Performance Anxiety: SEC Proposes Pay Versus Performance Rule

Eversheds Sutherland (US) LLP

On April 29, 2015, by a 3-2 vote, the Securities and Exchange Commission (the SEC) voted to propose a rule to implement Section 14(i) of the Securities Exchange Act of 1934 (the Exchange Act), as added by Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). Section 953(a) was part of a series of changes to executive compensation disclosure which also included the say-on-pay rule adopted in 2011 and the pay-ratio rule1 proposed in 2013, which awaits final action.

The proposed rule under Section 14(i) of the Exchange Act would amend Item 402 of Regulation S-K to require registrants to provide (1) tabular disclosure of the executive compensation actually paid and the financial performance of the registrant, as indicated by the registrant’s total shareholder return, and (2) a description of the relationship between the information provided in the table. The SEC has issued a press release announcing the proposed rule, and a copy of the proposed rule. The comment period for the proposed rule will expire on July 6, 2015, 60 days after the proposed rule was published in the Federal Register.

Summary of Proposed Rule

Section 14(i) of the Exchange Act mandated that the SEC enact rules requiring registrants to provide “a clear description of… the information that shows the relationship between executive compensation actually paid and the financial performance of the issuer.” In order to fulfill this charge, the SEC proposed a rule creating Item 402(v) of Regulation S-K, which would require tabular disclosure of the following:

  • The “executive compensation actually paid” to the principal executive officer (PEO) and the total compensation reported in the Summary Compensation Table for the PEO;
  • An average of the “executive compensation actually paid” to the remaining named executive officers and an average of the total compensation reported in the Summary Compensation Table for the remaining named executive officers;
  • The registrant’s cumulative total shareholder return (TSR); and
  • The cumulative TSR of the companies in a peer group chosen by the registrant.

The rule specifies that the information be disclosed in tabular format as shown below:


Summary Compensation Table Total for PEO
Compensation Actually Paid to PEO  
Average Summary Compensation Actually Paid to Non-PEO Named Executive Officers
Average Compensation Actually Paid to Non-PEO Named Executive Officers
Total Shareholder Return
Peer Group Total Shareholder Return

Further, the registrant would be required to describe (1) the relationship between executive compensation actually paid and the registrant’s TSR; (2) the relationship between the registrant’s TSR and the peer group TSR. Such disclosure would follow the table and could be described in a narrative, a graphic form, or a combination of the two.


The disclosure would be required in any proxy statement or information statement for which disclosure under Item 402 of Regulation S-K is required. Currently, SEC forms for proxy and information statements require Item 402 disclosure if the action involves: (i) the election of directors; (ii) any bonus or profit sharing or similar arrangement with the registrant’s directors or executive officers; or (iii) certain pension or retirement plans for directors or executive officers. Although Item 402 disclosure is also required in Form 10-K and registration statements under the Securities Act of 1933, as amended, (the Securities Act), the SEC has proposed to limit the pay for performance disclosure required under new Item 402(v) to proxy and information statements.

Item 402(v) calls for registrants to provide pay-versus-performance disclosure information for the registrant’s five2 most recently completed fiscal years that the registrant was subject to reporting under the Exchange Act. Smaller reporting companies must provide such information for the three3 most recently completed fiscal years. Under the terms of Section 14(i), “emerging growth companies”4 are excluded from the pay-versus-performance disclosure requirements. Neither would foreign private issuers be subject to new Item 402(v).

Registered investment companies would not be required to provide Item 402(v) disclosure. Business development companies (BDCs) would be treated in the same manner as issuers other than registered investment companies, and therefore, would be subject to the disclosure requirement of new Item 402(v). However, BDCs that are externally managed or that qualify as emerging growth companies would not be subject to Item 402(v).

Executive Officers Covered

The SEC’s proposal would cover the registrant’s “named executive officers” as defined in Item 402(a)(3) of Regulation S-K. For smaller reporting companies, executives covered by the new Item 402(v) disclosure would be the “named executive officers” required to be disclosed under Item 402(m). The SEC notes that the named executive officers are the persons covered by current disclosure in the Item 402(c) Summary Compensation Table. However, unlike the Summary Compensation Table, Item 402(v) requires information to be separately provided: (i) for the principal executive officer5 and (ii) as an average for the remaining named executive officers identified in the Summary Compensation Table. Under the SEC’s proposal, if more than one person served as the principal executive officer of the registrant, then the disclosure must be aggregated to reflect the total amount that was paid by the registrant for the services of a principal executive officer. In its proposal, the SEC explains that disclosing the average compensation actually paid for the remaining named executive officers would provide shareholders with meaningful information about executive compensation despite variability in the composition and number of named executive officers over the years for which disclosure is required.

Executive Compensation Actually Paid

Exchange Act Section 14(i) does not define the phrase “executive compensation actually paid,” nor is there a current definition under Item 402 of Regulation S-K. The SEC proposes a definition that would start with total compensation as reported in the Summary Compensation Table,6 and modify that amount to adjust for pension benefits and equity awards.

