On September 18, the Securities and Exchange Commission proposed a rule that would amend Item 402 of Regulation S-K to require an issuer to disclose, in addition to the annual total compensation of the issuer’s chief executive officer, the median of the annual total compensation of all employees of such issuer and its subsidiaries (excluding the chief executive officer) and the ratio of such median annual total employee compensation to the annual total compensation of the chief executive officer. The proposed rule was approved by the SEC by a three to two vote over the objection of two SEC commissioners, who argued for postponing the proposal of the rule. Those objecting commissioners argued that the economic benefits of the proposed rule could not be clearly articulated, and that investors could be harmed because the pay ratio disclosure would not be precisely comparable across industries and issuers due to differing business practices and other company-specific factors. Prior to the SEC publishing the proposed rule, it received almost 23,000 comment letters and a petition with approximately 84,700 signatories. The SEC is required to implement this rule pursuant to Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The proposed rule would generally apply to issuers other than issuers that are emerging growth companies, smaller reporting companies or foreign private issuers (including issuers eligible for the US-Canadian Multi-Jurisdictional Disclosure System). Issuers subject to the rule would only be required to provide the pay ratio disclosure in annual reports on Form 10-K, registration statements and proxy and information statements, to the extent that such filings require the disclosure of a summary compensation table pursuant to Item 402(c) of Regulation S-K. In addition, the proposed rule would cover all employees of an issuer and its subsidiaries that are employed as of the end of the issuer’s fiscal year, including part-time, temporary, seasonal and foreign employees, despite comments from numerous large international corporations that including international employees would lessen the comparative value of the pay ratio disclosure due to differences in costs of labor and costs of living.
The proposed rule would mandate that specific compensation figures and ratios be disclosed and would require that total compensation for employees be calculated in the manner prescribed by Item 402(c)(2)(x) of Regulation S-K. The proposed rule would, however, provide for some flexibility in making the required calculations. For example, issuers would be permitted to use a representative sample of employees instead of making the calculation based on all employees. The proposed rule would allow an issuer to calculate total compensation for each of the employees included in its calculation (whether all employees or a sample) pursuant to Item 402(c)(2)(x), and determine the median employee based on these calculations.
Alternatively, an issuer would be permitted to identify the median employee included in its calculation based on any consistently applied measure of compensation (e.g., compensation amounts reported in the issuer’s tax or payroll records), and then calculate the total compensation for such employee in accordance with Item 402(c)(2)(x). An issuer would also be permitted to use reasonable estimates and assumptions when calculating annual total compensation, but would be required to disclose any material assumptions, adjustments or estimates used in its calculations, as well as the methodology used to identify the median employee.
Under the proposed rule, an issuer would be required to make the pay ratio disclosure with respect to compensation for its first fiscal year commencing on or after the effective date of the final rule. In other words, if the final rule becomes effective at some point in 2013, a calendar year filer would be required to include pay ratio disclosure regarding compensation for the 2014 fiscal year in its annual report for the 2014 fiscal year (filed in the first quarter of 2015) or its proxy or information statement for its 2015 annual meeting of stockholders. The proposed rule would also include a transition period for any newly public issuer, which would be required to make the pay ratio disclosure with respect to compensation for its first fiscal year commencing on or after the date on which such issuer became subject to the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934.
Significant concerns have been raised by large corporations and interest groups regarding the cost of obtaining the data needed to calculate the required median annual total compensation. The SEC believes that the proposed rule fulfills the requirements imposed by the Dodd-Frank Act while also minimizing the cost and time burden on issuers subject to the rule. The SEC has requested comments on the proposed rule by no later than 60 days following the date on which the proposed rule is published in the Federal Register.
A fact sheet regarding the proposed rule is available here, and the full proposing release is available here.