Over two years ago, the US Securities and Exchange Commission (the SEC) adopted rules implementing Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), creating an obligation for public companies to disclosethe median of the annual total compensation of all employees (excluding the CEO), the annual total compensation of the CEO and the ratio of the median of the annual total compensation of all employees to the annual total compensation of the CEO. At times during the past two years, it seemed that legislative or regulatory action might derail the final implementation of the rule, but as 2017 draws to a close it is now clear that proxy statements filed in 2018 will need to include the new CEO pay ratio disclosure. This last minute guide to the disclosure requirement provides an overview of the rule and available SEC guidance, and discusses key considerations for issuers as they calculate the ratio and draft the disclosures required by the SEC rule.

The CEO Pay Ratio Disclosure Requirement

Item 402(u) of Regulation S-K requires disclosure of: (i) the median of the annual total compensation of all employees of the issuer, except the CEO of the issuer; (ii) the annual total compensation of the CEO of the issuer; and (iii) the ratio of the amount in (ii) to the amount in (i), presented as a ratio in which the amount in (i) equals one, or, alternatively, expressed narratively in terms of the multiple that the amount in (ii) bears to the amount in (i). In other words, the ratio must be presented so that the annual total compensation of the median employee equals one (for example, “the ratio is 50 to 1”), or in narrative form by stating the CEO’s annual total compensation as a multiple of the median employee’s annual total compensation (for example, “the CEO’s annual total compensation is 100 times that of the median employee”).

Subject Issuers must provide the disclosure starting with the first fiscal year beginning on or after January 1, 2017, therefore proxy statements filed in 2018 which provide disclosure regarding 2017 compensation must include the CEO pay ratio and related disclosure. CEO pay ratio disclosure is required in any filing that calls for executive compensation disclosure pursuant to Item 402 of Regulation S-K, including annual reports on Form 10-K and registration statements under the Securities Act of 1933, as amended (the “Securities Act”), as well as proxy materials to the same extent that the forms require compliance with Item 402 of Regulation S-K. The pay ratio disclosure, as with other information required pursuant to Item 402 information, is treated as “filed” for purposes of the Securities Act and the Securities Exchange Act of 1934, as amended (the “Exchange Act”).The disclosure requirement does not apply to emerging growth companies, smaller reporting companies or foreign private issuers. Newlyreporting issuers are required to report their pay ratio for the first fiscal year following the year in which they become subject to the SEC’s reporting requirements. This same transition period applies to companies that no longer qualify as emerging growth companies or smaller reporting companies.

In Regulation S-K Compliance and Disclosure Interpretation Question 128C.06, that SEC notes that it would not object if an issuer describes the CEO pay ratio as a reasonable estimate calculated in a manner consistent with Item 402(u) of Regulation S-K. 

An issuer also must briefly describe the methodology it used to identify the median employee and any material assumptions, adjustments or estimates it used to identify the median employee or to determine total compensation or any elements of total compensation, which shall be consistently applied. Issuers are not required to include any technical analyses, formulas, confidence levels or the steps used in data analysis.

An issuer may supplement its pay ratio disclosure or provide additional pay ratios, but an issuer is not required to do so. Additional pay ratios are not limited to any particular information. If an issuer includes any additional ratios, the ratios must be clearly identified, not misleading and not presented with greater prominence than the required ratio. For example, an issuer may want to present a supplemental pay ratio to explain the effect of including part-time, seasonal and temporary employees on its CEO pay ratio disclosure, or to show the pay ratio if only US employees are included in the calculation. 

Issuers may want to consider accompanying their CEO pay ratio disclosure with “disclaimer” language indicating that, due to the flexibility afforded by Item 402(u) in calculating the CEO pay ratio, the ratio may not be comparable to CEO pay ratios presented by other issuers.

