By a 3-2 margin at an open meeting on September 18, the SEC voted to propose a rule requiring public companies to disclose the ratio of pay disparity between the company’s chief executive officer and its employees.  Section 953(b) of the Dodd-Frank Act requires the SEC to promulgate the rule, which would amend Item 402 of Regulation S-K to require disclosure of the median of the annual total compensation of all employees of the company and the ratio of that median to the annual total compensation of the company’s CEO (pay ratio disclosure).

Many public companies already disclose the pay of their top five executives, but the new rule proposal would include a comparison of the CEO’s compensation to the median pay of the company’s workforce.  The rule proposal provides flexibility for companies to determine how they will calculate median worker pay, including the ability to use a sampling of the company’s workforce under certain circumstances.

Some have viewed Section 953(b) of Dodd-Frank as a move to empower activist investors.  Others have been critical of the value such disclosure might offer, if any.  In the open meeting to consider the rule proposal, Commissioner Daniel Gallagher stated:  “There are no – count them, zero – benefits [of the proposed rule] that our staff have been able to discern.”  SEC Chairman Mary Jo White noted the statutory mandate requiring the SEC to act, and said that the rule proposal offers “significant flexibility” in complying with the proposed disclosure requirement.

In proposing the rule under the statutory mandate, the SEC in a number of instances took a narrower, more flexible approach than some have argued the statute requires.  Examples include:

  • The rule would not apply to smaller reporting companies or to foreign private issuers.
  • The rule would require registrants to include pay ratio disclosure in SEC filings that require executive compensation disclosure under Item 402 of Regulation S-K, rather than in every SEC filing.
  • Registrants would be permitted to use statistical sampling or another reasonable method to identify the median.
  • Registrants would be permitted to estimate the compensation of certain employees, such as those shielded by data privacy laws overseas.
  • The pay ratio disclosure would not need to be updated more than once each year.

The rule proposal will be open for comment for 60 days after it is published in the Federal Register, and the comment period is expected to close just before Thanksgiving in November.

The rule proposal will be open for comment for 60 days after it is published in the Federal Register, and the comment period is expected to close just before Thanksgiving in November.


The proposed disclosure would be required in any filing described in Item 10(a) of Regulation S-K:

  • annual reports on Form 10-K,
  • registration statements filed pursuant to the '33 and '34 Acts, and
  • proxy statements and  information statements. 

A transition period for compliance by new registrants is described below.

The proposal excludes:

  • emerging growth companies,
  • smaller reporting companies,
  • foreign private issuers that file reports on Form 20-F, and
  • entities filing registration statements on Form 40-F pursuant to the U.S.-Canadian Multijurisdictional Disclosure System.


New Paragraph (u) of Item 402 of Regulation S-K

The proposed rule would amend Item 402 of Regulation S-K to include a new paragraph (u), which would require disclosure of:

  • the median of the annual total compensation of all employees of the registrant, except the principal executive officer (PEO),
  • the annual total compensation of the PEO of the registrant, and
  • the ratio of the amount of the median employee compensation to the amount of the PEO’s compensation (see example below).

The proposed rule uses the term “principal executive officer” in place of chief executive officer for consistency with the terminology used in Item 402.  The ratio may be expressed in one of two proposed forms, for which the SEC provided two examples of appropriate disclosure:

“For example, if the median of the annual total compensation of all employees of a registrant is $45,790, and the annual total compensation of a registrant’s PEO is $12,260,000, then the pay ratio disclosed would be ‘1 to 268’ (which could also be expressed narratively as ‘the PEO’s annual total compensation is 268 times that of the median of the annual total compensation of all employees’).”  (Footnote references omitted.)

Employees Included in Identification of the Median

The proposed rule would include “all employees” as expressly required by Section 953(b) of Dodd-Frank.  “Employees” of the registrant would include any full-time, part-time, seasonal, or temporary worker employed by the registrant or any of its subsidiaries.  Independent contractors, “leased” workers, or other temporary workers employed by a third party would not be covered.  The calculation would include all employees on the last day of the registrant’s most recently completed fiscal year and would permit annualization of compensation for permanent employees who were not employed for the full fiscal year.  Annualization of compensation for temporary employees would not be permitted.

While acknowledging cost concerns for multinational companies, the SEC did not carve out non-U.S. employees from the proposed rule.  The proposal permits the use of compensation estimates and statistical sampling to manage costs and address foreign data privacy laws.

Identifying the Median

The proposed rule does not require any specific methodology for calculating the median.  Rather, instructions and guidance are provided to allow registrants to choose from several alternative methods to identify the median.  Those methods include those identified in Item 402(c)(2)(x) of Regulation S-K, reasonable estimates, and/or statistical sampling.  The SEC stated in the proposing release that whether an estimate is “reasonable” will turn on the registrant’s particular facts and circumstances.

The release offers a number of facts and circumstances that could affect the calculation methodology, including:

  • the size and nature of the workforce,
  • the complexity of the organization,
  • the types of compensation the employees receive, and
  • the extent to which different currencies and tax or accounting regimes are involved.

The proposed rule would require that the methodology and any material assumptions, adjustments, or estimates used to identify the median be briefly disclosed and consistently used, and that any estimated amounts be clearly identified as such.

Determination of Total Compensation

As mandated by Section 953(b) of Dodd-Frank, “total compensation” is defined by reference to Item 402(c)(2)(x) of Regulation S-K.  In response to commenter observations that the calculations required are complex and often produced manually, the proposing release noted that the calculation is only required for the PEO and the identified median employee.  In determining total compensation, registrants may use reasonable estimates for elements of compensation that are more difficult to value, such as multi-employer pension benefit plans or the value of housing provided in foreign jurisdictions as part of a total compensation package.

