The Dodd-Frank Wall Street Reform and Consumer Protection Act, as enacted in 2010, directs the Securities and Exchange Commission to adopt new rules requiring the disclosure of an executive pay ratio for public companies. Specifically, Section 953(b) of the Dodd-Frank Act requires the SEC to amend Item 402 of Regulation S-K to require an issuer to disclose the median annual total compensation of all employees of the issuer, other than the chief executive officer, the annual total compensation of the chief executive officer and the ratio of these two values. The statute provides that Item 402(c)(2)(x) of Regulation S-K is to be used for the purpose of calculating total compensation.

On September 18, 2013, the SEC proposed adding paragraph (u) to Item 402 of Regulation S-K (the “Proposed Rules”) to implement this requirement. The Proposed Rules were adopted by a three to two vote over strong dissents objecting to the cost of implementing the Proposed Rules and the absence of any definable benefits. The SEC is seeking public comments on the Proposed Rules for a period of 60 days from their publication in the Federal Register. Following the review of comments by the SEC, the final rules are to be issued. As of the date of this client update, publication of the Proposed Rules in the Federal Register is pending.

The Proposed Rules

Under the Proposed Rules, a registrant must include the compensation pay ratio in filings that otherwise require compensation information under Item 402 of Regulation S-K; these filings can include annual reports, proxy and information statements and registration statements. The pay ratio disclosure consists of (i) the median annual total compensation of all employees of the registrant, other than the principal executive officer (“PEO”), (ii) the annual total compensation of the PEO and (iii) a ratio comparing these two values. Prior to the announcement of the Proposed Rules, there was considerable discussion regarding the scope of the pay ratio and proposals to simplify what could otherwise be a very burdensome computational task. The Proposed Rules clarify which employees need to be included in the determination of the median, the methodology for identifying the median employee and other implementation issues. The SEC emphasizes that in drafting the Proposed Rules it has prioritized providing registrants considerable flexibility in complying with the pay ratio disclosure requirements.

Scope of 'All Employees'

The Proposed Rules adhere to a broad definition of all employees that includes part-time, seasonal and temporary workers, and require that the registrant include all worldwide employees in the determination. The Proposed Rules implement a bright-line rule requiring that all employees employed by the registrant as of the last day of the registrant’s fiscal year be included in the calculation. This date is consistent with the calculation date for determining PEO compensation, even if it may not include temporary or seasonal workers that are not employed at year-end.

In determining how to calculate the total compensation of employees as of the end of a registrant’s fiscal year, the Proposed Rules permit an adjustment to annualize the salaries of full-time employees hired during the previous fiscal year. Annualization is not permitted for part-time, temporary or seasonal employees nor are cost-of-living adjustments permitted for non-U.S. employees.

Identifying the Median Employee

The Proposed Rules offer several ways of identifying the median employee. A registrant is permitted to examine the entire employee population or may use reasonable methods to identify the median employee, including the use of statistical sampling. The Proposed Rules do not provide detailed requirements for a given methodology; rather, the filing must briefly describe the methodology used to identify the median employee and any material assumptions, adjustments or estimates used. Any such methodology must be consistently applied by the registrant.

Calculation of the Median Employee’s Salary

Once the individual median employee has been identified, the Proposed Rules require that the registrant calculate the employee’s total compensation under the rules provided in Item 402(c)(2)(x) of Regulation S-K. The registrant is allowed to use reasonable estimates to determine the annual total compensation or any elements of the total compensation for the median employee.1 Disclosure related to the total compensation of the median employee must briefly describe the methodology used and any material assumptions, adjustments or estimates.


The Proposed Rules clarify that the ratio must be expressed with the median of the total compensation of all employees equal to one or expressed in narrative form. For example, a registrant could state that the pay ratio is “1 to 5” or could describe the PEO’s compensation as “five times the median of the annual total compensation of all employees.” In addition, registrants are permitted to include additional ratios to supplement the required pay ratio, so long as any additional ratios are clearly identified and not misleading.

Excluded Registrants

The Proposed Rules excludes certain registrants from the pay ratio disclosure requirement. This includes smaller reporting companies2 and companies that are classified as emerging growth companies under the JOBS Act. In addition, U.S.-Canadian Multijurisdictional Disclosure System registrants and foreign private registrant are excluded from the pay ratio disclosure requirement.

Report Timing and Transition

Registrants will need to comply with the Proposed Rules in the first fiscal year commencing on or after the date the Proposed Rules go into effect, although the registrant will be permitted to omit disclosing the pay ratio until it files its annual report for such fiscal year. For example, if the Proposed Rules become effective during 2014, a company with a fiscal year ending December 31 would first be required to provide pay ratio information in its filings in 2016 based on compensation information gathered during fiscal year 2015. Similarly, newly registered companies will not have to comply in a Form S-1, Form S-11 or Form 10. Rather, new registrants will have to comply in their first fiscal year commencing on or after the being subject to the Securities Exchange Act of 1934, with disclosure of the pay ratio included in the subsequent proxy or information statement for that fiscal year.