New SEC Rules on Executive Compensation Reporting

Pay versus performance requirements

SEC registrants: Have you seen the new pay versus performance requirements? On August 25, 2022, the SEC adopted a final rule aimed at providing more insight into the relationship between company performance and executive compensation.

This new rule created a new Item 402(v) of Regulation S-K, which requires registrants to clearly disclose the relationship between the executive compensation actually paid by the registrant and the financial performance of the registrant over the applicable time period of the disclosure.

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

What does this mean?

The SEC’s new rule requires companies to disclose the relationship between executive compensation and the company’s financial performance, including information on the company’s total shareholder return and the performance of the company’s peers. This allows shareholders to better evaluate whether executive compensation is aligned with company performance.

The new rule requires registrants to provide a table disclosing specified executive compensation and financial performance measures for the registrant’s five most recently completed fiscal years. Scaled-back disclosure requirements for smaller reporting companies (SRCs) require the three most recently completed fiscal years. Emerging growth companies, as defined, are exempted from the disclosure requirements.

Transition guidance allows for non-SRCs to provide the disclosures for three years (instead of five) in the first applicable filing and provide an additional year in each of the two subsequent annual filings. SRCs may provide two years of data (instead of three) in the first applicable filing and an additional year in the subsequent filing.

The following information is to be presented in tabular format for each of the past five years (three years if an SRC):

• Year
• Total compensation shown in the summary compensation table (SCT total) for the company’s principal executive officer (PEO)
• Compensation actually paid to the PEO
• Average SCT total for the company’s remaining named executive officers (NEOs)
• Average compensation paid to the remaining NEOs
• Cumulative total shareholder return (TSR) of the company
• The TSR of the company’s peer group (not required for SRCs)
• The company’s net income
• A measure chosen by the company and specific to the company as a measure of financial performance (not required for SRCs)

Computing “compensation actually paid” requires vesting date and year-end measurement of outstanding and unvested equity awards, as of the respective valuation dates. Post-vesting changes in fair value are not considered — to distinguish a registrant’s compensatory decision from an executive’s (post-vesting) investing decision.

Equity awards are required to be disclosed in the years they are granted, and changes in their values must be reported from year to year until the awards have vested or until the company determines that the awards will not vest. “Fair value” must be used to measure of the amount of equity awards.

Equity award amounts reported in the SCT total in Item 402(v) require the addition (or subtraction, as applicable) of the following:

• The year-end fair value of any equity awards granted in the covered fiscal year that are outstanding and unvested as of the end of the covered fiscal year.
• The amount of change as of the end of the covered fiscal year (from the end of the prior fiscal year) in fair value of any awards granted in prior years that are outstanding and unvested as of the end of the covered fiscal year.
• For awards that are granted and vest in the same covered fiscal year, the fair value as of the vesting date.
• For awards granted in prior years that vest in the covered fiscal year, the amount equal to the change as of the vesting date (from the end of the prior fiscal year) in fair value.
• For awards granted in prior years that are determined to fail to meet the applicable vesting conditions during the covered fiscal year, a deduction for the amount equal to the fair value at the end of the prior fiscal year.
• The dollar value of any dividends or other earnings paid on stock or option awards in the covered fiscal year prior to the vesting date that are not otherwise reflected in the fair value of such award or included in any other component of total compensation for the covered fiscal year.

Companies must disclose, in a footnote, any valuation assumptions that materially differ from those disclosed at the time of an equity grant. When multiple equity awards are being valued in any given year, a company must disclose a range of assumptions used or a weighted-average amount for each assumption.

Do you need a valuation?

Valuation is also an important aspect of the pay-for-performance rule, as it may be required in certain situations. A valuation may be needed for stock option plans and other forms of equity-based compensation, as it is used to determine the fair value of the securities that have been granted.

If your company has complex awards, such as those with market-based vesting, the valuation may require the use of a more sophisticated valuation technique, such as Monte Carlo simulation model or lattice model.

How we can help

CLA can help you value your equity-based compensation and comply with this new rule. CLA can also help you efficiently gather the data and calculations necessary to measure performance relative to your peers. Please reach out to CLA if your company needs assistance in understanding the requirements or revaluating the equity-based compensation.