SEC Requires Public Companies to Disclose Pay-Versus-Performance Measures

The U.S. Securities and Exchange Commission (SEC) has issued a long-awaited final rule that significantly expands executive pay disclosures by publicly traded U.S. companies. The new disclosures, which will provide detailed information about the performance metrics companies use to determine executive compensation payouts, are effective for the 2023 proxy season.

The final rule, issued on Aug. 25 along with a fact sheet summarizing its provisions, was published in the Federal Register on Sept. 8.

The rule implements requirements under 2010's Dodd-Frank Wall Street Reform and Consumer Protection Act. The SEC first proposed a pay-versus-performance disclosure rule in 2015 and reopened the comment period on the proposal in January of this year.

The final rule "provides for new disclosures, describing which performance measures a company deems most important when determining what it pays executives," SEC Chair Gary Gensler said in a statement. "When we reopened the proposal, we asked about requiring companies to name and rank the five most important factors they used for this determination. Based on public comment, the final rule includes a more flexible requirement, allowing companies to disclose the three to seven most important measures in an unranked list."

SEC Commissioner Hester M. Peirce, a Republican appointee, issued a statement that criticized the rule as "a sweeping and complex prescriptive approach that is not required under the [Dodd-Frank] statute." She added that "a simple rule would have accomplished what Congress asked us to do, but with each iteration of this rule, it has gotten more complicated and less useful to the investors it is supposed to serve."

New Disclosures

In addition to the executive-pay summary compensation table that is currently required in company proxy statements, large companies now must provide, in a new table, a five-year history of pay versus performance-related metrics, with a shorter, three-year reporting requirement for smaller companies.

In this table, a company must disclose financial performance measures for specified years, including:

• Total shareholder return (TSR).
• TSR of companies in its peer group.
• Net income.
• A company-selected financial performance measure that the company determines is the most important metric it uses to link compensation actually paid to its named executive officers with company performance.

Companies also must describe the relationships between each of these financial performance measures and the executive compensation paid to the "principle executive officer" (typically, the chief executive officer) and, on average, to its other named executive officers.

Whether the new disclosures will be burdensome, especially for smaller public companies, "depends on to what extent they are already tracking pay versus performance now, but it will be somewhat burdensome regardless," said Brennan Rittenhouse, a managing director with consulting firm A&M Taxand LLC in Denver.

"The specific items and tabular calculations may be different than what is presently being disclosed and require additional effort to detail," he noted.

For smaller reporting companies, "while the scaled disclosure requirements reduce some of these burdens, these entities are least likely to already be including the required information in their current disclosures," Rittenhouse said. As a result, "the additional requirements, despite being scaled down, will still require a significant amount of effort that these companies are not accustomed to."

'Most Important' Measures

Another disclosure under the final rule requires public companies to list, in a separate table, at least three and up to seven of the most important financial performance measures they use to link executive compensation "actually paid" to company performance during the most recently completed fiscal year. One of these metrics must be the company-selected measure included in the new "pay versus performance" table.

As Rittenhouse explained, "the disclosures around the company-selected measure and the three to seven financial performance measures—the 'tabular list'—will require additional narrative to explain how those are calculated and how they impact and influence executive compensation, no easy task given the complexity of some compensation arrangements."

ESG Metrics

Brian Soares and Celia Soehner, partners at law firm Morgan Lewis in Washington, D.C., and Pittsburgh, respectively, blogged that "some commenters asked that the SEC mandate the inclusion of ESG [environmental, social and government] metrics" in the disclosure of a company's most important performance measures.

"While the final rules do not require disclosure of ESG metrics, [companies] may supplement their mandatory pay-for-performance disclosure with a discussion of ESG metrics (or any other nonfinancial performance measure)," Soares and Soehner wrote.

Telling Their Story

A key takeaway from the new rule, Rittenhouse said, is that "it's as important as ever for companies to design their incentive metrics based on behaviors and financials that drive their business and are a good measure of success."

The new rule, he added, "continues the trend of pushing companies to better tell their story, and so it's important to not fall into the trap of just filling out the table, but rather spend time crafting the narrative to really help the reader understand how your pay and performance are aligned."

Effective Dates

Companies must begin to comply with the new disclosure requirements in proxy and information statements for fiscal years ending on or after Dec. 16, 2022.

For the first annual filings after the new requirements take effect, large companies may provide three years of data, instead of five, and small companies may provide two years of data, instead of three.