On February 10, 2023, the staff of the Division of Corporation Finance (Staff) of the U.S. Securities and Exchange Commission (SEC) published new Regulation S-K Compliance and Disclosure Interpretations (C&DIs) regarding the pay versus performance disclosure requirements specified in Item 402(v) of Regulation S-K.[1]

The Staff’s guidance on the pay versus performance disclosure requirements comes at a time when many companies are preparing their pay versus performance disclosure for the first time. While preparing the new disclosure, a number of interpretive issues have come up as companies and their advisors have encountered a number of interpretive issues as they consider how to apply the new rules to their own particular circumstances. The new C&DIs published by the Staff provide guidance on some of these interpretive questions.

Background of the Pay Versus Performance Disclosure Requirement

On August 25, 2022, the SEC adopted the pay versus performance disclosure requirements that the agency was directed to promulgate by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.[2] The pay versus performance disclosure requirements specified in paragraph (v) of Item 402 of Regulation S-K became effective on October 11, 2022.

Item 402(v) of Regulation S-K requires that companies provide a new table disclosing specified executive compensation and financial performance measures for the company’s five most recently completed fiscal years.[3] This table includes, for the principal executive officer (PEO) and, as an average, for the other named executive officers (NEOs), the Summary Compensation Table measure of total compensation and a measure reflecting “executive compensation actually paid,” as specified by the rule. The financial performance measures to be included in the table are:

• Cumulative total shareholder return (TSR) for the company;
• TSR for the company’s self-selected peer group;
• The company’s net income; and
• A financial performance measure chosen by the company and specific to the company that, in the company’s assessment, represents the most important financial performance measure the company uses to link compensation actually paid to the company’s NEOs to company performance for the most recently completed fiscal year (Company-Selected Measure).

In addition, Item 402(v) of Regulation S-K also requires a clear description of the relationships between each of the financial performance measures included in the table and the executive compensation actually paid to its PEO and, on average, to its other NEOs over the company’s five most recently completed fiscal years. The company is also required to include a description of the relationship between the company’s TSR and its peer group TSR.

Item 402(v) of Regulation S-K requires a list of three to seven financial performance measures that the company determines are its most important measures. Companies are permitted, but not required, to include non-financial measures in the list if they considered such measures to be among their three to seven “most important” measures.

Location of the Pay Versus Performance Disclosure

In Regulation S-K C&DIs Question 128D.01, the Staff indicates that the information required pursuant to Item 402(v) of Regulation S-K is not required to be included in an annual report on Form 10-K. The information required by Item 402(v) of Regulation S-K must be provided in connection with any proxy or information statement for which executive compensation disclosure pursuant to Item 402 of Regulation S-K is required. Furthermore, the Staff notes that information provided under Item 402(v) of Regulation S-K will not be deemed to be incorporated by reference into any filing under the Securities Act or Exchange Act, unless an issuer specifically incorporates it by reference.

Calculating and Presenting Compensation Actually Paid

In Regulation S-K C&DIs Question 128D.02, the Staff notes that the change in the value of equity awards that are granted to a company’s NEO prior to that individual being appointed as an NEO is required to be included in the calculation of compensation actually paid under Item 402(v) of Regulation S-K.

In Regulation S-K C&DIs Question 128D.03, the Staff notes that, in a company’s first Pay Versus Performance table, the company should provide footnote disclosure of each amount deducted and added to calculate the compensation actually paid to the PEO and the average of the compensation actually paid to the other NEOs for each of the periods presented in the table. After the first Pay Versus Performance table, companies are required to provide footnote disclosure for years other than the most recent fiscal year only if it is material to an investor’s understanding of the information reported in the Pay Versus Performance table or the relationship disclosure provided under Item 402(v)(5) of Regulation S-K.

In Regulation S-K C&DIs Question 128D.04, the Staff notes that Item 402(v)(3) of Regulation S-K requires footnote disclosure of each of the amounts deducted or added in calculating compensation actually paid. The Staff indicates that disclosing only the aggregate amount calculated for pension value adjustments and equity award adjustments does not satisfy the footnote disclosure requirement. The footnote disclosure must include each of the amounts deducted and added pursuant to Item 402(v)(2)(iii)(B) and Item 402(v)(2)(iii)(C) to calculate the compensation actually paid to the PEO and the average of the compensation actually paid to the other NEOs.

Issuer and Peer Group TSR

In Regulation S-K C&DIs Question 128D.05, the Staff notes that for purposes of calculating the peer group TSR under Item 402(v)(2)(iv) of Regulation S-K, a company may use a peer group that is disclosed in its Compensation Discussion & Analysis (CD&A), even if such peer group is not used for “benchmarking” purposes under Item 402(b)(2)(xiv) of Regulation S-K, as that term is explained in Regulation S-K C&DIs Question 118.05. In Regulation S-K C&DIs Question 128D.07, the Staff indicates that a company electing to use the peer group from its CD&A should present the peer group TSR for each year in the Pay Versus Performance table using the peer group as disclosed in its CD&A for the respective period.

In Regulation S-K C&DIs Question 128D.06, the Staff notes that a company that went public during the earliest year included in the Pay Versus Performance table should calculate the TSR and peer group TSR beginning with the date that the company’s class of securities was registered under Section 12 of the Securities Exchange Act of 1934, as amended (Exchange Act) during the earliest year included in the table, consistent with the calculation of TSR under Item 201(e) of Regulation S-K.

Net Income

In Regulation S-K C&DIs Question 128D.08, the Staff notes that a company is required to present in the Pay Versus Performance table its net income or loss as required by Regulation S-X in the company’s audited GAAP financial statements. Other net income amounts, such as net income attributable to a controlling interest or income from continuing operations, cannot be reported in the Pay Versus Performance table for this purpose.

Company-Selected Measure

In Regulation S-K C&DIs Question 128D.09, the Staff notes that the Company-Selected Measure must be a financial performance measure that is not otherwise required to be disclosed in the Pay Versus Performance table, and the financial measures required to be reported in the Pay Versus Performance table include net income and the cumulative TSR of the company. The Staff notes that the Company-Selected Measure can be any financial performance measure that differs from the financial performance measures otherwise required to be disclosed in the table, including a measure that is derived from, is a component of, or is similar to, net income or cumulative TSR, such as earnings per share, gross profit, income or loss from continuing operations, or relative TSR.

Further, in Regulation S-K C&DIs Question 128D.10, the Staff indicates that a company’s stock price can be disclosed as a Company-Selected Measure only if the company uses its stock price to link the compensation actually paid to its NEOs to company performance, even if stock price has a significant impact on the amounts reported in the Pay Versus Performance table. Therefore, if the only impact of stock price on an NEO’s compensation is through changes in the value of share-based awards, the company could not include its stock price as the Company Selected Measure. By contrast, if the company’s stock price is used as a market condition applicable to an incentive plan award or is used to determine the size of the bonus pool, the stock price may be included as the company’s Company-Selected Measure.

In C&DIs Question 128D.11, the Staff notes that the Company-Selected Measure included in the Pay Versus Performance table cannot be measured over a multi-year period that includes the relevant fiscal year as the final year, because the Company-Selected Measure is a measure which, in the company’s assessment, represents the most important financial performance measure (that is not otherwise disclosed in the Pay Versus Performance table) used by the company to link compensation actually paid to the company’s NEOs, for the most recently completed fiscal year, to the issuer’s performance.

Tabular List of Financial Performance Measures

In Regulation S-K C&DIs Question 128D.12, the Staff addresses a situation where the only financial performance measure used by a company is in a “pool plan,” where a bonus pool is available for payout only upon achievement of a financial performance measure or the size of the pool is determined based upon the extent such measure is achieved, but where the compensation committee may allocate bonus payouts to participants in its discretion, based on criteria independent of the achievement of any financial performance measure(s). The Staff indicates that the company may not omit the Tabular List required under Item 402(v)(6) of Regulation S-K and the Company-Selected Measure required under Item 402(v)(2)(vi) of Regulation S-K and the related relationship disclosure required under Item 402(v)(5)(iii) of Regulation S-K from its disclosure under Item 402(v) of Regulation S-K, because the size of the bonuses paid from the “bonus pool” is determined based wholly or in part on satisfying the financial performance measure, therefore the company is using the financial performance measure to link the executive compensation actually paid to company performance within the meaning of Item 402(v)(2)(vi) and Item 402(v)(6) of Regulation S-K.

Relationship Disclosure

In Regulation S-K C&DIs Question 128D.13, the Staff states that if a company has multiple PEOs in a fiscal year, the Staff will not object to the aggregation of the PEOs’ compensation for purposes of the narrative, graphical, or combined comparison between compensation actually paid and TSR, net income, and the Company-Selected Measure.

Time Periods Presented in the Pay Versus Performance Table

In Regulation S-K C&DIs Interpretation 228D.01, the Staff indicates that if a company changes its fiscal year during the time period covered by the Pay Versus Performance table, the issuer must provide the disclosure required by Item 402(v) of Regulation S-K for the “stub period,” and the company may not annualize or restate compensation. For example, in late 2022, a company that is not a smaller reporting company changed its fiscal year end from June 30 to December 31. In the company’s first Pay Versus Performance table, the company must provide disclosure for each of the following four periods: July 1, 2022 to December 31, 2022; July 1, 2021 to June 30, 2022; July 1, 2020 to June 30, 2021; and July 1, 2019 to June 30, 2020. The company would continue providing such disclosure including the stub period until there is disclosure for five full fiscal years after the stub period. The Staff notes that this approach is consistent with the approach applicable to reflecting changes in fiscal year end in the Summary Compensation Table, as addressed in Regulation S-K C&DIs Interpretation 217.05.

In Regulation S-K C&DIs Interpretation 228D.02, the Staff addresses a situation where a company emerged from bankruptcy, and a new class of stock that was issued under the bankruptcy plan started trading in September 2020. The Staff notes that, consistent with Regulation S-K C&DIs Interpretation 206.14, the company will be presenting less than five full years of data in its stock performance graph under Item 201(e) using a measurement period for the graph from September 2020 through December 2022. For purposes of the requirement in Item 402(v)(2)(iv) of Regulation S-K, the Staff indicates that the company may provide its cumulative TSR and peer group cumulative TSR in the same manner. The Staff states that the company should provide footnote disclosure to explain the approach and its effect on the Pay Versus Performance table.

Next Steps

The Staff’s new guidance addresses some of the questions that have arisen regarding the new pay versus performance disclosure requirement, so this guidance should be factored into the disclosure that companies provide under these new requirements. We expect that further guidance may be coming once the Staff has had an opportunity to review the new disclosures provided during the 2023 proxy season and identify potential areas for improvement or clarification.

[1] Regulation S-K Compliance and Disclosure Interpretations

[2] Release No. 34-95607, Pay Versus Performance (Aug. 25, 2022)

[3] Companies (except for smaller reporting companies) will be required to provide the information for three years in the first proxy or information statement in which they provide the disclosure, adding another year of disclosure in each of the two subsequent annual proxy filings that require the Item 402(v) disclosure.

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