SEC Issues Additional Pay-Versus-Performance Guidance

On September 27th, the SEC issued 10 new Compliance & Disclosure Interpretations (CDIs) relating to the pay-versus-performance (PVP) disclosure rules. The new PVP CDIs supplement the 15 CDIs previously issued by the SEC on February 10, 2023.

The PVP CDIs (prior and new) are incorporated into the general Reg. S-K CDIs published by the SEC (link). For reference, the full set of PVP CDIs are excerpted below.

We will provide additional commentary as we consider the new CDIs and its application more fully.

New PVP CDIs – Issued on September 27, 2023

Question 118.08
Question: 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." Does this instruction extend to non-GAAP financial information that does not relate to the disclosure of target levels, but is nevertheless included in Compensation Discussion & Analysis ("CD&A") or other parts of the proxy statement - for example, to explain how pay is structured and implemented to reflect the registrant's or a named executive officer’s performance?

Answer: No. Instruction 5 to Item 402(b) is limited to CD&A disclosure of target levels that are non-GAAP financial measures. If non-GAAP financial measures are presented in CD&A or in any other part of the proxy statement for any other purpose, such as to explain how pay is structured or implemented to reflect the registrant's or a named executive officer’s performance or to justify certain levels or amounts of pay, then those non-GAAP financial measures are subject to the requirements of Regulation G and Item 10(e) of Regulation S-K (except with regards to the Company-Selected Measure or additional financial performance measures disclosed pursuant to Item 402(v)(2)(vi) of Regulation S-K).

In these pay-related circumstances only, the staff will not object if a registrant includes the required GAAP reconciliation and other information in an annex to the proxy statement, provided the registrant includes a prominent cross-reference to such annex. Or, if the non-GAAP financial measures are the same as those included in the Form 10-K that is incorporating by reference the proxy statement's Item 402 disclosure as part of its Part III information, the staff will not object if the registrant complies with Regulation G and Item 10(e) by providing a prominent cross-reference to the pages in the Form 10-K containing the required GAAP reconciliation and other information. [September 27, 2023]

Question 128D.14
Question: Should awards granted in fiscal years prior to an equity restructuring, such as a spin-off, that are retained by the holder be included in the calculation of executive compensation actually paid?

Answer: Yes. All stock awards and option awards that are outstanding and unvested at the beginning of the covered fiscal year or are granted to the principal executive officer and the remaining named executive officers during the covered fiscal year, including those awards modified in connection with an equity restructuring or retained following such a transaction, and for which compensation cost will be recognized under FASB ASC Topic 718 should be included in the table required by Item 402(v)(1) of Regulation S-K. [September 27, 2023]

Question 128D.15
Question: In periods prior to pursuing an initial public offering, a private company may grant stock awards or option awards. Once that company is required to provide Item 402(v) disclosures, should the change in fair value of awards granted prior to the date of a registrant’s initial public offering be based on the fair value of those awards as of the end of the prior fiscal year for purposes of determining executive compensation actually paid?

Answer: Yes. For outstanding stock awards and option awards, the calculations required by Item 402(v)(2)(iii)(C)(1) of Regulation S-K should be determined based on the change in fair value from the end of the prior fiscal year. The fair value of these awards should not be determined based on other dates, such as the date of the registrant’s initial public offering. [September 27, 2023]

Question 128D.16
Question: Market conditions under U.S. GAAP are certain conditions related to the price of the issuer’s shares that affect the exercise price, exercisability, or other pertinent factors used in determining the fair value of the award. Market conditions are not considered vesting conditions under U.S. GAAP even though the executive is not entitled to the compensation until the market condition is satisfied. How should awards with a market condition consider that condition in determining whether the applicable vesting conditions have been met in performing the calculation required by Item 402(v)(2)(iii)(C)(1) of Regulation S-K?

Answer: In accordance with FASB ASC Topic 718, the effect of a market condition should be reflected in the fair value of share-based awards with such a condition. In addition, for purposes of the table required by Item 402(v)(1) of Regulation S-K, market conditions should also 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. [September 27, 2023]

Question 128D.17
Question: An award did not meet vesting conditions during the year because the performance or market conditions were not met. However, there is still potential for the award to vest in the future. Should the award fair value be subtracted under Item 402(v)(2)(iii)(C)(1)(v) of Regulation S-K because it failed to vest in the current year?

Answer: No. 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. Awards that remain outstanding and have not yet vested, because, for example, performance or market conditions were not met in an eligible year, are not considered to have failed to meet the applicable vesting conditions for the purpose of Item 402(v). [September 27, 2023]

Question 128D.18
Question: Some stock and option awards allow for accelerated vesting if the holder of such awards becomes retirement eligible. If retirement eligibility was the only vesting condition, would this condition be considered satisfied for purposes of the Item 402(v) of Regulation S-K disclosures and calculation of executive compensation actually paid in the year that the holder becomes retirement eligible?

Answer: Yes. However, for awards with additional substantive conditions, in addition to retirement eligibility, such as a market condition as described in Question 128D.16, those other conditions must also be considered in determining when an award has vested. [September 27, 2023]

Question 128D.19
Question: Some stock and option awards with a performance condition require certification by others, such as the compensation committee, that the level of performance was attained. If the performance condition was met by fiscal year-end, however, the certification occurs after year-end, would the award be considered vested for purposes of the Item 402(v) of Regulation S-K disclosures at the end of the fiscal year-end?

Answer: If certification is an additional substantive vesting condition, then the award would not be considered vested. A performance-based vesting condition is considered satisfied when the applicable condition is achieved. However, 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. [September 27, 2023]

Question 128D.20
Question: Item 402(v)(2)(iii)(C)(3) of Regulation S-K requires the fair value of all stock awards, and all option awards, with or without tandem stock appreciation rights (“SARs”) to be computed in a manner consistent with the methodology used to account for share-based payments under GAAP. May a registrant satisfy this requirement by using 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?

Answer: Yes, as long as the valuation technique would be permitted under FASB ASC 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, which would meet the measurement objective in U.S. GAAP, then a registrant may use it to calculate executive compensation actually paid under Item 402(v) instead of the technique used to determine the grant-date fair value of share-based payments in the registrant's GAAP financial statements. Item 402(v)(4) of Regulation S-K requires disclosure about the assumptions made in the valuation that differ materially from those disclosed as of the grant date of such equity awards. A change in valuation technique from the technique used at the grant date of such equity awards in the registrant’s financial statements would require disclosure of the change if such technique differs materially. We would expect a registrant to disclose under Item 402(v)(4) both the change in valuation technique from the grant date and the reason for the change. [September 27, 2023]

Question 128D.21
Question: To comply with Item 402(v)(2)(iii)(C)(3) of Regulation S-K, the methodology used to compute the fair value amounts of all stock awards, and all option awards, with or without tandem SARs, must be consistent with the methodology used to account for share-based payments in the financial statements under GAAP. Is it ever acceptable to value these awards as of the end of a covered fiscal year based on methods not prescribed by GAAP?

Answer: No. The fair value of stock awards and option awards must be computed using a methodology and assumptions consistent with FASB ASC Topic 718. For example, the expected term assumption to value options 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. U.S. 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. [September 27, 2023]

Question 128D.22
Question: Instruction 4 to Item 402(b) of Regulation S-K provides that “registrants are not required to disclose target levels with respect to specific quantitative or qualitative performance-related factors considered by the compensation committee or the board of directors, or any other factors or criteria involving confidential trade secrets or confidential commercial or financial information, the disclosure of which would result in competitive harm for the registrant.” Item 402(v)(2)(iii)(C)(3) of Regulation S-K provides that “for any awards that are subject to performance conditions, calculate the change in fair value as of the end of the covered fiscal year based upon the probable outcome of such conditions as of the last day of the fiscal year.” In addition, Item 402(v)(4) of Regulation S-K provides that “for the value of equity awards added pursuant to paragraph (v)(2)(iii)(C) of this section, disclose in a footnote to the table required by paragraph (v)(1) of this section any assumption made in the valuation that differs materially from those disclosed as of the grant date of such equity awards.” If the disclosure required by Item 402(v)(4) would involve confidential trade secrets or confidential commercial or financial information, the disclosure of which would result in competitive harm for the registrant, may the registrant omit such information?

