SEC Clarifies Dodd-Frank Act Pay-Versus-Performance Rules with New C&DIs

Alerts / February 24, 2023
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 format, 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.
  • In anticipation of registrants finalizing their Annual Reports, Proxy Statements and Information Statements, on Feb. 10, the SEC released Compliance and Disclosure Interpretations (C&DIs) to clarify the Final Rules.

As registrants work toward including the new required Item 402(v) of Regulation S-K executive compensation disclosure, the SEC issued new C&DIs to provide some much-needed guidance in applying the Final Rules.

Final Rules

As a reminder, on Aug. 25, 2022, the SEC adopted final pay-versus-performance rules, which can be found here; the BakerHostetler alert regarding the Final Rules can be found here. These pay-versus-performance disclosures are required to 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 new 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 below, and the full C&DIs released by the SEC can be found here. These C&DIs provide clarifications and are generally consistent with how many have been interpreting the Final Rules since their release. The C&DIs, however, do provide additional insight, especially with respect to selecting and identifying peer groups from year to year. 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 calculations and disclosures.

128D.01 – Disclosure Not Required in Form 10-K

The information required pursuant to Item 402(v) of Regulation S-K does not need to be included in Form 10-K despite the directives in Item 11 of Form 10-K that the company provide all information required under Item 402. Instead, the Item 402(v) information need only be supplied in connection with any Proxy Statement or Information Statement. Further, such information provided under Item 402(v) will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

128D.02 – First-Time NEOs and Prior Equity Awards

For the equity award adjustment calculations required by Item 402(v)(2)(iii)(C)(1), equity awards granted to a first-time named executive officer (NEO) in a year prior to the NEO’s appointment as officer are required to be included in the calculations, even if they were not reported in the Summary Compensation Table. 

128D.03 – Footnote Disclosure of Adjustments

Item 402(v)(3) requires that for each amount disclosed in columns (c) (compensation actually paid to the principal executive officer (PEO)) and (e) (average compensation actually paid to the other NEOs) of the Pay-Versus-Performance Table, the registrant must include footnote disclosure of each of the amounts deducted and added pursuant to Item 402(v)(2)(iii) (adjustments for pension benefits and equity awards). Initially, the footnote disclosure is required for each of the periods presented in the table. However, for subsequent years, the footnote disclosure is only required for the most recent fiscal year presented in the table unless including all years presented in the table would be deemed material to an investor’s understanding of the information presented in the table or of the relationship under Item 402(v)(5).

128D.04 – No Aggregation of Adjustments

Item 402(v)(3) requires that for each amount disclosed in columns (c) (compensation actually paid to the PEO) and (e) (average compensation actually paid to the other NEOs) of the Pay-Versus-Performance Table, the registrant should provide footnote disclosure of each of the amounts deducted and added pursuant to Items 402(v)(2)(iii)(B)(1)(i) - (ii) and Items 402(v)(2)(iii)(C)(1)(i) - (vi). The aggregate amount calculated for pension value adjustments alone is not sufficient.

128D.05 – Compensation Peer Group Selection

Under Item 402(v)(2)(iv), the registrant is required to calculate peer group total shareholder return (TSR) using the same index or issuers as used for its performance graph or the companies used as a peer group for purposes of its Compensation Discussion and Analysis (CD&A), which does not need to be a peer group used for “benchmarking” under Item 402(b)(2)(xiv). Benchmarking is further explained in C&DI 118.05 and C&DI 128D.05.

128D.06 – Calculating TSR for Newly Public Companies

For purposes of determining the time period required to be presented in the Pay-Versus-Performance Table for cumulative TSR and peer group TSR, if the registrant went public during the earliest year in the table, the “measurement point” for the calculations should begin on the Exchange Act registration date, consistent with the calculation of TSR under Item 201(e) of Regulation S-K.

128D.07 – Compensation Peer Group Changes

For purposes of peer group TSR, if a registrant uses different peer groups for the various years over the disclosure period in its CD&A, the registrant should present the peer group TSR for each year in the table using the same peer group disclosed in its CD&A for that year.

128D.08 – Net Income Must Be from Audited GAAP Financial Statements

A registrant is required to provide in column (h) of the Pay-Versus-Performance Table its net income or loss as required by Regulation S-X, as disclosed in the registrant’s audited GAAP financial statements. The net income is not to include consolidated subsidiaries or discontinued operations.

128D.09 – Company-Selected Measure as a Derivation of Net Income or TSR

The Company-Selected Measure required by Item 402(v)(2)(vi) can be any financial performance measure that differs from the financial performance measures otherwise required to be disclosed in the table (net income and the cumulative total shareholder return), and it may be derived from, a component of, or similar to those required measures.

128D.10 – Bona Fide Link Between Financial Performance Measure and Compensation

A financial performance measure may be used as a Company-Selected Measure under Item 402(v)(2)(vi) only if the company actually uses that measure to link compensation actually paid to NEOs to company performance. The impact on the amounts reported in the Pay-Versus-Performance Table does not matter; only the fact that the measure links NEO compensation to company performance matters. While stock price is considered a “financial performance measure” for purposes of Item 402(v)(2)(vi), it should not be disclosed as a Company-Selected Measure if stock price is not used to link compensation actually paid to NEOs to company performance.

128D.11 – Company-Selected Measure and Multiyear Performance Periods

Under Item 402(v)(2)(vi), the Company-Selected Measure is the most important financial performance measure (that is not otherwise required to be disclosed in the table) used by the registrant to link compensation actually paid to the registrant’s named executive officers, for the most recently completed fiscal year, to company performance. Therefore, the Company-Selected Measure cannot be measured over a multiyear period.

128D.12 – Financial Performance Measures and ‘Pool Plans’

Even if a registrant under a “pool plan” does not use any other financial performance measures in determining executive compensation, the registrant may not omit the Tabular List required under Item 402(v)(6) or the Company-Selected Measure and related relationship disclosure.

128D.13 – Multiple PEOs and Comparative Disclosure

If the registrant has multiple PEOs in a fiscal year, Item 402(v) requires that it provide separate columns in the Pay-Versus-Performance Table for each PEO. However, the registrant may aggregate 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, so long as the presentation is not misleading to investors.

228D.01 – Change of Fiscal Year

If a registrant changes its fiscal year during the periods covered by the Pay-Versus-Performance Table, the registrant should provide the disclosure required by Item 402(v) for the “stub period” and should not annualize or restate compensation. 

228D.02 – Emergence from Bankruptcy

If a registrant emerged from bankruptcy and issued a new class of stock under a bankruptcy plan starting in September 2020, for the Pay-Versus-Performance Table, the registrant may present its cumulative total shareholder return and peer group cumulative total shareholder return over a period less than five full years, using a measurement period from September 2020 through December 2022. However, the registrant should provide footnote disclosure to explain the approach and its effect on the Pay-Versus-Performance Table.

Baker & Hostetler LLP publications are intended to inform our clients and other friends of the firm about current legal developments of general interest. They should not be construed as legal advice, and readers should not act upon the information contained in these publications without professional counsel. The hiring of a lawyer is an important decision that should not be based solely upon advertisements. Before you decide, ask us to send you written information about our qualifications and experience.