What do the SEC’s pay versus performance rules mean for firms?

As we embark on an increasingly transparent regulatory landscape, key global players have been doing their bit to tie up any loose ends and close gaps.

Just recently, the US Securities and Exchange Commission (SEC) finalised its long-awaited pay versus performance disclosure rules, which implement a requirement mandated by the Dodd-Frank Act. The Commission actually recommended pay versus performance disclosure rules back in 2015, and reopened the comment period at the beginning of this year, likely to keep up with shifting investor focus.

Commencing from December 2022, public companies will now be required to include in proxy or consent solicitation material for a yearly meeting of shareholders additional disclosure, showing the relationship between the executive compensation paid and the company’s financial performance.  The rules apply to all public companies except foreign private issuers, registered investment companies, and emerging growth companies, as well as scaled disclosure requirements for smaller reporting companies.

Pay versus performance disclosure rules summary

The rules now require firms to communicate information regarding the relationship between executive compensation paid and the firm’s financial performance. In short, this means that regulators want to see how well the firm has done against how much it has paid senior executives.

The new rules place a significant new burden on firms, asking them to:

• Provide a table disclosing specified executive compensation and financial performance measures for their five most recently completed fiscal years.
• Report total shareholder return (TSR), the TSR in the firm’s peer group, its net income and chosen financial performance measures.
• Describe the relationships between the amount of executive content paid and each of the performance measures and the relationship between the registrant’s TSR and the TSR of its selected peer group.
• Provide a list of three to seven financial performance measures that it determines are most important for linking executive compensation to company performance.

All registrants must start to comply with these new disclosure requirements on or after 16 December 2022.

The Dodd-Frank Act & pay versus performance rules

As many will remember, after the 2008 financial crisis the Dodd-Frank Wall Street Reform and Consumer Protection Act was put in place to maintain financial stability. It aimed to target sectors of the financial industry’s deceptive practices that were assumed to have caused the financial crash, for example, banks, mortgage lenders, and credit rating agencies.

It looked to improve accountability and transparency as well as protect consumers from neglectful or mismanaged financial services by ensuring financial service providers played by the rules in place.

While many welcomed the Act, some expressed concerns that it could harm the competitiveness of US firms in comparison to other countries. Consequently, in May 2018, during President Trump’s term, a new law was signed where large segments of Dodd-Frank were rolled back.  

Fast forward four years, we see a shift away from Trump-era deregulation with the SEC’s announced pay versus performance rules to achieve a greater level of accountability and transparency for shareholders, the executives and the company – venturing towards a more equal financial industry, one step at a time.

The SEC recognises that these rules make “it easier for shareholders to assess a public company’s decision-making with respect to its executive compensation policies”, which reflects a broader shift towards increased company disclosures.

SEC Chair Gary Gensler added, “I am pleased that the final rule provides new, more flexible disclosures that allow companies to describe the performance measures it deems most important when determining what it pays executives. I think that this rule will help investors receive the consistent, comparable, and decision-useful information they need to evaluate executive compensation policies.”

CUBE comment

As investors move towards an attitude of information-empowered investment, regulators are taking steps to implement regulatory frameworks that match the shifting societal mood. The end goal ultimately builds on the notion that knowledge is power, if investors understand where their money goes, they can make more informed decisions.

By proposing rules that ask firms for more information regarding executives’ compensation, the SEC would understand the inner workings of this world much better – airing any dirty laundry and introducing a sense of balance.

Even though the SEC has not cited any repercussions for companies if these rules aren’t followed, they’re setting a clear standard for best practice which only makes a corporation attain a more respectable reputation – one where everything is out in the open and misconduct is prevented. In time, investors will use company disclosures as a benchmark for investment decisions – companies who fail to disclose will not be looked upon favourably.

On the other hand, new rules do mean more work for compliance teams. The ever-increasing compliance burden can be challenging to manage, especially when done manually, or when using patchy or outdated technology. To navigate any new changes, automated regulatory intelligence (ARI) products are the only viable solution in ensuring your business is operating to the best possible standards – sleep peacefully at night with no stone unturned.

CUBE can help future-proof and steer through regulatory changes. With the whole world of regulatory intelligence at your fingertips, all your regulatory obligations can be found in one place, in any language, reflective of your business needs.