Determining the Employees Covered by the CEO Pay Ratio Rule

Item 402(u) of Regulation S-K defines the term “employee” to include an issuer’s US and non-US employees, as well as part-time, seasonal and temporary employees employed by the issuer or any of its consolidated subsidiaries (as determined by the applicable accounting rules and typically requiring ownership of over 50% of the outstanding voting shares of an entity). This definition also includes all of the issuer’s officers, other than the CEO. The definition of “employee” does not include independent contractors or “leased” workers employed by a third party and whose compensation is determined by the third party. Item 402(u) of Regulation S-K further defines “employee” as an individual employed on any date of the issuer’s choosing within the last three months of the issuer’s last completed fiscal year. 

Exemptions for Employees Located Outside the United States

Item 402(u) provides two exemptions from the requirement to include all employees located outside of the United States.

An exemption is available when a foreign jurisdiction’s data privacy laws or regulations are such that, despite an issuer’s reasonable efforts to obtain or process information necessary to comply with the rule, it is unable to do so without violating those laws or regulations. To utilize the exemption, issuers are required to exercise reasonable efforts to obtain or process the information necessary for compliance with the rule. As part of its reasonable efforts, the issuer must seek an exemption or other relief under the applicable jurisdiction’s governing data privacy laws or regulations and use the exemption, if granted. If an issuer excludes any non-US employees in a particular jurisdiction under the data privacy exemption, it must exclude all non-US employees in that jurisdiction. 

If an issuer relies on the data privacy exemption, the issuer must: 

  • list the excluded jurisdictions;
  • identify the specific data privacy law or regulation;
  • explain how complying with the Item 402(u) of Regulation S-K violates the law or regulation (including the efforts made by the issuer to use or seek an exemption or other relief under such law or regulation); and
  • provide the approximate number of employees exempted from each jurisdiction based on this exemption.

An issuer relying on the exemption must obtain a legal opinion as to the inability of the issuer to obtain or process the information necessary for compliance with the final rule without violating that jurisdiction’s laws or regulations governing data privacy, including the issuer’s inability to obtain an exemption or other relief under any governing laws or regulations. This legal opinion must be filed as an exhibit to any filing in which the CEO pay ratio disclosure is included.

The conditions for relying on the data privacy exemption have been perceived as so onerous that they are generally limiting the utility of the exemption. As a result, it is expected that few issuers will choose to avail themselves of the exemption.

A second exemption from the requirement to include non-US employees in identifying the median employee is available in situations where a de minimis number of an issuer’s employees work outside the United States: 

  • if an issuer’s non-US employees account for five percent or less of its total employees, the issuer may exclude all of those employees when determining the median of the annual total compensation of all employees of the issuer; or
  • if an issuer’s non-US employees exceed five percent of the issuer’s total US and non-US employees, the issuer may exclude up to five percent of its total employees who are non-US employees 

If an issuer excludes any non-US employees in a particular jurisdiction, it must exclude all non-US employees in that jurisdiction. 

When relying on this de minimis exemption, the issuer must disclose: 

  • the jurisdictions from which its non-US employees are being excluded;
  • the approximate number of employees excluded from each jurisdiction under the de minimis exemption;
  • the total number of its US and non-US employees irrespective of any exemption (de minimis or data privacy); and
  • the total number of its US and non-US employees used for its de minimis calculation.

In an interpretive release titled "Commission Guidance on Pay Ratio Disclosure," Release No. 33-10415 (September 21, 2017) (the “Interpretive Release”), the SEC clarifies that an issuer may use "appropriate existing accounting records" to determine if the de minimis exemption is available. The SEC specifically notes tax or payroll records as examples of records that an issuer could review in making its determination.

Independent Contractors or "Leased" Workers

As noted above, Item 402(u) of Regulation S-K excludes from the definition of employee those workers who are employed and whose compensation is determined by an unaffiliated third party, but who provide services to the issuer or to its consolidated subsidiaries as independent contractors or "leased" workers. The SEC's rationale for excluding these workers from the definition of "employee" was that issuers generally did not control the level of compensation that these workers are paid, so they should not be considered employees when seeking to identify the median employee. 

