On Sept. 18, 2013, the Securities and Exchange Commission (SEC) issued its proposed rule on the CEO-to-median employee pay ratio disclosure. This proposed rule adds disclosure requirements to Item 402 of Regulation S-K, as mandated by Section 953(b) of the Dodd-Frank Act. Under the proposed rule, registrants will be required to disclose the ratio of the median annual total compensation paid to all employees as compared to the annual total compensation of the chief executive officer (CEO).

The proposed disclosure rule, slated to become Item 402(u) of Regulation S-K, was approved by a 3-2 vote amid contentious opposition from newly appointed Commissioner Piwowar and from Commissioner Gallagher, who contended that the disclosure bears no relevance to the SEC’s mission, “costs a lot and teaches little,” and serves only to “name and shame” U.S. registrants and corporate executives.

The proposed rule will require registrants to determine the total annual compensation for all employees in establishing the “median employee.” Registrants must consider all employees, including all full-time, part-time, temporary, seasonal, and non-U.S.-based workers employed by the registrant or any of its subsidiaries on the last day of the prior fiscal year. A registrant can annualize compensation for certain employees, such as new hires and seasonal workers.

The proposed rule does not mandate the use of a particular methodology for calculating total annual compensation for employees; rather, it provides registrants with the flexibility to use a calculation method suited for its specific facts and circumstances. For example, a registrant may

• calculate total annual compensation in accordance with Regulation S-K Item 402(c)(2)(10) or use another reasonable method; or


• use statistical sampling, reasonable estimates, and “reasonable and consistently applied compensation measures,” such as compensation reported on payroll or tax records.

Registrants will be allowed to choose a statistical method but must apply the method selected consistently and will be required to disclose the methodology, material assumptions, estimates, or adjustments used in the calculation in their disclosure of the pay ratio.

The pay ratio disclosure must be included in any filing that requires executive compensation disclosure under Item 402 of Regulation S-K, including a definitive proxy statement or information statement relating to an annual meeting of shareholders, and the annual report on Form 10-K.

Emerging growth companies, smaller reporting companies, and foreign private issuers and MJDS filers will be exempt from the pay ratio disclosure under the proposed rule.

The proposed rule contemplates a transition period so that each registrant will be required to begin complying with the disclosure requirements for the first full fiscal year after it becomes subject to the rule. So, for a calendar year-end company, if the final rule is issued in 2014, the first year for which the pay ratio information will need to be collected and disclosed will be 2015, and included in the annual report or proxy statement filed in 2016.

Commissioner Gallagher noted that the rule is broadly construed and, if finalized, will have a negative competitive impact that could disproportionately fall on U.S. companies with large work forces and global operations. Of particular concern is the cost burden associated with collecting and analyzing the information necessary to calculate the pay ratio according to the rule. In addition, Commissioner Piwowar expressed concerns that the pay ratio disclosure is not a relevant indicator of a company’s economic strength and could ultimately stifle capital formation and harm investors by providing them with distracting and misleading information. Even Commissioner Aguilar, who ultimately voted in favor of the proposed rule, acknowledged that superfluous benchmarking based on the disclosures could result in “economic decisions that are not economically efficient.”

The proposed rule is subject to a 60-day public comment period.