alerts & publications
SEC Proposes Pay-for-Performance Disclosure RuleMay 4, 2015
On April 29, 2015, the SEC proposed a new rule requiring disclosure of the relationship between executive pay and company performance (the “Proposed Rule”). This Alert summarizes some of the key features of the Proposed Rule, and includes our thoughts on some of the implementation challenges issuers may face. The full text of the adopting release for the Proposed Rule is available here.
The Proposed Rule was adopted in response to Section 953(a) of the Dodd-Frank Act. Section 953(a) required the SEC to adopt a rule requiring reporting issuers to disclose a clear description of compensation information that shows the relationship between executive compensation actually paid and the financial performance of the issuer, as measured by taking into account increases or decreases in share price and any dividends or other distributions paid.
Unlike in past adopting releases, the SEC’s April 29 release did not give any indication when the new disclosure requirements will be effective.
New Pay Versus Performance Table
The Proposed Rule adds a new Item 402(v) to the existing executive compensation disclosure rules contained in Item 402 of Regulation S-K. Under the Proposed Rule, reporting companies will be required to include the following new Pay Versus Performance table in proxy or information statements where executive compensation disclosures are otherwise required:
The disclosures required by each column of the table can be summarized as follows:
- Year: Compensation information must be presented for the issuer’s last five fiscal years (three years for smaller reporting companies). The Proposed Rule provides transition relief, and the table initially will only require three years of compensation information (two years for smaller reporting companies). An additional year of data will be included for each year after the first year the disclosure is required until the requirement is fully phased in. In its first year as a reporting company, a newly public issuer is only required to provide compensation information for its most recent fiscal year.
- Summary Compensation Table Total For PEO: Total compensation for the issuer’s CEO as reported in the Summary Compensation Table for the applicable year is required to be included again here (and if there were multiple CEOs for any year, their total compensation gets added together and reported as one total amount).
- Compensation Actually Paid to PEO: The starting point for this column is total compensation for the issuer’s CEO (or CEOs) as reported in the Summary Compensation Table for the applicable year. From this amount, the grant date fair value of any stock, option or other equity awards granted during the applicable year (generally the amounts reported in the Stock Awards and Option Awards columns of the Summary Compensation Table for that year) is subtracted, while the fair value of any stock, option or other equity awards that vested during the applicable year is added back in (with the fair value of the vested awards determined as of the vesting date under the fair value guidance in FASB ASC Topic 718 under the GAAP accounting rules). In addition, the change in the actuarial present value of any defined benefit pension benefits during the applicable year is subtracted, while only the change in the actuarial present value of any defined benefit pension benefits attributable to “service cost” (within the meaning of FASB ASC Topic 715) is added back in. (Smaller reporting companies are not required to include any of the pension adjustments.) Additional footnote disclosure of the additions and subtractions is also required.
- Average Summary Compensation Table Total for non-PEO Named Executive Officers: The average (not aggregate) total compensation for the issuer’s “named executive officers” other than its CEO as reported in the Summary Compensation Table for the applicable year is required to be included here.
- Average Compensation Actually Paid to non-PEO Named Executive Officers: The average total compensation actually paid to the issuer’s “named executive officers” other than its CEO for the applicable year is required to be included here. The compensation actually paid to these executives is determined in the same manner as described above for the issuer’s CEO.
- Total Shareholder Return: The issuer’s cumulative total shareholder return for the applicable year (determined under the same rules as for the performance graph that is currently required to be included in an issuer’s annual report) is required to be included here.
- Peer Group Total Shareholder Return: The cumulative total shareholder return for the applicable year (determined in the same manner as for the issuer) for the issuer’s peer group is required to be included here. For the peer group, an issuer may either use the same index or peer companies used in the issuer’s performance graph, or the companies used as compensation benchmarking peers and disclosed in the issuer’s CD&A. Smaller reporting companies are not required to include this column.
Description of Relationship Between Compensation Actually Paid and Performance
In addition to the Pay Versus Performance table, the Proposed Rule requires reporting issuers to provide a clear description of the relationship between the compensation actually paid to the issuer’s CEO and other named executive officers and the issuer’s cumulative total shareholder return for each of the five (or fewer) years covered by the Pay Versus Performance table. Issuers are also required to include a comparison of the issuer’s cumulative total shareholder return to the cumulative total shareholder return achieved by the issuer’s peer group during each of the years covered by the Pay Versus Performance table. This disclosure may be provided as a narrative, graphically, or a combination of the two.
JOBS Act emerging growth companies, foreign private issuers and registered investment companies are exempt from the disclosures required under the Proposed Rule.
Our thoughts on some of the key features of the Proposed Rule and implementation challenges issuers may face are highlighted below:
- Calculating the Value of any Stock, Option or Other Equity Awards “Actually Paid”: One approach the SEC could have used to value equity awards on the vesting date would have been to require issuers to include the aggregate dollar value of the awards on the vesting date (i.e., the spread value of options and the market value of full-value awards). This approach would have been consistent with the information issuers are already required to report in the “Option Exercises and Stock Vested” table included in proxy statements. However, rather than adopt this relatively straightforward approach, the Proposed Rule requires issuers to value vested equity awards under the fair value guidance in FASB ASC Topic 718. For stock options, this approach will presumably require issuers to value the options on the vesting date using a Black-Scholes or similar binomial pricing model, even though issuers are generally not otherwise required by the SEC’s disclosure rules or GAAP accounting rules to perform this calculation or disclose this information.
- Pension Calculations: For issuers with defined benefit pension plans, the Proposed Rule requires the change in the present value of these pension benefits attributable to “service cost” to be included in the amount of compensation actually paid. While this service cost is typically calculated to report the change in pension benefits that is currently required to be reported in the Summary Compensation Table, the service cost is not otherwise currently required to be separately disclosed by issuers.
- Potential Overlap with “Realized Pay” and “Realizable Pay” Disclosures: In recent years, certain issuers have elected to voluntarily include alternative compensation tables in their proxies disclosing their executives’ “realized pay” or “realizable pay.” Because of the overlap between these two compensation concepts and the Proposed Rule’s compensation “actually paid” concept, issuers will need to consider how their realized or realizable pay disclosures will synch up with the new Pay Versus Performance table.
- Multiple CEO Issues: For issuers who have more than one CEO serving in any fiscal year, the Proposed Rule’s requirement to aggregate their total compensation and report it as one amount has the potential to overstate reported compensation amounts. For example, if the outgoing CEO receives severance in connection with his or her departure and the incoming CEO receives a signing bonus to replace foregone benefits at his or her prior company, all of this compensation would likely be included as compensation actually paid in the same year (in addition to the CEO’s “normal” compensation for that year).
- XBRL Tagging: The disclosures required by the Proposed Rule must be provided in XBRL format in a new separate tagged exhibit that will need to be included with proxy statements. This would be the first proxy statement compensation table required to be provided in XBRL format.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Chris Del Rosso, an O'Melveny partner licensed to practice law in California and New York, Wayne Jacobsen, an O'Melveny partner licensed to practice law in California, Robert Plesnarski, an O'Melveny partner licensed to practice law in the District of Columbia and Pennsylvania, Jeff Walbridge, an O'Melveny partner licensed to practice law in California, and Warren Fox, an O'Melveny senior counsel licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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