SEC Proposes Pay Versus Performance Disclosure Requirements
On April 29, 2015, the SEC issued a proposing release regarding the so-called "pay versus performance" disclosure mandated by Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposed rules would require certain companies registered under Section 12 of the Securities Exchange Act of 1934 (excluding, for example, emerging growth companies and foreign private issuers) to disclose in both tabular and narrative or graphical format the relationship between "actually paid" named executive officer ("NEO") compensation and total shareholder return ("TSR") performance in their proxy statements.
The proposed rules require each company to provide tabular disclosure of NEO compensation and TSR performance as follows:
- Both Summary Compensation Table ("SCT") total compensation and the compensation "actually paid" to the CEO;
- Both the average SCT total compensation and the average compensation "actually paid" to the company's other NEOs; and
- The company's annual TSR and the annual TSR for a peer group.
The proposed rules also require each company to (i) clearly explain the relationship between the compensation "actually paid" to the NEOs and the company's TSR, as provided in the table, and (ii) compare the company's TSR against the peer group's TSR, again as provided in the table. The SEC has also proposed that this pay versus performance information be provided in interactive data format using XBRL.
"Actually Paid" Compensation
To calculate compensation "actually paid," the proposed rules require each company to adjust SCT total compensation to remove amounts not "actually paid" to the NEOs. The SEC proposes removing from SCT total compensation (i) the change in actuarial present value of pension benefits, and (ii) the grant date fair value of equity awards granted during the year, because these amounts do not reflect compensation "actually paid" for the particular year.
However, to properly account for pension benefits and equity awards, the SEC proposes adding back to this now-adjusted compensation amount (i) the actuarial present value of benefits (under defined benefit or pension plans) attributable to services rendered by the NEO during the year, and (ii) the fair value of equity awards that vested (whether or not actually exercised) during the year, determined as of the vesting date, under accounting rules and guidance, to capture the compensation "actually paid" to a NEO during the year.
This pay versus performance table will require footnote disclosure detailing the adjustments made to SCT total compensation amounts and any material differences between the assumptions used to calculate vesting date fair value and the assumptions used to calculate grant date fair value for the SCT.
Total Shareholder Return
Each company would be required to disclose its TSR and the TSR of a peer group for the year. To calculate both values, the SEC proposes using the same methodology for TSR that the company uses when calculating TSR for the performance graph that appears in the annual report. This calculation takes into account any changes in stock price and dividends or distributions made by the company. In terms of the peer group, the company can either use the peer group it uses for the annual report performance graph or it can use the peer group it uses for NEO compensation benchmarking purposes, as described in the company's Compensation Discussion and Analysis.
Time Periods Covered and Transition Period
The proposed rules require each company to provide the pay versus performance tabular and explanatory information for the five most recently completed fiscal years. The SEC has proposed a transition period under which, initially, the company will be required to disclose the pay versus performance information for only the three most recently completed fiscal years. Additionally, newly reporting companies will be required to disclose the pay versus performance information for only their most recently completed fiscal year. Each subsequent proxy statement will require an additional year of disclosure until all five years are disclosed.
Likely Effectiveness of Proposed Rules
The proposed rules will be subject to comment for 60 days after they are published in the Federal Register. We believe the SEC's goal is to finalize these rules later in 2015 and have them effective for the 2016 proxy season.
Revising disclosure rules to create better disclosure is one thing, but requiring additional, convoluted disclosure simply for disclosure's sake might actually make it harder for investors to clearly understand the connection between a company's NEO pay and its financial performance. We expect these rules will lead to longer and more defensive disclosure by companies, as the proposed disclosure scheme will tell too superficial a story (or perhaps an inaccurate story) of how the company's NEO pay decisions relate or compare to recent company and industry stock price performance. The proposed rules also inject further complexity into NEO compensation measurement and disclosure. For example, will investors mistake "actual" pay for "take home" pay? Will they be able to understand proxy statements that use inconsistent approaches to disclosing the value of NEO pension benefits and equity awards in different sections?
The proposing release states that the SEC believes these proposed rules will not create significant additional work for reporting companies because most of the information required to be disclosed under the proposed rules is already required to be disclosed in a company's proxy statement. Our clients may disagree.
The SEC also states that the proposed rules will not affect how companies set optimal pay packages. However, it is possible that companies may overreact to how equity awards and severance packages are expected to affect their pay versus performance disclosure and affect their say on pay votes in the future. While large equity awards with cliff vesting and carefully crafted severance packages can promote long-term shareholder value, under the proposed rules, these types of awards or payments and benefits could skew the comparison of compensation "actually paid" to NEOs as provided in the required disclosure.
Additionally, we believe companies should prepare for certain stakeholders to attempt to "shame" companies as a result of their pay versus performance and the related Dodd-Frank Act pay ratio disclosure requirements, even where the companies have developed and implemented thoughtful and effective NEO pay programs.
Finally, it remains to be seen to what degree proxy advisory firms will focus on compensation "actually paid" versus realizable pay and to what degree companies will continue to voluntarily disclose realizable or realized pay in their proxy statements.
For further information, please contact your principal Firm representative or one of the lawyers listed below. General email messages may be sent using our "Contact Us" form, which can be found at www.jonesday.com.
Robert T. Clarkson
Stephen P. Coolbaugh
Thomas C. Daniels
Charles T. Haag
James E. O'Bannon
Robert A. Profusek
Kimberly J. Pustulka
Justin S. Reinus, an associate in the Dallas Office, and Robin C. Melman, an associate in the New York Office, assisted in the preparation of this Alert.
Jones Day publications should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general information purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at our discretion. To request reprint permission for any of our publications, please use our "Contact Us" form, which can be found on our website at www.jonesday.com. The mailing of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship. The views set forth herein are the personal views of the authors and do not necessarily reflect those of the Firm.