Securities and Exchange Commission rulemaking continued at a brisk pace in the first quarter of 2023 as the Commission implemented several significant reporting and compliance regulations adopted in 2022. Final rules and amendments became effective with respect to the following: pay-versus-performance disclosures; Rule 10b5-1 trading plans; universal proxy; incentive-based compensation recovery (“clawbacks”); electronic Rule 144 filings; and “glossy” annual report submissions. The New York Stock Exchange and Nasdaq proposed their respective listing rules for registrants to comply with the SEC’s new clawback rules. Additionally, the European Council approved its Corporate Sustainability Reporting Directive disclosure requirements both for companies headquartered in the European Union and non-European Union companies.
Pay Versus Performance Compliance Date, C&DIs & Early Observations
Disclosure Compliance Date
On August 25, 2022, the SEC adopted the pay-versus-performance (“PVP”) disclosure rules mandated by the Dodd-Frank Act. The new rules implement Item 402(v) of Regulation S-K requiring companies to provide both tabular and narrative disclosure of the relationship between executive compensation and financial performance.
Companies must comply with the final rules in proxy and information statements covering fiscal years ending on or after December 16, 2022. The final rules require PVP disclosure for each of the company’s five most recent fiscal years (or three years for smaller reporting companies), with the rule permitting a company’s first year to report only three fiscal years and thereafter an additional year in each subsequent filing until the company discloses the requisite five years of information. For a more detailed summary of the final rule, please refer to our blog post titled, “Pay for Performance Rules Finally Here – What You Need to Know”.
SEC Compliance & Disclosure Interpretations
On February 10, 2023, the Staff of the SEC issued new compliance and disclosure interpretations (“C&DIs”) providing guidance on PVP disclosure requirements. The Staff issued 15 new C&DIs; a summary of the ones likely applicable to most companies is below:
- Disclosure Not Required in Form 10-K – PVP disclosure is not required to be incorporated by reference into Part III of Form 10-K and is only required in proxy or information statements that require Item 402 of Regulation S-K disclosure.
- Footnote Disclosures for Compensation Actually Paid Adjustments – Aggregating adjustments to calculate “compensation actually paid” (“CAP”) is not permitted. The rule requires footnote disclosure of each amount deducted and added pursuant to Item 402(v)(2)(iii). Additionally, footnote disclosure of each adjustment amount is required for all fiscal years in the PVP table but for only the first year of disclosure. Subsequent years require footnote disclosure of adjustments for the most recent fiscal year in the table.
- Peer Groups – Companies may use any compensation peer group that is disclosed in its Compensation Discussion and Analysis (“CD&A”) as a peer group actually used to help determine executive pay for purposes of calculating peer group total shareholder return (“TSR”).
- GAAP Net Income Required – Column (h) of the PVP table must include the net income or loss measure required to be disclosed in the company’s audited GAAP financial statements.
- Multiple PEOs – Companies with multiple principal executive officers (“PEOs”) in a fiscal year may aggregate the PEOs’ CAP for purposes of the required narrative and/or graphical relationship disclosure but only to the extent that the presentation would not be misleading to investors.
- Equity Awards Granted Prior to Becoming NEO – Equity awards granted in a year prior to the year an individual becomes a named executive officer must be included in the calculation of the change in fair value of equity awards in determining CAP.
Early Observations
Below are some observations on early PVP disclosure trends for the first 100 company filings for the first quarter of 2023.
- Placement of PVP Disclosure
While the PVP rule affords flexibility as to where the disclosure should go in the proxy statement, the two most common choices of where to put the disclosure appear to be (1) outside the CD&A and (2) after the CEO pay ratio disclosure and the other proxy tables. None of the early proxy statements filed with the PVP disclosure included it within the CD&A section.
- Supplemental PVP Disclosure
The rule permits companies to include supplemental disclosure with its PVP disclosure. It is generally not advisable to add supplemental disclosure unless a company has a unique circumstance or a special message it wishes to deliver. From the early filings, very few companies elected to provide supplemental disclosure.
- Company-Selected Peer Group
The PVP table includes a column presenting cumulative TSR comparisons for a company-selected peer group. This peer group either can be from the Form 10-K performance graph or from the company’s CD&A section. A majority of early filers have chosen the companies on their Form 10-K performance graph. Using the Form 10-K performance graph group is simpler and easier to roll forward than using some other peer group that must contain disclosure if the peer group changes year-over-year.
- Company-Selected Financial Measure
The PVP table also requires a company-selected measure, which is the most important financial measure linking compensation actually paid to company performance. This cannot be a measure that is already on the table elsewhere and can be omitted if no such measure exists. The most popular measure so far is profit or income, representing approximately 60% of early filers. Among those, earnings per share-based measures are the most common. Very few companies are including additional or supplemental measures.
Additionally, the rule instructs companies to provide a tabular list of at least three, and up to seven, financial performance measures used to link CAP to company performance. Although the rule permitted non-financial performance measures to be included in the list (so long as there are at least three financial measures), most companies provided the minimum number of financial measures and disclosed either zero or one non-financial measure.
