United States: US Securities And Exchange Commission Proposes Pay Versus Performance Disclosure Rule

Keywords: pay versus performance, SEC, disclosure

The US Securities and Exchange Commission (SEC) has proposed a "pay versus performance" rule in accordance with a Dodd-Frank Wall Street Reform and Consumer Protection Act mandate to require SEC reporting companies to disclose in a clear manner the relationship between executive compensation actually paid and the financial performance of the company.1 If adopted as proposed, the rule would require disclosure in proxy or information statements in which executive compensation information is required to be included pursuant to Item 402 of Regulation S-K. Comments on the proposed rule must be submitted by July 6, 2015.

Description of Proposed Rule

The proposed rule would add new subsection (v) to Item 402 of Regulation S-K, requiring a new compensation table, showing the relationship between compensation actually paid and performance, with performance measured both by company total shareholder return (TSR) and peer group TSR. The disclosure would also have to include a description of the pay versus performance relationship. The table is required to be in the following format:

Pay Versus Performance

The new table would contain data for up to five years. Companies would have flexibility as to the exact placement of the table within the proxy or information statement, although the proposing release indicates that the SEC generally expects this new table to appear as part of the executive compensation disclosure section.

Companies Covered. As proposed, the pay versus performance rule would apply to all SEC reporting companies, except:

  • Foreign private issuers,
  • Registered investment companies and
  • Emerging growth companies.

Business development companies (a category of closed-end investment company that are not registered under the Investment Company Act) and smaller reporting companies would be subject to the rule, although the disclosure requirements for smaller reporting companies would be scaled down.

Filings Covered. Pay versus performance disclosure would be required in proxy or information statements that are required to contain executive compensation disclosure pursuant to Item 402 of Regulation S-K. The new pay versus performance information will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934 unless the company specifically incorporates it.

Executives Covered. Under the proposed rule, the pay versus performance table would have to separately provide compensation information for the principal executive officer, on an annual basis, for each of the past five fiscal years (three in the case of smaller reporting companies). If more than one person has served as principal executive officer in any year included in the new table, the compensation of all persons serving in that capacity would be aggregated. In addition, the table must provide average compensation, on an annual basis, for the named executive officers, other than the principal executive officer, identified in the summary compensation table (Remaining NEOs) for such years.

Pay Covered. For the purposes of the new pay versus performance table, executive compensation actually paid would consist of total compensation as reported in the summary compensation table, modified to adjust the amounts included for pension benefits and equity awards.

The aggregate change in actuarial present value of the executive's accumulated benefit under all defined benefit and actuarial pension plans set forth in the summary compensation table would be deducted from the total to calculate compensation actually paid, with only actuarially determined service costs for services rendered by the executive during the applicable year added back. Smaller reporting companies would not have to make this pension adjustment because their scaled disclosures do not include pension plan disclosure.

In addition, equity awards would be considered actually paid on the date of vesting, whether or not exercised. They would be valued at fair value on the vesting date, rather than fair value on the date of grant as reported in the summary compensation table. Accordingly, the stock and option award amounts shown in the summary compensation table would be subtracted from total compensation and the vesting date fair value amounts for these equity awards would be added back to calculate compensation actually paid. Vesting date valuation assumptions would have to be disclosed if they are materially different from those disclosed in the financial statements as of grant date.

The new pay versus performance table also would disclose, in an accompanying footnote, the amount of compensation deducted from, and added to, summary compensation table total compensation in determining compensation actually paid for both the principal executive officer compensation and average Remaining NEO compensation.

Measure of Performances. The proposed rule would require that TSR be the performance measure used in the pay versus performance table, calculated, in accordance with Item 201(e) of Regulation S-K, by "dividing the (i) sum of (A) the cumulative amount of dividends for the measurement period, assuming dividend reinvestment, and (B) the difference between the company's share price at the end and the beginning of the measurement period; by (ii) the share price at the beginning of the measurement period." TSR must be presented in the table both for the company and for a peer group which the company has identified either in its stock performance graph or its compensation discussion and analysis. Smaller reporting companies do not need to provide peer group TSR.

Description of Pay Versus Performance Relationship. A clear description of the relationship between pay and performance must accompany the table in narrative or graphic form, or a combination of both. For example, the proposing release indicates that the relationship could be expressed as a graph providing executive compensation actually paid and change in TSR on parallel axes and plotting compensation and TSR over the required time period. Another approach identified in the proposing release would show the percentage change over each year of the required time period in both executive compensation actually paid and TSR, with a brief discussion of that relationship.

