Corp Fin has posted some new CDIs on pay versus performance. In August last year, the SEC finally adopted a new rule requiring disclosure of information reflecting the relationship between executive compensation actually paid by a company and the company's financial performance—a new rule that had been 12 years in the making, mandated in 2010 by Dodd-Frank. (See this PubCo post.) The final amendments added new Item 402(v) of Reg S-K, which requires companies to describe the relationship between executive compensation actually paid and the financial performance of the company for the five most recently completed fiscal years (three for smaller reporting companies) in proxy or information statements in which executive compensation disclosure is required. Generally, for most companies, the new disclosures were first required for the 2023 proxy season. Apparently some issues cropped up, reflected in these new CDIs.
Summary of the rule
For the most part, the CDIs are fairly technical—several of them deal with the complex calculations required for compensation actually paid in the PVP table in Item 402(v)(2)(iii)(C)(1)—so a brief reminder of how the rule works might be useful. Item 402(v) requires companies to provide a table disclosing specified executive comp and financial performance measures for the principal executive officer and, as a "mean" average, for the other named executive officers (as defined in Item 402 for all companies and for SRCs, respectively). To allow investors to assess whether changes in the composition of the NEO group led to changes in the average compensation reported from year to year, companies also need to identify in a footnote the individual NEOs whose compensation is included in the average for each year. The table must include a measure of total comp (taken from the Summary Comp Table), as well as a measure reflecting "executive compensation actually paid," a complex calculation prescribed by the rule. In addition, the table must include as financial performance measures "total shareholder return" for both the company and for its peer group, as well as the company's net income and a financial performance measure selected by, and specific to, the company that the company believes "represents the most important financial performance measure," not otherwise in the table, that the company uses to link NEO CAP to company performance for the most recently completed fiscal year (referred to as the "Company-Selected Measure"). In years when a company had multiple PEOs, the company would need to include separate SCT total comp and CAP columns for each PEO.
The company is also required to "clearly describe," using the information presented in the table, the relationships between PEO CAP and the mean average remaining NEO CAP and three measures of the company's financial performance: cumulative TSR; net income; and the Company-Selected Measure, again over the five most recently completed fiscal years. The company also needs to describe the relationship between the company's TSR and the weighted TSR of its peer group over the same period. SRCs can take advantage of scaled disclosure, describing only the measures they are required to include in the table and for their three, rather than five, most recently completed fiscal years.
Finally, the company (other than an SRC) is also required to provide an unranked tabular list of three to seven of the most important financial performance measures—which must include the Company-Selected Measure—used by the company to link NEO CAP during the last fiscal year to company performance. Companies may also include non-financial performance measures in this list if they considered those measures to be among their "most important" measures. Companies may also voluntarily provide supplemental measures of compensation or financial performance or other supplemental disclosures, so long as they are "clearly identified as supplemental, not misleading, and not presented with greater prominence than the required disclosure." The rules apply to all reporting companies, except foreign private issuers, registered investment companies and emerging growth companies. SRCs may provide scaled disclosures.
New CDIs
The new CDIs can all be found under the caption for Reg S-K, Item 402(v), with one exception for a newly revised CDI under Item 402(b). Summaries are below, but each CDI number below is linked to the CDI on the SEC website, so you can easily read the version in full. (See this PubCo post for information about the PVP CDIs that Corp Fin posted in February.)
Item 402(b) ― Executive Compensation; Compensation Discussion and Analysis
- Question 118.08 Instruction 5 to Item 402(b) provides that "[d]isclosure of target levels that are non-GAAP financial measures will not be subject to Regulation G and Item 10(e); however, disclosure must be provided as to how the number is calculated from the registrant's audited financial statements." This instruction applies only to disclosure in CD&A of NGFMs that are target levels. If NGFMs are used in CD&A or elsewhere in the proxy for any other purpose, such as to explain how NEO pay is structured or implemented to reflect NEO or company performance or to justify certain levels of pay, those NGFMs are subject to Reg G and Item 10(e) of Reg S-K (except for PVP disclosure of the Company-Selected Measure or additional financial performance measures under Item 402(v)(2)(vi) of Reg S-K). The CDI provides that, in these pay-related circumstances only, the staff will not object if the company includes the required GAAP reconciliation and other information in an annex to the proxy statement, so long as company includes a prominent cross-reference to the annex. Or, if the NGFMs are the same as those included in Part III of the Form 10-K through incorporation by reference of Item 402 disclosure, the staff will not object if the company complies with Reg G and Item 10(e) with a prominent cross-reference to the pages in the Form 10-K containing the required GAAP reconciliation and other information.
Section 128D. Item 402(v) ― Pay versus Performance
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New Question 128D.14 All outstanding stock and option awards
that are unvested at the beginning of the covered fiscal year or
are granted during the year, and for which compensation cost will
be recognized under FASB ASC Topic 718, should be included in the
PVP table (Item 402(v)(1))—including awards modified in
connection with, or retained following, an equity
restructuring.
-
New Question 128D.15 For purposes of calculating CAP for stock
and option awards in the PVP table (Item 402(v)(2)(iii)(C)(1)), the
change in fair value of pre-IPO stock or option grants should be
determined based on the change from the end of the prior fiscal
year. The fair value of these awards should not be determined based
on the date of the IPO or other dates.