Rule 10b5-1 Plan & Form 4 Compliance Dates
In December 2022, the SEC adopted amendments to Rule 10b5-1 and new disclosure requirements to protect against insider trading. The 10b5-1 plan amendments went into effect February 27, 2023, the revisions to Forms 4 and 5 go into effect April 1, 2023, and the new disclosures for Forms 10-Q or 10-K go into effect in filings that cover the first full fiscal period beginning on or after April 1, 2023. The following are key highlights from the amendments, which we previously reviewed here:
- A cooling-off period for individuals who adopt 10b5-1 plans, delaying the first trade after a plan is adopted.
- Restriction of the use by anyone, other than issuers, of multiple overlapping plans.
- Limit on single-trade plans to one per every 12-month period.
- When adopting a new 10b5-1 trading plan or modifying an existing plan, a director or officer will need to include with the plan written representations certifying that he or she is not aware of material nonpublic information about the issuer or its securities and is adopting or modifying the plan in good faith.
- A mandatory checkbox will be added to Forms 4 and 5, where filers will have to indicate whether a transaction reported on that form was made under a plan intended to satisfy the affirmative defense conditions of Rule 10b5-1. If yes, the filer will need to provide the date the plan was adopted.
- Bona fide gifts of equity securities are no longer reported on Form 5, and instead are reported on Form 4 and filed before the end of the second business day following the date of the gift. Any dispositions by gift made on or after February 27, 2023 are reportable on Form 4 within two business days of the transaction, even though the compliance date for the amendments to Forms 4 and 5 is not until April 1, 2023.
Companies are also now required to provide new quarterly disclosure if, during the last fiscal quarter, any director or officer has adopted or terminated a 10b5-1 plan or a pre-arranged trading plan that does not qualify as a 10b5-1 plan, including a description of the material terms of such plans, the name and title of the director or officer, the date of the adoption or termination, the duration of plan, and the aggregate number of shares to be sold or purchased. On a yearly basis, companies are required to disclose whether the company has adopted insider trading-related policies and procedures and if not, explain why. A copy of such policy and procedure must be filed as an exhibit to the Form 10-K.
Universal Proxy Reminders
Under new SEC Rule 14a-19, which was adopted November 2021 and went into effect September 2022, universal proxy cards must be used by management and shareholders soliciting proxy votes for their candidates in contested director elections. The universal proxy card must include all director nominees presented by management and shareholders for election at the upcoming shareholder meeting. Previous summaries of the rule and its requirements can be found here and here.
This change now permits shareholders to pick and choose a combination of candidates from each slate in a contested election. Before this rule change, essentially shareholders could only vote for one slate and were unable to vote for a combination of director nominees from competing slates. This meant shareholders either could vote the management proxy card or the dissident proxy card.
The new rules require the dissident shareholder to notify the company of its intent to solicit proxies and provide the names of its nominees at least 60 calendar days before the anniversary of the previous year’s annual meeting. On the other hand, the company must provide the dissident shareholder with the names of its nominees at least 50 calendar days before that anniversary. The dissident must file its definitive proxy statement with the SEC by the later of 25 calendar days before the shareholders meeting or five calendar days after the company files its definitive proxy statement. The new rules provide a minimum notice requirement and do not supersede any advance notice bylaw requirements the company may have. Companies must include this Rule 14a-19 notice deadline in their proxy statements.
Further, Rule 14a-19 requires shareholders presenting their own director candidates to solicit a minimum of 67% of the voting power. To satisfy this requirement, the dissident shareholder may mail the proxy materials to shareholders or use the “notice and access” method, which is less costly.
The new universal proxy rules also adopted Rule 14a-4, which provides that the proxy card in all director elections (not just contested elections) may not include an “against” voting option when there is no legal effect to such a vote. The new rule mandates that when state law gives legal effect to a vote cast against a nominee, then the proxy card must include “against” and “abstain” voting options in lieu of a “withhold” vote.
Companies may consider adopting amendments to their corporate bylaws to help ensure the new requirements are properly followed. Any amendments to the bylaws should also provide for the company’s redress in case shareholders do not comply with the new rules. This would allow companies to avoid SEC oversight and the uncertainty on how such noncompliance would be viewed under state law. Further, it is important to adopt these amendments to the bylaws on a “clear day” and before any shareholder campaign is initiated.
Incentive-Based Compensation Clawback Rule Update
In October 2022, the SEC adopted its incentive-based compensation recovery (“clawback”) provisions contemplated by the Dodd-Frank Act. Final Exchange Act Rule 10D-1 directs stock exchanges, including Nasdaq and NYSE, to establish listing standards requiring listed companies to implement a policy providing for the recovery of erroneously awarded incentive-based compensation received by current or former executive officers and to satisfy related disclosure obligations. Under this rule, final listing standards must be effective no later than November 28, 2023.
On February 22, 2023, both the NYSE and Nasdaq proposed their listing standards that would require listed companies to adopt and comply with Rule 10D-1. The rules closely follow the requirements of Rule 10D-1 with respect to the scope and content of the clawback policy, the obligations of a listed company under its clawback policy, and other related requirements. Additionally, both the NYSE and Nasdaq proposals include procedures for companies who are not in compliance with the listing standards.
