The US Securities and Exchange Commission (SEC) announced on August 25, 2022, that it has adopted new rules to require enhanced pay for performance disclosure that will apply to 2023 proxies for calendar year-end issuers.
New Item 402(v) of Regulation S-K requires registrants to provide a table disclosing specified executive compensation and financial performance measures for their five most recently completed fiscal years. Registrants must begin to comply with the new disclosure requirements in applicable proxy and information statements[1] for fiscal years ending on or after December 16, 2022; therefore, calendar year-end registrants will need to address Item 402(v) in their 2023 proxy statements.
Registrants also will be required to provide a list of three to seven financial performance measures that they determine are their most important performance measures for linking actual executive compensation to company performance. Smaller reporting companies will be subject to scaled disclosure requirements under the rules, as discussed below.
Please refer to this table (also at the end of this LawFlash) for the new pay versus performance table.
In 2015, the SEC proposed a new rule to implement Section 953(a) of the Dodd-Frank Act by creating a new requirement in Item 402 of Regulation S-K that would require a registrant to provide a clear description of (1) the relationship between executive compensation actually paid to the registrant’s named executive officers (NEOs) (including the registrant’s principal executive officer (PEO)) and the cumulative total shareholder return (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 reopened the comment period for the proposed rules in 2022 and subsequently included the “pay versus performance” final rules as part of its spring 2022 rulemaking agenda.
The final rules reflect several significant distinctions from the proposed rules, as described below.
New Item 402(v) requires tabular disclosure containing the following information, in each case over the last five fiscal years:
Registrants must provide a clear description, either in narrative or graphical format, of the relationships between (1) each of the financial performance measures included in the table and (2) the executive compensation actually paid to the PEO and, on average, to the other NEOs. Item 402(v) also will require a description of the relationship between the registrant’s TSR and its peer group TSR, which the SEC believes will “provide a useful point of comparison to assess the relationship between the registrant’s executive compensation actually paid and its financial performance compared to the performance of its peers during the same time period.”[2]
In addition, registrants must provide a list of three to seven financial performance measures (the Tabular List) that the registrant believes are its most important measures to link pay and performance, using the same approach as taken for the Company-Selected Measure. Registrants are permitted, but not required, to include nonfinancial measures in the Tabular List if they consider such measures to be among their three to seven “most important” measures. Registrants may provide the Tabular List disclosure as a single list, as two separate lists (one for the PEO and one for all NEOs other than the PEO), or as separate Tabular Lists for the PEO and each NEO other than the PEO.
The final rules require the following with respect to a Company-Selected Measure:
Non-GAAP Financial Measures
In the adopting release, the SEC recognizes that registrants may opt to provide a non-GAAP financial measure as their Company-Selected Measure. The amendments specify that disclosure of “a measure that is not a financial measure under GAAP”[4] will not be subject to Regulation G and Item 10(e) of Regulation S-K. However, the SEC did note in the adopting release that disclosure must be provided as to how the number is calculated from the registrant’s audited financial statements.
Exemption for Company-Selected Measure
Registrants that do not use any financial performance measures to link pay and performance, or that only use measures already required to be disclosed in the table (i.e., TSR and net income), would not be required to disclose a Company-Selected Measure or its relationship to executive compensation actually paid.
Smaller reporting companies (SRCs) are exempt from a number of the new disclosure requirements. Specifically, SRCs
Several comments to the proposed rules addressed environmental, social, and governance (ESG) metrics, noting, among other things, that the practice of linking ESG performance to pay has been increasing.[5] Some commenters asked that the SEC mandate the inclusion of ESG metrics in a “ranked list” of most important measures used by registrants to link compensation and performance.[6] While the SEC acknowledged in the adopting release that linking pay to ESG performance “appears to be a growing practice,” it noted further that ESG metrics typically are not tied to “specific quantitative goals” and “are generally used in short-term incentive plans” rather than long-term incentive plans.[7]
The final rules bucket ESG metrics as nonfinancial performance goals, along with measures of individual performance or broader “strategic goals.” Therefore, while the final rules do not require disclosure of ESG metrics, registrants may supplement their mandatory pay-for-performance disclosure with a discussion of ESG metrics (or any other nonfinancial performance measure), consistent with the requirements of Item 402(v)(6)(iii).[8]
Information for fiscal years prior to the last completed fiscal year will not be required if the registrant was not required to report under the Exchange Act at any time during that year. For example, a registrant with a calendar fiscal year-end that goes public in 2023 would not be required to provide pay versus performance disclosure beyond fiscal year 2022.