In the Interpretive Release, the SEC acknowledges concerns expressed by commenters that the SEC should allow registrants to use widely recognized tests to determine who is an "employee" for the purposes of Item 402(u) of Regulation S-K, such as the guidance published by the Internal Revenue Service with respect to independent contractors in "Publication 15-A Employer's Supplemental Tax Guide" (2017).

In the Interpretive Release, the SEC notes that Item 402(u)(3) of Regulation S-K makes clear that an “employee” is an individual employed by the issuer, and that the provision in Item 402(u)(3) indicating that the definition of “employee” does not include workers who are employed and whose compensation is determined, by an unaffiliated third party “describes one category of workers that is expressly excluded from the definition of 'employee' under the rule.” The Interpretive Release indicates that this provision was not intended to serve “as an exclusive basis for determining whether a worker is an employee of the registrant,” therefore it is consistent with Item 402(u) of Regulation S-K for an issuer to apply “a widely recognized test under another area of law that the issuer otherwise uses to determine whether its workers are employees.” 

The Interpretive Release notes that most widely recognized tests will consider how compensation is determined as a factor in identifying employees, which would provide a reasonable means for complying with Item 402(u). The Interpretive Release further notes that an explanation of any material assumptions and adjustments, such as the treatment of independent contractors or “leased” workers, would be required under Instruction 4 to Item 402(u).

The IRS guidelines referenced above will most likely be the framework that issuers will use, particularly given that the issuers’ systems may already characterize the employment status of individuals for tax purposes. The general rule under the IRS guidelines is that “an individual is an independent contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result.” The determination is based on the facts and circumstances of the relationship, considering, among other things: 

  • instructions that the business gives to the worker;
  • training that the business gives to the worker;
  • the extent to which the worker has unreimbursed business expenses;
  • the extent of the worker’s investment;
  • the extent to which the worker makes his or her services available to the relevant market;
  • how the business pays the worker;
  • the extent to which the worker can realize a profit or loss; and
  • the type of relationship, which could be demonstrated by written contracts describing the relationship the parties intended to create, whether or not the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay or sick pay, the permanency of the relationship and the extent to which services performed by the worker are a key aspect of the regular business of the issuer. 

Furloughed Workers

Item 402(u) of Regulation S-K does not address the treatment of furloughed workers as employees for purposes of the rule. In Regulation S-K Compliance and Disclosure Interpretation Question 128C.04, the SEC Staff indicates that because a “furlough” could have different meanings for different employers, issuers will need to determine whether furloughed workers should be included as employees based on the facts and circumstances. If the furloughed worker is determined to be an employee of the company on the date the employee population is determined, his or her compensation should be determined by the same method as for a non-furloughed employee:

  • the issuer must determine into which class (full-time, part-time, temporary, or seasonal) the furloughed employee belongs on the determination date; and 
  • the issuer must determine that individual’s compensation using annual total compensation or another “consistently applied compensation measure” in accordance with Instruction 5 of Item 402(u). 

An issuer may annualize the total compensation for all permanent employees (full-time or part-time) that were employed by the company for less than the full fiscal year or who were on an unpaid leave of absence during the period; however, the issuer may not annualize the total compensation for employees in temporary or seasonal positions. In addition, an issuer may not make a full-time equivalent adjustment for any employee. 

Identifying the Median Employee 

To compute the CEO pay ratio, an issuer must identify a median employee from its employee population. That same median employee’s compensation can be used for the annual total compensation calculation over three years, unless there has been a change in the issuer’s employee population or employee compensation arrangements such that the issuer reasonably believes the change would result in a significant change in the CEO pay ratio, in which case disclosure must be provided to explain the change. Alternatively, if there has been no change, the issuer must disclose that it is using the same median employee in its pay ratio calculation and describe briefly the basis for its reasonable belief. If the median employee identified in year one is no longer in the same position or no longer employed by the issuer on the median employee determination date in year two or year three, the rule permits the issuer to replace its median employee with an employee in a similar compensation position.

