CLS Blue Sky Blog

SEC Proposes Rules for Pay Ratio Disclosure

The following is the SEC’s press release and fact sheet, originally published here.  The proposed rule is available here.

The Securities and Exchange Commission today voted 3-2 to propose a new rule that would require public companies to disclose the ratio of the compensation of its chief executive officer (CEO) to the median compensation of its employees.

The new rule, required under the Dodd-Frank Act, would not prescribe a specific methodology for companies to use in calculating a “pay ratio.”  Instead, companies would have the flexibility to determine the median annual total compensation of its employees in a way that best suits its particular circumstances.

“This proposal would provide companies significant flexibility in complying with the disclosure requirement while still fulfilling the statutory mandate,” said SEC Chair Mary Jo White.  “We are very interested in receiving comments on the proposed approach and the flexibility it affords.”

The proposal will have a 60-day public comment period following its publication in the Federal Register.

Background

Section 953(b) of the Dodd-Frank Act directs the Commission to amend existing rules to require companies to disclose:

Under SEC rules, companies are required to provide extensive information about the compensation of their CEO and other named executive officers.  Companies are not, however, required to disclose the same compensation information for other employees.

SEC rules require compensation information to be calculated and presented in accordance with U.S. Generally Accepted Accounting Principles (GAAP), which differs from the tax accounting and reporting standards that companies may use for purposes of determining employee compensation.  As a result, Section 953(b) calls for new disclosure about employee compensation that is not currently required.

SEC Proposal

New Pay Ratio Disclosure Requirement

As required by the Dodd-Frank Act, the proposal would amend existing executive compensation disclosure rules to require companies to disclose:

Methodology for Identifying the Median Employee

The proposed rule would not specify any required calculation methodologies for identifying the median employee in terms of total compensation for all employees.  Instead, it would allow companies to select a methodology that is appropriate to the size and structure of their own businesses and the way they compensate employees.

For example, a company would be permitted to identify the median employee based on total compensation using either its full employee population or a statistical sample of that population.

A company could, for example, identify the median of its population or sample:

Determination of Total Compensation    

As required by the Dodd-Frank Act, median employee total compensation would be calculated using the definition of “total compensation” in existing executive compensation rules, namely Item 402(c)(2)(x) of Regulation S-K.  Item 402(c)(2)(x) requires companies to provide extensive compensation information about the CEO and other named executive officers, which is not ordinarily calculated for all employees.

“Annual total compensation” would mean total compensation for the last completed fiscal year, consistent with the Commission’s existing executive compensation disclosure requirements.

The proposal would allow companies to use reasonable estimates when:

Identification of Employees Covered by the Proposed Rule   

“All employees of the registrant” would include:

Companies would be permitted but not required to annualize the total compensation for a permanent employee who did not work for the entire year, such as new hires.  In contrast, full-time equivalent adjustments for part-time workers, annualizing adjustments for temporary and seasonal workers, or cost-of-living adjustments for non-U.S. workers would not be permitted.

Disclosure of Methodology, Assumptions, and Estimates

Companies would be required to disclose the methodology used to identify the median, and any material assumptions, adjustments or estimates used to identify the median or to determine total compensation.  If a company identifies a median employee based on a consistently applied compensation measure, the proposed rule would require disclosure of the measure that it used.  Also, companies would be required to clearly identify any amounts that are estimated.

Additional Disclosure Permitted But Not Required

Companies would be permitted but not required to supplement the required disclosure with a narrative discussion or additional ratios if they choose to do so.

Filings Where Disclosure Is Required

Companies would be required to describe the information in registration statements, proxy and information statements, and annual reports that must already include executive compensation information as set forth under Item 402 of Regulation S-K.

Companies would not be required to:

Companies Subject to the Proposed Disclosure Requirement

As provided by the JOBS Act, the proposed rule would not apply to emerging growth companies.  In addition, the proposed rule would not apply to smaller reporting companies or foreign private issuers.

The proposal would provide a transition period for newly public companies.  For these companies, initial compliance would be required with respect to compensation for the first fiscal year commencing on or after the date the company becomes subject to the reporting requirements.

Proposed Compliance Date

A company would be required to report the pay ratio with respect to compensation for its first fiscal year commencing on or after the effective date of the final rule.

What’s Next?

The proposal will be subject to a 60-day public comment period once it is published in the Federal Register.

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