SEC Issues Guidance on Final Pay Versus Performance Rules

By David Gordon, Dina Bernstein, Bindu M. Culas, Samantha Nussbaum


On February 10, 2023, the SEC issued much-awaited additional guidance (the “SEC Guidance”) on how to implement the pay versus performance (“PVP”) disclosure rules (the “PVP Rules”) that were adopted on August 25, 2022.  For a general discussion of those rules, see here.  While additional governmental guidance is generally welcome, the timing of this guidance at the beginning of “proxy season” presents a challenge as companies have had to forge ahead in the past few months and already made decisions with respect to the form and content of their PVP disclosures.  These decisions will now need to be revisited in many cases. 

Rather than discuss each of the 15 areas of guidance just issued (the Compliance and Disclosure Interpretations (“CDIs”) consist of 13 CDIs numbered from 128D.01 through 128D.13 and two numbered from 228D.01 and 228.02), this blog will focus on the areas that seemed most likely to impact PVP disclosures, based on the work we have been doing with clients.  The new CDIs are part of the SEC’s CDIs covering Regulation S-K and can be found here.

Also, for those of you not enmeshed in the PVP disclosures, some of this discussion may seem overly arcane.  For a summary overview of the PVP Rules, please see our client alert linked above.

128D.04 – Detailed Compensation Actually Paid (“CAP”) Reconciliation Footnote is Required 

An area of uncertainty has been the extent to which footnotes to the PVP table could show adjustments in the aggregate versus setting out separately each category of adjustment.  This CDI indicates that the footnote disclosure to the PVP table must be done on an item-by-item basis, tracking to the regulatory language, and not in the aggregate.  Companies will need to show up to six categories of equity adjustments (fair value at end of year of awards granted during year, change in fair value of awards granted before the year that are outstanding and unvested at end of year, etc.).  Presumably, adjustments that are not applicable for a company need not be covered.  If a company does not pay dividends, for example, the dividend adjustment could be omitted.  Interestingly, 128D.03 suggests that, once there has been a full footnote disclosure for a year, it need not be repeated in future years (i.e., the 2024 proxy need only have a full footnote disclosure for 2023) unless prior year footnotes are material to understanding the 2023 disclosure.

128D.05 – Use of Compensation Discussion & Analysis (“CD&A”) Compensation Peer Group is Permitted

Due to a somewhat limited definition of benchmarking in CDI 118.05, some uncertainty has existed with respect to whether a company could compute its peer group cumulative total shareholder return (“TSR”) for purposes of the PVP table by using the peer group disclosed in its CD&A for compensation determination purposes.  The SEC has resolved the uncertainty by stating that a company “may use a peer group that is disclosed in its CD&A as a peer group actually used by the registrant to help determine executive pay,” even if it does not meet the standards of CDI 118.05. 

Suppose a company has granted a long-term incentive (“LTI”) with a relative TSR (“rTSR”) performance metric and the peer group used for the LTI is different than the CD&A benchmarking discussion peer group.  Since executive pay will obviously be affected by the performance of the company against the LTI peer group, one may argue that the LTI peer group can also be used.  As of now, we can’t tell if using the LTI peer group will be permissible.

128D.07 – Impact of Year-over-Year Changes to CD&A Compensation Peer Group

Suppose a company uses a different CD&A-disclosed peer group in 2022 than in 2021 and plans to use the peer group for cumulative TSR purposes in the PVP table.  Many of us read the PVP Rules to require using the 2022 peer group to compute cumulative TSR for each of the time periods required in the table, and to explain in a footnote how that return differed from the return that would have been computed using the 2021 peer group.  Instead, this CDI appears to indicate that the cumulative TSR for each year is computed using the CD&A-disclosed peer group for that year. 

128D.09 – rTSR can be a Company-Selected Measure (“CSM”), but Some Ambiguities Remains

This very interesting CDI provides:

Question.  [A] registrant’s Company-Selected Measure must be a financial performance measure that is not otherwise required to be disclosed in the [PVP table].  The required financial performance measures include net income and the cumulative total shareholder return of the registrant.  May a registrant provide a Company-Selected Measure that is derived from, a component of, or similar to these required measures, such as earnings per share, gross profit, income or loss from continuing operations, or relative total shareholder return?

Answer: Yes, the Company-Selected Measure can be any financial performance measure that differs from the financial performance measures otherwise required to be disclosed in the table that meets the definition of [Company-Selected Measure], including a measure that is derived from, a component of, or similar to those required measures...

Due to the way “financial performance measure” is defined in the PVP Rules, there was some uncertainty as to whether rTSR was technically a financial performance measure.  The reference to rTSR in this CDI seems to favorably resolve that question.

Just as important, this CDI can be read to suggest the CSM may be very similar to the required tabular measures, so long as there is some difference.  How far this goes is not clear to us.  It seems to that the CSM can be the rTSR of a different peer group than that used to compute the required tabular disclosure of peer group cumulative TSR, which would be the case, for example if the required tabular computation used the CD&A-disclosed peer group and the CSM used the peer group used for LTI rTSR purposes (the same result should occur if the required tabular disclosure used an industry or line-of-business index, as permitted under the PVP Rules). 

An interesting question to us is whether the same peer group could be used if the derived metric were different.  For example, could the CSM be the percentile ranking of the company against the same peer group used to compute cumulative TSR?  It should be noted that these metrics can lead to different results.  For example, a company might have a 50th percentile rTSR percentile ranking against its peer group but have a cumulative TSR significantly higher than that of the same peer group if the companies with the higher market capitalizations had TSRs below median.  This difference arises because the computation of cumulative TSR is weighted by market capitalization.

128D.10 – Limited Permission to use Stock Price as CSM

So far, we find this the hardest CDI to decode.  It provides that a company’s stock price cannot be the CSM unless stock price is used as an actual metric in one of the company’s incentive programs.  The SEC acknowledges that stock price may have a major, if not the most major impact, on CAP when the executive officer holds equity awards such as time-vested restricted stock units.  This is not enough, however.  The SEC states: “if the only impact of stock price on a named executive officer’s compensation is through changes in the value of share-based awards (which would be evident from the registrant’s Summary Compensation Table disclosure), the registrant could not include its stock price as the Company-selected measure.”  Stock price could be the CSM, however, if it is a specific performance metric— “if, for example, the registrant’s stock price is a market condition applicable to an incentive plan award, or is used to determine the size of a bonus pool, it may be included as a registrant’s Company-Selected Measure.”

One immediate question is whether this means stock price can still be a financial performance measure for purposes of the tabular list of most important measures, even though it is not the CSM.  The SEC’s explanation for why stock price cannot be a CSM is that (unless it is a specific metric), “the registrant does not use it to link [CAP] to its named executive officers to company performance.”  In describing the list of other financial performance measures that can be listed, the PVP Rules refer to them as “the most important financial performance measures 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.”  Companies that want to use stock price in the table of financial performance measures may want to consider the implications, if any, of this similarity in language.

Another issue raised by the CDI is whether the SEC has concluded that no measure can be a financial performance measure unless it is specifically used as a metric.  Such a position would be quite significant.  For example, in our experience, almost every compensation committee is greatly influenced in evaluating executives by the company’s relative performance against some similar group of companies or a broad market index.  On the other hand, while it is an explicit metric in many LTI plans (the most recent Cook survey of large companies found that around 70% of issuers in the sample used some type of rTSR metric), many don’t explicitly use it.  Does this mean it can’t be used as a financial metric?

At this stage, we are uncertain what will emerge as the answer to this important question.

128D.11 – No Multi-Year CSM Measurement Period

The SEC somewhat surprisingly (at least to us) has announced that the CSM cannot be measured over a multi-year period that includes the applicable fiscal year as the final year, similar to the use of multi-year measurement periods for calculating TSR for the required company and peer group TSR columns.  We are still digesting the implications of this rule, but it may lead to some surprising results in cases where the CSM is a metric in the LTI plan.

For many companies, the LTI plan metric is tied to the greatest proportion of total direct compensation in any given year and from our experience to date, LTI metrics are significant contenders for the CSM.  Further, it is very common, and considered to be a strong pay practice, to measure performance over three years for purposes of LTI awards.

For example, suppose the LTI metric for a company is an aggregate EPS growth rate of 8% over a three-period.  If a company would like to select EPS growth as the CSM, it appears that the metric cannot be three-year EPS growth, as used for LTI purposes.  Instead, it appears that it must use one-year EPS growth for each year in the PVP table, although the one-year growth rate is not the LTI metric.

At one point we wondered whether, using our example, you could not use EPS growth as a CSM since the only data you could show is for a one-year period, which is not the LTI metric.  Since this conclusion would mean that in most cases the CSM could never be an LTI metric, we are hopeful (but not sure) that you can still use a multi-year LTI metric, for example, EPS growth, on a one-year basis as a CSM.

Portrait of David Gordon, Managing DirectorDavid Gordon
Managing Director

Dave Gordon’s practice as an executive compensation consultant covers a variety of industries, including extensive experience with financial institutions and utilities. Based on his years of experience as an executive compensation lawyer, he acts as the senior resource on numerous technical issues for the Firm. He frequently acts as an expert witness.

Dina Bernstein

Dina Bernstein has extensive experience advising on all aspects of executive compensation, working with companies on an ongoing basis, as well as in the context of mergers and acquisitions, spin-offs, initial public offerings, and other corporate events. Dina provides guidance to private and public companies across various industries regarding cash and equity incentive compensation arrangements, employment, severance and change in control agreements, overall compensation program design, pay governance practices, taxation, stock exchange listing requirements and securities regulation compliance.

Portrait of Bindu M. Culas, PrincipalBindu M. Culas
Managing Director

Bindu Culas has over 15 years of experience advising clients on the US and international legal, tax and regulatory aspects of designing and structuring equity incentive programs, employment agreements, and severance and change-of control plans. Bindu has worked with both domestic and foreign publicly traded and privately held companies as well as pre-IPO companies.

Samantha Nussbaum

 Samantha Nussbaum has consulted on behalf of public and private companies, compensation committees, and senior management on all aspects of executive compensation. Samantha’s consulting and legal background includes advising on executive compensation in the context of mergers and acquisitions, spin-offs, and initial public offerings; executive employment, severance, and change in control agreements; equity incentive plans; deferred compensation; and securities laws, including reporting and disclosure implications.


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