Changes in Pension Value. The first adjustment requires the registrant to deduct the change in actuarial present value of all defined benefit pension plans, as disclosed in the Summary Compensation Table, and then add the actuarially determined service cost for services rendered by the executive during the applicable year. The change in the actuarial present value of all defined benefit and pension plans is currently required disclosure under column (h) of the Summary Compensation Table and the Pension Benefits Table required by Item 402(h). By removing this measure and adding back in only the pension costs for benefits earned during the particular year, the SEC has stated that it believes the amount included will more accurately estimate the value set aside to fund the pension benefits payable upon retirement for services rendered during the applicable year.

Equity Awards. While the Summary Compensation Table requires that equity awards be presented using the grant date fair value, the SEC’s proposal would use the fair value of equity awards on the date of vesting. The SEC explains that by using vesting-date valuations, the compensation disclosed will take into account any presumed change in value of equity awards between the grant and vesting date. Accordingly, for purposes of Item 402(v), the grant date fair value awards of stock and options, with or without tandem stock appreciation rights (SARs), would be subtracted from total compensation reported in the Summary Compensation Table, and the following would be added in their place:

  • For awards of stock that vested in the applicable year, the fair value at the vesting date, computed in accordance with the fair value guidance in FASB ASC Topic 718; and
  • For awards of options with or without tandem SARs that vested in the applicable year, the fair value at the vesting date, computed in accordance with the fair value guidance in FASB ASC Topic 718, whether or not the awards were exercised in the year of vesting.

As proposed, a registrant would be required to disclose vesting date valuation assumptions if they are materially different from those disclosed in its financial statements as of the grant date.

If during the last completed fiscal year the registrant adjusted or amended the exercise price of previously vested options or SARs held by a named executive officer, then the new proposed Item 402(v) would require the registrant to include the incremental fair value, computed as the excess fair value of the modified award over the fair value of the original award upon vesting of the modified award. If the modified award is subject to multiple vesting dates, the pro rata incremental fair value would be determined and included in compensation actually paid at each vesting date.

Measure of Performance – Total Shareholder Return

New Item 402(v) would utilize TSR, as defined in Item 201(e) of Regulation S-K, as the measure of financial performance of the registrant for the purposes of pay-versus-performance disclosure. In addition to disclosing the registrant’s TSR for the applicable period, the new Item 402(v) also requires the registrant to disclose the TSR of a peer group, either using the same peer group used for purposes of Item 201(e) of Regulation S-K (the performance graph), or a peer group used in the compensation discussion and analysis for purposes of disclosing the registrant’s compensation benchmarking practices. If the peer group is not a published industry or line-of-business index, the registrant would be required to disclose the identity of the issuers in such group. A registrant that has previously disclosed the composition of issuers in its peer group in prior filings with the SEC would be permitted to comply with the proposed requirement by incorporating a reference to those filings.

XBRL Tagging

The SEC’s proposal would also require that the disclosure provided by Item 402(v), and any related footnote disclosure, be provided in an interactive data format using XBRL. The proposal would require registrants to tag separately the values disclosed in the required table, and to separately block-text tag: (i) the disclosure of the relationship among the measures; (ii) the footnote disclosure of deductions and additions used to determine “executive compensation actually paid”; and (iii) the footnote disclosure regarding vesting date valuation assumptions. As a result, shareholders and others will be able to readily compare and create databases based on the information provided by Item 402(v).

Supplemental Disclosure

Under new Item 402(v), registrants would be permitted to provide supplemental measures of executive compensation actually paid and financial performance so long as any additional disclosures are clearly identified, are not misleading, and are not presented with greater prominence than the required disclosure. This aspect of the proposal offers some flexibility for registrants that, for example, use concepts such as “realizable pay” and “realized pay” in their proxy statements as a means of comparing pay and performance. However, the SEC’s proposal makes clear that supplemental information must be identified as such and should not take away from the comparability of uniform disclosure across registrants.

Closing Considerations

The SEC’s proposal comes on the heels of a push from House Democrats to encourage the SEC to implement Dodd-Frank Act Section 953(b). A letter to SEC Chair Mary Jo White signed by 58 Democrats, including the ranking member of the House Financial Services Committee, urged the SEC to “move quickly” to finalize the rules implementing Section 953(b).

The comment period for the proposed rule will expire on July 6, 2015, 60 days after the rule was published in the Federal Register. If the rule is finalized in 2015, it could be effective as soon as the 2016 proxy season.

1 Section 953(b) of the Dodd-Frank Act required the SEC to adopt rules requiring public companies to disclose the ratio of the compensation of its chief executive officer to the median compensation of its employees. The proposed pay-ratio rule.
2 The rule would provide transitional relief, requiring three years of pay-versus-performance information in the first year of the rule’s applicability, four years of information in the second, and disclosure covering the five most recently completed fiscal years in the third year of the rule’s applicability.
3 Similarly, smaller reporting companies would be allowed transitional relief to provide only two years of information in the first year of the rule’s applicability.

4 As defined in Section 3(a) of the Exchange Act, an issuer with total annual gross revenues of less than $1 billion during its most recently completed fiscal year.

5 The term “principal executive officer” used in Section 402(v) would have the same meaning as in Items 402(a)(3) and 402(m)(2) of Regulation S-X and would include an individual acting in the same capacity.
6 Inclusive of items such as salaries, bonuses, stock awards, option awards, changes in pension value, non-qualified deferred compensation earnings, and all other compensation as required by Item 402(c), with such modifications as discussed in this section.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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