Regulators Are Back: What to Watch in Compensation Plans

After taking more than a decade to finalize pay-for-performance compensation rules, the U.S. Securities and Exchange Commission now expects companies to take about six months to comply with them.

“There will be a lot of computers blowing up in the next several months,” says Todd Leone, a partner at the compensation consulting firm McLagan, an Aon company. “There’s a lot of eye-rolling that we didn’t have much time to do this.”

Leone was speaking to a group of more than 250 human resources professionals, directors and industry leaders attending Bank Director’s Bank Compensation and Talent Conference, taking place November 8 through 9 in Dallas. The new SEC disclosure rule is one of a host coming down the pipeline for publicly traded companies. Leone says the agency introduced 26 new proposals so far in 2022, the highest it has been in five years.

“It’s turned into quite a big to-do,” says Susan O’Donnell, a partner at Meridian Compensation Partners, who also spoke about the pay-for-performance regulation on stage.

After years of little activity finalizing what languished in the Dodd-Frank Act of 2010, regulators under President Joe Biden have taken renewed interest in adopting rules that will impact a broad swath of mostly public companies. In 2015, the SEC first proposed rules to require companies to disclose more about the relationship between executive pay and performance. In August, the SEC adopted the rules, which go into effect for fiscal years ending on or after December 16, 2022. In other words, most public banks will be required to provide the new disclosures starting in the 2023 proxy season. Smaller reporting companies are subject to scaled disclosure requirements.

“I think that this rule will help investors receive the consistent, comparable, and decision-useful information they need to evaluate executive compensation policies,” SEC Chair Gary Gensler said in a statement at the time. O’Donnell says companies will have to report executive compensation alongside financial performance metrics, including total shareholder return, as well as TSR of a peer group, net income and a financial performance metric chosen by the company. In all, the company will be required to report three to seven financial performance metrics.

This could cause problems for banks that complete M&A deals, Leone says. Typically, net income falls after an acquisition because of one-time expenses. At the same time, compensation increases, sometimes to motivate the executive team to make the deal a success. He recommends banks include a description in the disclosure that describes why pay and performance may not appear to align.

“Institutional investors aren’t looking at this to tell them anything they don’t already know,” Leone says. “The one area where we’re scratching our heads is what are the plaintiffs’ lawyers going to do. You have to make sure there’s a story behind this and a narrative that you’re telling.” The first year, Leone says companies will have to disclose three fiscal years of compensation metrics, so he advises companies to get started now on 2020 and 2021 calculations. Each year, another year will be added, until companies report five years’ worth of data.

Companies will have more time to comply with the other recently finalized disclosure rule required by the Dodd-Frank Act, this one having to do with clawing back incentive compensation that was granted in error. Leone referred to the rule as “lovely bedtime reading for those of you with insomnia,” because it encompasses more than 200 pages.

In October, the SEC finalized the rule that had first been proposed in 2015 requiring companies to disclose their policies regarding clawing back compensation from named executives. Usually, those clawbacks occur due to restatements of earnings or misconduct. Although the rule doesn’t say that clawbacks must occur for misconduct, the rule does require companies to claw back compensation that was based on erroneous calculations, regardless of whether the executive was at fault for the error. Leone expects the rule to go into effect later in 2023. Smaller reporting companies do have to comply with this one.

And the third disclosure rule coming down the pike for public companies is Nasdaq’s new board diversity rule. Laura Hay, lead consultant for Meridian Compensation Partners, says the exchange will require companies to have at least one diverse director starting in 2023 and two starting in 2025, or explain why they don’t have them. Diversity may include gender or underrepresented minorities, as well as LGBTQ individuals.

The exchange also requires that companies include a diversity matrix in their disclosures, which went into effect in August for the next proxy season.