Pay Ratio Disclosure Guidance from the SEC (and a Reminder)

As everyone knows by now, the SEC adopted new pay ratio disclosure rules in August 2015. The good news back then was that the rules are effective for compensation during the first fiscal year beginning on or after January 1, 2017. For calendar-year companies, that means that the new disclosure will first be included in spring of 2018 proxy statements, which was more than two years away and was, therefore, well down many priority lists.

Well, here we are, nearing the start of 2017, and many companies have not yet begun the extensive data collection and analysis necessary to satisfy the new rules. Nevertheless, the SEC is apparently unwilling to similarly pretend that the new rules never happened, as evidenced by its recent new CDIs (128C.01-.05) addressing some of their many complexities. Therefore, if you have not yet done so, now is the time to be sure your company is putting the proper procedures and compliance timeline in place.

A brief refresher…

The pay ratio rules state that all companies required to provide executive compensation disclosure under Item 402(c) of Regulation S-K (which excludes smaller reporting companies, foreign private issuers, emerging growth companies, MJDS filers and registered investment companies) must provide new executive compensation disclosure regarding:

  • the median of annual total compensation of all employees,
  • the annual total compensation of the CEO, and
  • the ratio of those two amounts.

Companies may identify the median employee using annual total compensation under the current executive compensation rules or using their own methodology, which may include the total employee population, statistical sampling or another reasonable, consistently applied methodology. Companies may identify the median employee once every three years, rather than annually, unless a change has occurred that the company reasonably believes would result in a significant change to its pay ratio disclosure.

The total employee population may be based on a date within the last three months of its recently completed fiscal year selected by the company and is subject to specified limited exclusions.

Once identified, the median employee’s annual total compensation must be calculated using the same rules as are applicable to the CEO’s compensation, though reasonable estimates may be used when calculating elements of annual total compensation.

The new disclosures:

  • Must include a description of the methodology, material assumptions, cost-of-living adjustments and estimates used to identify the median employee,
  • May, but need not, include any supplemental narrative or ratio disclosures (provided with no greater prominence) that the company would like to include for context or color regarding the mandatory pay ratio disclosures, and
  • Must be included in any reports or filings required to contain the executive compensation information specified in Item 402 of Regulation S-K (for example, registration statements, proxy statements and annual reports).

The new CDIs

The new CDIs address some questions left unanswered by the rules themselves, and no doubt there will be others as we navigate the process for the first time. Due to their complexity, I won’t attempt to summarize the CDIs here. However, they address:

  • How to select another consistently applied compensation measure (CACM) to identify the median employee if a company choses not to use annual total compensation;
  • The prohibition against using hourly and annual pay rates as an exclusive means (rather than a component) for determining an employee’s overall compensation;
  • The proper time period for identifying an employee when using a CACM;
  • How to treat furloughed employees in the analysis, and when to annualize the compensation of full-time, part-time, temporary and seasonal employees; and
  • How to determine when a worker is considered an independent contractor or leased worker under the rules.

A public relations opportunity…really

Companies are understandably concerned that these disclosures may be a public relations challenge as investors, governance advocacy groups and the media attempt to use them to their respective advantages. Likewise, there is understandable concern that the disclosure could negatively impact employee morale.

Wise companies will proactively use this pay ratio information as catalyst to educate their investors, analysts and employees regarding the process followed to evaluate and determine executive compensation. Employees in particular may not be aware of the amount of effort put into creating compensation structures that reward performance, encourage behaviors that inure to the benefit of all stakeholders and allow the company to hire and retain top executives in highly competitive industries.

This is an opportunity to engage frankly and openly with these important constituencies on a sensitive subject that has been around for a long time. Be sure your investor relations and human resources personnel are plugged in early.

All the best,

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