Abstracted from SEC Pay Ratio Rules—A Recipe For Compliance And Model Disclosure By Jason Halper and Jeremy Erickson Orrik Herrington & Sutcliffe, New York NY (JH) and San Francisco CA (JE) Review of Securities & Commodities Regulation, Vol. 49, No. 7, Pgs. 81-87
Pay-ratio rules divide experts. The SEC adopted final rules on pay-ratio disclosure in August 2015, thereby fulfilling a Dodd-Frank directive. From early 2018 onward, non-exempt public companies must disclose the CEO’s total yearly compensation, the median of all other employees’ yearly compensation, and a ratio that compares the two. According to Senator Robert Menendez, who drafted that Dodd-Frank provision, the ratio will show “whether companies’ pay practices are fair to their average employees, especially [when] compared to their highly compensated CEOs.” Some state agencies, unions, and pension funds support the rules, but critics abound.
One former SEC commissioner called the rules distracting and possibly deceptive. The US Chamber of Commerce, groups such as the American Benefits Council, and companies such as ExxonMobil predict that actual compliance costs and time will be many times greater than the SEC’s estimates. These authors—attorneys Jason Halper and Jeremy Erickson—concur: Compliance will probably be costly, time-consuming,
Figure the CEO’s total pay. Disclosure of the pay ratio must appear in every corporate filing for which Regulation S-K Item 402 requires disclosure of executive pay, the authors
explain. (Note that disclosure is not required in Forms 10-Q; and Forms 10-K can incorporate disclosures from a proxy statement filed within 120 days after the fiscal yearend covered by the 10-K.) In working out the ratio, the first and simplest step is to compute the CEO’s total yearly pay. With a few exceptions, this will be the amount reported in the proxy statement’s Summary Compensation Table pursuant to S-K Item 402(c)(2)(x).
Select an employee. The most onerous and intricate step under the pay-ratio rules is determining the company’s median employee, who has to be an actual employee. The
rules are, however, somewhat flexible. “Employee” is defined as comprising all global employees of a company and its consolidated subsidiaries, whether full- or part-time, seasonal, or temporary, but not independent contractors if an unaffiliated third party retains them and sets their pay. Foreign employees are excludable if compliance would trigger a breach of foreign law on data privacy or if they represent no more than 5% of the global employees.
Find a date. The date for determining the median employee whose compensation will be compared can be any day during the final three months of the fiscal year, and the
date chosen must be disclosed. The median employee can be selected once every third year, the authors note, unless the company reasonably believes that shifts in the employee population or compensation have substantially changed the ratio before then. If the median employee’s compensation changes, the filer may substitute a different employee but must disclose that it is doing so. Except for compensation, the filer should not provide any data that could identify the actual employee selected as the median.
Calculate the median. The company may calculate the yearly total pay of each employee by a means similar to that used in the proxy statement for executive officers
or may make reasonable estimates by any method applied uniformly to all employees. Annualizing compensation is permissible, but only for full- or part-time employees. The filer may apply cost-of-living adjustments to the pay of employees who do not live in the same jurisdiction as the CEO.
Add to disclosure. The next step is to create either a ratio, with the median employee’s total yearly pay being one and the CEO’s being a number compared to
one (for example, 100 to 1), or the multiple that the CEO’s total yearly pay bears to the median employee’s. Disclosure is the last step, the authors observe. Beyond the required pay ratio, the company may disclose others or include a narrative to counteract any unjustified conclusions to which the required ratio could lead, provided the other ratios are clearly labeled as such, are not deceptive, and are no more conspicuous than the required one. The filer may also disclose the median employee’s job (without identifying that person); the effect on the required ratio of omitting part-time, temporary, or seasonal employees, or all of them; the effect of omitting foreign employees (beyond those within the rules’ exclusions); general pay practices, so as to put the required ratio in context; and a comparison of the required ratio to that of industry peers.
Abstracted from Review of Securities & Commodities Regulation, published by RSCR Publications, 2628 Broadway, Ste. 29A, New York NY 10025-5055. To subscribe, call (866) 425-1171; or visit www.rscrpubs.com.
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