United States: SEC Proposes CEO Pay Ratio Disclosure

On September 18, 2013, the Securities and Exchange Commission (SEC) proposed to amend Item 402 of Regulation S-K to require issuers to disclose the ratio of the annual total compensation of the issuer's CEO to the median annual total compensation of all of the issuer's employees. The proposed rules, known as "pay ratio" disclosure, were approved by a 3-2 vote of the SEC Commissioners and will renew the focus on issuers' compensation practices.  

Given the reaction of commentators, market participants and even the SEC Commissioners, the proposal is expected to generate critical commentary. The SEC has asked for comments on more than 60 issues relating to the proposed rules. The 60-day public comment period concerning the proposed rules expires on December 2, 2013. The rules are expected to be effective for the 2016 proxy season.  

Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires the SEC to amend executive compensation disclosure rules to require issuers to disclose: 

  • The median of the annual total compensation of all employees, excluding the CEO; 
  • The annual total compensation of the CEO; and 
  • The ratio of the median of annual total employee compensation to the annual total compensation of the CEO. 

Currently, issuers are not required to disclose detailed compensation information for employees other than their CEO and named executive officers. 

The Proposed Rules 

The proposed rules will amend Item 402 of Regulation S-K to include a new paragraph (u). The pay ratio disclosure will be required in any filing that must include executive compensation disclosure under Item 402 of Regulation S-K, including annual reports on Form 10-K, proxy and information statements and certain registration statements. The pay ratio disclosure requirements would apply only to those issuers that must provide summary compensation table disclosure pursuant to Item 402(c).  Accordingly, emerging growth companies, smaller reporting companies and foreign private issuers will not be subject to the new rules.  

The Pay Ratio Disclosure 

The proposed rules require that the ratio of CEO compensation to median employee compensation be expressed either as a ratio, with the median employee compensation equal to one, or in narrative form setting forth the multiple that the CEO's compensation represents to the median employee's compensation. 

Finding the Median Employee  

The proposed rules provide flexibility to issuers in that they do not prescribe the methodology by which issuers should calculate the median employee. Each issuer is free to select a methodology that is appropriate in light of its operations, size and current compensation practices. The SEC indicated that an issuer may identify the median employee by applying a consistent compensation measure (such as salary plus bonus, using payroll records), or could calculate the "total compensation" (as defined under Item 402(c) of Regulation S-K) for each employee included in the calculation and then determine the median. Issuers may use statistical sampling or may include in the calculation the entire employee population. 

Calculating Total Compensation for the Median Employee 

Once a company identifies its median employee by compensation, it must calculate total compensation for that employee under Item 402(c)(2) of Regulation S-K.  Reasonable estimates and certain adjustments are permitted, in part due to the concern that applying rules designed for executive compensation to a non-executive could prove challenging to the issuer. 

Which Employees Are Covered? 

Employees included in the calculation of the median employee include full-time, part-time, temporary, seasonal and foreign employees of the issuer and its subsidiaries employed as of the last day of the prior fiscal year. With regard to employees working for a portion of the fiscal year, an issuer may annualize the total compensation for such employees, but may not make adjustments for part-time, temporary or seasonable workers or make cost-of living adjustments for foreign workers. The SEC believes that such adjustments have the potential to distort the actual composition of issuers' workforces and compensation practices. 

Disclosure of Methodology, Material Assumptions, Adjustments and Estimates 

Issuers must include disclosure of the methodology and any material assumptions, adjustments and/or estimates that are used to determine the median employee and to calculate the median employee's annual total compensation. Issuers must disclose any consistently applied compensation measure so used. If statistical sampling is used, the size of the sample, the estimated size of the whole population and any assumptions used in determining sample size must be disclosed. Any amounts estimated must also be disclosed. The proposed rules provide issuers with some latitude to provide additional disclosures and/or ratios to the required pay ratio disclosure. 


The SEC has proposed that an issuer will be required to include the initial pay ratio disclosure for the issuer's first fiscal year commencing after the effective date of the rules and may be included on Form 10-K or incorporated by reference from a proxy statement on Schedule 14A or an information statement on Schedule 14C. However, the initial pay ratio disclosure must be provided within 120-days after the end of such first fiscal year. Accordingly, if the issuer will not file a proxy or information statement until after this 120 day period, such issuer must include the initial pay ratio disclosure on Form 10-K or an amendment thereto, covering the first fiscal year.  

What About IPOs? 

Importantly, the pay ratio disclosure is not required in a registration statement on Form S-1 for an IPO. Instead, a new issuer required to provide a summary compensation table pursuant to Item 402(c) would first provide the pay ratio disclosure for the fiscal year beginning on or after the date the issuer becomes subject to the requirements of Section 13(a) or 15(d) of the Exchange Act. For example, if an issuer completes an IPO in 2015, it would need to include the pay ratio disclosure in its proxy or information statement for its 2017 annual meeting of stockholders. 


The new rules will bring increased attention to the disparity between executive compensation and rank and file employees.  It may also impose substantial compliance costs, particularly for large multinational companies.  It is expected that the final rules will not be adopted until 2014.  Accordingly, issuers with a calendar year fiscal year end will need to include pay ratio disclosure in their proxy statements for the 2016 annual meeting of stockholders (covering the fiscal year 2015). 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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