The SEC issued a proposed rule on September 18, 2013, that would require most public companies to report the ratio between the annual total compensation of its chief executive officer, or CEO, and the median annual total compensation of all of its employees. Under current SEC rules, public companies are required to disclose detailed compensation only for its CEO and certain other named executive officers. The proposed “pay ratio” disclosure rule, which was approved for public comment by a commission vote of 3-2, is required by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act. Referring extensively to letters already received, the SEC noted that the rule as proposed was intended to provide companies with flexibility to lower the costs of compliance while still satisfying the Dodd-Frank Act mandate. Comments on the proposed rule will be due 60 days after publication in the Federal Register.

Pay Ratio Disclosure Requirement

The proposed pay ratio disclosure would require most public companies to present an annual comparison between (i) the median of the annual total compensation of all employees of the company and its subsidiaries, excluding the company’s CEO, and (ii) the annual total compensation of the company’s CEO. The ratio between these two amounts may be expressed as a ratio in which the median compensation is equal to one (e.g., “1-to-X”) or, alternatively, as a multiple of the CEO’s compensation in narrative form (e.g., “CEO compensation is X times the median employee compensation”).

The SEC intends for these disclosure requirements to work within the existing executive compensation disclosure regime of Item 402 of Regulation S-K. The pay ratio disclosure requirements would be set forth in a new Paragraph (u) of Item 402. Total compensation of the median employee and CEO for purposes of the pay ratio disclosure would be determined in accordance with Item 402(c)(2)(x), which aggregates salary, bonuses, stock and option grants and certain other compensation, including perquisites.

Median Employee Compensation

The proposed rule does not specify any required methodology to determine the median employee. Instead, a company may identify its median employee using any consistently applied compensation measure appropriate to the size and structure of its business and the way it compensates employees. In determining the set of employees from which the median employee is identified, and in recognition of the diverse size and makeup of enterprise-wide workforces, the proposed rule permits a company to use either its full employee population or a statistical sample of that population. To identify the median employee within that set, a company may calculate total compensation for each employee in accordance with Item 402(c)(2)(x) or any other consistently applied measure, such as payroll or tax records, or use reasonable estimates in identifying the median employee.

All employees other than the CEO, including full-time, part-time, seasonal, temporary and non-U.S. employees, employed by the company and each its subsidiaries as of the last day of the fiscal year must be included in calculating the median compensation. The proposed rule would allow companies to annualize compensation for full-time and part-time permanent employees at year-end who did not work the full fiscal year, such as new hires or employees who took leaves of absence. Companies would not, however, be permitted to annualize the salaries of temporary or seasonal workers, which the SEC recognized would affect companies with large seasonal employment differently, depending on whether the seasonal hiring occurs mid-year or at year-end. In addition, no adjustments would be permitted to account for cost-of-living differences of non-U.S. employees or the impact on salaries of foreign currencies.

Once the median employee is identified, the company must calculate that employee’s annual total compensation in accordance with Item 402(c)(2)(x) of Regulation S-K to ensure comparability with the CEO’s annual total compensation. As proposed, companies would be permitted to use reasonable estimates to calculate the annual total compensation or any elements of total compensation for employees other than the CEO.

The methodology used to identify the median employee or to determine total compensation, including any material assumptions, adjustments or estimates, would need to be briefly disclosed, providing enough information for an investor to evaluate the appropriateness of the methodology. If the company uses estimates in calculating the median employee or total compensation, the estimated amounts must be identified and any methodology used for the estimates must also be described. Companies would also need to briefly describe any material changes from year to year, including reasons for the changes, to the methodology or material assumptions, adjustments or estimates used. The proposed rule would permit, but not require, companies to further supplement this disclosure with a narrative discussion of the pay ratio or other information about employee compensation.

Companies and Filings Subject to the Pay Ratio Disclosure Requirement

As proposed, the pay ratio disclosure would be made in any proxy or information statement, annual report on Form 10-K or registration statement that requires executive compensation disclosure pursuant to Item 402 of Regulation S-K, and the disclosure would be deemed “filed” and not “furnished.” Consistent with existing exemptions from executive compensation disclosure in these filings, emerging growth companies, smaller reporting companies and foreign private issuers would be exempt from the disclosure requirements. Covered companies would need to comply with the pay ratio disclosure with respect to compensation for the first fiscal year commencing on or after the effective date of the final rule. Newly public companies not otherwise exempt from the rule would be required to comply with the pay ratio disclosure with respect to compensation for the first fiscal year commencing on or after the date the company becomes subject to SEC reporting requirements.

Given the extensive requests for comment on the proposal by the SEC, and anticipated volume and detail of comments in response to the proposal, adoption of a final rule does not appear likely until after the 2014 proxy season. Assuming effectiveness of the rule in 2014, covered companies with calendar year-ends would first be required to include pay ratio disclosure relating to compensation for fiscal year 2015 in its proxy statement or annual report filed in 2016. The SEC states that it believes this interim period would provide companies with a full reporting cycle to identify and test its implementation of a methodology to determine median employee compensation.

The full text of the proposed rule set forth in Release No. 33-9452 is available from the SEC at: