SEC Publishes FAQs on Pay Ratio Rule

by Stinson Leonard Street - Dodd-Frank and the Jobs Act
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The SEC has published five FAQs on its pay ratio rule – see new questions 128C.01 to 128C.05. As we noted in our checklist of preliminary planning matters for the upcoming proxy season, the pay ratio disclosure need not be made in annual reports or proxy statements that include information for the calendar year ended December 31, 2016 (i.e., this proxy season). The disclosures must be included in annual reports and proxy statements which include information for the first fiscal year beginning on or after January 1, 2017.

Some of the FAQs, or in SEC parlance CDIs (Compliance and Disclosure Interpretations), address the question of certain permissible matters if an issuer decides to identify the median employee using a consistently applied compensation measure (“CACM”) instead of annual total compensation. According to the SEC:

  • Any measure that reasonably reflects the annual compensation of employees could serve as a CACM. The appropriateness of any measure will depend on the registrant’s particular facts and circumstances. For example, total cash compensation could be a CACM unless the registrant also distributed annual equity awards widely among its employees. Social Security taxes withheld would likely not be a CACM unless all employees earned less than the Social Security wage base.
  • Can a registrant exclusively use hourly or annual rates of pay as its CACM? Using an hourly rate without taking into account the number of hours actually worked would be similar to making a full-time equivalent adjustment for part-time employees, which is not permitted. Similarly, using an annual rate only, without regard to whether the employees worked the entire year and were actually paid that amount during the year, would be similar to annualizing pay, which the rule only permits in limited circumstances.
  • To calculate the required pay ratio, a registrant must first select a date, which must be within three months of the end of its fiscal year, to determine the population of its employees from which to identify the median. Once the employee population is determined, the registrant must then identify the median employee from that population using either annual total compensation or another CACM. In applying the CACM to identify the median employee, a registrant is not required to use a period that includes the date on which the employee population is determined nor is it required to use a full annual period. A CACM may also consist of annual total compensation from the registrant’s prior fiscal year so long as there has not been a change in the registrant’s employee population or employee compensation arrangements that would result in a significant change of its pay distribution to its workforce.

The SEC also noted that Item 402(u) does not define or even address furloughed employees. Because a furlough could have different meanings for different employers, registrants will need to determine whether furloughed workers should be included as employees based on the facts and circumstances. If the furloughed worker is determined to be an employee of the registrant on the date the employee population is determined, his or her compensation should be determined by the same method as for a non-furloughed employee.

The SEC also addressed the question of “Who is an employee?” In furtherance of this, a registrant should include those workers whose compensation it or one of its consolidated subsidiaries determines regardless of whether these workers would be considered “employees” for tax or employment law purposes or under other definitions of that term. Frequently, a registrant will obtain the services of workers by contracting with an unaffiliated third party that employs the workers. When a registrant obtains services in this way, we do not believe it is determining the workers’ compensation for purposes of the rule if, for example, the registrant only specifies that those workers receive a minimum level of compensation. Further, an individual who is an independent contractor may be the “unaffiliated third party” who determines his or her own compensation.

Mysteriously, the SEC also posted this document to its web site titled “17 CFR §229.402(a)(6) of Regulation S-K in effect as of July 20, 2010.” The document also includes the text of 17 CFR §229.402(c) as of July 20, 2010.

What is the SEC trying to signal? It may be difficult to discern, but the adopting release for the pay ratio rules states “In the Proposing Release, we noted that Section 953(b) refers to Item 402(c)(2)(x) [which is a reference to total compensation in the summary compensation table.] in effect on the day before enactment of the Dodd-Frank Act, or July 20, 2010. We also indicated that, because no substantive amendments have been made to Item 402(c) since that date, the proposed rule would refer to Item 402(c)(2)(x) without reference to the rules in effect on July 20, 2010. We further stated that we expect to address the impact on the proposed rule of any future amendments to Item 402(c)(2)(x) if and when such future amendments are considered. No substantive amendments have been made to Item 402(c) since July 20, 2010. We continue, therefore, to take the approach articulated in the Proposing Release on this issue.”

Some research showed that Item 402(c)(2)(x) has not been amended since the pay ratio rules were adopted. So perhaps the SEC is putting this document out there for historical reference, or so that people can see that has been no change yet to Item 402.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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