United States: Watch Out For The Median! SEC Drives Home Final Pay Ratio Disclosure

On August 5, 2015, the Securities and Exchange Commission (the "SEC") adopted a final rule implementing what the SEC calls the "pay ratio disclosure" requirements, mandated by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act").1 This Stroock Special Bulletin provides an overview of the rule, which will require most public companies to disclose the ratio of the compensation earned by the company's median employee to the compensation earned by a company's principal executive officer (the "CEO"). Companies must begin reporting pay ratio disclosure for the compensation paid in the first fiscal year beginning on or after January 1, 2017 (for example, a reporting company with a calendar fiscal year will include pay ratio disclosure starting with filings made in 2018).2


The pay ratio disclosure rule is set forth as paragraph (u) to Item 402 of Regulation S-K. It specifically requires disclosure which is deemed to be "filed" (and not "furnished") with the SEC of:

  1. the median annual total compensation of all employees of a company (other than the CEO),
  2. the annual total compensation of the company's CEO, and
  3. the ratio between (i) and (ii).

The rule permits companies to present the pay ratio as a numerical ratio, where the median employee's compensation is 1 ("X to 1" or "X:1"), or as a multiple in narrative form ("CEO pay is X times the median employee pay"). The pay ratio may not be expressed as a percentage.3

The pay ratio disclosure must be made in any registration statements under the Securities Act of 1933 and the Securities Exchange Act of 1934 (the "Exchange Act"), proxy and information statements, annual reports, or any other documents required to be filed under the Exchange Act that call for executive compensation disclosure under Item 402 of Regulation S-K.4

Pay ratio disclosure, however, is not required in a registration statement on Form S-1 or S-11 for an initial public offering or registration statement on Form 10, providing assistance for those contemplating an initial public offering or a spin-off of one or more companies from a public company registrant.5 In addition, emerging growth companies, smaller reporting companies, foreign private issuers and U.S.-Canadian Multijurisdictional Disclosure System filers are exempt from the rule.6

Application to Changed Corporate or Reporting Status

For newly publicly traded companies, pay ratio disclosure is only required following the company's first full fiscal year beginning after the company has (a) been subject to the requirements of Section 13(a) or 15(d) of the Exchange Act for a period of at least 12 calendar months beginning on or after January 1, 2017 and (b) filed at least one annual report that does not contain the pay ratio disclosure.7 Companies that cease being smaller reporting companies or emerging growth companies do not need to provide the pay ratio disclosure until after the first full fiscal year after exiting such status.8

Companies that engage in acquisitions may choose to omit the employees of a newly acquired entity from their pay ratio calculation for the fiscal year in which the acquisition becomes effective and will only need to start including them in their median employee calculation in the first full fiscal year following the acquisition. In this situation, however, companies may not be entirely relieved of any new disclosure obligations, as some disclosure relating to the company acquired and its workforce may be required under the pay ratio disclosure rule.9

Determination of "All Employees"

Because companies must determine the median compensation of "all employees," it is important for companies to understand how to determine which employees are captured in the rule's scope. The rule does not define the term "employee," however it construes the definition of "employee" broadly to mean all employees of the company and all consolidated subsidiaries, including both U.S. and non-U.S. employees, as well as part-time, seasonal and temporary employees.10 The rule excludes independent contractors and "leased" workers employed by unaffiliated third parties. The SEC explained that excluding these employees is appropriate since their compensation is determined by third parties, and not by the company.

The rule provides two general exemptions to the definition of "employee": a de minimis exemption and a data privacy exemption. The de minimis exemption enables companies to exclude any non-U.S. employees, if such employees account for 5% or less of the company's total employees.11 The data privacy exemption permits companies to exclude employees that are employed in a foreign jurisdiction in which, despite reasonable efforts, the company would be unable to gather the necessary data without violating data privacy laws.

However, if the company relies on either of these exemptions, it must do so subject to certain limitations. For example, if it excludes any non-U.S. employees from a certain jurisdiction, it must exclude all non-U.S. employees from that jurisdiction. The company must also provide certain information regarding the excluded jurisdiction and the approximate number of employees that have been excluded. If the company relies on the data privacy exemption, it must also obtain a legal opinion opining on the inability of the company to obtain the required information.12

The application of these exemptions means that any non-U.S. employees excluded under the data privacy exemption must also be counted against the de minimis exemption. If the number of non-U.S. employees excluded under the data privacy exemption equals or exceeds the 5% threshold, the de minimis exemption would not seem to be available.

