SEC Proposes Disclosure Rules on the Relationship Between Executive Pay and Company Performance, as Required by Dodd-Frank

Practical Law Legal Update 9-610-9725 (Approx. 7 pages)

SEC Proposes Disclosure Rules on the Relationship Between Executive Pay and Company Performance, as Required by Dodd-Frank

by Practical Law Corporate & Securities

Proposed Item 402(v) of Regulation S-K

The proposal would add new paragraph (v) to Item 402 of Regulation S-K, as summarized below.

Proxy and Information Statement Disclosure

Registrants would need to provide the disclosure required under new proposed Item 402(v) only in any proxy or information statement for which disclosure under Item 402 of Regulation S-K is required. This would include proxies solicited for the election of directors as well as for executive compensation matters. The disclosure would not be required in a registrant's Form 10-K or in Securities Act registration statements.

Because the proposed disclosure would be provided under Item 402 of Regulation S-K, it would be subject to the say-on-pay advisory vote under Rule 14a-21(a) of the Exchange Act.

Incorporation by Reference

Disclosures under proposed Item 402(v) would not be required in or deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, unless the registrant specifically incorporates it by reference. The disclosure would therefore not be subject to forward incorporation by reference under Item 12(b) of Form S-3.

Format and Location of Proposed Disclosure

Proposed Item 402(v) would require registrants to disclose in a new table the following information:

The total executive compensation reported in the Summary Compensation Table for the principal executive officer (PEO).
An average of the reported amounts for the remaining named executive officers (NEOs).
Executive compensation actually paid for the PEO, which would be the total compensation as disclosed in the Summary Compensation Table, with adjustments to the amounts included for pensions and equity awards (see Determining "Executive Compensation Actually Paid"). The amount disclosed for the remaining NEOs would be the average executive compensation actually paid to those executives. For each amount disclosed as executive compensation actually paid, proposed Item 402(v) would require footnote disclosure for both PEO compensation and average NEO compensation of each amount deducted from, and added to, the total compensation amount as provided in the Summary Compensation Table.
The registrant's total shareholder return (TSR) on an annual basis, using the definition of total shareholder return included in Item 201(e) of Regulation S-K.
The TSR on an annual basis of the companies in a peer group, using the peer group identified by the company in its stock performance graph or in its compensation discussion and analysis (CD&A) (see Measure of Performance).

Using the values presented in the new table, proposed Item 402(v) would require the registrant to describe:

The relationship between the executive compensation actually paid and the registrant's TSR.
The relationship between the registrant's TSR and the identified peer group's TSR.

The disclosure about the relationships would follow the table and could be described as a narrative, graphically or a combination of the two. Disclosure of the relationships could include, for example:

A graph providing executive compensation actually paid and change in TSR on parallel axes and plotting compensation and TSR over the required time period.
Showing the percentage change over each year of the required time period in both executive compensation actually paid and TSR together with a brief discussion of that relationship.

Location of Proposed Disclosure

Rather than specifying where in the proxy or information statement to provide the disclosure required by proposed Item 402(v), the proposal would give registrants full flexibility to determine location, although it is generally expected that registrants would disclose this information with their Item 402 executive compensation disclosure. It is also worth noting that while the CD&A may be a natural place for Item 402(v) disclosure, this suggests that the registrant considered the pay-versus-performance relationship in its compensation decisions, which is not likely to be the case in a registrant's first 402(v) disclosures.

Executives Covered by Proposed Item 402(v)

For registrants other than smaller reporting companies, the executives covered by proposed Item 402(v) would be the NEOs as defined in Item 402(a)(3) of Regulation S-K. For smaller reporting companies, the executives covered would be the same as the NEOs required to be disclosed under Item 402(m).

Under the proposal, if more than one person served as the PEO of the registrant, then the disclosure for the persons who served as PEO would need to be aggregated for the years in which more than one person served as the PEO because this would reflect the total amount that was paid by the registrant for the services of a PEO.

Determining "Executive Compensation Actually Paid"

Under the proposal, "executive compensation actually paid" under proposed Item 402(v) would be total compensation as reported in the summary compensation table, with adjustments relating to:

Changes in actuarial pension value. The proposal would deduct the change in the actuarial present value of all defined benefit and pension plans from the summary compensation table total. However, the actuarially-determined service cost for services rendered by the executive during the applicable period would be added back. This would result in the exclusion of only the portion of the total change in actuarial pension value that results solely from changes in interest rates, executive's age and other actuarial inputs and assumptions regarding benefits accrued in previous years. Smaller reporting companies would not be required to make adjustments in pension amounts because they are subject to scaled disclosure requirements that do not include disclosure of pension plans.
Earnings on non-qualified deferred compensation. The proposal would include above-market or preferential earnings on deferred compensation that is not tax qualified. These represent amounts accrued during the year that are based on the registrant's compensatory decision to pay an above-market return.
Equity awards. Under the proposal, equity awards would be considered actually paid on the date of vesting and valued at fair value on that date, rather than valued at fair value on the date of grant as required in the Summary Compensation Table. The amounts reported under Items 402(c)(2)(v) and (vi) would be subtracted from total compensation reported in the Summary Compensation Table, and the following would be added in their place:
- for awards of stock that vested in the applicable year, the fair value at vesting date, computed in accordance with the fair value guidance in FASB ASC Topic 718; and
- for awards of options with or without tandem stock appreciation rights (SARs) that vested in the applicable year, the fair value at vesting date, computed in accordance with the fair value guidance in FASB ASC Topic 718. If, during the last completed fiscal year, the registrant adjusted or amended the exercise price of previously vested options or SARs held by an NEO, whether through amendment, cancellation or replacement grants, or any other means, or otherwise has materially modified these awards, proposed Item 402(v) would require the registrant to include the incremental fair value, computed as the excess fair value of the modified award over the fair value of the original award upon vesting of the modified award. If the modified award is subject to multiple vesting dates, the pro rata incremental fair value would be determined and included in compensation actually paid at each vesting date.
A registrant would be required to disclose vesting date valuation assumptions if they are materially different from those disclosed in its financial statements as of the grant date.