Answer: Yes. A registrant is not required to disclose detailed quantitative or qualitative performance condition 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, the registrant 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. [September 27, 2023]

Prior PVP CDIs – Issued on February 10, 2023

Question 128D.01
Question: Is the information required pursuant to Item 402(v) of Regulation S-K required to be included in Form 10-K, given that Item 11 of Form 10-K indicates that the registrant is required to furnish the information required under Item 402 of Regulation S-K?

Answer: No. Item 402(v) of Regulation S-K provides that the information required thereunder must be provided in connection with any proxy or information statement for which the rules of the Commission require executive compensation disclosure pursuant to Item 402 of Regulation S-K, and Instruction 3 to Item 402(v) specifies that the information provided under Item 402(v) of Regulation S-K will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference. [February 10, 2023]

Question 128D.02
Question: In calculating the equity award adjustments required by Item 402(v)(2)(iii)(C)(1), are equity awards granted to a first-time named executive officer (“NEO”) in a year prior to (and not otherwise related to) their appointment as a NEO required to be included? For example, if a non-NEO employee is granted a stock option in year 1, and subsequently appointed as a NEO in year 2, must that NEOs “compensation actually paid” in year 2 reflect the adjustments required by subparagraphs (ii), (iv) or (v) (relating to prior fiscal year awards) of Item 402(v)(2)(iii)(C)(1) with respect to the stock option granted in year 1?

Answer: Yes. Although such awards may not be reported in the Summary Compensation Table required by Item 402(c) (see Question 119.01), the change in value of such awards during the executive’s tenure as a NEO should be included in the calculation of compensation actually paid. [February 10, 2023]

Question 128D.03
Question: Item 402(v)(3) of Regulation S-K requires, for each amount disclosed in columns (c) and (e) of the Pay Versus Performance table, footnote disclosure of each of the amounts deducted and added pursuant to Item 402(v)(2)(iii). Is footnote disclosure required for each of the fiscal years presented in the table?

Answer: Item 402(v) footnote disclosure for years other than the most recent fiscal year included in the Pay Versus Performance table would be required only if it is material to an investor’s understanding of the information reported in the Pay Versus Performance table for the most recent fiscal year, or of the relationship disclosure provided under Item 402(v)(5). However, in the registrant’s first Pay Versus Performance table under the new rules, the registrant should provide footnote disclosure for each of the periods presented in the table. [February 10, 2023]

Question 128D.04
Question: Item 402(v)(3) of Regulation S-K requires, for each amount disclosed in columns (c) and (e) of the Pay Versus Performance table, footnote disclosure of each of the amounts deducted and added pursuant to Item 402(v)(2)(iii). May a registrant satisfy this requirement by providing the aggregate amount calculated for pension value adjustments under Item 402(v)(2)(iii)(B)(1) and equity award adjustments under Item 402(v)(2)(iii)(C)(1)?

Answer: No. The registrant should provide footnote disclosure of each of the amounts deducted and added pursuant to Items 402(v)(2)(iii)(B)(1)(i) – (ii) and Items 402(v)(2)(iii)(C)(1)(i) – (vi). [February 10, 2023]

Question 128D.05
Question: For purposes of calculating peer group total shareholder return under Item 402(v)(2)(iv) of Regulation S-K, may a registrant use any compensation peer group that is disclosed in its Compensation Discussion & Analysis (“CD&A”), or is the registrant limited only to a peer group used in the CD&A for purposes of disclosing the registrant’s compensation benchmarking practices under Item 402(b)(2)(xiv) of Regulation S-K?

