Yet Another SEC PvP CDI Update Brings Some Welcome Relief

On November 21st, the SEC issued 10 new or revised Compliance & Disclosure Interpretations (CDIs) relating to the Pay Versus Performance (PvP) rule and disclosure, supplementing the PvP CDIs previously issued by the SEC.

We have identified one CDI that may have the greatest impact and examine it here.  The other nine CDIs strike us either dealing with less controversial subjects or having less widespread application and are described very briefly at the end of this blog.  The new or revised PVP CDIs are incorporated into the general Reg. S-K CDIs published by the SEC (link) and for reference are set forth below at the bottom of this post.

CDIs 128D.18 – Retirement eligibility and determining when equity is vested for PvP

In September and October we blogged that the SEC had issued PvP CDIs, and we then identified CDI 128D.18 (retirement eligibility and determining when equity is vested for PvP purposes) as raising complicated interpretative issues.  The SEC revised this CDI (as part of newly released guidance) in what some may consider a Thanksgiving present.  The updated guidance follows (with the new relevant language underlined below):

Question: Some stock and option awards allow for accelerated vesting if the holder of such awards becomes retirement eligible. If retirement eligibility was the sole 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, if retirement eligibility is not the sole vesting condition, other substantive conditions must also be considered in determining when an award has vested. Such conditions would include, but not be limited to, a market condition as described in Question 128D.16 or a condition that results in vesting upon the earlier of the holder’s actual retirement or the satisfaction of the requisite service period.

We blogged in October here that the initial version of the CDI raised many questions about how to determine compensation actually paid (CAP) in the case of retirement-eligible holders of equity awards.  We were concerned about the situation where retirement resulted in either (1) accelerated vesting with immediate payout or (2) continued vesting (no requirement of additional service but payout on the dates that would have occurred if the executive had remained employed).  The prior CDI language appeared to indicate that, if retirement eligibility were the only vesting condition and there were no other substantive conditions, vesting occurs for purposes of determining CAP in the year during which the holder first becomes retirement eligible, regardless of whether the holder terminates employment.  This left companies with several potentially difficult questions—what was a “substantive condition”; if there was no additional substantive condition, how did one calculate the additional vested amount (a particular challenge with pro-rated vesting on retirement); and what, if any, retroactive changes would be required to already-filed PvP tables. 

It is our understanding that practitioners expressed their concerns to the SEC and the revised CDI was intended to address at least some of them.  The CDI now appears to indicate that for purposes of calculating CAP the concept of retirement eligibility is no longer an issue in the typical case where the holder must actually retire to be “vested.”  This would be the result, for example, where the award contains an explicit service period and also states that vesting of the award will accelerate upon a termination due to retirement.  In other words, even if there were no barrier to the holder retiring immediately, the act of retiring is itself treated as a substantive condition.

However, the CDI may leave open one potential situation where the interpretive issues noted in our October 24th blog could still apply.  The issues previously noted may arise if the award agreement explicitly states that a holder is vested upon the earlier of the requisite service period or meeting the definition of “retirement” (as opposed to actually having to retire).  We also recognize that there will be some award agreements that do not clearly fit into one category or the other, due to nuanced differences in drafting. 

We note that the specific language used for the CDI is unusual and could have been more precise as to its intent and impact, but we cannot think of any other interpretation, and other practitioners with whom we have discussed have reached the same conclusions.  As such, in light of the revised CDI, companies should yet again review their equity award agreements to assess the specific language around retirement favorable vesting, in order to determine how they may be impacted by this guidance. 

Remaining nine new or revised PVP CDIs

As mentioned above, we view the remaining nine CDIs as having less extensive application but note a few brief comments:

• Five of the CDIs deal with peer group issues and four of them deal with issues arising when the peer group is not a published industry or line-of-business index used in the 10-K (CDI 128.07, 128D.25, 128D.26, and 128D.27).  Since it appears the vast majority of companies use an industry or line-of-business index,¹ we will not further describe these CDIs in detail.  CDI 128D.24 states that if an issuer has more than one 10-K industry or line-of-business index from which to choose, it can choose either one but must disclose which it has selected.
• CDI 128D.23 provides that the value of dividends or dividend equivalents paid prior to vesting of a stock award need not be taken into account if the value of the dividends or the dividend equivalents is reflected in the fair value of the stock award or otherwise included in total compensation.  The only update from the original rule is to make specific reference to dividend equivalents.  We believe this reinforces the conclusion that such amounts are to be factored into CAP, recognizing that the actual calculation steps will vary with different companies’ accounting practices.²  While we think most companies had previously believed this to be the case, there may have been some divergence in practice.
• Two CDIs (128D.28 and 128D.29) deal with transition issues involving smaller reporting companies and emerging growth companies. 
• CDI 128D.30 states that, if there are two chief financial officers during the year, they are counted separately for purposes of computing average compensation amounts paid to the named executive officers.

