Key Takeaways

• On Aug. 25, 2022, the Securities and Exchange Commission (SEC) adopted final pay-versus-performance rules (the Final Rules) that guide the implementation of Section 953(a) of the Dodd-Frank Act, requiring registrants to disclose, in both tabular and narrative formats, how their executive compensation is paid in relation to their financial performance.
• Since the adoption of the Final Rules, numerous questions have arisen regarding their implementation.
• On Feb. 10, the SEC released Compliance and Disclosure Interpretations (C&DIs) to clarify the Final Rules. The BakerHostetler alert regarding the Feb. 10 C&DI can be found here.
• In an effort to clarify some of the common questions, the SEC released 10 additional C&DIs on Sept. 27.
• Beginning on July 27, 2023, the SEC submitted the first of several comment letters on the pay-versus-performance disclosure required under Section 402 of Regulation S-K.

Overview

Although registrants have already had to comply with the Final Rules in annual reports, proxy statements and information statements beginning with the fiscal year ended on or after Dec. 16, 2022, registrants continue to have numerous questions regarding the implementation of the Final Rules. In an effort to answer some of the common questions, the SEC released 15 C&DIs on Feb. 10, 2023, and an additional 10 C&DIs on Sept. 27, 2023, to provide some much-needed guidance in applying the Final Rules.

Final Rules

As a reminder, on Aug. 25, 2022, the SEC adopted the Final Rules, which can be found here; the BakerHostetler alert regarding the Final Rules can be found here. These pay-versus-performance disclosures must be included in any proxy and information statements that are required to include Item 402 executive compensation disclosure for fiscal years ending on or after Dec. 16, 2022, by a registrant other than an emerging growth company, foreign private issuer or registered investment company.

Compliance and Disclosure Interpretations

On Feb. 10, the SEC released 15 C&DIs that clarify the Final Rules it adopted on Aug. 25, 2022. The 15 C&DIs can be found under Sections 128D and 228D of Regulation S-K Item 402(v). Summaries of each of the 15 C&DIs are provided in the BakerHostetler alert here, and the full 15 C&DIs released by the SEC can be found here. On Sept. 27, the SEC release another 10 C&DIs that further clarify the Final Rules. The 10 C&DIs can be found under Section 128D Regulation S-K Item 402(v). Summaries of each of the 10 C&DIs are provided below, and the full 10 C&DIs released by the SEC can be found here.

These C&DIs provide clarification and are generally consistent with the way that many companies have been interpreting the Final Rules since their release. Any reporting companies that are in the process of preparing their executive compensation disclosures should review this new guidance and analyze its impacts on proposed disclosures.

128D.14 - Awards Granted Prior to an Equity Restructuring

For purposes of calculating “Compensation Actually Paid,” the pay-versus-performance table (PVP table) must include all stock awards and option awards that are outstanding and unvested at the beginning of the covered fiscal year or are granted during the covered fiscal year, including awards modified in connection with an equity restructuring or retained following such a transaction, and for which compensation cost will be recognized.

128D.15 - Awards Granted Prior to an Initial Public Offering

For purposes of calculating Compensation Actually Paid, the required calculations for outstanding stock and option awards should be determined based on the change in fair value from the end of the prior fiscal year (and not based on other dates, such as the date of the initial public offering date).

128D.16 - Awards that Vest Based on Market-Based Conditions

For purposes of calculating Compensation Actually Paid, the effect of a market condition under U.S. GAAP should be reflected in the fair value of share-based awards containing such a condition (and no award subject to a market condition will be considered “vested” until the market condition is satisfied).

128D.17 - Potential for Vesting in Future Years

Awards that remain outstanding and have not yet vested, because performance or market conditions were not met in an eligible year, are not considered to have failed to meet the applicable vesting conditions (i.e., these awards should not be treated as being forfeited for purposes of calculating Compensation Actually Paid).

128D.18 - Retirement Vesting

For purposes of calculating Compensation Actually Paid, if accelerated vesting for retirement is the only vesting condition, this condition would be considered satisfied as of the date the holder becomes retirement eligible.

128D.19 - Certification of Performance

For purposes of calculating Compensation Actually Paid, if certification by the compensation committee that performance conditions have been attained is an additional substantive vesting condition, and such certification occurs after year-end, the award would not be considered vested until such certification has occurred.

128D.20 - Valuation Techniques

For purposes of calculating Compensation Actually Paid, a registrant may satisfy the requirement to compute the fair value of stock and option awards in a manner consistent with the methodology used to account for share-based payments under GAAP, by using a valuation technique that differs from the one used to determine the grant date fair value of option or other equity-based awards that are classified as equity in the financial statements if the valuation technique would be permitted under FASB ASC Topic 718. However, if the change in valuation technique differs materially from the valuation technique used to determine the grant date fair value, the registrant must disclose the change in valuation technique and the reason for the change.

128D.21 - GAAP Methodologies

It is not acceptable to compute the fair value of stock or option awards as of the end of a covered fiscal year based on methods not prescribed by GAAP.

128D.22 - Disclosure of Confidential Information

A company is not required to disclose detailed quantitative or qualitative performance condition for its awards under Item 402(v)(4) to the extent such information would be subject to the confidentiality protections of Instruction 4 to Item 402(b) of Regulation S-K regarding factors or criteria involving confidential trade secrets or confidential commercial or financial information, the disclosure of which would result in competitive harm for the registrant.

118.08 - Non-GAAP Financial Measures

C&DI 118.08 has been updated to clarify that Instruction 5 to Item 402(b) also applies to non-GAAP measures presented for purposes of the Company-Selected Measure (CSM) or additional financial performance measures disclosed for pay-versus-performance purposes. Disclosure must be provided as to how the measure is calculated from the registrant’s audited financial statements, but it does not have to comply with Regulation G or Item 10(e) of Regulation S-K.

SEC Comment Letters

Beginning on July 27, 2023, the SEC submitted comment letters to various registrants regarding failures to fully comply with the pay-versus-performance requirements. A survey of the first 16 released comment letters identified common areas of issue with the pay-versus-performance disclosure requirements, including:

(a) Failure to include all required disclosure elements in the PVP table
(b) Failure to include or including extra CSMs
(c) Failure to provide a reconciliation of non-GAAP measures against GAAP financial statements when a non-GAAP measure is selected as the CSM
(d) Failure to align the TSR peer group with the Form 10-K industry group or compensation peer group
(e) Failure to accurately describe in footnotes the information presented in the PVP table
(f) Failure to include and/or identify all applicable named executive officers (NEOs) in the PVP table
(g) Failure to accurately disclose the compensation of those NEOs that only worked a partial year
(h) Failure to value awards as of the date of vesting rather than at year-end

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