SEC Issues Proposed Pay Ratio Rules

by BakerHostetler

On September 18, 2013, the SEC voted 3 to 2 in favor of proposed "pay ratio" rules[1], which require each registrant to disclose the median of the annual total compensation of all of its employees (the MATC), the annual total compensation of its principal executive officer (PEO), and the ratio of the MATC to the annual total compensation of its PEO. The SEC proposed the amendments to implement Section 953(b) of the Dodd-Frank Act and is seeking comments on various points of the proposed rules. Should the rules be adopted as proposed, each registrant would be required to disclose the information in its annual reports on Form 10-K and in each proxy or information statement or registration statement that requires executive compensation disclosure pursuant to Item 402 of Regulation S-K.

SEC Chairman Mary Jo White and Commissioners Luis A. Aguilar and Kara M. Stein voted in favor of the proposal. Commissioners Daniel M. Gallagher and Michael S. Piwowar voted against the proposal, casting the rules as a costly administrative burden to registrants that is of little use to their shareholders.

The SEC commented that the proposed rules "allow registrants flexibility in developing the disclosure required by the statute" and noted that the flexibility permitted under the rules could enable registrants to substantially reduce the compliance costs. The following is a brief summary of the proposed rules:

Compliance Date:

Registrants would be required to comply with the proposed disclosure rules for the first fiscal year commencing on or after the effective date of the rules. Thus, if the final requirements were to become effective in 2014, a registrant with a calendar year fiscal year would be first required to include the pay ratio disclosure in its annual report for 2015, or if later, its proxy or information statement for its 2016 annual meeting of shareholders. Registrants would be permitted to begin compliance earlier on a voluntary basis.

Calculating the MATC

To determine the employees that are to be included in the calculation of the median compensation of all employees, registrants may use the full employee population, a statistical sampling or another reasonable selection. The definition of "employees" includes all worldwide full-time, part-time, seasonal and temporary workers employed by the registrant and its subsidiaries (excluding the PEO, but including other officers) as of the last day of the registrant's last completed fiscal year. From the identified employee population, the registrant would identify the median employee based on any consistently applied compensation measure, and may use reasonable estimates. The proposed rules do not specify any required calculation methodology for identifying the median. Once the median employee is identified, the registrant would calculate the annual total compensation for that median employee in accordance with Item 402(c)(2)(x) of Regulation S-K and disclose that amount as part of the pay ratio disclosure.

Calculating the Annual Compensation of the PEO

The PEO total compensation to be used in the pay ratio disclosure would be calculated in accordance with Item 402(c)(2)(x) of Regulation S-K, and would include salary, bonus, stock awards, option awards, long-term incentive pay, change in pension value and nonqualified deferred compensation earnings.

Expression of the Pay Ratio

Under the rules, the pay relationship must be expressed as a ratio in which the MATC is equal to one, or, alternatively, expressed narratively in terms of the multiple of the PEO total compensation amount to the MATC amount.

Disclosure of Methodology, Assumptions and Estimates

The proposed rules require the registrant to disclose briefly and apply consistently its methodology used in its calculations, and disclose any material assumptions, adjustments or estimates and any change, the reasons for the change and an estimate of the impact of the change on the median employee compensation and the ratio from one year to the next. Registrants would be permitted to supplement the required disclosure with a narrative discussion if they choose to do so.

Certain Registrants Excluded from the Proposed Pay Ratio Rules

The proposed pay ratio disclosure requirements would apply only to those registrants required to provide the summary compensation table disclosure pursuant to Item 402(c) of Regulation S-K; emerging growth companies, smaller reporting companies, foreign private issuers and MJDS filers would not be subject to the rules.

[1] A copy of the proposing release

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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