New PVP CDIs – Issued on November 21, 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. In the 2024 proxy statement, if the registrant uses the same peer group for 2023 as it used for 2022, the registrant should present its peer group total shareholder return for each of the years in the table using the 2023 peer group. If it changes the peer group in subsequent years, it must provide disclosure of the change in accordance with Regulation S-K Item 402(v)(2)(iv).

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 sole 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, if retirement eligibility is not the sole vesting condition, other substantive conditions must also be considered in determining when an award has vested. Such conditions would include, but not be limited to, a market condition as described in Question 128D.16 or a condition that results in vesting upon the earlier of the holder’s actual retirement or the satisfaction of the requisite service period.  

Question 128D.23
Question: Some stock awards entitle the holder to receive dividends or dividend equivalents paid on the underlying shares prior to the vesting date. If the dollar value of dividends or dividend equivalents paid are not reflected in the fair value of such awards, should they be included in the calculation of executive compensation actually paid?

Answer: Yes. Item 402(v)(2)(iii)(C)(1)(vi) of Regulation S-K requires the calculation of executive compensation actually paid to include dividends or dividend equivalents paid that are not already reflected in the fair value of stock awards or included in another component of total compensation.

Question 128D.24
Question: When identifying a total shareholder return peer group under Regulation S-K Item 402(v)(2)(iv), the registrant must use either the same index or issuers used by it to comply with Item 201(e)(1)(ii) or the companies it uses as a peer group under Regulation S-K Item 402(b). If a registrant uses more than one “published industry or line-of-business” index for purposes of Item 201(e)(1)(ii), may a registrant choose which index it uses for purposes of its pay versus performance disclosure?

Answer: Yes. In order to provide clarity to investors, the registrant should include a footnote disclosing the index chosen. If the registrant chooses to use a different published industry or line-of-business index from that used by it for the immediately preceding fiscal year, it is required under Item 402(v)(2)(iv) to explain, in a footnote, the reason(s) for this change and compare the registrant's cumulative total return with that of both the newly selected peer group and the peer group used in the immediately preceding fiscal year.

Question 128D.25
Question: For purposes of determining the total shareholder return of a registrant’s peer group under Regulation S-K Item 402(v)(2)(iv), the registrant must use the same index or issuers used by it for purposes of Item 201(e)(1)(ii) or the companies it uses as a peer group for purposes of its disclosures under Item 402(b). If registrant discloses in its Compensation Discussion & Analysis that it determines the vesting of performance-based equity awards based on relative TSR compared to a broad-based equity index, can the registrant use that broad-based index as its peer group for purposes of Item 402(v)(2)(iv)?

Answer: No. Item 402(v)(2)(iv) does not contemplate the use of a broad-based equity index as a peer group for purposes of the pay versus performance disclosure.

Question 128D.26
Question: Pursuant to Regulation S-K Item 402(v)(2)(iv), if the registrant’s peer group is not a published industry or line-of-business index, the identity of the issuers composing the group must be disclosed in a footnote. The returns of each component issuer of the group must be weighted according to the respective issuers' stock market capitalization at the beginning of each period for which a return is indicated. In what circumstances is such market capitalization-based weighting required?

Answer: For purposes of Item 402(v)(2)(iv), the weighting requirement is applicable only if the registrant is not using a published industry or line-of-business index pursuant to Item 201(e)(1)(ii).

Question 128D.27
Question: If a registrant that uses a peer group other than a published industry or line-of-business index as its peer group under Regulation S-K Item 402(v)(2)(iv) adds or removes any of the companies in the peer group, is it required to footnote the change(s) and compare its cumulative total shareholder return with that of both the updated peer group and the peer group used in the immediately preceding fiscal year?

