SEC Proposes Rule Requiring Disclosure of CEO-to-Employee Pay Ratio

September 18, 2013

After a long delay, on September 18, 2013, the Securities and Exchange Commission (the “SEC”) released a proposed rule establishing the CEO-to-employee pay ratio disclosure requirement mandated by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The proposed rule implements Section 953(b) of the Dodd-Frank Act by amending Item 402 of Regulation S-K to require companies to disclose:

  1. the median of the annual total compensation for all employees of the company (except for the CEO);
  2. the annual total compensation of the CEO or equivalent officer; and
  3. the ratio of those two figures (the “pay ratio disclosure”).

Under the proposed rule, the pay ratio disclosure will be required in annual reports, proxy and information statements, and registration statements that already require executive compensation disclosure under Item 402 of Regulation S-K. The pay ratio disclosure will not be required in reports that do not require executive compensation information, such as current or quarterly reports. The new disclosure requirements apply to only those issuers that are required to provide summary compensation table disclosure pursuant to Item 402(c) of Regulation S-K. As such, the proposed rule will not apply to emerging growth companies, smaller reporting companies, Canadian Multijurisdictional Disclosure System filers (“MJDS”) or foreign private issuers. This is true even if an exempt issuer, such as a smaller reporting company, voluntarily chooses to report the more extensive executive compensation information required for larger companies.

The following sections provide a summary of the key provisions of the proposed rule:

Employees Covered

The proposed rule defines “employee” as an individual employed as of the last day of the last completed fiscal year. Employees include full-time, part-time, seasonal and temporary workers employed both in the United States and abroad by the company and its subsidiaries. Non-employees such as independent contractors or temporary workers employed by a third party are not included. The proposed rule permits, but does not require, compensation to be annualized for permanent employees hired mid-year or on a leave of absence during the year. Adjusting part-time employee salary to its full-time equivalent, annualizing temporary or seasonal employee salaries, and making cost-of-living adjustments for international employees, however, are prohibited.

Methodology for Determining the Median Employee

In light of concerns regarding the cost of complying with these new requirements, the proposed rule provides flexibility in determining the median employee. Rather than prescribing a required calculation methodology for calculating the median, the proposed rule provides that a company may choose to calculate the median of its full employee population or a group of employees selected through the use of statistical sampling or another reasonable method. Companies have discretion to determine the appropriate sampling method based on the size and structure of the business and the way in which it compensates employees.
Additionally, companies have flexibility in determining the compensation measure used to determine the median annual total compensation of all employees. One option is to determine the “total compensation” of each employee in accordance with Item 402(c)(2)(x) of Regulation S-K. The proposed rule acknowledges that requiring companies to calculate the compensation of every employee in accordance with the complex and detailed requirements in Item 402(c)(2)(x) may impose an increased burden on some companies. In response, the proposed rule allows companies to use any reasonable compensation measure, such as payroll or tax records, to determine the median annual total compensation for all employees, so long as it is consistently applied.

Total Compensation

After a company has determined the median employee using a reasonable method, it will then be required to determine the “total compensation” for the median employee in accordance with existing executive compensation rules found in Item 402(c)(2)(x) of Regulation S-K. Item 402(c)(2)(x) requires disclosure of the total sum of all compensation, including salary, bonuses, stock awards, stock options, change in pension value and non-qualified deferred compensation. The proposed rule permits the use of reasonable estimates in determining any of the elements of total compensation of the median employee under Item 402(c)(2)(x), provided that all estimates are clearly disclosed. Note that estimates cannot be used in calculating the total compensation of the CEO.
The proposed rule requires companies to disclose the methodology, material assumptions, adjustments and estimates used to calculate the median or to determine the total compensation or any element of total compensation. Additionally, any estimated figures must be clearly identified.

Compliance Date

Luckily, issuers will likely have a couple of years to prepare for these new disclosures. The proposed rule states that a company must begin to comply with the new disclosure requirements for the company’s first fiscal year commencing on or after the effective date of the rule. It is unlikely that the final rule will become effective in 2013, meaning that the new rule will not likely affect the 2014 proxy season. If the final rule becomes effective in 2014, a company with a fiscal year ending on December 31 will be required to provide the pay ratio disclosure in its 2016 filings based on compensation figures from its 2015 fiscal year.

The SEC will be accepting comments for 60 days after the proposed rule is published in the Federal Register.

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