Securities Law Blog

In preparing proxy statements for their 2018 annual stockholder meetings, most public companies will be required to include CEO pay ratio disclosure.  In order to assist companies in their efforts to comply with these new rules and reduce the costs associated with preparing such disclosure, on Thursday, September 21, 2017, the Securities and Exchange Commission approved interpretive guidance.  The new pay ratio disclosure rules, which were mandated by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, will require public companies to calculate and disclose the following items:

• The median of the annual total compensation of all employees of a company, other than its chief executive officer (“CEO”);
• The annual total compensation of the company’s CEO; and
• The ratio of the annual total compensation of the company’s “median employee” to the CEO’s annual total compensation.

In performing the pay ratio calculation, a company is generally required to include all U.S. and non-U.S. employees of the company and its consolidated subsidiaries (including part-time, seasonal and temporary employees), determined as of a date chosen by the company within the last three months of its most recently completed fiscal year (which date must be disclosed).

The interpretive guidance offers the SEC’s views on the use of reasonable estimates, assumptions and methodologies, and statistical sampling in order to identify the median employee and calculate the median employee’s annual total compensation.  Acknowledging that the use of estimates, assumptions and statistical sampling may involve a degree of imprecision, the SEC stated that “if a registrant uses reasonable estimates, assumptions or methodologies, the pay ratio and related disclosure that results from such use would not provide the basis for Commission enforcement action unless the disclosure was made or reaffirmed without a reasonable basis or was provided other than in good faith.”

The interpretive guidance also clarified that a registrant is permitted to use existing internal records, such as tax or payroll records, in identifying its median employee, even if such records do not include every element of compensation.  Such internal records may also be used for purposes of determining whether non-U.S. employees need to be included for purposes of calculating the median of the annual total compensation of all of its employees.  Under the pay ratio rules, companies are generally permitted to exempt non-U.S. employees where these employees account for 5% or less of the company’s total U.S. and non-U.S. employees. 

In addition, the SEC also stated in the interpretive guidance that companies may use widely recognized tests, such as guidance published by the Internal Revenue Service, to determine whether its workers are employees or independent contractors for purposes of the pay ratio disclosure rules.

The SEC separately published guidance about the use of statistical sampling to assist companies in determining their median employee for pay ratio disclosure purposes. The additional guidance includes hypothetical examples of the use of sampling and other reasonable methodologies.

In issuing this interpretive guidance, the SEC confirmed that the schedule for compliance with the pay ratio disclosure rules remains in effect.  There had been some speculation earlier this year that the rule may be repealed or delayed when then acting chairman Michael Piwowar ordered the SEC to reconsider implementing the rule.  In June 2017, the U.S. House of Representatives passed the Financial CHOICE Act, which included a provision for the repeal of Section 953(b) of the Dodd-Frank Act.  However, such proposed legislation has not been passed by the Senate.  In addition, even if the Financial CHOICE Act is enacted, it is not certain that such legislation would repeal the pay ratio rule . Accordingly, companies should continue to prepare to make such pay ratio disclosure in their 2018 proxy statements.

Companies must make the pay ratio disclosure in any registration statement, proxy or information statement, and annual report in which they are required to include the executive compensation disclosure under Item 402 of Regulation S-K.  A company does not need to update its disclosure for its most recently completed fiscal year until it files its proxy or information statement for its next annual meeting of stockholders, but no later than 120 days after the end of the fiscal year.

Companies are required to include the pay ratio disclosure with respect to their first fiscal year beginning on or after January 1, 2017.  Therefore, as a general rule, for calendar year registrants, the pay ratio disclosure initially would be made in connection with the proxy statement for their 2018 annual meetings.

Companies that become subject to the reporting requirements of the Securities Exchange Act of 1934 must comply with this rule with respect to the following fiscal year.  Thus, a calendar year company that first becomes a reporting company in 2017 may omit the pay ratio disclosure until its proxy statement for its 2019 annual meeting.

Smaller reporting companies, emerging growth companies, foreign private issuers, MJDS filers, and registered investment companies are not subject to the pay ratio disclosure rules.