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 Topics
 
Related Articles
 
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions