On February 10, 2023, the staff (Staff) of the U.S. Securities and Exchange Commission (SEC) issued Compliance and Disclosure Interpretations (C&DIs) relating to the SEC’s new rules on the correlation between executive pay and company performance (pay-versus-performance). As discussed in our previous client alert, the SEC approved final rules on pay-versus-performance disclosure in August 2022. Companies must comply with the new rules in proxy or information statements for fiscal years ending on or after December 16, 2022. Calendar year companies will first need to include this information in their proxy or information statements filed in 2023.

The newly issued C&DIs offer some welcome guidance on the pay-versus-performance rules just as most companies are beginning to draft their first disclosures. The following are some key highlights of the new guidance:

• Disclosure Not Required in Form 10-K. As was made clear in the adopting release and the Dodd-Frank statutory language, the pay-versus-performance disclosure under Item 402(v) of Regulation S-K is required only in proxy statements and information statements that call for executive compensation information and not in a Form 10-K. (Question 128D.01)
• Adjustments for Prior Equity Awards Included. The equity adjustments required under Item 402(v)(2)(iii)(C)(1) must include the change in value of any equity awards held by a named executive officer (NEO), even if those awards were granted prior to the date that the individual became an NEO. This is the case even though the previously granted awards themselves would not be required to be included in the summary compensation table under Item 402(c). (Question 128D.02)
• No Aggregation of Adjustments in Footnotes.The footnote disclosure required by Item 402(v)(3) must include each of the separate categories deducted and added to arrive at the reported compensation and cannot aggregate amounts for pension plan adjustments pursuant to Items 402(v)(2)(iii)(B)(1)(i) – (ii) or equity adjustments pursuant to Items 402(v)(2)(iii)(C)(1)(i) – (vi). Note that after the first year that the pay-versus-performance is presented, the company is generally required to include the footnote disclosure only for the most recent year. (Question 128D.04)
• Peer Group Not Required to Be That Used in Benchmarking.The peer group used for calculating peer group shareholder return pursuant to Item 402(v)(2)(iv) may be any peer group that the company actually uses to help determine executive pay and discloses in its Compensation Discussion and Analysis (CD&A), even if that peer group is not used for benchmarking as described in Item 402(b)(2)(xiv) of Regulation S-K. (Question 128D.05)
• Measurement Period for Newly Trading Companies. For purposes of the shareholder return calculations required in the pay-versus-performance table, the Staff provided conflicting guidance with respect to companies that begin trading due to bankruptcy and those that begin trading due to initial public offerings. The shareholder return calculations are supposed to be done in a manner consistent with the calculations done for the performance graph under Item 201(e) and C&DI 106.09 under Item 201(e) is explicit that a company should begin those return calculations based on the closing price on the first day of trading. Until the SEC clarifies this disparity, we believe that the best approach is to start with the closing price on the first day of trading (which will match your 10-K performance graph) and footnote this assumption. (Questions 128D.06 and 228D.01)
• Net Income. For the purposes of the pay-versus-performance table, the net income shown must be net income as it appears on that line of the financial statements and it cannot be adjusted, even if the adjusted amount is derived from net income and also appears on the face of the financial statements. So, for example, a company may not use net income from continuing operations or net income of controlling interests to satisfy the requirement to show net income in the pay-versus-performance table. (Question 128D.08)
• Company Selected Measure Derived from a Required Measure. Although a company is not permitted to use net income or shareholder return as the company selected measure, a company may use a measure that is derived from net income or shareholder return. (Question 128D.09)
• Stock Price as a Company Selected Measure. Stock price may be used as a company selected measure only if a company actually uses it as a compensation plan metric to link company performance to executive pay (as, for example, in the case of an incentive plan that uses stock price as a metric to determine the amount of a bonus pool). If the only effect of stock price on an executive’s pay is the increase or decrease in the value of their equity holdings, then stock price may not be used as a company selected measure, even if the company has no other company selected measures to include in the pay-versus-performance table. (Question 128D.10)
• No Multiyear Company Selected Measure.The company selected measure cannot be one which is measured over multiple years, even if the measurement period concludes with the most-recently disclosed fiscal year. For example, if three-year revenue growth is used in a long-term incentive plan, that measure cannot be used as the company selected measure for the purposes of the pay-versus-performance table. (Question 128D.11)
• Multiple PEOs. Under the new rules, if a company has more than one principal executive officer (PEO) in a given year, each PEO’s compensation must be presented in a separate column of the pay-versus-performance table. However, the Staff will not object if a company aggregates PEO compensation for the purposes of the descriptions of the relationship between PEO compensation actually paid and shareholder return, net income, or a company selected measure, as long as the aggregation is not misleading. (Question 128D.13)

For more information on these C&DIs or any related matter, please contact any member of the firm's public company representation or employee benefits and compensation practices.