Key Takeaways

• On August 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 format, how their executive compensation is paid in relation to their financial performance.
• The Final Rules largely adopt the earlier rules proposed by the SEC.
• Registrants must begin to comply with the new disclosure requirements in Annual Reports, Proxy Statements and Information Statements that are required to include Item 402 executive compensation disclosure for fiscal years ending on or after December 16, 2022.

Overview

Under Congress’ directive, Section 953(a) of the Dodd-Frank Act requires the SEC to adopt rules around public company disclosure of compensation paid to its executives versus financial performance. Although it has taken 12 years to adopt the Final Rules, Section 953(a) was enacted at the same time as two other executive compensation-related provisions that were designed to address shareholder rights and executive compensation practices. These other provisions, which have already been implemented, require, respectively, that a separate resolution be put to a non-binding shareholder vote, not less than every three years, to approve compensation of executives, and that registrants disclose the ratio of the median annual total compensation of employees to the annual total compensation of the chief executive officer.

After seven years of engaging in rulemaking, on August 25, 2022, the SEC adopted the Final Rules, which incorporate aspects from the Proposed Rules (see section below) in addition to new mandated items.

Proposed Rules

Section 953(a) of the Dodd-Frank Act added Section 14(i) to the Securities Exchange Act of 1934, which directs the SEC to adopt a rule requiring disclosure of the relationship between executive compensation actually paid and the issuer’s financial performance. On April 29, 2015, the SEC, by a 3-2 vote, proposed the pay-versus-performance disclosure rule required by Section 953(a) (the “2015 Proposal”). The 2015 Proposal can be found here and the BakerHostetler alert about the 2015 Proposal here.

On January 27, 2022, the SEC reopened the comment period for the 2015 Proposal, which set forth proposed rules requiring registrants to disclose, in both tabular and narrative format, how their executive compensation is paid in relation to their financial performance (the “Reopening Release”). The Reopening Release can be found here and the BakerHostetler alert about the Reopening Release here.

Final Rules

Tabular Disclosure

The Final Rules largely adopted the 2015 Proposal. The Final Rules require tabular disclosure of the following items, for the registrant’s five most recently completed fiscal years:

1. the Summary Compensation Table measure of total compensation for the principal executive officer (“PEO”);
2. a measure reflecting “compensation actually paid” for the PEO;
3. the average Summary Compensation Table measure of total compensation for the other named executive officers (“NEOs”);
4. a measure reflecting the average “compensation actually paid” for the NEOs;
5. total shareholder return (“TSR”) for the registrant;
6. TSR for the registrant’s peer group;
7. the registrant’s net income; and
8. a “Company-Selected Measure” of financial performance.

The above-mentioned tabular disclosures should be presented in the following manner, with the asterisked items denoting the exemptions for smaller reporting companies (“SRCs”):

17 CFR Parts 229, 232 and 240 [Release Nos. 34-95607; File No. S7-07-15] at page 12.

Items 7 and 8 (net income and Company-Selected Measure) are the new additions from the Proposed Rules. The SEC noted in the Reopening Release that it was also considering requiring disclosure of income or loss before income tax and expense, but ultimately the SEC decided not to require such disclosure.

In addition, new Item 402(v) of Regulation S-K requires registrants to provide an unranked list of three to seven of the most important performance measures that link executive compensation actually paid to the registrant’s NEOs during the last fiscal year to company performance. Registrants may include non-financial performance measures if such measures are among their most important performance measures. However, the newly added Company-Selected Measure must be chosen from such list and reflect the registrant’s single most important financial performance measure for that fiscal year, not otherwise already disclosed in the pay-versus-performance table. The Final Rules allow registrants to voluntarily provide additional measures of compensation or financial performance and other supplemental disclosures, provided any such additional information is clearly identified as supplemental, is not misleading and is not presented with greater prominence than the required disclosure.

If a registrant had multiple PEOs at any point over the past five years, the Final Rules, diverging from the Proposed Rules, require registrants to report compensation for each PEO in its own column rather than aggregating the compensation of all PEOs.

Narrative/Graphical Disclosure

As proposed, registrants are also required to provide a clear narrative, graphical, or combined narrative and graphical description of the relationship between executive compensation actually paid and the registrant’s TSR, and between the registrant’s TSR and peer group TSR, also over the registrant’s five most recently completed fiscal years.

Likewise, the Final Rules require registrants to provide a clear narrative, graphical, or combined narrative and graphical description of the relationship between executive compensation actually paid and net income, and between executive compensation actually paid and the Company-Selected Measure.

The Proposed Rules considered mandating registrants to include the disclosures in the Compensation Discussion and Analysis (CD&A) section of its Proxy Statement; however, the Final Rules provide registrants with flexibility in determining where in the Proxy Statement or Information Statement to include the required disclosure.

Smaller Reporting Companies

As with the limited disclosure requirements for smaller reporting companies (SRCs) under the 2015 Proposal and Reopening Release, the Final Rules provide exemptions for companies that qualify as SRCs under Section 13(a) or 15(d) of the Exchange Act. The Final Rules adopt scaled disclosure requirements for SRCs, requiring three instead of five years of disclosures. Moreover, SRCs are not required to disclose peer group TSR, a Company-Selected Measure, a Tabular List or amounts related to pensions.

In addition, SRCs will only be required to present narrative or graphical descriptions with respect to the measures they are required to include in the table and for their three, rather than five, most recently completed fiscal years.

Reporting companies that qualify as foreign private issuers, registered investment companies or emerging growth companies will not be required to provide these disclosures.

Additional Information

The Final Rules require registrants to separately tag each value disclosed in the table, block-text tag the footnote and relationship disclosure, and tag specific data points (such as quantitative amounts) within the footnote disclosures, all in Inline XBRL.

The Final Rules will become effective 30 days following publication of the release in the Federal Register. Registrants must begin to comply with the new disclosure requirements in Annual Reports, Proxy Statements and Information Statements that are required to include Item 402 executive compensation disclosure for fiscal years ending on or after December 16, 2022.

The Final Rules can be found here.

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