Disclosure of Methodology, Assumptions and Estimates

The proposal also includes instructions for the disclosure of the calculation of the median or the annual total compensation of employees.  Specifically, the instruction provides that registrants must briefly disclose and consistently apply any methodology used to identify the median and any material assumptions and adjustments or estimates used to identify the median or to determine total compensation.  Registrants must clearly identify any estimated amounts.  In its release, the SEC stated that it is requiring this disclosure so that registrants provide sufficient information for a reader to be able to evaluate the appropriateness of the estimates.

As an example of what the SEC expects registrants to disclose, the SEC stated that when statistical sampling is used, registrants should disclose:

“the size of both the sample and the estimated whole population, any material assumptions used in determining the sample size, which sampling method (or methods) is used, and, if applicable, how the sampling method deals with separate payrolls such as geographically separated employee populations or other issues arising from multiple business or geographic segments.”

The instruction also addresses year-to-year comparability, noting that if a registrant changes its methodologies, assumptions, etc., from those it previously used, and if the effects are material, the registrant must describe the changes and the reasons for them and must provide an estimate of the impact on the median and the ratio.

In seeking to ensure that disclosure does not become so technical such that it defeats its purpose, the instruction to the proposal provides for a “brief overview” of the calculation by the registrant in lieu of technical analysis or formulas.  However, the SEC stated that, as with other mandated disclosure under SEC rules, registrants would be permitted under the rule to supplement the required overview with an additional narrative discussion.  Similarly, registrants would be permitted to present one or more additional ratios to supplement the required ratio, provided the supplemental ratios are not misleading or presented with greater prominence.

The SEC expressed concern that registrants may be tempted to use methodology to manipulate the outcome of the identification of the median or the ratio.  To address this, the instruction to the proposed rule provides that the registrant must apply the methodology consistently in identifying the median and calculating the annual total compensation of employees.  Similarly, when a registrant uses a compensation measure to identify the median employee, the registrant must consistently apply that compensation measure to each employee included in the calculation.

Clarification of the Meaning of “Annual”

The proposed requirement defines “annual total compensation” to mean total compensation for the last completed fiscal year, consistent with the period used for the other Item 402 disclosure requirements, i.e., the period used in connection with preparation of a registrant’s Form 10-K and proxy statement.  The SEC stated that this clarification is intended to make clear that the disclosure does not need to be updated more than once each year.

Timing of Disclosure – Updating Pay Ratio Disclosure for the Last Completed Fiscal Year

The proposed rule would require annual total compensation amounts used in the ratio to be calculated for the registrant’s last completed fiscal year and would also require pay ratio disclosure in any filing by the registrant that requires Item 402 disclosure.  Accordingly, the SEC addressed timing requirements for updating pay ratio disclosure after the end of a registrant’s fiscal year.  The SEC determined that pay ratio disclosure should not have to be updated until the registrant files its proxy statement for its annual meeting of shareholders, but it noted that not all registrants file proxy statements (for example, reporting companies without securities registered under Section 12 of the Exchange Act).

To ensure that the rule is applied consistently to all registrants who are subject to the rule, the SEC structured the proposed rule to provide that a registrant would not be required to include pay ratio disclosure until it files its annual report for that last completed fiscal year or it files a definitive proxy or information statement relating to an annual meeting of shareholders, provided that updated pay ratio information must, in any event, be filed not later than 120 days after the end of such fiscal year.  As an example, the SEC noted that a registrant would not be required to disclose pay ratio information relating to compensation for fiscal year 2015 until its definitive proxy or information statement for its 2016 annual meeting of shareholders.

Proposed Instruction for Pay Ratio Disclosure When the Registrant Omits Salary or Bonus Information for a Named Executive Officer

In proposing its rule, the SEC took care to address the instruction to the executive compensation rules that permits registrants to omit disclosure in the summary compensation table of the salary or bonus of a named executive officer if it is not calculable as of the latest practicable date, in which case the information must be filed on Form 8-K when it is determined.  In this scenario, the SEC decided that it is also appropriate for a registrant to omit pay ratio disclosure until those elements of the named executive officer’s total compensation are determined.  Accordingly, the proposed rule would include an instruction that provides that a registrant relying on this rule would be required to disclose that the pay ratio disclosure is being omitted because the compensation information is not available and the expected date that the total compensation for the named executive officer will be determined, along with a requirement to include the pay ratio disclosure in the Form 8-K that includes the omitted compensation information.


Proposed Compliance Date

All registrants that are subject to the rule would be required to begin to comply with proposed Item 402(u) with respect to compensation for the registrant’s first fiscal year commencing on or after the effective date of the rule.  For example, if the proposed rule were to become effective in 2014, a registrant with a fiscal year ending on December 31 would be first required to include pay ratio information relating to compensation for fiscal year 2015 in its proxy or information statement for its 2016 annual meeting of shareholders.

Proposed Transition for New Registrants

New public companies would be entitled to a transition period, under which they would not be required to comply with the rule until they either had been required to file an annual report pursuant to section 13(a) or 15(d) of the Exchange Act for the prior fiscal year or had filed an annual report with the SEC for the prior fiscal year.

The proposed rule is subject to a 60-day comment period and is likely to draw extensive comments.  The ultimate form of the proposed rule and the timing of its adoption are difficult to predict.  We will continue to monitor developments regarding this proposed rule.