The NYSE and Nasdaq both published their listing standards to the Federal Register on March 13, 2023. There is now a 21-day public comment period. The NYSE and Nasdaq proposals contemplate the new listing standards would be approved by the SEC, and become effective, within 45 days of the date of publication to the Federal Register, which is April 27, 2023, or within such longer period, up to 90 days, (i) as the SEC may designate if it finds such longer period to be appropriate and publishes its reasons for finding so, or (ii) as to which the listing exchange consents. After the listing standards are approved by the SEC, companies will then have 60 days to adopt a compliant clawback policy.
Because these rules and listing standards could be adopted as early as June 26, 2023, companies should begin to evaluate their clawback policies, if they have not already done so, or consider adopting a new policy that is compliant with Rule 10D-1 and the final listing standard.
For more information regarding the NYSE’s and Nasdaq’s proposed rules and listing standards, please read our previous post here.
Rule 144 Electronic Filing Compliance Date
On June 2, 2022, the SEC adopted rule amendments impacting Form 144. Rule 144 requires directors, executive officers and other affiliates of issuers to file a Form 144 when relying on the rule to effect a sale of certain restricted securities. Forms 144 are required to be filed concurrently with the placing of an applicable sale order, historically done by a sales broker in paper. Under the revised rules, Forms 144 will now be electronically filed on the SEC’s EDGAR filing system under the affiliate’s EDGAR code. This revision means the Forms 144 will be immediately available to the public.
The amended rules also delete the requirement in Rule 144(h)(1) to send a copy of the Form 144 notice to the principal exchange on which the restricted securities are listed. This is no longer necessary since Forms 144 will be filed electronically and the information will be immediately available upon filing.
Directors, executive officers and other affiliates will be required to file Forms 144 electronically beginning April 13, 2023.
Glossy Annual Report Requirements
Effective January 11, 2023, reporting companies are required to furnish their “glossy” annual reports electronically on EDGAR no later than the date on which the report is first sent or given to shareholders.
The SEC adopted amendments in June 2022 to Rule 101 of Regulations S-T that mandated the electronic submission of certain documents on EDGAR, including annual reports. This amendment applies to both standalone “glossy” annual reports and annual reports that use the “10-K wrap” approach. As a result of this adoption, the previous rule which allowed a company to only post its annual report to its website will no longer be sufficient. However, while posting the annual report on the corporate website is now optional, companies are still required to post a copy of the annual report to a website other than EDGAR pursuant to Rule 14a-16 of the Exchange Act.
Further, companies are no longer permitted to submit the annual report in paper format to the SEC. Effective January 11, 2023, the annual reports must be submitted to EDGAR in PDF format using EDGAR Form ARS. The annual report should not be reformatted, resized or otherwise redesigned when submitted to EDGAR. The PDF must reflect the same graphics, styles of presentation and prominence of disclosures as are contained in the annual report sent to shareholders.
EU Environmental, Social, and Governance Directive
On January 5, 2023, the European Council of the European Union (“EU”) formally adopted the Corporate Sustainability Reporting Directive (the “CSRD”). The CSRD is the EU’s initiative to improve the quality and consistency of corporate ESG disclosures. While companies are not subject to the specific reporting requirements until at least 2024, the impact on ESG reporting for companies that are subject to the CSRD will be significant and companies should identify the extent to which they may be subject to the directive and implement the processes, procedures and internal controls necessary to comply with the reporting requirements. The following entities would be required to provide new sustainability disclosures, as more fully defined in the CSRD: (1) large or listed EU companies; (2) parents of large EU groups; and (3) global groups with significant presence in the EU.
The introduction of reporting requirements for non-EU companies is one of the more significant aspects of the CSRD. Corporations with their ultimate parent companies outside of the EU, but with a significant presence in the EU, may be required to issue sustainability reports under the CSRD in relation to the whole global group, including in relation to non-EU group companies that are not doing business in the EU. To be included within this regulatory scheme, the global corporate group of the non-EU company must have generated “net turnover” within the EU of €150 million for two consecutive financial years and also either (a) have an EU subsidiary that meets the thresholds of a “large undertaking” or “public interest entity”, or (b) have a branch in the EU that generated €40 million “net turnover” in the preceding financial year. Note that the “large undertaking” or “public interest entity” definitions in the CSRD differ from the “significant subsidiary” definition used to determine significant subsidiaries for purposes of Form 10-K. Net turnover is defined as the amount derived from the sale of products and the provision of services after deducting sales rebates and value added tax (and other taxes directly linked to turnover).
While the deadline by which the CSRD commission must adopt an initial set of European Sustainability Reporting Standards (“ESRS”) is not until June 2023, companies should determine the extent of their EU presence and whether their subsidiaries or global group could be within the scope of the CSRD.
Now that the CSRD has been enacted, the next step is for each EU Member State to enact the terms of the CSRD into national legislation. Once enacted, companies will be required to report to the CSRD depending on the category it falls into. For large EU companies and parents of large EU groups, the reporting requirements begin January 1, 2024. For global group reporting requirements, compliance begins January 1, 2028.
