The 2018 proxy season will be the first time many companies are required to comply with the SEC’s pay ratio disclosure rule, which was adopted by the Commission in 2015 pursuant to the Dodd-Frank Act. The pay ratio disclosure rule requires companies to disclose the annual total compensation of the median employee, the CEO, and the ratio of those two amounts, as well as certain estimates and assumptions used in determining the median employee and calculating annual total compensation.

The SEC first proposed the pay ratio disclosure rule in September 2013, provided additional analysis in June 2015, and finalized the rule in August 2015. The SEC then provided interpretive guidance in October 2016. Most recently in September 2017, the SEC issued additional clarifying guidance, which provided examples of how reasonable estimates and statistical methodologies may be used to assist companies in identifying the median employee and otherwise implementing the rule, and in drafting their disclosure. The SEC also withdrew a portion of its October 2016 guidance because that guidance left unanswered a number of questions on independent contractors and “leased” employees. In its place, the new September 2017 guidance permits the use of widely recognized tests to determine who is an “employee” for purposes of the rule and who is an “independent contractor” or “leased” worker, including guidance published by the Internal Revenue Service with respect to independent contractors.

From a practical perspective, the following questions are designed to help guide companies in drafting their pay ratio disclosure for the first time, and will also help in-house lawyers determine whether their company’s implementation and disclosure are compliant with the rule (companies should still have their disclosure reviewed by experts since unique situations will arise). In-house lawyers also may want to discuss the potential repercussions of the disclosure with their human resources team.

1. How was the median employee identified?

a. Were any groups or types of employees excluded from the pool of workers from which the median employee was identified? If so, on what basis?

i. Were any employees located in a jurisdiction outside of the United States excluded? If so, on what basis were they excluded, and how many employees were excluded from which jurisdiction(s)?

ii. Were any employees that became employees as a result of a business combination or acquisition of a business excluded? If so, how many employees have been excluded?

b. Does the company have independent contractors or “leased” employees and were they excluded from the pool of workers from which the median employee was identified? If so, on what basis?

c. On what date was the median employee identified?

d. What methodology did the company use to identify the median employee?

i. Was statistical sampling used? If so, what was the sample size, and what was the company’s methodology in determining the sample size?

ii. What compensation measure over what period of time was used to identify the median employee? What company records were used?

iii. Were personal benefits, equity awards, bonus/incentive awards or other benefits or perquisites excluded from the compensation measure?

iv. Were cost-of-living adjustments used? If so, what were the adjustments? What jurisdiction does the median employee live/work in?

v. Were estimates, assumptions or adjustments used? If so, what estimates, assumptions or adjustments?

vi. Was the compensation of any employee annualized? If so, on what basis?

2. What is the “annual total compensation” of the median employee?

a. How was “annual total compensation” for the median employee calculated? Did the company consider all forms of possible compensation?

b. Were estimates, assumptions or adjustments used? If so, what estimates, assumptions or adjustments?

3. What is the “annual total compensation” of the chief executive officer?

a. How was “annual total compensation” for the chief executive officer calculated? Did the company consider all forms of possible compensation?

b. Were estimates, assumptions or adjustments used? If so, what estimates, assumptions or adjustments?

4. What is the ratio of the median employee and the chief executive officer’s “annual total compensation”?

The median employee’s compensation shall equal one, or, alternatively, the ratio may be expressed narratively as the multiple that the chief executive officer’s compensation bears to the median employee’s compensation.