The Securities and Exchange Commission’s Division of Corporation Finance (CorpFin) staff has already been getting implementation inquiries about the commission’s so-called pay versus performance rule, which was adopted less than three months ago.
While the staff is responding to individual inquiries, CorpFin is also thinking about how broadly—and in what form—the most commonly asked questions could be answered.
“There is a requirement related to equity awards and pensions within the rule that, for example, the rule requires evaluation of equity awards at fair value using like
ASC 718 the stock comp U.S. GAAP guidance for valuing the equity awards on an annual basis, which is not something we traditionally do frequently in GAAP,” CorpFin Chief Accountant Lindsay McCord said at the Corporate Financial Reporting Insights Conference hosted by the Financial Executives International in New York on Nov. 7, 2022.
“So, we have received a lot of implementation questions related to that aspect from the financial reporting community,” McCord added. “We’re … trying to go through some of those questions now along with any of the other implementation questions we received and trying to figure out… how can we get information back to the public on this because… the whole purpose of this rule was to disclose information about the relationship between executive compensation actually paid by the registrant and its financial performance.”
The rules are described in Release No. 34-95607, Pay Versus Performance. The release was published in August and became effective on Oct. 11. And because companies must begin to comply with the disclosures for fiscal years ending on or after Dec. 16, 2022, the staff has been getting a lot of queries on how to apply the rules.
The rules were mandated by Section 953(a) of the Dodd-Frank Act. Sec. 953(a) of PL111-203
The financial reform law requires companies to disclose numbers that show the relationship between executive compensation and the financial performance of the company.
The SEC’s final rules require companies to include in proxy or information statements a Summary Compensation Table for the principal executive officer (PEO) and, as an average, for the other named executive officers (NEOs). This will require total compensation and a measure reflecting “executive compensation actually paid,” as McCord said in her remarks.
Companies must provide financial performance measures that show total shareholder return (TSR); industry TSR; the company’s net income; and a financial measure chosen by the company. This last requirement—which the SEC calls company-selected measure—would be specific to that company, and it would represent the most important financial performance metric that it uses to link compensation actually paid to the company’s NEOs to company performance for the most recent fiscal year.
For pension, the SEC is requiring companies to include the value of plan amendments in the calculation of compensation actually paid. As for equity awards, the SEC requires companies to use fair value as the measure of the amount of an award.
This is “consistent with accounting in the financial statements, [but] we are adjusting the date on which the award is valued in response to comments, so that the first fair value disclosure is made in the year of grant, and changes in value of the award are reported from year to year until the award is vested,” the SEC said in the release. “We believe this approach will better align the timing of the disclosure and valuation with when the award is actually ‘earned’ by the executive, resulting in disclosure that more clearly shows the relationship between executive compensation and the registrant’s performance.”
McCord said that the words “actually paid” when it comes to stock-based compensation or pension are tricky and involve some interpretation to figure out how and when the calculation must occur.
“So, the staff did spend a lot of time with the accountants in the agency to kind of discuss that, and you will see in the release if anyone wants to pick it up for fun and read,” she said.
Non-GAAP Measure and Pay vs. Performance
At the conference, she was asked about the requirement for the company selected measure and whether there could potentially be some problems related to the use of non-GAAP measures when companies do their pay versus performance analysis. Corporate presentation of misleading non-GAAP figures has been a perennial problem for CorpFin.
CorpFin’s top accountant responded that some companies might well use a non-GAAP measure as the most important metric in showing pay versus performance figures.
“But that’s why also the rule has in there that we are requiring that net income be disclosed. And that’s net income from the GAAP financial statements,” McCord explained.
“When you kind of look across the board in executive compensation disclosures and what companies are doing, most companies have some sort of profit measure that they are tying executive compensation to, but we didn’t want to mandate a non-GAAP measure that not everyone’s going to calculate…like operating margin. A lot of companies do not have operating margin on the base of their financial statements. But everyone does have an income because it’s prescribed by Regulation S-X, or it’s prescribed by IFRS,” she said. “And so, we were trying to be thoughtful and saying, ‘let’s make sure we put up a profit measure as a mandatory requirement. Let’s make sure it’s something that every preparer can easily pull from their financial statements, instead of it being something that we then have an implementation question of: ‘how do I calculate this profit margin?’”
This article originally appeared in the November 17, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.
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