On August 25, 2022, the Securities and Exchange Commission (the SEC) adopted new provisions under Item 402 of Regulation S-K, 17 CFR 229.402(v) (the "Pay Versus Performance Rule" or "New Item 402(v)") mandating certain registrants disclose information in proxy and information statements regarding the relationship between the registrant’s executive compensation and financial performance. Citing a 2010 report by the Senate Committee on Banking, Housing and Urban Affairs calling the relationship between executive pay and performance a “significant” shareholder concern, the SEC characterized New Item 402(v) as an optimization of the existing executive compensation disclosure regime, standardizing the format and presentation of quantitative metrics to better allow investors to “assess a registrant’s executive compensation actually paid relative to its financial performance . . . at a lower cost.”1 The Pay Versus Performance Rule will become effective October 11, 2022, and registrants included in the rule must comply with its requirements in affected filings (as discussed below) for fiscal years ending on or after December 16, 2022.
As finalized, the Pay Versus Performance Rule mandates companies – including internally managed business development companies, but not entities which are emerging growth companies, registered investment companies, or foreign private issuers – to include the information set forth in New Item 402(v) in proxy and information statements which require Item 402 executive compensation disclosures.2 While disclosures under Item 402 of Regulation S-K are mandated in registrants’ annual reports on Form 10-K and registration statements under the Securities Act of 1933, as amended, the SEC has specifically limited these new disclosure rules to proxy and information statements calling for the inclusion of Item 402 information, as the intent is to provide shareholders with such disclosure “in circumstances in which shareholder action is to be taken with regard to an election of directors or executive compensation.”3 While the SEC declined to mandate registrants include the new disclosure in any particular section of the Schedule 14 filings (e.g., the Compensation Discussion and Analysis (CD&A) section), it notes that it expects registrants to incorporate New Item 402(v) in a manner so as to “provide investors with direct comparisons of an executive’s pay with their company’s performance . . . over a timespan longer than the most recent reporting period.”
New Disclosure Items Required Under New Rule 402(v)
“Pay Versus Performance” Metrics Table
In the initial filing incorporating New Item 402(v), registrants (other than small reporting companies) must include a table disclosing certain executive compensation and financial performance metrics listed below for the registrant’s three most recently completed fiscal years; the subsequent two annual proxy or information statements which require Item 402 information must include an additional year of disclosure in this table, for a total five-year lookback” period by the third year of filing.4
The executive compensation metrics registrants must provide include:
- The total compensation reported in the registrant’s summary compensation table (SCT) for the registrant’s principal executive officer (PEO). This amount should match the total amount contained in the registrant’s SCT. If the registrant has multiple PEOs, the registrant should disaggregate each PEO’s compensation into separate columns in the table.
- The value of the compensation actually paid to the registrant’s PEO. To obtain the value of the compensation “actually paid” to a PEO, New Item 402(v) requires registrants to adjust the SCT total for certain compensation components, including defined benefit and actuarial pension plans and equity awards, among others. Registrants must include a footnote disclosing the amounts added to – and deducted from – the SCT total.
- The average total compensation reported in the registrant’s SCT for non-PEO named executive officers (NEOs). Registrants should include the mean compensation reported in the SCT for its NEOs, as that term is defined in Item 402(a)(3) to Regulation S-K.5 The registrant must include a footnote to this disclosure identifying the individual NEOs whose compensation amounts are included in the average for each year.
- The value of the average compensation actually paid to the registrant’s non-PEO NEOs. As with a registrant’s PEO, to obtain the value of the compensation “actually paid” to the registrant’s NEOs (and, in turn, calculate the reportable mean of such actually-paid compensation), New Item 402(v) requires registrants to adjust the SCT total for certain compensation components, including defined benefit and actuarial pension plans and equity awards, among others. Similarly, registrants must include a footnote disclosing the amounts added to – and deducted from – the SCT total.
Registrants must also include certain financial performance metrics, including:
- The value of a fixed investment scaled by the cumulative total shareholder return (TSR) of the affected registrant. Item 201(e) of Regulation S-K, 17 CFR 229.201(e), defines TSR as the value derived by dividing (1) the sum of (a) the cumulative amount of dividends for the measurement period, assuming dividend reinvestment and (b) the difference between the registrant’s share price at the end and the beginning of the measurement period by (2) the share price at the beginning of the measurement period.