Issuers may choose a method to identify the median employee based on their own facts and circumstances. Issuers may use a methodology that uses reasonable estimates. The median employee may be identified using annual total compensation, or any other compensation measure that is consistently applied to all employees included in the calculation, such as information derived from, for example, tax or payroll records.

In determining the employees from which the median is derived, an issuer is permitted to use its employee population or statistical sampling, and/or other reasonable methods. Issuers must briefly describe and consistently apply any methodology used to identify the median, as well as any material assumptions, adjustments (including cost-of-living adjustments, discussed below) or estimates used to identify the median employee or to determine total compensation or any elements of total compensation. The issuer also must clearly identify any estimates used.

In adopting this approach, the SEC noted in the adopting release, “Pay Ratio Disclosure,” Release No. 33-9877 (August 5, 2015), that the rule “should be designed to allow shareholders to better understand and assess a particular registrant’s compensation practices and pay ratio disclosures rather than to facilitate a comparison of this information from one registrant to another.” 

The flexibility for determining the median employee’s annual total compensation in Item 402(u) utilizing reasonable estimates, assumptions and methodologies generally caused concern in the absence of more specific guidance in the rule and from the SEC, which prompted the SEC to state in the Interpretive Release that if an issuer uses reasonable estimates, assumptions or methodologies, “the pay ratio and related disclosures that results from such use would not provide the basis for Commission enforcement action unless the disclosure was made or reaffirmed without a reasonable basis or was provided other than in good faith.”

Based on Item 402(u) of Regulation S-K and the SEC guidance, an issuer may choose to identify the median employee by simply selecting the median employee from a list of all of the individuals that meet the definition of “employee” as discussed above, along with the measure of annual total compensation selected by the issuer. In larger organizations, that approach may not be feasible and it would therefore be necessary for the issuer to approach the task by using samples of the employee population as a means for creating more manageable sample sizes. In this context, the median employee may be identified through the use of statistical sampling and/or reasonable estimates and methodologies.

Annual Total Compensation or a Consistently-Applied Compensation Measure

Item 402(u) requires issuers to identify the median employee using annual total compensation or another “consistently applied compensation measure,” such as information derived from the registrant’s tax and/or payroll records.

“Annual total compensation” for both the median employee and CEO must be calculated using the requirements of Item 402(c)(2)(x) of Regulation S-K which is the "total compensation" computed in the Summary Compensation Table. Any compensation that is permitted to be excluded from annual total compensation under Item 402 of Regulation S-K, such as benefits under plans available to all employees, may be added back into the calculation if necessary to reflect benefits that are significant for non-management employees of the issuer. Issuers are permitted to use reasonable estimates in calculating the annual total compensation of their median employee, including any elements of the total compensation, but must clearly identify any estimates used and have a reasonable basis to conclude that their estimates approximate the actual amounts of compensation under Item 402(c)(2)(x) of Regulation S-K, or a particular element of compensation that is awarded to, earned by or paid to the median employee.

In Regulation S-K Compliance and Disclosure Interpretation Question 128C.01, the SEC Staff indicates that any measure which reasonably reflects the annual compensation of employees may serve as a consistently applied compensation measure. The appropriateness of any measure will depend on the issuer’s particular facts and circumstances. In the Interpretive Release, the SEC notes that an issuer may use internal records for the purpose of determining a consistently applied compensation measure, even if the records do not include every element of compensation, including equity awards that are "widely distributed" to employees. The SEC also notes that when the issuer computes total compensation for a median employee using a consistently applied compensation measure, and the employee’s compensation has anomalous characteristics that could impact the pay ratio, the issuer may substitute another median employee with substantially similar compensation rather than conclude that the consistently applied compensation measure was unsuitable to make the determination.

