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The SEC released two Compliance and Disclosure Interpretations (C&DI) sets in 2023, with guidance issued on February 10th and September 27th, to clarify its expectations and assist filers subject to the Pay versus Performance disclosure requirements.
What Are Pay Versus Performance Disclosure Requirements?
The SEC issued Pay vs. Performance disclosure requirements to provide additional context on executive compensation packages’ full scope, allowing shareholders to benchmark compensation packages against company performance. VRC’s Q1 2023 perspective provides an overview of the disclosure requirements, including which organizations are required to provide disclosures and specifics on the information filers need to provide.
How Has the SEC Clarified Its Reporting and Disclosure Expectations During 2023?
These additional compensation-related disclosure requirements resulted in confusion and stress for many financial reporting teams that were already working at capacity to complete year-end annual reporting packages before filing their proxy statements.
During 2023, the SEC released additional guidance to facilitate compliance with the regulations. A complete interpretation of Regulation S-K issued by the SEC can be found HERE.
Several excerpts that more clearly define the SEC’s intent and solidify best practices for compliance with guidelines follow:
- In response to a question regarding the inclusion of stock awards granted before a restructuring, the SEC confirmed that “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 … should be included in the table.”
- In response to a question regarding awards with market conditions, the SEC stated: “The effect of a market condition should be reflected in the fair value of share-based awards with such a condition… 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.” The SEC goes on to emphasize that awards are likely to have remaining value if there is potential for the award to vest in the future and should generally only be marked to zero in cases where the awards have been forfeited and not those with remaining vesting potential.
- In response to a question regarding whether or not a registrant may use a different valuation technique than the one used to determine grant date fair value for stock and option awards, the SEC clarifies that yes, a new valuation technique is permitted, “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.” The SEC continues by stating that material changes to technique require footnote disclosure. Additionally, the SEC specifically points to an example of shortcut approaches used to value options at grant date for financial reporting purposes and its interpretation of this methodology for Pay versus Performance disclosure requirements. In its words, for Pay vs. Performance disclosure, “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 expected term assumptions at the grant date… Similarly, the expected term for options referred to as ‘plain vanilla’… should not be determined using the ‘simplified’ method… 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.“
What Should Filers Subject to Pay Versus Performance Disclosures Be Considering as Proxy Season Approaches?
Preparation is key as filers work to disclose Pay versus Performance compensation tables in their proxy statements accurately.
Engaging a valuation team early in the process can facilitate a collaborative identification of the scope of the awards that will need to be valued and identify unique valuation considerations for each (i.e., market vesting conditions, term conclusions based on option moneyness, etc.).
Once these key valuation considerations are identified, the valuation team can develop and document the fair value conclusions and underlying calculations required to support disclosures of the non-cash compensation that is actually paid to covered executives.
At VRC, we work tirelessly to stay on top of relevant valuation guidance and summarized stock option valuation guidance specific to Pay versus Performance disclosure requirements that echo SEC best practices on plain vanilla options months before the SEC released its C&DI. We look forward to working with you as a trusted partner in preparing supportable Pay versus Performance disclosure tables that can withstand SEC scrutiny.
Proxy season will be upon us sooner than we realize. VRC’s Complex Securities Practice Group and its valuation teams supporting the fair value needs of more than half of the Fortune 500 are coordinating to address Pay versus Performance Disclosure Requirements. Our team offers deep experience valuing complex securities, including credit/debt instruments, derivatives, equity, and structured products. We welcome you to contact article authors Frank Mainville, Kevin Gawron, or any VRC professional for further expert views and assistance with share-based compensation considerations and other questions.