On September 18, a divided SEC proposed a rule to implement the Dodd-Frank mandate that public companies disclose the ratio of median pay of all employees to a CEO’s total compensation. While the proposed rule offers companies a flexible approach in determining median pay, many concerns remain. The proposal will not affect the 2014 proxy season.
Read the SEC press release, which includes a fact sheet and a link to the full proposal.
The Proposed Rule
The proposed rule amends Item 402 of Regulation S-K to require that U.S. public companies disclose:
- the median of the annual total compensation of all employees of the company, excluding the CEO;
- the annual total compensation of the company’s CEO; and
- the ratio comparing these two amounts.
Flexible Approach for Determining Median Pay
The proposed rule purports to offer a flexible approach to compliance, allowing companies to select their own method for calculating the median of the annual total compensation of all employees. That methodology may use reasonable estimates to both identify the median and the elements of compensation. In determining the employees from whom the median is identified, a company may use its total employee population, a statistical sampling or another reasonable method.
A company would be permitted to choose a methodology that is appropriate to its size, business structure and manner of compensating employees. A selected methodology could either (1) calculate the annual total compensation of the employees included in the calculation and identify the median of those amounts or (2) identify the median employee based on a consistently applied compensation measure and then calculate the annual total compensation for that employee under Item 402.
For example, a company with a large number of employees could take a random sample of employees (of a size consistent with the overall distribution of pay across employees) and determine the median employee on the basis of annual cash compensation, compensation reported for tax purposes or another consistently applied compensation measure. Once the median employee is identified on this basis, the company would then calculate that employee’s annual total compensation for the last completed fiscal year in accordance with S-K Item 402(c)(2)(x) and disclose that amount as part of the pay ratio disclosure.
All Employees Must be Covered by Calculation
Under the proposed rule, “all employees” would include full-time, part-time, temporary, seasonal, U.S. and non-U.S. employees employed by the company and any of its subsidiaries as of the last day of the company’s last-completed fiscal year. This portion of the rule is the subject of significant controversy.
Disclosure of Methodology Used
Companies would be required to describe the methodology used for making all determinations, including material assumptions, adjustments, estimates and any changes in methodology from one year to the next. However, as provided in the proposed instructions, “This disclosure should be a brief overview; it is not necessary to provide technical analyses or formulas.”
Covered Filings and Excluded Issuers
Pay ratio disclosure would be required in all Form 10-Ks, registration statements and proxy statements that call for Item 402 disclosure of executive compensation. Smaller reporting companies and foreign private issuers would not be subject to the disclosure requirement. In addition, emerging growth companies are specifically excluded from the rule in accordance with the JOBS Act.
Proposed Compliance Date
A company would be required to report the pay ratio with respect to compensation for its first fiscal year commencing on or after the effective date of the final rule. If final requirements become effective in 2014, calendar year companies would be first required to include pay ratio disclosure for fiscal year 2015 in a proxy statement for a 2016 annual meeting. Although the rule is not yet final, companies are beginning to gather the teams and resources that will be necessary to provide the information required under the rule.
Opportunity for Comment
The SEC received extensive comments before releasing its proposal, and credited these with influencing the outcome. While the SEC attempted to fulfill the Dodd-Frank mandate in a way that gives companies flexibility in compliance, many concerns remain. In particular, Commissioners Gallagher and Piwowar dissented from the proposal, each stating that rulemaking for the pay ratio mandate is a waste of time and resources. The dissenting Commissioners further opined that the rule will place special interests ahead of the SEC’s mission to protect investors, and that it will harm competition and promote inefficiency.
The SEC has requested comment on virtually every aspect of the proposal, including the costs of compliance, during a 60-day comment period. In his dissent, Commissioner Piwowar urged companies and their advisors to submit comment letters that provide estimates of their compliance costs and acknowledge the harm that the rule will cause to investors. Attorneys at Fredrikson & Byron will participate in the comment letter process and would welcome input from affected companies.