SEC Issues Additional Compliance and Disclosure Interpretations on Pay Versus Performance Disclosure

SEC Issues Additional Compliance and Disclosure Interpretations on Pay Versus Performance Disclosure
October 16, 2023 11 mins

SEC Issues Additional Compliance and Disclosure Interpretations on Pay Versus Performance Disclosure

SEC Issues Additional Compliance and Disclosure Interpretations on Pay Versus Performance Disclosure Hero Banner

The SEC published nine new Compliance and Disclosure Interpretations (C&DIs) covering the pay versus performance rule. The C&DIs focus on when awards are considered vested and the valuation of equity awards in specific circumstances.

Key Takeaways
  1. These new PVP C&DIs focus primarily on when awards are considered vested for purposes of the PVP calculations and on the valuation of equity awards in specific circumstances.
  2. There is also guidance related to equity restructurings, including spin-offs.
  3. The latest C&DIs arrive after most companies have already filed their first PVP disclosure. One question is whether a company should recalculate the “Compensation Actually Paid” for any impacted years reported in a previously filed proxy statement for the next proxy statement.

On September 27, 2023, the Division of Corporation Finance (Corp Fin) of the U.S. Securities and Exchange Commission (SEC) published nine new Compliance and Disclosure Interpretations (C&DIs) covering the pay versus performance (PVP) rule. Initial guidance, also in the form of C&DIs, was provided in February 2023. Therefore, these C&DIs are in addition to prior guidance from the SEC.

These new PVP C&DIs focus primarily on when awards are considered vested for purposes of the PVP calculations and on the valuation of equity awards in specific circumstances. In addition, there is guidance related to equity restructurings, including spin-offs. Below, we summarize these new C&DIs and provide our perspective on how this additional guidance may impact future disclosures. (See the full list of C&DIs here.)

C&DIs Related to Vesting and Forfeiture of Equity Awards

Question 128D.16 Though “market conditions” related to the price of a company’s shares in an equity award are not technically considered vesting conditions under U.S. GAAP, should they be treated as vesting conditions for purposes of the PVP calculation?

Yes. If a market condition continues to affect the value of the equity award that is realizable by an individual, the valuation should take the market condition into account, and the underlying award should be treated as unvested, with changes in fair value incorporated into “compensation actually paid.” This means that companies with awards with market conditions should still measure the value of the award through the end of the performance period including the impact of the market condition on the value, most commonly performed using Monte Carlo simulation.

Question 128D.17. Under what circumstances would an equity award with a market condition that was not met at year end but with some performance period remaining be treated as forfeited under the PVP rules?

Such an award would only be treated as forfeited (and its value subtracted) if the current value of the award is zero and there is no future possibility of realizing value from the award. In all other cases, the award will need to be revalued (even though the value may be quite low).

Question 128D.18. If accelerated vesting of an award is provided when the holder becomes eligible for retirement, should the award be treated as vested for purposes of the PVP rules once the holder is retirement eligible?

Yes, but only if there are no other substantive conditions that must first be met. For example, if the equity award continues to be subject to a market condition before realizing any value, then the award would not be treated as vested solely due to the holder becoming retirement eligible. In other words, once a holder becomes retirement eligible, an award should be treated as vested, unless there is a separate substantive condition like a market condition.

Aon Perspective: Generally, this new guidance appears to be aligned with how awards are handled for purposes of the Outstanding Equity Awards at Fiscal Year-End table and the Option Exercises and Stock Vested table. If an award has a substantive condition that puts realizing the underlying value at risk (other than from normal stock price volatility), then the award is treated as outstanding and unvested for purposes of the PVP calculation. Companies should carefully review the terms and conditions of equity awards to determine if there remain substantive forfeiture conditions up until the performance level is certified. While the intent of the C&DIs was to clarify, we believe the guidance remains ambiguous in the case of an award with only time-based vesting and a retirement eligibility condition, as such an award may be interpreted to be vested on the earliest of the executive’s retirement eligibility date, the explicit contractual vesting date, or the date of the executive’s actual retirement. Given the different possible interpretations associated with this C&DI, Aon recommends careful review of your equity plans and retirement provisions, while also consulting your counsel.

Question 128D.19. If settlement of an award with a performance condition is made only after performance is certified by others (e.g., the Compensation Committee), should the award be treated as vested in the year certification takes place or in the year the performance period ends?

The answer depends on whether the certification process is effectively a substantive condition. For example, if the individual must remain employed through the date of certification, then that is a substantive condition, and the award would not be treated as vested until certification takes place.

C&DIs Related to the Valuation of Equity Awards

Question 128D.20 May a valuation technique that differs from the one used to determine the grant date fair value of an equity award be used for purposes of the PVP disclosure?

Yes, if the technique is permitted under FASB ASC 718. However, if the technique differs materially from the technique used to determine the grant date fair value, then disclosure of the change in technique and the reason for the change is required.

Question 128D.21. May a valuation methodology not prescribed by GAAP be used for the PVP disclosure?

No shortcut or other methods are permitted to determine the expected life of stock options. Use of the simplified method in SAB 14.D.2, Question 6 for determining expected life must strictly comply with the “plain vanilla” assumptions required for use of that method. This means any companies that maintained options that were underwater could not simply subtract the elapsed time from grant to valuation date from the expected life and must also incorporate a methodology that considers other factors such as the “moneyness” of the option.

Question 128D.22. Registrants are not required to disclose target levels of performance in the CD&A if the information is confidential and disclosure would result in competitve harm. Is there similar relief with respect to any discussion that may be required as part of the PVP disclosure (for example, when the actual levels of performance used to determine the fair value of a performance equity award at fiscal year end differ materially from the assumption used to determine the award’s grant date fair value)?

Yes. However, there is a high bar for demonstrating that disclosure would result in competitive harm if disclosed, and the registrant would still be required to be as responsive as possible to the disclosure requirement without disclosing the confidential information. For example, discussion of the range of possible outcomes and the degree of difficulty of achieving a target level of performance may be appropriate.

Aon Perspective: Pragmatically, this can be somewhat delicate, as even discussing the range of possible outcomes could reveal information that is competitively sensitive. Then again, the concern about disclosing actual levels of performance is unlikely to be a significant concern in most instances. That’s because the values of all outstanding equity awards are combined within the PVP table and the footnotes, thus making it difficult to determine the performance associated with an individual performance-based award.

Question 128D.15. For equity awards outstanding as of the date of an initial public offering (IPO), should the change in fair value of the award be based on the fair value of the award at the end of the preceding fiscal year end or some other date such as the date of the IPO?

The change should be based on the fair value of the award at the end of the preceding fiscal year, not the IPO date or any other date.

Aon Perspective: Unlike a public company stock price, which reflects trading activity at or shortly preceding fiscal year end, there might not be a valuation that coincides with the last day of the fiscal year. In such cases, judgement will be required to determine the best estimate of the company’s equity value as of that date. In doing so, companies should look to existing indications of value on or around the valuation date. This may include the most recent valuation prior to year-end, internal valuation models and pre-IPO indications of value from external sources as examples. We expect that in most situations an approximate value as of the preceding fiscal year will already exist and, therefore, a new company valuation will not be required as of that date.

C&DIs – Other Guidance

Question 128D.14. Should awards granted prior to an equity restructuring, such as a spin-off, be included in the PVP calculations?

Yes. All equity awards that are unvested and outstanding at the beginning of a fiscal year during which a restructuring takes place or granted in the year the restructuring occurs, including awards modified in connection with the restructuring, or retained following such a transaction, should be reflected in the PVP disclosure.

Aon Perspective: The statement of this principle seems straightforward, but “the devil is in the details.” The C&DI covering treatment of awards granted prior to a restructuring does not attempt to address the complexities that may arise with certain restructurings. For example, if grantees in the parent company received unvested shares of stock in the spin-off company as part of the restructuring, how might that affect the PVP calculations going forward? This guidance will, in practice, require companies to make additional interpretations in preparing their PVP disclosure not addressed by this guidance.

Question 118.08. For non-GAAP financial measures included in the proxy statement, Regulation G and Regulation S-K Item 10(e) apply, requiring the definition of the measure, greater or equal prominence of GAAP measures and reconciliation to the closest GAAP measure. Must PVP disclosure of the Company Selected Measure and other financial performance measures also comply with Regulation G or Item 10(e)?

No, but disclosure must be provided as to how the measure is calculated from the audited financial statements.

Next Steps

With the latest C&DIs arriving after most companies have already filed their first PVP disclosure, the other remaining question is whether a company should, if impacted by the new guidance, recalculate the “Compensation Actually Paid” for any impacted years reported in the PVP disclosure of a previously filed proxy statement in the next proxy statement. The SEC does not provide clear guidance on the best approach, leaving it to companies to determine the most appropriate path.

Updating the information will come with more time and cost but will result in a disclosure that employs the same methodologies across years, making the information more consistent. Alternatively, updating the approach only prospectively will save time and cost but may create an odd transition from the prior years to the current one. The best path may vary by company, and companies may wish to discuss the appropriate approach with counsel.

The Aon Equity Services and Corporate Governance Teams have deep expertise in pay-versus-performance disclosure. Contact us to discuss this new guidance and its application to your company in more detail.