Answer: The registrant 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 such peer group is not used for “benchmarking” under Item 402(v)(2)(xiv) of Regulation S-K, as that term is explained in CDI 118.05. [February 10, 2023]

Question 128D.06
Question: What time period is a registrant required to present under Item 402(v) of Regulation S-K for its cumulative total shareholder return (“TSR”) and peer group TSR when the registrant went public during the earliest year included in the “Pay Versus Performance” table?

Answer: Consistent with the calculation of TSR under Item 201(e) of Regulation S-K, if the class of securities was registered under Section 12 of the Exchange Act during the earliest year included in the “Pay Versus Performance” table, the “measurement point” for purposes of calculating TSR and peer group TSR should begin on such registration date. [February 10, 2023]

Question 128D.07
Question: In each of 2020 and 2021, a registrant provided the same list of companies as a peer group in its Compensation Discussion & Analysis (“CD&A”) under Item 402(b) but provided a different list of companies in its CD&A for 2022. With respect to a registrant providing initial Pay versus Performance disclosure in its 2023 proxy statement for three years (as permitted by Instruction 1 to Item 402(v) of Regulation S-K), may the registrant present the peer group total shareholder return for each of the three years using the 2022 peer group?

Answer: No. In this situation, the registrant should present the peer group total shareholder return for each year in the table using the peer group disclosed in its CD&A for such year. [February 10, 2023]

Question 128D.08
Question: Item 402(v)(2)(v) requires “net income” to be included in column (h) of the Pay Versus Performance table required by Item 402(v)(1). May a registrant use other net income amounts presented in the audited financial statements? For example, may a registrant that consolidates subsidiaries that are not wholly-owned use net income attributable to the controlling interest or registrant to satisfy this requirement? May a registrant with material discontinued operations during the fiscal year use income or loss from continuing operations to satisfy this requirement?

Answer: No. The registrant is required to provide in column (h) its net income or loss as required by Regulation S-X to be disclosed in the registrant’s audited GAAP financial statements. [February 10, 2023]

Question 128D.09
Question: Under Item 402(v)(2)(vi), a registrant’s Company-Selected Measure must be a financial performance measure that is not otherwise required to be disclosed in the Pay Versus Performance table required by Item 402(v)(1). 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 in Item 402(v)(2)(vi) including a measure that is derived from, a component of, or similar to those required measures. Any such measures could also be included as financial performance measures in the Tabular List required by Item 402(v)(6) of Regulation S-K. [February 10, 2023]

Question 128D.10
Question: Would it be appropriate for a registrant to disclose its stock price as its Company-Selected Measure under Item 402(v)(2)(vi) if the registrant does not use any financial measures to otherwise link pay and financial performance, but the “compensation actually paid” reported in the Pay Versus Performance table required by Item 402(v)(1) includes the fair value of time-vested share-based awards, which value is largely tied to stock price?

Answer: No. While stock price is considered a “financial performance measure” for purposes of Item 402(v)(2)(vi), it should not be disclosed as the registrant’s Company-Selected Measure if the registrant does not use it to link compensation actually paid to its named executive officers to company performance, even if it has a significant impact on the amounts reported in the Pay Versus Performance table. That is, 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. However, 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. [February 10, 2023]

Question 128D.11
Question: Can the Company-Selected Measure included in the Pay Versus Performance table required by Item 402(v)(1) 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 total shareholder return under Item 402(v)(2)(iv), as long as such performance period is used consistently for all years in the table?

Answer: No. Under Item 402(v)(2)(vi), the Company-Selected Measure is the measure which in the registrant's assessment represents the most important financial performance measure (that is not otherwise required to be disclosed in the table) 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. [February 10, 2023]

Question 128D.12
Question: A registrant uses a “pool plan” to determine its annual bonus awards. Under the plan, a bonus pool is available for payout only upon achievement of a financial performance measure or the size of the pool is determined based upon the extent such measure is achieved. Once that financial performance measure is achieved, the compensation committee may allocate bonus payouts to participants in its discretion, based on criteria independent of the achievement of any financial performance measure(s). If the registrant’s executive compensation does not use any other financial performance measures, may the registrant omit the Tabular List required under Item 402(v)(6) of Regulation S-K and the Company-Selected Measure required under Item 402(v)(2)(vi) of Regulation S-K and the related relationship disclosure required under Item 402(v)(5)(iii) of Regulation S-K from its disclosure under Item 402(v)?