Companies may supplement the required disclosure by also showing pay versus performance using "realized pay," "realizable pay" or another appropriate measure. However, any such supplemental disclosure may not be misleading and may not be presented more prominently than the required disclosure.

XBRL. As proposed, the values in the pay versus performance table would have to be tagged in XBRL and the related footnotes would have to be block text tagged. This would be the first time the SEC's interactive financial data requirements would be applied to proxy statements.

Phase-In. The general phase-in for the rule will require pay versus performance disclosure for three years in the first proxy or information statement in which such disclosure is required. In each of the two subsequent years, another year of disclosure would be added.

Smaller reporting companies would only need to provide information for two years initially, adding the additional year in their next annual proxy or information statement that requires executive compensation disclosure. Also, smaller reporting companies will not have to comply with the XBRL requirement until the third annual filing containing pay versus performance disclosure.

Newly reporting companies would not need to include pay versus performance information for fiscal years prior to their last completed fiscal year.

Practical Considerations

Realized Pay. Many companies have already been including realized or realizable pay in their proxy statements. These companies will need to consider whether to conform their existing presentation formats to that required by the proposed rule or to retain their presentations in addition to that required by the proposed rule. To the extent companies choose to retain their existing disclosures, they will also have to consider whether any presentation changes are needed so that their supplemental realized or realizable pay disclosures are no more prominent than the mandated pay versus performance table. Companies that do not currently include realized or realizable pay will want to consider whether there are additional measures that they want to provide if the rule is adopted in order to better explain their compensation decisions.

Peer Groups. For the purposes of pay versus performance disclosure, companies would have to include peer group TSR in their tables, using either the peer group for the stock performance graph or the peer group identified in the compensation discussion and analysis. Therefore, companies should consider which peer group would be more appropriate for a pay versus performance analysis and whether they want to make any adjustments to either of these two peer groups.

Proxy Advisory Firms. It is too early to tell if the new pay versus performance disclosure requirements will lead to proxy advisory firms or investors targeting a pay versus performance correlation that they will seek to apply across the board. Companies may want to consider in advance how they would respond to such treatment in light of their particular facts and circumstances.

Cause and Effect Problem. If TSR is required to be used for pay versus performance disclosure, and this disclosure in the proxy statement becomes the measuring stick for a company's success in linking pay to company performance, companies may need to consider whether, as a practical matter, they should use TSR as the relevant performance criteria in all performance-related equity grants. While many companies already use TSR (both absolute and relative), many other companies like to use TSR in combination with other performance measures and others do not use TSR at all. However, if a company uses a combination, or a measurement for vesting other than TSR, it will run the risk of future disclosure of increased pay at a time when the TSR may not have increased proportionally (or, of course, decreased pay at a time when the TSR has increased). Based on the requirement for companies to disclose pay for company performance based on TSR, companies that do not use TSR (or only use it as one of many factors) will at least need to consider how their choice of performance conditions in equity awards will need to potentially be disclosed under the proposed rule.

Performance Period Timing Issue. Even if a company uses TSR as the way to measure performance for an equity award, the disclosure of the fair value upon vesting for a performance award may not result in the intended result of showing the relationship between pay and performance for many performance shares or performance share units. This is because the vesting often does not occur until the calendar year following the last calendar year of the performance period.

For example, a company may grant performance share units to an executive with cliff vesting at the end of five years, based on TSR over a five-year performance period. It is possible that TSR may increase greatly over each of those five years (resulting in vesting) but that TSR may drop greatly during the sixth year. Because public companies typically do not vest awards and distribute vested shares until the compensation committee can certify the results following the end of the performance period (because of requirements for federal tax issues requiring such certification), it is possible that this equity award may not be considered vested until the sixth year and included in the new table in the sixth year when the TSR has actually decreased. This is the type of example that companies will need to consider as they design future grants of equity awards in relation to the required disclosure in this new pay versus performance table.

Definition of Vesting. The vesting date of equity awards is not defined in the proposed rule, and the limited guidance on this topic leaves questions regarding the correct timing for when an award would be considered "vested" for purposes of this disclosure. For federal tax purposes, vesting is generally analyzed as occurring at the point in time when the equity award is no longer subject to a substantial risk of forfeiture (although the concept is defined differently in different sections of the Internal Revenue Code). Under the proposed rule, it would be necessary to include the fair value on the vesting date of all equity awards "for which all applicable vesting conditions were satisfied during the covered fiscal year," but the proposed rule does not offer any guidance on the complexities of analyzing when all applicable vesting conditions would be satisfied in many equity award grants or in identifying which conditions constitute vesting conditions.