In Regulation S-K Compliance and Disclosure Interpretation Question 128C.02, the SEC Staff indicates that an issuer may not exclusively use hourly or annual rates of pay as its consistently applied compensation measure. While an hourly or annual pay rate may be a component used to determine an employee’s overall compensation, the use of the hourly or annual rate of pay alone generally is not an appropriate consistently applied compensation measure to identify the median employee. Using an hourly rate without taking into account the number of hours actually worked would be similar to making a full-time equivalent adjustment for part-time employees, which is not permitted under Instruction 5 to Item 402(u) of Regulation S-K. Similarly, using an annual rate only, without regard to whether the employees worked the entire year and were actually paid that amount during the year, would be similar to annualizing pay, which the rule only permits in limited circumstances.

In Compliance and Disclosure Interpretation Question 128C.03, the SEC Staff indicates that, in applying a consistently applied compensation measure to identify the “median employee,” an issuer is not required to use: 

  • a period that includes the date on which the employee population is determined; nor
  • a full annual period. 

Instead, a consistently applied compensation measure may also consist of annual total compensation from the issuer’s prior fiscal year, so long as there has not been a change in the issuer’s employee population or employee compensation arrangements that would result in a significant change to the distribution of compensation across its workforce.

Cost of Living Adjustments

Item 402(u) allows issuers to make cost-of-living adjustments to the compensation of their employees in jurisdictions other than the jurisdiction in which the CEO resides when identifying the median employee. If an issuer chooses to make these adjustments, the issuer must:

  • disclose the country in which the median employee is located;
  • briefly describe the cost-of-living adjustments it used to identify the median employee; and
  • briefly describe the cost-of-living adjustments it used to calculate the median employee’s annual total compensation, including the measure used as the basis for the cost-of-living adjustment.

An issuer that determines to use cost-of-living must also disclose the median employee’s annual total compensation and pay ratio without the cost-of-living adjustments. To calculate this pay ratio, the issuer must identify the median employee without using any cost-of-living adjustments. 

Foreign Currency Conversion Method

Issuers with international employees must convert those employees’ compensation into US dollars. Item 402(u) of Regulation S-K does not specify a particular method for converting the currency information. It appears likely that many issuers will use the same blended conversion rate used in preparing the issuer’s annual financial statements. 

Reasonable Estimates, Assumptions, Methodologies and Statistical Sampling

As noted above, in determining the employees from which the median is derived, an issuer is permitted to use its employee population or statistical sampling and/or other reasonable methods. Issuers must briefly describe and consistently apply any methodology used to identify the median, as well as any material assumptions, adjustments (including cost-of-living adjustments) or estimates used to identify the median or to determine total compensation or any elements of total compensation. The issuer also must clearly identify any estimates used.

In an SEC Staff statement titled “Division of Corporation Finance Guidance on Calculation of Pay Ratio Disclosure” (September 21, 2017) (the “Staff Statement”), the SEC Staff provides some practical guidance on the use of statistical sampling and other reasonable methods that might be used in identifying the median employee through the discussion of a number of specific examples.

In the first Question & Answer included in the Staff Statement, the SEC Staff notes that an issuer may combine the use of reasonable estimates with the use of statistical sampling or other reasonable methodologies. In this regard, Instruction 4.2 to Item 402(u) of Regulation S-K expressly provides that, in determining the employees from which the median employee is identified, “a registrant may use its employee populations or statistical sampling and/or other reasonable methods.” The SEC Staff emphasizes that the use of “and/or” in the instruction is meant to indicate that an issuer is permitted to use statistical sampling, other reasonable methods or a combination of statistical sampling and other reasonable methods, and that “other reasonable method” was not defined in order to provide issuers with the ability to determine what reasonable methods might be best suited to its facts and circumstances. The SEC Staff describes an issuer with multinational operations or multiple business lines that might use statistical sampling for some geographic/business units, while using a combination of reasonable methodologies and reasonable estimates for other geographic/business units.

