) imposes the pay versus performance requirement only in connection with such meetings. The disclosure requirements do not apply to foreign private issuers, registered investment companies, and "emerging growth companies." Also, as described below, the proposed rule would impose only limited requirements on "smaller reporting companies."
Proposed Requirements with Respect to the Specified Table
The proposed rule would require that the following table be included in any proxy or information statement for which disclosures pursuant to Item 402 are required:
|Year||Summary Compensation Table for PEO||Compensation Actually Paid to PEO||Avg Summary Compensation Table Total for Non PEO named executive officers||Avg Compensation Actually Paid to non-PEO named executive officers||Total Shareholder Return||Peer Group Total Shareholder Return|
Disclosure of Executive Compensation:
Column (b) would be populated based on the total in the Summary Compensation Table which registrants prepare under current rules. Executive compensation for columns (c) and (e) would be calculated based upon that calculated for the currently-required Summary Compensation Table and modified as described below. Footnote disclosure of the amount so added or deducted relative to the Summary Compensation Table would need to be made.
For registrants other than smaller reporting companies, the rule would require the disclosure cover "named executive officers" under 402(a)(3) of Regulation S-K (essentially the principal executive officer, the principal financial officer and the three executives other than the PEO and PFO who are most highly compensated). In the case of smaller reporting companies, "named executive officers" would be as defined in 402(m) (essentially the principal executive officer and the two executives other than the PEO who are most highly compensated). Compensation each year of the principal executive officer (generally, the Chief Executive Officer) would be disclosed in column (c) separately from the average of the compensation of the other named executive officers, which would be disclosed in column (e).
The SEC has indicated the following would apply with respect to calculation of the "compensation actually paid," for columns (c) and (e):
- Because the SEC believes pension value is subject to significant volatility, in order to better measure pension benefits actually paid, the SEC has proposed disclosing the value of benefit and pension plans differently for Item 402(v) purposes than is done for the Summary Compensation Table. Specifically, the actuarial present value of all defined benefit and pension plans would be, for the Item 402(v) disclosure, subtracted from the amount set forth in the Summary Compensation Table total and the actuarially determined service cost for services rendered by the executive during the year would be added back in. Thus the portion of the change in actuarial pension value that results solely from changes in interest rates, the executive's age, and other actuarial inputs and assumptions regarding benefits accrued in previous years would be excluded. Smaller reporting companies would not be required to disclose amounts related to pensions.
- In order to ensure the disclosure of the relationship of company performance with compensation, above-market or preferential earnings on deferred compensation that is not tax-qualified would be included in the calculation of compensation.
- Values of grants of stock and options would be calculated in accordance with the fair value guidance in FASB ASC Topic 718 and included as part of compensation as of the date of vesting instead of the date of granting. The registrant would be required to disclose vesting date valuation assumptions if they are materially different from those disclosed in its financial statements as of the granting date. And if during the last completed fiscal year the registrant materially modified vested options or stock appreciation rights held by a named executive office, the rule would require the registrant to include the incremental fair value, computed as the excess fair value of the modified award over the fair value of the original award upon vesting of the modified award. If the modified award is subject to multiple vesting dates, the pro rata incremental value would be determined and included in compensation actually paid at each vesting date. Disclosure of the vesting date value would be required, even if the options are not exercised or even exercisable.
The SEC has stressed that with the exception of the values to be included with respect to pension benefits and option awards, all of the individual components needed to calculate executive compensation actually paid must already be reported under current disclosure rules, limiting the additional burden on registrants imposed by the proposed rule.
Disclosure of Total Shareholder Return:
As already noted, the TSR disclosure with respect to the registrant's performance and that of its peer group is the total shareholder return described in Item 201(e) of Regulation S-K. Specifically, the TSR is calculated by the following equation:
= (cumulative amount of dividends for the measurement period + (registrant's share price at the end of the period - registrant's share price at the beginning of the period)) / registrant's share price at the beginning of the period.
The peer group with respect to which TSR is reported would be either the peer group the registrant uses for purposes of the Item 201(e)(1)(ii) stock performance graph:
- A published industry or line-of-business index;
- Peer issuer(s) selected in good faith; or
- Issuers with similar market capitalizations, but only if the registrant does not use a published industry or line of business index and does not believe it can reasonably identify a peer group;
If the peer group is not a published industry or line-of-business index, the identity of the issuers comprising the group would be required to be disclosed. The returns of each component issuer of the group would be weighted according to the respective issuers' stock market capitalization at the beginning of each period for which a return is indicated. Smaller reporting companies would not be required to make the disclosure with respect to the TSR of a peer group.
Requirements with Respect to the Relationship Between Pay and Performance
In addition to the simple disclosure of the compensation actually paid and the financial performance metrics in the prescribed table, the proposed rule would require the registrant to describe the relationship between:
- Executive compensation actually paid and registrant TSR; and
- Registrant TSR and peer group TSR.
The SEC has indicated it would be flexible with respect to the form of the disclosure of the relationship and that the disclosure could be done through narrative, graphically or a combination of the two.
Periods of Time with Respect to which the Disclosures would be Required
For registrants other than smaller reporting companies, the rule would require disclosures for the five most recently completed fiscal years. And smaller reporting companies would be required to provide the disclosure for the three most recently completed fiscal years. The proposed rule includes a phase-in component, however. Existing smaller reporting companies would be required to provide the disclosures only for the last two fiscal years in the first applicable filing and thereafter would be subject to the three most recently completed fiscal years requirement. Any other registrant would be required to provide the disclosures only for the last three fiscal years in the applicable filing and for an additional year in each of the two subsequent annual proxy filings where such disclosure is required. Registrants would need only make the disclosures with respect to years that they were a reporting company pursuant to Section 13(a) or Section 15(d) of the Exchange Act.
Format of the Disclosures
The rule as proposed would not impose a specific place for the disclosures although the SEC has indicated that it is generally expected that registrants would disclose them with the Item 402 executive compensation disclosure. The rule would impose requirements with respect to making the disclosures utilizing eXtensible Business Reporting Language (XBRL).
Request for Comments
The Commissioners were not unanimous in their support for the proposed pay versus performance rule and dissenting Commissioners have criticized the proposed rule as overly prescriptive, although the registrant may choose to make supplemental disclosures under certain circumstances. The SEC has issued sixty-four questions requesting comments with respect to the proposed rule, including some regarding the flexibility the rule would give companies in making their required disclosures, perhaps suggesting a willingness to consider a less-prescriptive final rule. The SEC is accepting comments with respect to its proposed pay versus performance rule until July 6, 2015, as already noted.