- The value of a fixed investment scaled by the cumulative TSR of the registrant’s “peer group.” The peer group the registrant uses may be either (1) the same peer group used for purposes of Item 201(e) of Regulation S-K, 17 CFR 229.201(e), or (2) a peer group referenced in the registrant’s CD&A for disclosing its compensation benchmarking practices. If the peer group is not a published industry or line-of-business index, the registrant must disclose the identity of the issuers contained in the peer group in a footnote.
- The registrant’s net income. Registrants are required to include its net income for the most recent fiscal year ended.
- The Company-Selected Measure. This is a financial performance measure chosen by the registrant (the Company-Selected Measure) which is specific to the affected registrant as the “most important” measure of its financial performance, and the one which the registrant uses to link compensation actually paid during the fiscal year to company performance (e.g., total revenue).6 The registrant must include the Company-Selected Measure in its list of important performance measures. See “Performance Measures List” below for further discussion.
As set forth in New Item 402(v), the table including the above-listed information must appear in the following format:7
Descriptions of the Relationships between Executive Compensation and Selected Financial Performance Metrics
In addition to the table prescribed above, the Pay Versus Performance Rule mandates registrants provide “clear descriptions” of certain specified relationships between executive compensation and financial performance over the registrant’s five most recently completed fiscal years, with registrants retaining flexibility as to the format in which they present the descriptions (e.g. graphical, narrative, or a combination thereof). Specifically, registrants must describe (1) the relationships between (a) compensation actually paid to the registrant’s PEO and the average paid to non-PEO NEOs and (b) three measures of the registrant’s financial performance: (i) the cumulative TSR, (ii) net income, and (iii) the Company-Selected Measure; and (2) the relationship between the registrant’s TSR and the TSR of the peer group it has chosen.
Performance Measures List
New Item 402(v) imposes an additional requirement upon affected registrants who are not smaller reporting companies: registrants must also provide an unranked list of their most important financial (and non-financial) performance measures used to link their performance to the executive compensation actually paid to their NEOs. As noted above, the registrant must include the Company-Selected Measure incorporated into the Pay Versus Performance table in its list of performance measures.
XBRL Requirements
Registrants are required to use inline eXtensible Business Reporting Language (XBRL) to tag their New Item 402(v) disclosures.9 Specifically, registrants must separately tag each value disclosed in the Pay Versus Performance Metrics Table, block-text tag the footnotes to the table and relationship descriptions, and specifically tag data points contained in the footnotes to the table, such as quantitative amounts.
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1 Pay Versus Performance, Release No. 34-95607 (Aug. 25, 2022) (Adopting Release).
2 Internally managed business development companies are those with “named executive officers” within the meaning set forth in Item 402 of Regulation S-K, 17 CFR 229.402, and without a registered investment adviser.
3 Adopting Release at 16; see id. at 15-17.
4 Smaller reporting companies are initially required to provide the information for their two most recently completed fiscal years, adding an additional year of disclosure in the subsequent annual proxy or information statement which requires this disclosure, for a total three-year “lookback”.
5 Smaller reporting companies must provide this amount for its NEOs as that term is defined in Item 402(m) to Regulation S-K.
6 The Company-Selected Measure may be a non-US GAAP financial measure; however, if the registrant chooses a non-GAAP measure, it must provide disclosure as to how the measure is calculated from its audited financial statements.
7 Smaller reporting companies are exempt from reporting those metrics where the heading is marked with an asterisk (*). Notably, the tabular format provided in the Pay Versus Performance Rule is a baseline; registrants may supplement the table with additional metrics as desired, provided the additional disclosure is “clearly identified as supplemental, not misleading, and not presented with greater prominence than the required disclosure.” Adopting Release at 25.
8 New Item 402(v) calls on affected registrants to replace this heading with the name of the measure the affected registrant selects to include.
9 Smaller reporting companies need only provide the required inline XBRL data beginning in the third filing in which it provides the information mandated in New Item 402(v).
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