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Proposed Pay Ratio Disclosure
October 9, 2013
Recently, the Securities and Exchange Commission (SEC), in a three to two vote, approved a proposal to implement the controversial “pay ratio” disclosure mandated by the Dodd Frank Act. The proposal amends the SEC rule covering disclosure of executive compensation to require disclosure of:
- the median of the total annual compensation of all of the registrant’s employees except the Principal Executive Officer (PEO);
- the annual total compensation of the PEO; and
- the ratio of the two numbers.
This new disclosure and the accompanying ratio are often referred to as the “pay ratio” disclosure. Prior to issuing the proposed rule, the SEC received over 22,000 comment letters raising concerns over the Dodd Frank “pay ratio” disclosure’s compliance costs, complexity and materiality. In addressing these concerns, as drafted, the proposed rule allows registrants the flexibility in developing the “pay ratio” disclosure. Although the proposed flexibility should help to limit the compliance cost and complexity, this flexible approach may limit the ability of investors to compare “pay ratio” disclosures across registrants. It also remains to be seen whether the “pay ratio” disclosure as proposed will provide shareholders useful information in making an investment or voting decision. The “pay ratio” disclosure is contained in a new paragraph (u) added to Item 402 of Regulation S-K.
Methodology for Identifying the Median Employee
As Section 953(b) of the Dodd Frank Act does not set forth a methodology to be used in identifying the median employee, nor does it mandate that the SEC establish one, the SEC’s proposed rule attempts to give registrants a great deal of flexibility in determining the median employee and calculating his or her total annual compensation while remaining consistent with Dodd Frank’s statutory provision. Instead of requiring a specific methodology to determine the median employee’s total annual compensation, a registrant would be permitted to identify the median employee based on a methodology that is appropriate to its size and structure and how it compensates its employees. A registrant could use its entire employee population or a statistical sample of such population, and may use total annual compensation or any consistently used compensation measures to determine the median employee in the total or statistical sample population.
Once selected, the registrant would then calculate the median employee’s total annual compensation consistent with the SEC’s existing executive compensation disclosure requirements set forth in Item 402(c)(2)(x) of Regulation S-K. A registrant must also briefly describe the methodology used to identify the median employee and any material assumptions, adjustments or estimates used to identify the median employee or to determine total compensation. If the registrant changes its methodology, material assumptions, adjustments or estimates from the prior fiscal year, the registrant will need to disclose the changes and provide an estimate of the impact of the changes on the pay ratio.
For purposes of the proposed rule, employees include all full time, part-time, seasonal and temporary U.S. and Non U.S. employees employed by the registrant or any of its subsidiaries on the last day of the registrant’s fiscal year. Independent contractors, leased workers or other temporary workers that are employed by a third party are not included in the definition of employees. The SEC believes that this bright line approach to determining which employees are to be included in the calculation of median total annual compensation for all employees will further ease the burden on compliance costs, although it will tend to increase the ratio to the extent that part-time, seasonal, and temporary employees are lower-paid.
For full and part-time employees employed on the last day of the fiscal year, but who were not employed for the full fiscal year (new hires or workers on unpaid leaves of absence), the registrant would be permitted to annualize those employees’ total compensation. Any annualized adjustments would need to be consistently applied to all similarly situated employees. Significantly, the registrant would not be permitted to make full time equivalent adjustments for part-time workers, make annualizing adjustments for temporary or seasonal workers, or make cost of living adjustments for foreign workers.
Expressing the Pay Ratio
The pay ratio must be expressed as a ratio in which the median employee’s total annual compensation for all employees is equal to one, or alternatively, the registrant may express the pay ratio narratively in terms of the multiple that the PEO’s total annual compensation bears to the median employee’s total annual compensation. For example, a registrant could identify the pay ratio as 1 to 200 or that the PEO’s total annual compensation is 200 times the median employee’s total annual total compensation.
Disclosing the Pay Ratio
The pay ratio disclosure is required in annual reports, registration statements under the Securities Act and proxy and information statements under the Exchange Act to the same extent these forms require compensation disclosure under Item 402 of Regulation S-K. However, the pay ratio disclosure only applies to registrants that are required to provide summary compensation table disclosure pursuant to Item 402(c) of Regulation S-K. The proposed rule does not apply to emerging growth companies, smaller reporting companies or foreign private issuers. As with other Item 402 information, the pay ratio disclosure is deemed “filed” for purposes of the Securities Act and the Exchange Act.
Also, the proposed rule clarifies that the pay ratio disclosure does not have to be updated during the registrant’s fiscal year. Rather, it is updated each year in the Annual Report on Form 10-K, or in the proxy statement for the Annual Meeting of Stockholders.
Under the proposed rule, a registrant would not be required to report the pay ratio with respect to compensation disclosure until its first fiscal year commencing on or after the effective date of the final rule. By way of example, if the proposed rule becomes final and effective on June 30, 2014, the pay ratio would not be required for a registrant with a December 31 fiscal year end until it files its Annual Report on Form 10-K for the fiscal year ending December 31, 2015, which for an accelerated filer would be on or before March 15, 2016, or, if later, its proxy statement for its 2016 Annual Stockholders Meeting, provided such filing is made within 120 days of December 31, 2015.
This Alert is provided for information purposes only, and does not constitute legal advice. According to Mass. SJC Rule 3:07, this material may be considered advertising. ©2013 Posternak Blankstein & Lund LLP. All rights reserved.