Mayer Brown preps firms on key points in SEC's compensation-related rulemaking
Rather than simply waiting for proposed SEC rules regarding executive compensation to be finalized, companies should be using this time to prepare by looking at how their compliance policies will need to change as a result of new rules on incentive pay claw backs, hedging, pay for performance and pay ratio currently under consideration in Washington.
That was a key piece of advice offered by Laura Richman and Michael Hermsen, two securities lawyers in Mayer Brown’s Chicago office, on a recent teleconference held to update companies on the SEC’s Dodd-Frank compensation-related rulemaking.
Richman, who represents clients on stock exchange-related compliance matters and public disclosure obligations, spent most of her time on the call speaking about the claw backs, which would kick in if a company must prepare a financial restatement because of material non-compliance with any securities law financial reporting requirements.
Reminding participants that the proposed claw back rule relates to any incentive-based compensation granted, earned or vested upon attaining a financial reporting measure, she said it may surprise some people to learn that, as proposed, these measures include not only accounting measures used in financial statements but also stock price and total shareholder return (TSR).
‘Under the proposal, if compensation is based on stock price or TSR, companies would have to make reasonable estimates on how the accounting restatement impacted stock price and TSR since there’s no precise mathematical formula fro which you can re-calculate the effect,’ Richman said. ‘And I personally find this one of most challenging aspects of the SEC’s claw back proposal.’
Even though there already exists a currently effective claw back requirement as a result of the Sarbanes-Oxley Act, the claw back requirement under Dodd-Frank differs in some key ways. While the Sarbanes-Oxley claw back is limited to the CEO and CFO, Dodd-Frank’s applies to anyone who served as an executive officer at any time during the performance period, including former officers, Richman explained. And unlike S-Ox, the new proposed rule isn’t limited to executive officers who engaged in misconduct or were in any way responsible for erroneous financial statements. Instead, it would apply on a no-fault basis. Thos officers to whom it would apply are defined by Section 16 of the Securities Act of 1934, and not limited to the named officers listed in the compensation tables.
Richman urged listed companies not to postpone considering the implications of the proposal. ‘It will take thought and effort to develop compliance policies and related procedures to assess the implications of the claw back proposal on existing contracts, plans and governance documents and possibly draft claw back provisions to use in new agreements,’ she said. And because claw backs also may affect accounting treatment, she advises companies to take time now to involve their accountants in claw back conversations.
In addition, companies should evaluate those people they treat as Section 16 officers or otherwise identify as executive officers since that list will have claw back implications.
Hermsen focused on some key points about the pending rules on pay for performance and pay ratio disclosure. He explained that a new subsection of Regulation S-K would require inserting a new compensation table in the proxy statement showing the relationship between compensation actually paid and performance, with performance measured both by the company’s TSR and its peer group’s TSR.
‘The values in the pay for performance table have to be tagged in [the SEC’s] XBRL format and related footnotes would have to be block text tagged,’ he said. ‘This would be the first time that the SEC’s interactive financial data requirements would be applied to proxy statements or a portion of proxy statements.’
Many companies have been including realized or realizable pay in their summary compensation tables. To the extent either of these is different from the new pay versus performance calculation, ‘companies will need to decide whether to stop including their previous disclosure,’ Hermsen said. ‘In addition, they will need to consider whether to weave this new metric into their CD&As in their compensation programs.’
Under the proposed pay ratio disclosure rule, the relationship between the CEO’s annual compensation and the median salary of all employees may be expressed numerically or in narrative form. The only required narrative disclosure, Hermsen said, would be a brief non-technical overview of the methodology used to identity the median and any material assumptions or adjustments used to adjust the median or to determine compensation or elements of compensation.
‘Even with the various options available, many companies may find it challenging and or costly to gather the required information,’ he said. ‘Public companies may want to evaluate their payroll and other compensation record-keeping systems for advanced planning purposes to preliminarily develop strategies for future compliance, and to consider how they would update controls and procedures for pay ratio disclosure once finalized.’