The U.S. Securities and Exchange Commission (SEC) on Aug. 25, 2022, adopted final rules implementing Section 953(a) of the Dodd-Frank Act, which directed the SEC to adopt rules requiring public companies to disclose measures of executive pay versus performance. The final rules require public companies to disclose, in their proxy or information statements that are required to include Item 402 compensation disclosure, how the compensation actually paid to executives relates to company financial performance over a five-year time horizon (three years for smaller reporting companies or SRCs). The final rules apply to fiscal years that end on or after Dec. 16, 2022. As such, reporting companies with a fiscal year that ends on Dec. 31 will need to include this disclosure in their proxy or information statement that is filed in 2023 and that otherwise requires Item 402 disclosure for fiscal years ending on or after Dec. 16, 2022.
While many public companies have already begun to include pay-for-performance disclosure related to their chief executive officers (CEOs) in their proxy or information statements, the final rules now standardize and codify this disclosure and extend the rules to all named executive officers (NEOs). The final rules are similar to the analysis that is currently performed by proxy advisory services and compensation consultants, but pay-for-performance disclosure will likely need to be reexamined and adjusted in order to comply with these new rules.
This Info Flash is intended to include only a high-level summary of the final rules. Holland & Knight will release a more detailed analysis in the coming days.
Pay vs. Performance Table
The final rules require companies to provide, in their proxy or information statements, a pay-versus-performance table disclosing certain executive compensation data and financial performance measures for the five most recent fiscal years (three most recent fiscal years for SRCs). Specifically, for the principal executive officer (PEO) and, as an average, the other NEOs, the table must show 1) the summary compensation table (SCT) measure of total compensation, and 2) the "executive compensation actually paid," which is calculated by making certain adjustments to the amounts included in the SCT for pension benefits and equity awards.
The table must also include the following performance measures for each year:
- the company's total shareholder return (TSR)
- the weighted TSR for the company's peer group
- the company's net income, and
- a financial performance measure of the company's choice that, in the company's view, represents the most important financial performance measure that the company uses to link executive compensation actually paid to company performance
Description of Relationship Between Pay and Performance
Additionally, the final rules require companies to use the information in the pay-versus-performance table to provide a clear description of the relationship between actual compensation and financial performance. Specifically, for each of the five most recent fiscal years (three most recent fiscal years for SRCs), companies must describe the relationship between the compensation actually paid to the company's PEO and remaining NEOs, and each of 1) the company's cumulative TSR, 2) the company's net income, and 3) the financial performance measure that the company selected for the pay-versus-performance table. Companies will also be required to describe the relationship between the company's TSR and its peer group TSR. The final rules give companies flexibility to present these descriptions in graphical or narrative format (or a combination of the two).
Most Important Measures of Financial Performance
The final rules also require companies to disclose, for the most recently completed fiscal year, an unranked list of three to seven financial performance measures that the company deems most important in linking executive pay to performance (under the same approach used for the pay-versus-performance table). Notably, companies can include nonfinancial performance measures in this list. However, they must include at least three financial performance measures, and they must select their financial performance measure for the pay-versus-performance table from this list (meaning a nonfinancial performance measure cannot be selected for the pay-versus-performance table).
Scaled Disclosures for Smaller Companies
SRCs are exempt from certain of the disclosure requirements in the final rules. Notably, SRCs are not required to 1) report data for the fourth and fifth most recent fiscal years, 2) report their peer group TSR, 3) select an additional financial performance measure for the pay-versus-performance table, or 4) provide the list of three to seven financial performance measures.
Effective Date and Transition Relief
The new disclosure requirements will take effect 30 days after the final rules are published in the Federal Register (which is expected soon), and companies must begin complying with the new requirements in proxy and information statements for fiscal years ending on or after December 16, 2022 (i.e., 2023 proxy and information statements for calendar year companies).
Note that companies are not required to provide all five years of data in the first proxy or information statement for which the disclosures apply. Companies that are not SRCs will be required to disclose only three years in the first proxy or information statement subject to the disclosures, and then another year for each of the following two annual statements. SRCs will initially be required to provide the information for only two years, with an additional year for the following annual statement.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.