To illustrate how complicated a vesting date determination can be, consider a company that grants restricted stock units that become fully vested on the earlier of the three-year anniversary of the date of grant or the executive's retirement, and the grant is made to an executive who meets the criteria for retirement. Additionally, the restricted stock unit grant provides that shares will be distributed to the executive one year following the year in which the restricted stock units become vested, and the shares distributed are subject to a clawback for two years following the date of distribution. If the executive remains employed through the entire three-year vesting period and receives such shares in year four (one year after the date of vesting), it is unclear when such restricted stock units should be considered vested for purposes of the proposed rule. In this example, the restricted stock units would be considered vested on the date of grant for federal tax purposes because the shares would no longer be considered to be subject to a substantial risk of forfeiture, and the executive would be taxed on the fair market value of the shares in year four when distributed.

Under the proposed rule, it is not clear when this restricted stock unit award would be considered to have satisfied all applicable vesting conditions. The restricted stock units could be considered vested on the date of grant if the fact that the executive met the conditions of the retirement definition on the date of grant was analyzed as the point in time where the applicable vesting conditions were satisfied (similar to the federal tax analysis leading to the conclusion that this equity award was substantially vested on the date of grant). Alternatively, the restricted stock units could be considered vested on the completion of the three-year vesting period or when the executive receives the fully vested shares in year four and is able to realize the economic gain of the shares by selling them. Finally, the restricted stock units could be considered vested only after the end of the clawback period because until such period is complete there is a possibility that the executive will forfeit the shares. Hopefully, the SEC will provide additional guidance as to which is its intended interpretation.

Average Pay Disclosure. Although the proposed rule only requires tabular disclosure with respect to the Remaining NEOs on an aggregate basis, companies may want to consider whether also providing information for each such person on an individual basis provides investors with a more meaningful picture of their "realized" compensation and, if so, where to add this disclosure.

Say-On-Pay. Because the new pay versus performance disclosures would be an element of executive compensation disclosure pursuant to Item 402 of Regulation S-K, they would expressly become part of what is voted upon in the say-on-pay advisory vote. Companies should begin to reflect on how these disclosures may impact advocacy for favorable say-on-pay results.

Informing the Board. Companies should inform their boards of directors, and particularly their compensation committees, of the SEC's pay versus performance proposal.

Effective Date. The SEC did not indicate a proposed effective date for the pay versus performance rule. However, it is possible that final rule could be adopted in time to be applicable to the 2016 proxy season.

Draft Sample Table. Although the rule is still in the proposal stage, and it is not clear when the final rule will be adopted or become effective, it would be useful to prepare a draft table based on the proposed rule so that adequate disclosure controls and procedures can be developed to gather the additional required compensation information. For example, individuals who prepare executive compensation disclosure for proxy statements will need to start tracking vesting date valuations for equity awards. Also, average Remaining NEO compensation may include different individuals, and different numbers of individuals, in each year presented in the table. Mocking up a sample table may generate helpful experience for the creation of the actual table when the rule is finalized. In addition, practical issues that may arise may suggest comments that would be productive to submit to the SEC.

Comments. The SEC is actively seeking comments on its pay versus performance proposal. Companies that have concerns about any aspect of the proposal—such as the one-size fits all approach of requiring TSR as the table's performance measure or requiring of XBRL data tagging in the proxy statement—should consider submitting comments to the SEC on the proposed rule.

Technical Points. There are a number of technical points that practitioners will need to keep in mind if the pay versus performance rule is adopted as proposed. For example, the pay versus performance disclosure does not need to be incorporated into the Form 10-K. Companies will want to be careful not to unintentionally incorporate the section by reference by incorporating the entire executive compensation section into Part III of their annual reports on Form 10-K. Also, the interactive financial data requirement means that the XBRL exhibit would need to be filed with the proxy statement and posted on the company's website.

Originally published May 13, 2015

Footnote

1. Release No. 34-74835, available at http://www.sec.gov/rules/proposed/2015/34-74835.pdf.

Learn more about our Corporate & Securities and Employment & Benefits practices.

Visit us at mayerbrown.com

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

© Copyright 2015. The Mayer Brown Practices. All rights reserved.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.