The second Question & Answer of the Staff Statement discusses the potential sampling methods that an issuer could use, and notes that a combination of sampling methods could be used in the CEO pay ratio computation. The Staff Statement cites the following examples: 

  • random sampling, where a certain number or proportion of employees are drawn at random from the entire employee population; 
  • stratified sampling, where the issuer would divide the employee population up into strata (for example, by geographic location, business unit, categorization of employee, collective bargaining agreement or functional role);
  • cluster sampling, where the employee population is divided into clusters based on some specified criterion, drawing from a subset of the clusters, and sampling observations within appropriately selected clusters, either in a single stage or in multiple stages; and
  • systematic sampling, where the sample is drawn according to a random starting point and a samples are collected based on a fixed sampling interval, for example, every n th employee from a list of employees sorted based on some established criterion.

The third Question & Answer in the Staff Statement sets forth examples of situations where an issuer may use reasonable estimates, both in identifying the median employee and in computing employee compensation:

  • analyzing the composition of the issuer's workforce (by geography, business unit, type of employee); 
  • characterizing the statistical distribution of the company's employees, for example, a lognormal, beta, gamma or another distribution or a mixture of distributions; 
  • calculating a consistent measure of compensation and annual total compensation or elements of the annual total compensation of median employees; 
  • evaluating the likelihood of significant changes in employee compensation from year to year; 
  • identifying the median employee;
  • identifying multiple employees around the middle of the compensation spectrum; and
  • using the mid-point of a compensation range to estimate compensation. 

In the fourth Question & Answer included in the Staff Statement, examples of the methodologies, or combination of methodologies, that an issuer might use include: 

  • making one or more distributional assumptions (assuming a lognormal or another distribution), provided that the issuer has determined that the assumption is appropriate given the issuer's compensation distributions; 
  • reasonable methods of imputing missing values; and 
  • reasonable methods for addressing extreme observations or outliers. 

The fifth Question & Answer in the Staff Statement applies the rule and guidance by explaining how three different issuers can use reasonable estimates, statistical sampling and other reasonable methods:

  • an issuer with employees in the US and outside the US within three business units and 21 geographic units, covered by multiple payroll systems samples compensation date from each of the three business units, selects samples from those geographic locations where employee pay is generally representative of employee pay within the entire business unit; 
  • an issuer that has a global workforce with employees concentrated in North America, China, Europe and Latin America uses a combination of statistical sampling and other methods to identify the median employee, based on the issuer’s knowledge of the workforce distribution across the jurisdictions, composition of full-time and part-time employees, distribution of employees among typical occupations and the issuer's pay structures for typical occupations; and
  • an issuer that has employees located in the US and Asia, which reasonably believes, based on information about its workforce composition and compensation policies, that the distribution of employee compensation to be “multimodal” and approximately characterized as a mixture of lognormal distributions, weighted based on estimated workforce composition, identifies the median based on the resulting distribution mixture.

Location of the Disclosure 

Item 402(u) of Regulation S-K does not specify where within the issuer’s disclosures the CEO pay ratio disclosure should be presented. At present, it appears that issuers are not planning to include the CEO pay ratio disclosure in the Compensation Discussion and Analysis section of the proxy statement, unless the CEO pay ratio disclosure is taken into account when determining CEO or executive officer compensation. It is likely that many issuers will present the CEO pay ratio disclosure at the end of the tabular and narrative executive compensation disclosures required by Item 402 of Regulation S-K.

Investor Considerations

The proxy advisory firm Glass Lewis & Co. published a note indicating that Glass Lewis intends to display the CEO pay ratio as a data point in its reports, but does not intend to incorporate the pay ratio into the assessment and analysis of Say-on-Pay proposals. 

In September 2017, Institutional Shareholder Services (“ISS”) released the results of its Governance Principles Survey. With regard to upcoming CEO pay ratio disclosures, the Governance Principles Survey results reflect that approximately 66% of investors intend to make use of the disclosure to evaluate pay ratios across company and industry sectors, and to assess year-over-year changes in the ratio at an individual company. Investors also support the use of the pay ratio as one factor in determining how to vote on compensation-related resolutions and as a part of engagement efforts with issuers.

