The U.S. Securities and Exchange Commission (“SEC”) has adopted a new rule requiring companies to disclose information comparing executive compensation to the company’s overall financial performance.
The SEC announced the adoption of the so-called “pay-versus-performance” rule requirements on August 25, with SEC Chair Gary Gensler noting the new rules will “help investors receive the consistent, comparable, and decision-useful information they need to evaluate executive compensation policies.”
This change comes after Congress in 2010 directed the SEC under the Dodd-Frank Act to adopt rules mandating that public companies clearly describe the relationship between the compensation that companies actually pay to executives and the company’s financial performance.
Under the new rule, a company must provide the following disclosures relative to executive pay:
- A table disclosing specified executive compensation and financial performance measures for its five most recently completed fiscal years;
- Reporting on total shareholder return (“TSR”), the TSR of companies in its peer group, net income, and a financial performance measure chosen by the company;
- A description of the relationships between the executive compensation actually paid and each of the performance measures, as well as the relationship between the company’s TSR and the TSR of its selected peer group; and
- A list of three to seven financial performance measures that it determines are its most important performance measures for linking actually paid executive compensation to company performance.
While companies already disclose both net income on their income statements and TSR in their proxy filings, the new rule now require companies to set out a clear description of the relationship between each of these performance metrics and the pay received by top executives.
The SEC first proposed the rule under former chair Mary Jo White in 2015, but the agency did not move the amendments forward at that point. In January 2022, the SEC reopened the comment period for the rule, requesting, among other things, specific feedback about the initial requirement that companies name and rank the five most important factors they used for determining executive pay. After public comment, the final rule grants more flexibility in identifying the important factors, allowing companies to disclose between three and seven of the most important measures in an unranked list.
In its release on the adoption, the agency notes that smaller reporting companies will be subject to scaled disclosure requirements—such as reporting three instead of five years of disclosures—consistent with their existing scaled executive compensation disclosure requirements.
The Commission voted 3-2 in favor of the proposed rule amendments, with Republican Commissioners Mark Uyeda and Hester Peirce voting against the adoption. In a statement about the agency’s adoption of the amendments, Commissioner Peirce stated that the new rulemaking “will elicit costly, complicated, disclosure of questionable utility.”
Commissioner Jaime Lizárraga, however, heralded the adopted rulemaking.
“I commend SEC Chair Gary Gensler for advancing this important priority that makes executive pay more accountable to shareholders,” Lizárraga said. “With these vital reforms, investors will gain critical tools to make informed decisions on their investments and on their advisory votes on executive compensation.”
The amendments are set to go into effect 30 days after the adopting release is published in the Federal Register, meaning companies must begin to comply with these new provisions in statements requiring Item 402 executive compensation disclosures for fiscal years ending on or after December 16, 2022.
Click here to read the full text of the final rule.