The amendments will become effective 30 days after publication in the Federal Register. Registrants are required to comply with the new amendments in proxy and information statements that are required to include Item 402 executive compensation disclosure for fiscal years ending on or after December 16, 2022. Registrants may provide the disclosure for three years instead of five years in the first filing in which they provide pay versus performance disclosure, per Instruction 1 to Item 402(v).
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New Item 402(v) Pay Versus Performance Table |
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PAY VERSUS PERFORMANCE |
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Year (a) |
Summary Compensation Table Total for PEO (b) |
Compensation Actually Paid to PEO (c) |
Average Summary Compensation Table Total for Non-PEO Named Executive Officers (d) |
Average Compensation Actually Paid to Non-PEO Named Executive Officers (e) |
Value of Initial Fixed $100 Investment Based On: |
Net Income (h) |
[Company-Selected Measure] (i) |
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Total Shareholder Return (f) |
Peer Group Total Shareholder Return (g) |
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If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following:
Boston
Laurie A. Cerveny
Bryan S. Keighery
Carl A. Valenstein
Hong Kong
June Chan
Yile (Eli) Gao
William Ho
Louise Liu
Edwin Luk
Billy Wong
New York
Thomas P. Giblin, Jr.
Thurston J. Hamlette
Howard A. Kenny
Gina L. Lauriero
Kimberly M. Reisler
Philadelphia
Justin W. Chairman
James W. McKenzie
Erin Randolph-Williams
Joanne R. Soslow
Mims Maynard Zabriskie
David B. Zelikoff
Pittsburgh
Randall C. McGeorge
Celia A. Soehner
Princeton
David C. Schwartz
San Francisco
Leslie E. DuPuy
Shanghai
Matthew H. Lewis
Silicon Valley
Albert Lung
Singapore
Bernard Lui*
Joo Khin Ng*
Washington, DC
Leland S. Benton
Erin E. Martin
Patrick Rehfield
*A solicitor of Morgan Lewis Stamford LLC, a Singapore law corporation affiliated with Morgan, Lewis & Bockius LLP
[1] Registrants must provide pay-for-performance disclosure under Item 402(v) of Regulation S-K when they file proxy statements or information statements in which executive compensation disclosure pursuant to Regulation S-K Item 402 is required. Proxy statement disclosure obligations only arise under Section 14(a) of the Securities Exchange Act of 1934, as amended, when a registrant with a class of securities registered under Section 12 chooses to solicit proxies. Whether a registrant has to solicit proxies depends on requirements set forth in the registrant’s charter or bylaws, or whether such requirements are imposed by state law or the stock exchange on which the registrant’s securities are listed.
[2] Release at p. 26.
[3] In the adopting release, the SEC noted that the Company-Selected Measure may differ from year to year. In such cases, registrants would have to provide that measure for each fiscal year covered in the pay versus performance table.
[4] Item 402(v)(2)(vi) states that “[d]isclosure of a Company-Selected Measure, or any additional measure that the registrant elects to provide, that is not a financial measure under generally accepted accounting principles [GAAP] will not be subject to [Regulation G] and [Item 10(e) of Regulation S-K]; however, disclosure must be provided as to how the number is calculated from the registrant’s audited financial statements.” (Emphasis added.) The adopting release discusses the SEC’s objective to treat “non-GAAP financial measures” provided under the new amendments consistently with the Compensation Discussion & Analysis provisions of Item 402(b) of Regulation S-K. In this regard, footnote 374 to the adopting release cites Instruction 5 to Item 402(b), which addresses the disclosure of “non-GAAP financial measures.” However, the above-quoted language from Item 402(v)(2)(vi) refers to “a measure that is not a financial measure under GAAP” instead of “non-GAAP financial measures,” which is used in Instruction 5 to Item 402(b) and defined in Regulation G. Given the SEC’s stated objective to have Item 402(v)(2)(vi) treat non-GAAP financial measures consistently with Item 402(b), we believe non-GAAP financial measures disclosed as a Company-Selected Measure in response to Item 402(v)(2)(vi) would not be subject to either Regulation G or Item 10(e).
[5] Release at p. 134.
[6] See comments from As You Sow 2022; Better Markets; Ceres; PRI; Public Citizen 2022; and RAAI.
[7] Release at p. 134.
[8] Item 402(v)(6)(iii) permits registrants to include nonfinancial performance measures (i.e., performance measures other than those that fall within the definition of financial performance measures) used by the registrant to link pay and performance if it determines that such measures are among its three to seven most important performance measures, and it has disclosed its most important three (or fewer, if the registrant only uses fewer) financial performance measures, in accordance with the other provisions of Item 402(v)(6).