ISS also recently released a position paper titled “Contextualizing CEO Pay Ratio Disclosure.” In the statement, ISS recommends that issuers include in their disclosure a comparison to peer group disclosures. Based on the results of the above-referenced Governance Principles Survey, ISS notes that it appears that “pay ratio disclosures may influence investor voting and engagement behavior;” however, ISS notes, pay ratio on its own “provides limited insight into the board’s compensation philosophy.” ISS notes that both issuers and investors may want to ask the following questions regarding 2018 pay ratio disclosures: 

  • How does the issuer's ratio compare with peer issuers?
  • What is driving any difference uncovered in the ratio? Is it the CEO's pay, the median employee's pay or both?
  • Are there labor force issues, such as use of contractors, significant use of part-time employees or offshore labor sourcing that drive differences? 

Communications Considerations 

The first year of the CEO pay ratio disclosure is likely to result in media coverage and other attention outside of the investment community. Of particular concern to issuers is the potential reaction that employees will have to the new public information about the CEO pay ratio and the median employee’s annual total compensation. Issuers are concerned that the sensitive information about employee compensation, as well as the potentially large gap in pay between the CEO and the median employee, could prove troubling to workers. For this reason, issuers are considering providing separate in-house communication to employees so that they can better understand the context in which the CEO pay ratio disclosure is provided and the issuer’s overall approach to employee compensation. In drafting these communications, issuers need to be cognizant of SEC requirements with regard to the filing of proxy soliciting material, although it is generally anticipated that these sorts of employee communications, depending on their wording, would not likely constitute a solicitation. 

An issuer’s public relations department should also be prepared for inquiries from local and national media regarding CEO pay ratio disclosures. It may be necessary for the public relations staff to respond to questions about, for example, assumptions and methodologies used in calculating the ratio, the size of the differential between CEO pay and median employee pay and how the ratio compares to the ratios of an issuer’s peers. 

Next Steps for CEO Pay Ratio Disclosure 

While it now appears certain that the CEO pay ratio disclosure will be required for 2018, it is less certain whether CEO pay ratio disclosure will continue to be required in future years. Several legislative efforts, including the Financial CHOICE Act, would repeal the Dodd-Frank Act directive to adopt the CEO pay ratio disclosure rule. While these legislative efforts have not yet moved toward enactment, it is possible that, during 2018, some form of CEO pay ratio repeal could be enacted which would then require the SEC to eliminate the rule.

On February 6, 2017, then-Acting SEC Chairman Michael Piwowar issued a public statement titled “Reconsideration of Pay Ratio Rule Implementation.” In the public statement, Acting Chairman Piwowar stated “it is my understanding that some issuers have begun to encounter unanticipated compliance difficulties that may hinder them in meeting the reporting deadline” and indicated that he was seeking public input on any unexpected challenges that issuers have experienced as they prepare for compliance with the rule and whether relief is needed. Then-Acting Chairman Piwowar also directed the SEC Staff to reconsider the implementation of the rule based on any comments submitted and to determine as promptly as possible whether additional guidance or relief may be appropriate. While the SEC did issue the Interpretive Release in response to concerns raised by commenters in this process, it may also be possible that the SEC will consider further rulemaking with regard to the requirement in the absence of an outright repeal of the Dodd-Frank Act's statutory directive. 

In the meantime, issuers should be focusing their efforts on computing the CEO pay ratio based on 2017 data, using an approach that is grounded in a reasonable basis and provided in good faith. The approach to calculating the ratio should be repeatable and well-documented. The ratio should then be disclosed in a manner where investors can understand the issuer’s approach, including a brief description of the methodology that the issuer used to identify the median employee and any material assumptions, adjustments or estimates used to identify the median employee or to determine total compensation or any elements of total compensation. Finally, issuers should carefully consider any engagement that may be necessary in 2018 with investors, employees, the media or others with regard to first year CEO pay ratio disclosures.