General Disclaimer

This document is not intended to address any specific situation or to provide legal, regulatory, financial, or other advice. While care has been taken in the production of this document, Aon does not warrant, represent or guarantee the accuracy, adequacy, completeness or fitness for any purpose of the document or any part of it and can accept no liability for any loss incurred in any way by any person who may rely on it. Any recipient shall be responsible for the use to which it puts this document. This document has been compiled using information available to us up to its date of publication and is subject to any qualifications made in the document.

Terms of Use

The contents herein may not be reproduced, reused, reprinted or redistributed without the expressed written consent of Aon, unless otherwise authorized by Aon. To use information contained herein, please write to our team.

Aon's Better Being Podcast

Our Better Being podcast series, hosted by Aon Chief Wellbeing Officer Rachel Fellowes, explores wellbeing strategies and resilience. This season we cover human sustainability, kindness in the workplace, how to measure wellbeing, managing grief and more.

Aon Insights Series Asia

Expert Views on Today's Risk Capital and Human Capital Issues

Aon Insights Series Pacific

Expert Views on Today's Risk Capital and Human Capital Issues

Aon Insights Series UK

Expert Views on Today's Risk Capital and Human Capital Issues

Construction and Infrastructure

The construction industry is under pressure from interconnected risks and notable macroeconomic developments. Learn how your organization can benefit from construction insurance and risk management.

Cyber Labs

Stay in the loop on today's most pressing cyber security matters.

Cyber Resilience

Our Cyber Resilience collection gives you access to Aon’s latest insights on the evolving landscape of cyber threats and risk mitigation measures. Reach out to our experts to discuss how to make the right decisions to strengthen your organization’s cyber resilience.

Employee Wellbeing

Our Employee Wellbeing collection gives you access to the latest insights from Aon's human capital team. You can also reach out to the team at any time for assistance with your employee wellbeing needs.

Environmental, Social and Governance Insights

Explore Aon's latest environmental social and governance (ESG) insights.

Q4 2023 Global Insurance Market Insights

Our Global Insurance Market Insights highlight insurance market trends across pricing, capacity, underwriting, limits, deductibles and coverages.

Regional Results

How do the top risks on business leaders’ minds differ by region and how can these risks be mitigated? Explore the regional results to learn more.

Human Capital Analytics

Our Human Capital Analytics collection gives you access to the latest insights from Aon's human capital team. Contact us to learn how Aon’s analytics capabilities helps organizations make better workforce decisions.

Insights for HR

Explore our hand-picked insights for human resources professionals.

Workforce

Our Workforce Collection provides access to the latest insights from Aon’s Human Capital team on topics ranging from health and benefits, retirement and talent practices. You can reach out to our team at any time to learn how we can help address emerging workforce challenges.

Mergers and Acquisitions

Our Mergers and Acquisitions (M&A) collection gives you access to the latest insights from Aon's thought leaders to help dealmakers make better decisions. Explore our latest insights and reach out to the team at any time for assistance with transaction challenges and opportunities.

Navigating Volatility

How do businesses navigate their way through new forms of volatility and make decisions that protect and grow their organizations?

Parametric Insurance

Our Parametric Insurance Collection provides ways your organization can benefit from this simple, straightforward and fast-paying risk transfer solution. Reach out to learn how we can help you make better decisions to manage your catastrophe exposures and near-term volatility.

Pay Transparency and Equity

Our Pay Transparency and Equity collection gives you access to the latest insights from Aon's human capital team on topics ranging from pay equity to diversity, equity and inclusion. Contact us to learn how we can help your organization address these issues.

Property Risk Management

Forecasters are predicting an extremely active 2024 Atlantic hurricane season. Take measures to build resilience to mitigate risk for hurricane-prone properties.

Technology

Our Technology Collection provides access to the latest insights from Aon's thought leaders on navigating the evolving risks and opportunities of technology. Reach out to the team to learn how we can help you use technology to make better decisions for the future.

Top 10 Global Risks

Trade, technology, weather and workforce stability are the central forces in today’s risk landscape.

Trade

Our Trade Collection gives you access to the latest insights from Aon's thought leaders on navigating the evolving risks and opportunities for international business. Reach out to our team to understand how to make better decisions around macro trends and why they matter to businesses.

Weather

With a changing climate, organizations in all sectors will need to protect their people and physical assets, reduce their carbon footprint, and invest in new solutions to thrive. Our Weather Collection provides you with critical insights to be prepared.

Workforce Resilience

Our Workforce Resilience collection gives you access to the latest insights from Aon's Human Capital team. You can reach out to the team at any time for questions about how we can assess gaps and help build a more resilience workforce.

More Like This

View All
View All
Subscribe CTA Banner