On August 5, 2015, the Securities and Exchange Commission (SEC) adopted a final rule requiring public companies to disclose the ratio of the compensation of their chief executive officers to the median compensation of their employees (the “Rule”). The Rule was mandated by the Dodd-Frank Wall Street Reform Consumer and Protection Act (the “Dodd-Frank Act”). Issuers will be required to make a pay ratio disclosure in any filing described in Item 10(a) of Regulation S-K that requires executive compensation disclosure pursuant to Item 402 of such regulation. The largest burden is expected to be associated with companies’ annual filing of Form 10-K. Other filings that may require a disclosure include registration statements, proxy statements, and information statements. Companies must account for U.S. and non-U.S. (with very limited exceptions), full-time, part-time, temporary, and seasonal employees, as well as employees of its consolidated subsidiaries.
Many SEC registrants will be subject to the Rule. However, there are exclusions available for emerging growth companies, smaller reporting companies, and foreign private issuers.
Business groups have generally opposed the imposition of the proposed rule, not the least of their concerns being generated by the staggering compliance costs, which, even for just the initial compliance costs and by the SEC’s own estimates, are expected to exceed $1.3 billion for all issuers or nearly $370,000 per issuer. Ongoing compliance costs varied widely among market participants, but the SEC estimated ongoing compliance costs to be approximately 40% of first-year costs (an annual estimated industry-wide expense of more than half a billion dollars). The Rule will permit companies some flexibility. Notably, the Rule allows companies some options in selecting the methodology that will be used to determine their median employee and that employee’s compensation. Registrants may use reasonable estimates of annual total compensation or any elements of total compensation and may also use the entire employee population, statistical sampling of the employee population, and/or other reasonable methods.
Additionally, companies may determine the median employee once every three years rather than every year (as was contemplated in the proposed rule); provided, however, that there have been no changes to the company’s employee population or compensation arrangements which would reasonably cause the company to believe there would be significant changes to the pay ratio disclosure.
Special transition rules apply to newly public companies and companies that have recently completed an acquisition of another company.
The Rule is expected to become effective 60 days after publication in the Federal Register, and companies will have to start reporting the new pay ratio disclosures in the first fiscal year beginning on or after January 1, 2017. The full text of the Rule is available at: SEC Final Rule.