SEC Proposes Rules for Pay Ratio Disclosure

by Holland & Knight LLP

At an open meeting on September 18, 2013, the Securities and Exchange Commission (SEC) approved for public comment proposed "pay ratio" disclosure rules to implement Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.


As noted in our September 23, 2013, issue of Securities and Financial News to Note, SEC commissioners voted three to two to approve the controversial proposed rules, with commissioners Daniel M. Gallagher and Michael Piwowar voting against approval. In their remarks, the commissioners who voted against approval said the proposed rules wrongly favor special interests ahead of investors and are a tactic designed to "name and shame" companies and their executives. Stakeholders have shown significant interest in pay ratio disclosure, as evidenced by the more than 22,000 comment letters and a petition with approximately 84,700 signatories received by the SEC prior to the issuance of the proposing release.

Summary of the Proposed Rules

The proposed rules would implement Section 953(b) of the Dodd-Frank Act by amending Item 402 of Regulation S-K to include a new Paragraph (u) that would require companies (other than emerging growth companies, smaller reporting companies or foreign private issuers) to disclose all of the following:

  • the median of the annual total compensation of all employees, excluding the principal executive officer (CEO)
  • the annual total compensation of the CEO
  • the ratio of the median to the annual total compensation of the CEO

The disclosure would be required to be presented as either a ratio of the median of annual total compensation of all employees to the CEO’s annual total compensation, with the median equal to one (e.g., one to 20), or as a multiple (e.g., "our CEO’s annual total compensation is 20 times the median of the annual total compensation of all our employees"). The narrative description may be easier for investors to understand than a numerical ratio.

Companies would be required to present the new pay ratio disclosure in any registration statement, proxy statement, information statement and annual report that is required to include the executive compensation disclosure required by Item 402 of Regulation S-K. The proposed rules do not mandate where the pay ratio disclosure should appear, but companies are likely to include it as part of their Compensation Discussion and Analysis rather than provide it on a stand-alone basis. Like the other executive compensation disclosure, the pay ratio disclosure would be "filed" not "furnished" under the Securities Act and the Exchange Act, making the disclosure subject to a higher level of potential liability.

Covered Employees

The employees covered by the pay ratio disclosure would include "all employees of the registrant," which is defined to include all full-time, part-time, temporary and seasonal employees of the company or any of its subsidiaries in the United States and abroad as of the last day of the company’s last completed fiscal year. Independent contractors or "leased" workers or other temporary workers who are employed by a third party would not be covered. Compensation would be permitted, but not required, to be annualized for employees who were not employed for a full fiscal year. However, full-time equivalent adjustments for part-time workers, annualizing adjustments for temporary or seasonal workers and cost-of-living adjustments for non-U.S. workers would not be permitted.

Comment letters expressed that very few, if any, large companies currently calculate employee pay in the same way that companies are required to calculate CEO compensation for disclosure purposes. Additionally, companies may not track and record all of the payroll and non-payroll information necessary to calculate total annual pay for each employee at the parent company, since many large firms use outside accounting, actuarial and compensation and pension administration firms to perform separate functional calculations.

Many commentators raised concerns about the inclusion of workers located outside of the United States, including compliance costs for multinational companies, the impact of data privacy laws in various jurisdictions and the impact of non-U.S. pay structures on the comparability of data without off-shore operations.

Determining the Median

While Section 953(b) requires companies to calculate median employee compensation in the same way that "named executive officer" total compensation is calculated under Item 402(c)(2(x) of Regulation S-K, it does not specify a methodology to identify the median. Responding to commentators’ concerns about compliance costs of U.S. companies with large workforces and global operations, the SEC sought to provide flexibility in allowing companies to choose from several alternative methods to identify the median, including:

  • Total Compensation for Each Employee: This involves applying the standards of 402(c)(2)(x) to determine "annual total compensation" of all employees, and then identifying the median. This may be most appropriate for companies with only a few employees.
  • Statistical Sampling: Median employee pay may be based upon the full employee population, a statistical sample of all employees or some other reasonable method. Identification of a median employee need not require a determination of exact compensation amounts for every single employee included in the sample. The variance of underlying wage distributions can materially affect the appropriate sample size for statistical sampling. The larger the variance, the larger the sample that may be needed.
  • Consistently Applied Compensation Measures: Identification of the median employee may be based on any consistently applied compensation measure, such as compensation amounts reported in a company’s payroll or tax records, as long as the company briefly discloses the measure it used (e.g., "we found the median using salary, wages and tips as reported to the IRS on Form W-2 and the equivalent for non-U.S. employees"). Companies would be permitted to choose a method that is workable based upon their particular facts and circumstances.

Determining Total Compensation

Once the median employee is determined, the proposed rules require that the total compensation of the median employee be calculated in accordance with Item 402(c)(2)(x). Because the total compensation calculation using Item 402(c)(2)(x) would only be required for one additional employee (the median employee), the SEC did not propose simplifying the total compensation definition that is required to be used to disclose the median employee compensation and the ratio. However, the proposed rules permit companies to use reasonable estimates to determine the value of the various elements of total compensation. In using an estimate for annual total compensation (or for a particular element of total compensation of employees other than the CEO), a company must have a reasonable basis to conclude that the estimate approximates the actual amount of compensation under Item 402(c)(2)(x) awarded to, earned by or paid to those employees.

Disclosure of Estimates

As discussed above, the proposed rules permit the use of reasonable estimates in determining the median salary and any element of total compensation of employees other than the CEO under Item 402(c)(2)(x). If estimates are used, companies must briefly disclose and consistently apply any methodology used to identify the median and any material assumptions, adjustments or estimates used to identify the median or to determine total compensation or any elements of total compensation. Companies must also clearly identify any estimated amount as such.

Compliance Date and Timing Considerations

The first disclosures would not be required until after the end of a company’s first fiscal year commencing on or after the effective date of the final rules. Assuming that final rules are not adopted until 2014, the first required disclosures for companies with a calendar fiscal year would be in 2016 for 2015 compensation. Generally, a company would satisfy the pay ratio disclosure requirement by making disclosure in its Form 10-K or, if filed within 120 days after the end of its fiscal year end, its definitive proxy statement. A company that files a registration statement at the beginning of its fiscal year would not be required to include pay ratio disclosure for the last completed fiscal year until the timely filing of its proxy statement for its annual meeting of shareholders.

Omission of Salary and Bonus Information for CEO and Conforming Form 8-K Amendments

Where the salary or bonus of a named executive officer is not calculable as of the latest practicable date, Instruction 1 to Items 402(c)(2)(iii) and (iv) of Regulation S-K, permits a company to omit such disclosure from the summary compensation table, if the company includes a footnote disclosing that fact and provides the date the amount is expected to be determined. Once the omitted information is determined, the company must disclose the final amounts under Item 5.02(f) of Form 8-K, as well as a new total compensation figure for the named executive officer. Under the proposed rules, a company relying on such instruction, would be required to include its pay ratio disclosure in the same filing under Item 5.02(f) of Form 8-K.

The proposed rule release is available at The public comment period is open and will end on December 2, 2013. Comments may be submitted using the SEC’s Internet comment form by submitting an email to with File Number S7-07-13 in the subject line, or through the Federal Rulemaking ePortal at

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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