SEC Issues Final Rule Related to Pay Versus Performance

On August 25, 2022 the Securities and Exchange Commission (the Commission or SEC) issued a final rule¹ requiring public companies to disclose information about their executives’ compensation and how it relates to the company’s financial performance. This final “pay versus performance” rule is meant to increase the transparency and quality of executive compensation disclosures. It also reflects public comment on the SEC’s April 2015 pay versus performance proposed rule, which was reopened for comment in January 2022.

The Commission has long recognized the value that information on executive compensation offers to investors. The first requirements for disclosures on executive compensation originated in the Securities Act of 1933. Since then, from time to time the Commission has continued to update compensation disclosure requirements. This rule builds on a long tradition of disclosure and makes it easier for shareholders to assess a public company’s decision-making with respect to executive compensation².

The final rule requires certain companies to provide a five-year history of pay versus performance-related metrics, with a shorter, three-year reporting requirement for smaller reporting companies (SRCs). Companies will disclose several key performance metrics related to executive compensation. These key performance metrics include total shareholder return (TSR), peer group TSR, net income, and a measure specific to the company. In addition, companies will disclose the amount of compensation paid (including the compensation total and the newly defined “compensation actually paid” total) to the principal executive officer (PEO) and, to named executive officers (NEOs). In years when there are multiple PEOs, additional information is required for each individual. The release must indicate certain adjustments to the compensation actually paid, including fair value adjustments (additions or subtractions) to the unvested stock-based awards.

The final rule also requires companies to disclose which performance measures it deems most important when determining what it pays executives. Based on public comment, the final rule is more flexible, allowing companies to disclose the three to seven most important measures.

The disclosure requirements are effective beginning with fiscal years ending on or after December 16, 2022. Under the final rule’s transition relief, a non-SRC registrant may provide the required tabular disclosure for “three years, instead of five years, in the first filing in which it provides this disclosure, and may provide disclosure for an additional year in each of the two subsequent annual filings in which this disclosure is required.” The final rule’s requirements give calendar year-end companies approximately six to nine months to provide the disclosures, and many activities need to be performed before that deadline.

However, the final rule’s requirements do not apply to registration statements or annual reports — they only apply to proxy statements and information statements for which executive compensation disclosures are required. A registrant can determine the best location within the proxy statement or information statement for the required disclosures. They do not have to be included in CD&A since some registrants may not consider pay versus performance in compensation decisions. Further, the final rule requires registrants to tag the information by using Inline XBRL.

The final rule is effective on October 11, 2022 and companies must begin to comply with the disclosure requirements for fiscal years ending on or after December 16, 2022.

Sources

1. SEC Final Rule Release No. 34-956-7, Pay Versus Performance: https://www.sec.gov/rules/final/2022/34-95607.pdf
2. SEC Final Rule Statement: https://www.sec.gov/news/statement/gensler-statement-pay-vs-performance-082522