United States: SEC Finalizes CEO Pay-Ratio Rule With Delayed Effective Date

On Aug. 5, 2015, the Securities and Exchange Commission (SEC) adopted a final rule implementing the CEO pay-ratio disclosure requirements of Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The final rule provides that starting with their first annual report, annual proxy or information statement filed for fiscal years beginning in 2017, each public company (other than smaller reporting companies, emerging growth companies and foreign private issuers) will need to disclose as a ratio or multiple how the annual total compensation of its principal executive officer (PEO) compares to the annual total compensation of its median employee. This means that for a calendar-year issuer that is not exempt, the first time it will need to provide the disclosure will be with its annual report or annual proxy or information statement filed in 2018 for its 2017 fiscal year, which represents a one-year additional delay in the effective date, as compared to the proposed rule released in September 2013 (which is described in an earlier WorkCite article). If, as is generally the case, the annual report is filed first, the disclosure could be made in the later-filed annual proxy as long as the proxy is filed within 120 days after the end of the fiscal year.

Once the final rule is effective, non-exempt issuers will need to provide the disclosure in all filings (annual reports, proxy statements, and registration statements included) in which the executive compensation disclosure required by Item 402 of Regulation S-K is also required, but not in periodic filings such as Form 8-K or 10-Q. The disclosure will need to be updated each year with the annual report or annual proxy statement.

The final rule is generally consistent with the proposed rule, including in the following areas:

  • Mandatory inclusion of all employees (e.g., non-U.S., part-time, seasonal and temporary employees), but not independent contractors or "leased" employees (as long as a third party pays the leased employee's compensation)
  • The requirement that the median employee's compensation be determined based on the SEC disclosure requirements applicable to named executive officers
  • The permissible use of reasonable estimates to determine both the median employee, including statistical sampling or consistently applied alternative compensation definitions (e.g., W-2 compensation), as well as the median employee's annual total compensation
  • Mandatory disclosure regarding the methodology used to identify the median employee and any material assumptions, adjustments or estimates used to identify the median employee or determine the median employee's annual total compensation
  • Permissible inclusion of perquisites less than $10,000 and nondiscriminatory employee benefits in the median employee's annual total compensation, as long as these are included in the PEO's annual total compensation as well
  • Permissible annualization of compensation for permanent (full-time or part-time) employees (but not temporary or seasonal employees) who are employed less than the entire year for purposes of identifying the median employee
  • If the company employs more than one PEO during the year, permissible aggregation of the annual total compensation for each PEO or, alternatively, annualization of the compensation of the individual who is PEO as of the median employee determination date
  • Mandatory nondisclosure of any personally identifiable information with respect to the median employee

However, in addition to the delayed effective date discussed above, the final rule adds some flexibility in certain areas, as follows:

  • Limited Exclusion of Non-U.S. Employees: Issuers will be allowed to exclude non-U.S. employees if either (i) foreign data privacy laws or regulations make issuers unable to comply with the final rule, despite their reasonable efforts, or (ii) non-U.S. employees account for 5 percent or less of the issuer's total U.S. and non-U.S. employees, with certain limitations.
  • COLA Adjustment for Non-U.S. Employees: Issuers are permitted, but not required, to make cost-of-living adjustments for the compensation of employees in jurisdictions other than the jurisdiction in which the PEO resides to identify the median employee and calculate such employee's annual total compensation.
  • Permissible Disclosure of Additional Pay Ratios: Issuers are permitted, but not required, to provide additional pay ratios (e.g., separate ratios for U.S. and non-U.S. employees) as long as any additional pay ratios are not misleading and are not presented with greater prominence than the required ratio.
  • Employees of Consolidated Subsidiaries: Issuers are only required to include their employees and the employees of their consolidated subsidiaries in determining the median employee. (The proposed rule had not restricted subsidiaries to consolidated subsidiaries for this purpose.)
  • Median Employee Determination Date: Issuers may use any date within three months prior to the last day of their last completed fiscal year to identify the median employee. (The proposed rule would have required issuers to use the last day of the fiscal year.) Issuers must disclose the date used for this purpose and, if the date changes from one year to the next, disclose the reasons for the change.
  • Three-Year Cycle for Median Employee Determination: Instead of every year as under the proposed rule, the final rule allows issuers to identify the median employee every three years, unless there has been a change in employee population or employee compensation arrangements that the issuer reasonably believes would result in a significant change in the pay-ratio disclosure. If an issuer relies on such a three-year cycle, it must disclose that it has done so and why it believes there has been no change in circumstances that would significantly change the pay ratio. The median employee's annual total compensation must still be calculated each year, however. If the median employee leaves or changes position or otherwise experiences a material change in compensation during this period, the issuer may use an employee in a similarly compensated position instead.
  • Transition Period for New Issuers and Issuers that Lose their Exemption: A new issuer, like existing issuers, will not need to comply with the final rule before its first annual report or proxy or information statement for fiscal years beginning in 2017. In addition, an issuer that ceases to be a smaller reporting company or emerging growth company is not required to provide pay-ratio disclosure until it files a report for the first fiscal year commencing on or after it ceases to be a smaller reporting company or emerging growth company.
  • Transition Period for Mergers and Acquisitions: The final rule permits an issuer that engages in business combinations and/or acquisitions to omit the employees of a newly acquired entity from its pay-ratio calculation for the fiscal year in which the business combination or acquisition occurs.

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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