On August 25, 2022, after a seven-year delay, the SEC has finally adopted rules to implement Section 14(i) to the Securities Exchange Act of 1934, as amended1, which will require new disclosure aimed at illuminating the relationship between executive compensation and the company’s financial performance. The rules, encapsulated in new Item 402(v) of Regulation S-K, mandates specific tabular, as well as narrative or graphical “pay-for-performance disclosures” be included in proxy or information statements, and are intended to provide investors with more transparent, readily comparable, and understandable disclosure of a company’s executive compensation, so that they may better assess a company’s executive compensation program when making voting decisions. Furthermore, the rules are intended to drive disclosure that enables direct analysis of the correlation between executive compensation and shareholder value creation.
The final rules will become effective 30 days after publication in the Federal Register. Registrants must comply with the new requirements in proxy and information statements that include Item 402 executive compensation disclosures for fiscal years ending on or after December 16, 2022.
Item 402(v) requires tabular disclosure of certain executive compensation and financial performance measures for a company’s five most recent fiscal years. Financial performance measures required include:
- Total Shareholder Return (TSR)2 for the company.
- TSR for the company’s peer group.
- The company’s net income.
- The most important financial performance measure the company used to connect executive compensation to performance for the most recent fiscal year, known as the “Company Selected Measure,” as selected by the company. To the extent a company does not use any other financial performance measures to link executive compensation actually paid to company performance (or only uses measures already required to be disclosed), it will not need to disclose an additional Company Selected Measure.
With respect to compensation received by Named Executive Officers (NEOs), both the Summary Compensation Table (SCT) measure of total compensation, as well as a measure reflecting “executive compensation actually paid” must be included for the company’s principal executive officer(s) (PEOs); with respect to the other NEOs included in the proxy or information statement, an average of the SCT measure, as well as executive compensation actually paid, is required. To calculate compensation actually paid, companies will be permitted to make certain revisions as it relates to defined benefit and pension plans, deferred compensation measures, and treatment of equity awards. A sample of the tabular presentation required under Item 402(v) is included in the release.
Additional Required Disclosures
Item 402(v) also requires companies to make the following disclosures in narrative and/or graphical form:
- A clear description of the relation between each financial measure included in the tabular disclosure and the compensation paid to its PEO(s) over the company’s five most recent fiscal years.
- For other NEO’s, on average, a description of the connection between each financial measure included in the tabular disclosure and compensation paid.
- An unranked list of three to seven financial performance metrics (and non-financial measures if appropriate) that the company used in the most recently completed fiscal year, to link its compensation actually paid to company performance, which list must include the Company Selected Measure.
- A description of the relationship between a company’s TSR and those of the company’s peer group.
Companies must use Inline XBRL tagging for all “pay-for-performance” disclosures, whether in the table, footnotes or accompanying narrative disclosure.
Exemptions for Certain Registrants & Phased Implementation
Item 402(v) applies to all SEC reporting companies, other than foreign private issuers; registered investment companies; and emerging growth companies. For the first year of implementation, companies must provide the required disclosures for its three most recent fiscal years (two years for SRCs); subsequently, another year will be added in each of the two subsequent annual proxy filings to meet the five-fiscal-year requirement described above (with SRC’s being capped at three years of disclosure).
As noted above, SRCs will be able to make scaled disclosures. SRCs are not required to include peer group TSR information or a specific Company Selected Measure into the required tabular disclosure. Further, they will only be required to provide narrative or other descriptions with respect the measures they are required to include in their table. SRCs also receive phased implementation for the XBRL requirement – as they only must begin to provide this data beginning with their third filing of pay-for-performance disclosures.
How to Prepare
When evaluating the inclusion of Item 402(v) disclosure into a proxy or information statement, a company should carefully consider the following steps:
- Engage with your compensation committee, HR team and other internal stakeholders regarding the new requirements, to allow for thoughtful evaluation of the potential impact of the new disclosure on the company’s uniquely tailored executive compensation programs and structure.
- Assess which performance metrics drive executive compensation strategies and evaluate their relative importance.
- Determine if executives are compensated using different performance indicators than those captured by the new SEC requirements, and assess whether revised or more flexible arrangements should be considered.
- Craft model disclosures in advance of proxy season, which should help to help guide the approach to be taken with respect to the narrative or graphical disclosure that will accompany the Item 402(v) table.
Buchanan’s team of dedicated professionals in the Securities practice group and Executive Compensation practice group are ready to assist registrants in evaluating their existing executive compensation structures and disclosures to proactively prepare for the implementation of the SEC’s new requirements.
- As added by the Dodd-Frank Wall Street Reform and Consumer Protection Act.
- TSR is to be calculated in accordance with Item 201(e) of Regulation S-K, by dividing the sum of the cumulative amount of dividends for the measurement period, assuming dividend reinvestment, and the difference between the registrant’s share price at the end and the beginning of the measurement period; by the share price at the beginning of the measurement period.