Registrants could choose to supplement this disclosure by providing additional disclosure based on a measure of realized pay, realizable pay or another appropriate measure if they believe it provides useful information about the relationship between compensation and registrant performance, provided that the supplemental disclosure is not misleading and is not presented more prominently than the required disclosure.

Measure of Performance

The proposal would require registrants to use TSR as defined in Item 201(e) of Regulation S-K as the measure of financial performance for purposes of the proposed Item 402(v) disclosure. The proposal would also require registrants (other than smaller reporting companies) to disclose peer group total shareholder return, using either:

The same peer group (or industry or line-of-business index) used for purposes of the performance graph required by Item 201(e) of Regulation S-K.
A peer group used in the CD&A for purposes of disclosing registrants' compensation benchmarking practices.

If the peer group is not a published industry or line-of-business index, the registrant would be required to disclose the identity of the issuers. A registrant that has previously disclosed the composition of issuers in its peer group in prior SEC filings would be permitted to comply with the proposed requirement by incorporation by reference to those filings.

Time Period Covered

Under the proposal, registrants (other than smaller reporting companies) would be required to provide disclosure under proposed Item 402(v) for the five most recently completed fiscal years. Smaller reporting companies would be required to provide the disclosure for the three most recently completed fiscal years.

The proposal would provide the following transition period for registrants to provide the new disclosure:

Registrants (other than smaller reporting companies) would be required to provide:
- the proposed Item 402(v) disclosure for three fiscal years, instead of five, in the first applicable filing after the proposal takes effect; and
- disclosure for an additional year in each of the two subsequent annual proxy filings where disclosure is required.
Smaller reporting companies would be required to provide:
- the proposed Item 402(v) disclosure for two years, instead of three, in the first applicable filing after the proposal takes effect; and
- disclosure for the last three fiscal years in subsequent years.

The proposal would require a registrant to provide the proposed Item 402(v) disclosure only for years that it was a reporting company under Section 13(a) or Section 15(d) of the Exchange Act. Therefore, a newly-reporting registrant would be required to provide the disclosure for only the most recently ended fiscal year in any proxy statement or information statement in which executive compensation disclosure under Item 402 is required in its first year as a reporting company, and for the two most recently completed fiscal years in any proxy statement or information statement in which executive compensation disclosure under Item 402 is required in its second year as a reporting company.

Interactive Data Tagging

Under the proposal, registrants would be required to provide the above disclosure, including any footnote disclosure, in interactive data format using eXtensible Business Reporting Language (XBRL). The proposal would require registrants to tag separately the values disclosed in the required table, and to separately block-text tag:

The disclosure of the relationship among the measures.
The footnote disclosure of deductions and additions used to determine executive compensation actually paid.
The footnote disclosure regarding vesting date valuation assumptions.

Registrants would need to provide the interactive data as an exhibit to the definitive proxy or information statement filed with the SEC, in addition to appearing with and in the same format as the rest of the disclosure provided under proposed Item 402(v). Registrants would be required to prepare their interactive data using the list of tags the SEC specifies and submit them with any supporting files required by the EDGAR Filer Manual.

Smaller reporting companies would be permitted to phase in the requirement for providing disclosure in XBRL format. A smaller reporting company would be required to provide the data in XBRL beginning with the third filing in which it provides the proposed Item 402(v) disclosure.

Clear Description

The proposal would require that the proposed Item 402(v) disclosure be "clear, concise and understandable" as required by Item 402(a)(2) of Regulation S-K and follow the Plain English principles in Rules 13a-20 and 15d-20 under the Exchange Act.

Issuers Subject to the Proposal

The proposal would apply to all reporting companies other than foreign private issuers, registered investment companies and emerging growth companies.

For more information on executive compensation disclosure, see Practice Note, Proxy Statements: Executive Compensation. For information on provisions of the Dodd-Frank Act relating to executive compensation, see Practice Note, Summary of the Dodd-Frank Act: Executive Compensation.

Update: On May 7, 2015, the proposal was published in the Federal Register. The SEC is accepting comments on the proposal until July 6, 2015.

SEC Proposes Disclosure Rules on the Relationship Between Executive Pay and Company Performance, as Required by Dodd-Frank | Practical Law