Answer: Yes. However, consistent with Regulation S-K Compliance and Disclosure Interpretations Question 206.05, comparison of the registrant's cumulative total return with that of both the newly selected peer group and the peer group used in the immediately preceding fiscal year is not required if (1) an entity is omitted solely because it is no longer in the line of business or industry, or (2) the changes in the composition of the index/peer group are the result of the application of pre-established objective criteria. In these two cases, a specific description of, and the bases for, the change must be disclosed, including the names of the companies deleted from the new index/peer group.

Question 128D.28
Question: A smaller reporting company (SRC) with a December 31 fiscal year end provided scaled pay versus performance disclosure covering fiscal years 2021 and 2022 in its proxy statement filed in April 2023. It subsequently loses its SRC status based on its public float as of June 30, 2023. The registrant proposes to rely on General Instruction G(3) of Form 10-K to incorporate by reference executive compensation and other disclosure required by Part III of Form 10-K into its 2023 Form 10-K from its definitive proxy or information statement to be filed not later than 120 days after its 2023 fiscal year end. What pay versus performance information is the registrant required to include in such proxy or information statement?

Answer: The staff will not object if a registrant that loses SRC status as of January 1, 2024, continues to include scaled disclosure under Regulation S-K Item 402(v)(8) in its definitive proxy or information statement filed not later than 120 days after its 2023 fiscal year end from which the registrant’s Form 10-K will forward incorporate the disclosure required by Part III of Form 10-K. The pay versus performance disclosure in such filing must cover fiscal years 2021, 2022, and 2023. Unless the registrant regains SRC status in subsequent years, any other proxy or information statement in which Item 402(v) disclosure is required and that is filed after January 1, 2024, must include non-scaled pay versus performance disclosure. For example, in the registrant’s annual meeting proxy statement filed in 2025, it must include non-scaled pay versus performance disclosure for fiscal year 2024. A non-SRC is required to provide Item 402(v) disclosure covering five years; however, the staff will not object if the registrant does not add disclosure for a year prior to the years included in the first filing in which it provided Item 402(v) disclosure. The registrant generally is not required to revise the disclosure for prior years (in this example, 2021, 2022, and 2023) to conform to non-SRC status in such filings. However, because peer group TSR is calculated on a cumulative basis, the registrant should include peer group TSR for each year included in the pay versus performance table, measured from the market close on the last trading day before the registrant’s earliest fiscal year in the table. In addition, the registrant should include its numerically quantifiable performance under the Company-Selected Measure for each fiscal year in the table. The entirety of the Item 402(v) disclosure provided for all fiscal years must be XBRL tagged in accordance with Item 402(v)(7).

Question 128D.29
Question: A registrant that previously qualified as an emerging growth company loses that status as of December 31, 2024. Is it required to provide pay versus performance disclosure in its proxy statement filed in 2025? How many years are required in the table?

Answer: The registrant is required to provide pay versus performance disclosure in any proxy or information statement filed after it loses its EGC status. It may apply the transitional relief in Instruction 1 to Item 402(v).

Question 128D.30
Question: Two (or more) individuals served as a registrant’s principal financial officer (PFO) during a single covered fiscal year included the pay versus performance table and related disclosure under Regulation S-K Item 402(v). Each such individual is included in the Summary Compensation table as a named executive officer (NEO) pursuant to Item 402(a)(3)(ii). For purposes of the calculation of average compensation amounts for the NEOs other than the principal executive officer reported pursuant to Items 402(v)(2)(ii) and (iii), may the registrant treat the PFOs as the equivalent of one NEO?

Answer: No. Each NEO must be included individually in the calculation of average compensation amounts. In such cases, the registrant should consider including additional disclosure on the impact of the inclusion of such individuals on the calculation in order to provide clarity to investors.

¹ Based on a FW Cook survey of the S&P 500 companies that filed 2023 proxy statements as of June 1, 2023 (alert posted June 13, 2023, which can be read here), most companies (76%) used their 10-K published industry or line-of-business index as their total shareholder return peer group for purposes of the PvP disclosure.
² For example, a company reporting cash dividends in the Summary Compensation Table would not add the dividends into CAP because they are already included in total compensation.  Conversely, a company that does not include paid dividends in the Summary Compensation Table would need to add these amounts to determine CAP unless the underlying measurement date fair value reflected the dividends paid during the covered period .  

Samantha Nussbaum
Principal

 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.

David 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.