Answer: No. Because the size of the bonuses paid from the “bonus pool” is determined based wholly or in part on satisfying the financial performance measure, the registrant is using the financial performance measure to link the executive compensation actually paid to company performance within the meaning of Item 402(v)(2)(vi) and Item 402(v)(6). [February 10, 2023]

Question 128D.13
Question: If a registrant has multiple principal executive officers (“PEOs”) in a fiscal year, Item 402(v) requires the registrant to provide separate columns for each PEO in the Pay Versus Performance table required by Item 402(v)(1). May the registrant aggregate (i.e., use the total sum of) the compensation of such PEOs in a given year for purposes of the narrative, graphical, or combined comparison between compensation actually paid and total shareholder return (“TSR”), net income, and the Company-Selected Measure provided under Item 402(v)(5)?

Answer: To the extent the presentation will not be misleading to investors, the staff will not object if a registrant aggregates the PEOs’ compensation for purposes of the narrative, graphical, or combined comparison between compensation actually paid and TSR, net income, and the Company-Selected Measure. [February 10, 2023]

228D.01

If a company changes its fiscal year during the time period covered by the Item 402(v) Pay Versus Performance table, provide the disclosure required by Item 402(v) for the "stub period," and do not annualize or restate compensation. For example, in late 2022, a company that is not a Smaller Reporting Company changed its fiscal year end from June 30 to December 31. In the registrant’s first Pay Versus Performance table, provide disclosure for each of the following four periods: July 1, 2022 to December 31, 2022; July 1, 2021 to June 30, 2022; July 1, 2020 to June 30, 2021; and July 1, 2019 to June 30, 2020. Continue providing such disclosure including the stub period until there is disclosure for five full fiscal years after the stub period. This is consistent with the approach applicable to Summary Compensation Table disclosure for changes in fiscal year end. See Question 217.05. [February 10, 2023]

228D.02

A registrant emerged from bankruptcy, and a new class of stock that was issued under the bankruptcy plan started trading in September 2020. Registrant is preparing its first Pay Versus Performance disclosure for inclusion in its 2023 proxy statement. Consistent with Question 206.14, registrant will be presenting less than five full years of data in its stock performance graph under Item 201(e) using a measurement period for the graph from September 2020 through December 2022. For purposes of the requirement in Item 402(v)(2)(iv), the registrant may provide its cumulative total shareholder return and peer group cumulative total shareholder return in the same manner. The registrant should provide footnote disclosure to explain the approach and its effect on the Pay Versus Performance table. [February 10, 2023]

Our previous articles relating to the PVP disclosure rules are set forth below:

Observations From S&P 500 Pay Versus Performance Disclosures (link)

SEC Issues Guidance on Final Pay Versus Performance Rules (link)

SEC Finalizes Pay Versus Performance (PVP) Disclosure Rule, Requiring Complex Calculations for 2023 (link)

SEC Finalizes “Pay versus Performance” Disclosure Rules (link)

Bindu M. Culas
Managing Director

Bindu Culas has over 20 years of executive compensation experience. She works across industries with domestic and foreign public companies, pre-IPO companies and privately-held companies. She has deep expertise in designing annual and long-term incentive programs, structuring equity plans and award vehicles, navigating talent attraction, motivation and retention challenges through business cycles, and advising on governance and investor considerations. Previously, Bindu was a partner at Linklaters LLP and she is well versed in the complex regulatory, compliance and tax aspects of executive compensation.

Michael Abromowitz
Consultant

Michael Abromowitz consults on all aspects of executive and board compensation including executive compensation benchmarking, annual and long-term incentive program design, peer group development, and executive severance and change-in-control plans.