-
New Question 128D.16 Consistent with Topic 718, the effect of a
market condition should be reflected in the fair value of
share-based awards with market conditions. Even though, under GAAP,
market conditions are not considered vesting conditions, for
purposes of determining CAP for stock and option awards in the PVP
table (Item 402(v)(2)(iii)(C)(1)), market conditions "should
be considered in determining whether the vesting conditions of
share-based awards have been met. That is, until the market
condition is satisfied, registrants must include in executive
compensation actually paid any change in fair value of any awards
subject to market conditions. Similarly, registrants must deduct
the amount of the fair value at the end of the prior fiscal year
for awards that fail to meet the market condition during the
covered fiscal year if it results in forfeiture of the
award."
-
New Question 128D.17 For purposes of determining CAP for stock
and option awards in the PVP table (Item 402(v)(2)(iii)(C)(1)(v)),
awards that have not vested because, for example, performance or
market conditions were not met in an eligible year, but remain
outstanding and may vest in the future, "are not considered to
have failed to meet the applicable vesting conditions for the
purpose of Item 402(v)" and should not be subtracted.
According to Corp Fin, Item 402(v)(2)(iii)(C)(1)(v) is referring to
awards that were forfeited and the cumulative reported
value of that award is $0.
-
New Question 128D.18 For stock and option awards that allow
accelerated vesting if the holder becomes retirement eligible, for
purposes of the PVP table and calculation of CAP, the award
condition would be considered satisfied in the year that the holder
becomes retirement eligible, provided that retirement eligibility
is the only vesting condition. For awards with substantive
conditions in addition to retirement eligibility, those other
conditions must also be considered in determining when an award has
vested.
-
New Question 128D.19 If a stock or option award includes a
performance condition that, as an additional substantive
vesting condition, requires certification by others, such as
the comp committee, that the level of performance was attained,
then the award would not be considered vested until certification.
Accordingly, in those circumstances, if the performance condition
was met by fiscal year end and the certification occurred after
year-end, for purposes of the PVP table, the award would not be
considered vested by year end. However, Corp Fin cautions, "a
provision which requires the compensation committee to certify the
level of performance attained should be analyzed to determine if it
creates an additional substantive vesting condition, such as an
employee does not vest in the award unless and until they remain
employed through the date such certification occurs."
-
New Question 128D.20 For purposes of determining CAP for stock
and option awards in the PVP table (Item 402(v)(2)(iii)(C)(3)), the
fair value of all stock and option awards must be computed in a
manner consistent with the methodology used to account for
share-based payments under GAAP. The company may use a valuation
technique that differs from the one used to determine the grant
date fair value of option or other equity-based awards that are
classified as equity in the financial statements, so long as the
valuation technique would be permitted under Topic 718,
"including that it meets the criteria for a valuation
technique and the fair value measurement objective. For example, if
another valuation technique provides a better estimate of fair
value subsequent to the grant date," and would meet the
measurement objective in GAAP, then the company may use that
technique to calculate CAP in the PVP table. However, if the
technique differs materially, Corp Fin expects the company to
disclose both the change in valuation technique from the grant date
and the reason for the change under Item 402(v)(4), which requires
disclosure about the assumptions made in the valuation that differ
materially from those disclosed as of the grant date of such equity
awards.
-
New Question 128D.21 For purposes of determining CAP for stock
and option awards in the PVP table (Item 402(v)(2)(iii)(C)(3)),
which requires use of the same methodology and assumptions to
compute the fair value of stock and option awards as used to
account for share-based payments in the financial statements under
Topic 718, it is "not acceptable to value these awards as of
the end of a covered fiscal year based on methods not prescribed by
GAAP." For example, the assumption related to the expected
term "should not be determined using a method that is not
acceptable under GAAP, such as a 'shortcut approach' that
simply subtracts the elapsed actual life from the expected term
assumption at the grant date. This approach would not be acceptable
because it does not consider whether there were changes in the
factors that a registrant considers in determining the expected
term assumption at grant date, such as volatility and/or exercise
behavior." According to Corp Fin, "GAAP fair value
measurement objectives require that assumptions and measurement
techniques be consistent with those that marketplace participants
would likely use in determining an exchange price for the share
options. Similarly, the expected term for options referred to as
'plain vanilla' in Staff Accounting Bulletin 14.D.2 should
not be determined using the 'simplified' method described
in that Staff Accounting Bulletin if those options do not meet the
'plain vanilla' criteria at the re-measurement date, such
as when the option is now out-of-the-money."
- New Question 128D.22 In connection with equity awards reflected in the PVP table (Item 402(v)(2)(iii)(C)(3)), companies are required under Item 402(v)(4) to disclose in a footnote to the table "any assumption made in the valuation of equity awards that differs materially from those disclosed as of the grant date of such equity awards." If the disclosure would involve confidential trade secrets or confidential commercial or financial information, the disclosure of which would result in competitive harm to the company, the company may omit that information. A company "is not required to disclose detailed quantitative or qualitative performance condition[s] for its awards under Item 402(v)(4) to the extent such information would be subject to the confidentiality protections of Instruction 4 to Item 402(b) of Regulation S-K." However, Corp Fin advises that the company "must provide as much information responsive to the Item 402(v)(4) requirement as possible without disclosing the confidential information, such as a range of outcomes or a discussion of how a performance condition impacted the fair value. In addition, consistent with Instruction 4 to Item 402(b), the registrant should also discuss how the material difference in the assumption affects how difficult it will be for the executive or how likely it will be for the registrant to achieve undisclosed target levels or other factors."
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