Overview

On 25 August 2022, the Securities and Exchange Commission adopted final rules (Final Rules) implementing the “pay versus performance” disclosure requirement set forth in the Dodd-Frank Wall Street Reform and Consumer Protection Act, marking the most significant executive compensation disclosure development in the last decade. 

The Final Rules apply to all reporting companies (including business development companies), other than foreign private issuers, registered investment companies, and emerging growth companies. 

Disclosure under the Final Rules is required in proxy statements on Schedule 14A and information statements on Schedule 14C in which executive compensation disclosure pursuant to Item 402 of Regulation S-K is required for fiscal years ending on or after 16 December 2022.

Compliance with the Final Rules will require significant time and expense in order to make required computations, select company-specific performance measures that are required to be disclosed, design formats for required descriptions, draft footnotes and supplementary disclosures that are deemed necessary, apply Inline XBRL data tagging, and ensure appropriate review by management, in-house counsel, outside counsel and members of the board of directors.

The Final Rules

Tabular disclosure

For companies other than smaller reporting companies (SRCs), the Final Rules require a table containing, for each of the five most recently completed fiscal years:

1. The company’s Summary Compensation Table measure of total compensation for the company’s principal executive officer (PEO) and, as an average, for the company’s other named executive officers (NEOs);
2. “Executive compensation actually paid” for the company’s PEO;
3. “Executive compensation actually paid,” as an average, for the company’s other NEOs;
4. Total stockholder return (TSR) for the company;
5. Weighted TSR for the company’s peer group;
6. The company’s net income; and
7. A financial performance measure chosen by the company (the Company-Selected Measure) that represents the most important financial performance measure the company uses to link executive compensation to the company’s performance for the most recently completed fiscal year.

In fiscal years when a company has multiple PEOs, the company must include separate Summary Compensation Table total compensation and “executive compensation actually paid” columns for each PEO. “Executive compensation actually paid” for a fiscal year is the total compensation reported in the Summary Compensation Table for that year modified by complex adjustments to equity award and pension benefit amounts, which will require complex and frequent annual fair valuations for equity awards and actuarial input for pension amounts. The TSR disclosure in the table is the value of a fixed US$100 investment scaled by cumulative total shareholder return (i.e., the TSR for the first covered fiscal year in the table will represent the TSR over that year and the TSR for the second fiscal year will represent the cumulative TSR over the first and the second fiscal years). A company may use as its peer group either the group that it uses for purposes of disclosing its performance graph in its Form 10-K or the group that it uses for disclosing its compensation benchmarking practices in its compensation discussion and analysis. Companies are required to separately tag the values disclosed in the table, block-text tag the footnote disclosure, and tag specific data points (such as quantitative amounts) within the footnote disclosures, all in Inline XBRL. Companies may provide additional performance measures as new columns in the table. However, such additional disclosures may not be misleading or obscure the required information, and the additional performance measures may not be presented with greater prominence than the required disclosure.

Relationship Disclosure

In addition to the tabular disclosure described above, the Final Rules require a clear description of:

1. The relationships between executive compensation actually paid to the company’s PEO and, on average, its other NEOs and the company’s TSR;
2. The relationships between executive compensation actually paid to the company’s PEO and, on average, its other NEOs and the net income of the company;
3. The relationships between executive compensation actually paid to the company’s PEO and, on average, its other NEOs and the company’s Company-Selected Measure; and
4. The relationships between the company’s TSR and its peer group TSR, in each case over the company’s five most recently completed fiscal years. 

The relationship disclosure may be in narrative, graphical, or combined narrative and graphical form. For example, the required relationship disclosure could include a graph providing executive compensation actually paid and change in the financial performance measures (TSR, net income, or Company-Selected Measure) on parallel axes and plotting compensation and such measures over the required time period. Alternatively, the required relationship disclosure could include narrative or tabular disclosure showing the percentage change over each year of the required time period in both executive compensation actually paid and the financial performance measures together with a brief discussion of how those changes are related. Companies are required to block-text tag the relationship disclosure in Inline XBRL.

Other Performance Measure Disclosure

The Final Rules also require companies to provide a list of at least three, and up to seven, of their most important financial performance measures used to link executive compensation actually paid to the company’s performance. The “most important” determination is made on the basis of looking only to the most recently completed fiscal year. A company has the option of including non-financial performance measures in the list, provided that (i) such measures are included in its three to seven most important performance measures, and (ii) the company has disclosed at least three (or fewer, if the company only uses fewer) most important financial performance measures. Performance measures on the list are not required to be ranked. A company may present one list used by the company to link compensation actually paid to the company’s NEOs to company performance. Alternatively, a company may break up the disclosure into two separate lists: one for the PEO and one for the remaining NEOs. Any disclosure of performance measures (including in the table discussed above) that are non-GAAP financial measures will require disclosure as to how they are calculated from the company’s audited financial statements.

Scaled Disclosure for SRCs

In the tabular disclosure, SRCs must disclose the required amount for the three, rather than five, most recently completed fiscal years, and are not required to disclose weighted TSR for a peer group, disclose a Company-Selected Measure, or make pension related adjustment to their Summary Compensation Table total amounts in order to arrive at “executive compensation actually paid.” Correspondingly, SRCs are not required to provide a description of the relationships between executive compensation actually paid to the company’s PEOs and, on average, its other NEOs and the company’s Company-Selected Measure, nor the relationships between the company’s TSR and its peer group TSR. Finally, SRCs are not required to disclose a list of their most important performance measures, and will have until their third filing with pay-versus-performance disclosure, instead of their first, to provide the required Inline XBRL data.

Transition Relief

SRCs are required to provide the new pay-versus-performance disclosure for the last two fiscal years in their first applicable filing after the Final Rules became effective, and three years of disclosure in subsequent filings. All other companies are required to provide the disclosure for three fiscal years in their first applicable filing after the Final Rules becomes effective, and disclosure for an additional year in each of the two subsequent filings where disclosure is required. The disclosure is only required to be provided for years in which a company is a reporting company.

Conclusion

As noted above, compliance with the Final Rules will entail significant time and expense. Companies are encouraged to consult with their outside compensation and legal consultants well in advance of the first required pay-versus-performance disclosure. K&L Gates stands ready to assist clients to navigate the Final Rules.