The SEC adopted final rules
on August 5 that require public companies to disclose the ratio of the compensation of their CEO to the median compensation of their employees. Mandated by Section 953(b) of the Dodd-Frank Act, the commission said the rules provide shareholders with valuable information to use when casting their say-on-pay votes, but also allow companies some flexibility in calculating this ratio.
The new information will have to be included in companies’ registration statements, proxy and information statements and annual reports that call for executive compensation disclosure.
The rules do not apply to smaller reporting companies, emerging growth companies, foreign private companies or registered investment firms.
The commission’s 2-3 vote on the rules fell along party lines. The two Republican commissioners, Daniel Gallagher and Michael Piwowar, voted against the regulations, labeling them “name and shame rules” and saying they were pushed forward by shareholder activists interested in shaming CEOs into taking pay cuts.
The SEC had proposed and sought public comments on pay ratio rules in September 2013. Most of the comments received in response focused on which employees would be included in the calculations, how often the ratio would have to be disclosed and which companies would have to comply with the rules. The final rules contain the following new provisions addressing those issues:
• the pay ratio calculations include both U.S. and non-U.S. employees
• companies in circumstances in which foreign data privacy laws or regulations make them unable to comply with the disclosure requirements can use a special exemption (To qualify, companies will be required to obtain a legal opinion from counsel on their inability to obtain the information necessary for compliance.)
• companies where non-U.S. employees account for 5 percent or less of their total U.S. and non-U.S. employees generally are exempt from including their non-U.S. employees in the ratio calculations (If a company excludes any non-U.S. employee in a particular jurisdiction, it must exclude all non-U.S. employees in that jurisdiction.)
• companies are allowed to identify the median employee every three years unless there has been a change in their employee population or employee compensation arrangements that they believe would result in a significant change in the pay ratio disclosure
• companies are permitted to make cost-of-living adjustments for the compensation of employees in jurisdictions other than the jurisdiction in which the principle executive officer resides to identify the median and calculate annual total compensation
• the definition of employee includes only the employees of a company’s consolidated subsidiaries
• an employee is defined as an individual employed as of the last day of a company’s last completed fiscal year
• the first reporting period for the pay ratio disclosure is the first full fiscal year beginning on or after Jan. 1, 2017
• companies that cease to be smaller reporting or emerging growth companies are not required to provide pay ratio disclosure until they file a report for the first fiscal year beginning on or after their status changes
To identify the median employee, the rule will allow companies to select a methodology based on their own facts and circumstances. A company could use its total employee population or a statistical sampling of that population and/or other reasonable methods. Whatever methodology was used must be described briefly and any material assumptions, adjustments (including cost-of-living adjustments), or estimates used to identify the median employee or to determine annual total compensation must be disclosed.
Companies are permitted, but not required, to supplement the required disclosure with a narrative discussion or additional ratios.
“The final rules make the pay ratio disclosure requirement more workable and less burdensome than the proposed rules,” said a long-time CII corporate fund member who has been closely following developments on the pay ratio rules. “The new three-year provision definitely helps.I hope Senators Menendez and Warren and the labor funds can live with this so we can all move on,” he added.