SEC Proposes Rules on CEO Pay Ratio Disclosure

by Foley & Lardner LLP

On September 18, 2013, the Securities and Exchange Commission (SEC) proposed rules requiring publicly-traded companies to disclose the ratio of median compensation of all employees to the compensation of the principal executive officer. The SEC proposed these rules in response to the mandate of Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Highlights of the Proposed Rules

  • The median employee for purposes of the ratio would be identified from all employees of the registrant and its subsidiaries on the last day of the most recently completed fiscal year, including all domestic and foreign full-time, part-time, seasonal or temporary workers employed on that day.
  • In determining the employees from whom the median employee is identified, companies will be permitted to use either their entire employee population or statistical sampling or other reasonable methods, and a company would need to disclose its method.
  • In identifying the median employee with reference to compensation, companies would not be required to calculate the “total compensation,” as defined by the SEC for purposes of the Summary Compensation Table, for their entire employee population or the statistical sample. Instead, companies would be permitted to use any compensation measure that is consistently applied to all employees included in the calculation, including amounts derived from payroll or tax records. Once the median employee has been identified using such a compensation measure, however, the company would need to use the SEC’s Summary Compensation Table definition of “total compensation” to calculate and disclose the compensation of the median employee and the ratio.
  • Smaller reporting companies, emerging growth companies and foreign private issuers that file annual reports and registration statements on Form 20-F would be exempt from the pay ratio disclosures.

Effective Date

The proposed rules would require companies to begin to comply with the new rule with respect to compensation for their first fiscal year commencing on or after the effective date of the rules. Disclosure of the pay ratio, however, would not be required until the annual report for that fiscal year or, if filed later, the proxy or information statement for the next annual meeting following the end of that fiscal year, subject to a requirement that the pay ratio be filed within 120 days after the end of the fiscal year. This means that, if the final rules become effective in 2014 (which we view as the likely scenario), a company with a fiscal year ending on December 31 would first be required to disclose the pay ratio in its proxy or information statement for its 2016 annual meeting, based on fiscal year 2015 compensation.

Recommended Actions for Publicly Traded Companies

  • Consider providing comments on the proposed rules, particularly with respect to the anticipated costs and feasibility of compliance if they are adopted
  • Begin to evaluate whether you are able to determine median pay from your existing payroll or tax records, or what modifications might be needed to your systems to permit this calculation
  • Begin to analyze the extent to which the annual pay of your part-time, seasonal and temporary workers, as well as your international workers, is captured by your existing systems
  • Begin to consider how you might use statistical sampling to identify the median employee and the effects of such sampling on the calculation of your ratio

Summary of the Proposed Rules

The rules as proposed would require U.S. issuers subject to the reporting requirements of the Securities Exchange Act of 1934, other than smaller reporting companies and emerging growth companies, to disclose the following items:

  • The median of the annual total compensation of all employees of the company and its subsidiaries (Median Pay) other than the principal executive officer (CEO);
  • The annual total compensation of the CEO (CEO Pay); and
  • The ratio of the Median Pay to the CEO Pay, expressed either as a ratio in which the Median Pay is one (e.g., 1 to 100) or in narrative as a multiple (e.g., “our CEO’s pay for 2015 was 100 times the median of the total compensation of all of our employees (other than our CEO) for 2015”).

This disclosure would generally be required in proxy statements, information statements, annual reports and registration statements that require disclosure of executive compensation under Item 402 of Regulation S-K.

Both the Median Pay and the CEO Pay would be calculated based on the rules that a company currently uses to calculate total compensation for purposes of the Summary Compensation Table under Item 402(c)(2)(x) of Regulation S-K. Under these rules, total compensation is the sum of (1) base salary, (2) bonuses (both discretionary bonuses and those paid under a pre-established incentive plan), (3) grant date fair value of equity awards, (4) change in pension value and above-market or preferential nonqualified deferred compensation earnings and (5) all other compensation, including such items as perquisites, tax gross ups and severance.

Under the proposed rules, companies may, but are not required to, annualize the total compensation for all permanent employees who were employed for less than the full fiscal year. However, the proposed rules would not permit full-time adjustments for part-time workers, annualization for temporary or seasonal employees or cost-of-living adjustments for non-U.S. workers. A company may use reasonable estimates to determine the Median Pay, but not the CEO Pay.

In determining the Median Pay, the potential pool of employees will include all individuals employed by the listed company or any of its subsidiaries on the last day of the most recently completed fiscal year, including all full-time, part-time, seasonal or temporary worker employed on that day. There is no exclusion for non-U.S. employees or for employees who are subject to a collective bargaining agreement. However, independent contractors and leased workers employed by a third party would not be included as employees.

In determining the employees from whom the median employee is identified, companies will be permitted to use either their entire employee population or statistical sampling or other reasonable methods.

In identifying the median employee from the relevant group, companies will be permitted to use either (1) actual annual total compensation, calculated using the Summary Compensation Table rules, or (2) any other compensation measure that is consistently applied to all employees included in the calculation. The proposed regulations provide as examples of alternative compensation measures amounts derived from the company’s payroll or tax records. Such records may be used to identify the median employee even if they are kept on an annual basis other than the fiscal year of the registrant.

Companies will be required to disclose the methodology used to identify the median employee and disclose any material assumptions, adjustments or estimates that are used to identify the median or to determine any elements of total compensation. Estimated amounts will need to be clearly identified. A company will need to explain any change in methodology from year to year, including the reason for the change and an estimate of its impact on the median and the ratio.

The proposed rules include a one-year transition period for newly public companies and exempt emerging growth companies entirely from the pay ratio disclosure.

The proposed rules would treat the pay ratio disclosure as being “filed,” not merely “furnished,” for purposes of liability under the Securities Act of 1933 (Securities Act) and the Securities and Exchange Act of 1934 (Exchange Act). Filed information is subject to liability under Section 18 of the Exchange Act, which imposes liability for misleading statements in reports or documents filed with the SEC, and is subject to automatic incorporation by reference into the company’s Securities Act registration statements, which could give rise to liability under Section 11 of the Securities Act.

Comment Period

The comment period for the proposed rules will run for 60 days after the rules are published in the Federal Register. The SEC has asked for comments on, among other things:

  • Whether pay ratio disclosure should be required only in filings in which Item 402 disclosure is required, as proposed.
  • Whether smaller reporting companies or foreign private issuers should be required to provide pay ratio disclosure.
  • Whether the rules should permit exclusion of non-U.S. employees or non-full-time employees.
  • Whether two separate pay ratios – one for U.S. employees and one for non-U.S. employees – should be permitted.
  • Identification of data privacy laws or regulations that could impact the gathering of data necessary to comply with the rules.
  • Competition concerns raised by the inclusion of all employees in the ratio.
  • The extent to which disclosure about the methodology and material assumptions used to identify the median or calculate compensation should be required.
  • Whether the length of the initial transition period is appropriate.


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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