SEC Adopts New Disclosure Rules on Executive Pay
Commentary by Amy L. Blackman
The SEC adopted amendments to disclosure rules on executive compensation under Regulation S-K. The amendments require most reporting companies to provide specific disclosure concerning the relationship between executive compensation "actually paid" to their named executive officers and the companies' financial performance.
In an accompanying Fact Sheet describing the major provisions, the SEC stated that the rule applies "to all reporting companies, except foreign private issuers, registered investment companies, and Emerging Growth Companies," while so-called smaller reporting companies "will be permitted to provide scaled disclosures." The amendments require that information be compiled into a new table and tagged with interactive data. (New Item 402 requires "registrants to provide specified executive compensation and financial performance measures for the registrant's five most recently completed fiscal years.")
The table must include information reporting (i) compensation "actually paid" to the company's principal executive officer and, as an average, the compensation "actually paid" to the company's other named executive officers; (ii) the total shareholder return ("TSR") for the company and the company's peer group; (iii) the company's net income; and (iv) a company-selected financial performance measure. The new rule is to provide "a list of three to seven financial performance measures that the registrant determines are its most important measures."
The effective date of the new rule will be 30 days from the date of publication in the Federal Register. Disclosures will be required for proxy and information statements for fiscal years ending after December 16, 2022. The initial disclosures require reporting three years of compensation information, which will be increased one year at a time for the next two years, and then will be maintained at five-year disclosure.
SEC Chair Gary Gensler supported the final rule, saying that the rule "makes it easier for shareholders to assess a public company's decision-making with respect to its executive compensation policies." SEC Commissioner Jaime Lizárraga added that the rule gives investors the tools to "make informed decisions on their investments and on their advisory votes on executive compensation." SEC Commissioner Caroline A. Crenshaw also supported the rule, asserting that the rule adds much needed transparency to executive compensation disclosure.
SEC Commissioner Mark T. Uyeda expressed concern that the process of reopening the comment period instead of re-proposing the amendments bypassed necessary regulatory checkpoints and did not include any updated economic analysis. SEC Commissioner Hester M. Peirce also dissented, maintaining that the final rule promulgates (i) prescriptive requirements that may limit executive compensation flexibility, (ii) unclear benefits and (iii) unnecessary compliance costs.
Commentary
The adoption of rules implementing Section 14(i) of the Exchange Act of 1934 (added by Section 953(a) of Dodd-Frank Act), requiring reporting companies to disclose information showing the connection between their executives' compensation and the companies' financial performance, is a long time coming. Understanding their shareholders' interest in this topic, and under the existing principals-based disclosure concepts, the vast majority of reporting companies have been addressing the connection between their companies' executive compensation pay programs and the companies' performance for many years in the CD&A section of their executive compensation disclosure.
However, the new pay versus performance rules require a set of information, and a level of specificity, that goes well beyond the information typically covered in current disclosures. Implementation of the new rules will not be a simple exercise. For one thing, the new table requires, among other items, a different calculation of compensation for the companies' named executive officers than is used for the summary compensation table. Data is also needed for specific company and peer group financial performance metrics, and a narrative describing the link between those financial metrics and the named executive officers' compensation must be added.
The new disclosures must be included in proxy and information statements that are required to include Item 402 executive compensation disclosure for fiscal years ending on or after December 16, 2022. This means that, for a calendar year company, as a general matter, the new disclosure will be required in the company's proxy statement for the 2023 annual meeting of shareholders. In other words, there is no time to waste. Companies should work with their advisors to review the new rules' requirements, put discussion of the new requirements on the agenda of autumn compensation committee meetings for their understanding and form a strategy to gather and draft the required information.