Date of Determination of "All Employees"

To identify the number of employees used in the determination of the median employee, a company is permitted to use as a cut-off date any date within the three months prior to the last day of the company's last completed fiscal year. This differs from the date used to determine the three most highly compensated officers for which executive compensation information must be disclosed under the current Item 402 requirements of Regulation S-K. That determination is made as of the last day of the company's last completed fiscal year.13

The SEC diverged from this approach because it wanted to provide companies with some flexibility and additional time to identify the median employee prior to year-end. The SEC explained that a hard date of fiscal year-end could potentially have a negative impact on retailers with a significant number of employees on the last day of the fiscal year. It would also make it difficult for companies that do not operate on a calendar fiscal year to collect information for the pay ratio disclosure from payroll and tax records.

The SEC further explained that having the company choose a date, rather than requiring all companies to use the last day of the fiscal year, may reduce the likelihood of companies making inefficient changes in corporate structure in order to avoid having a certain employee pool by fiscal year-end. Whatever date the company chooses, it must disclose which date it used. Further, if the company changes the cut-off date from the one used in the previous year, it must explain the reason for the change.14

Change in CEO

The final rule uses the term "principal executive officer" (and not CEO) for consistency with Item 402. This term includes all individuals serving in the capacity as the company's principal executive officer (or a similar capacity) during the last completed fiscal year. Therefore, if a company has more than one CEO during its last completed fiscal year, a company will likely need to provide pay ratio information for both.

Separately, the final rule provides guidance on how companies should disclose a situation in which the company's CEO is replaced by a different CEO during the fiscal year. In this situation, the rule allows a company to choose between two alternative disclosure methods, either: (i) calculate the total compensation provided to each CEO that served during the fiscal year and combine those amounts, or (ii) calculate only the compensation of the CEO that is serving on the date the company selects as the determination date of the median employee and annualize that amount. The company must disclose which method it chose and how it performed its calculation of the CEO's total compensation.15

Calculating "Total Compensation"

The total compensation paid to the CEO and the employees is to be calculated in the same way "total compensation" is determined in accordance with Item 402(c)(2)(x) of Regulation S-K (which covers calculations of total compensation paid to named executive officers in the Summary Compensation Table under Item 402(c) of Regulation S-K).16 The rule also addresses how total compensation should be calculated for: (i) full time or part-time employees (both categories of which are considered permanent employees), who did not work for the full fiscal year due to various circumstances, such as new hires, employees on leave under the Family and Medical Leave Act of 1993, and the like, and (ii) employees who are not permanent, such as seasonal or temporary employees.

The rule advises that the salary of a permanent employee (whether full-time or part-time) may be annualized, meaning that the company may calculate the salary that the employee would have been paid if he or she had worked the same schedule for the full fiscal year. The rule provides, however, that other compensation adjustments, such as adjusting a part-time employee's salary to a full-time equivalent, are not permitted.

Therefore, with respect to a permanent, part-time employee, who worked only part of the year due to a special circumstance as described above, the company may project what the employee would have earned if he or she worked part-time for the full fiscal year. The company may not project what the employee would have earned if the employee had worked full-time instead of part-time. In the case of seasonal and temporary employees, the rule clearly states that no annualizing or adjustments may be made.17

The rule permits companies to include certain items of compensation such as health benefits, employee discounts, tuition reimbursements and other employee benefits provided under a non-discriminatory plan or perquisites and other personal benefits with an aggregate value of less than $10,000 that are not taken into account in the company's Summary Compensation Table. However, if these elements of compensation are included in the median employee's annual total compensation, then they must also be included (to the extent applicable) in the CEO's annual total compensation for purposes of the pay ratio disclosure.18

Methodology for Identifying the Median Employee

Companies may choose between several alternative methods for identifying the median employee based on a company's own facts and circumstances. Recognizing that the identification of the median employee could involve significant costs and resources, the rule favors a flexible approach that is not one-size-fits-all. In determining the population pool from which to identify the median employee, companies may, instead of looking at the entire employee population, use reasonable estimates and statistical sampling19 or any "other reasonable methods."20 The median employee may be identified using annual total compensation, or by any other compensation measure that is consistently applied to all employees included in the calculation, such as using compensation amounts reported in the company's payroll or tax records.21

Once the median employee is identified, however, the company must calculate the total compensation of that employee in accordance with Item 402(c)(2)(x) as described above.22 The company must consistently use whichever method it chooses, and briefly disclose and describe the method used and any material assumptions, adjustments or estimates applied in the process.23

Frequency of Identification of the Median Employee

The rule permits companies to make the identification of the median employee only once every three years instead of identifying the median employee in each fiscal year – so long as the company can state that there have been no changes in its employee population or employee compensation arrangements that it reasonably believes would result in a significant change in the pay ratio disclosure.

A company must still calculate anew each fiscal year the total compensation for such median employee and the ratio of that to the CEO's compensation, but it may use the same median employee (or any other employee that is similarly compensated if the employee was promoted or is no longer employed by the company). If the company chooses to rely on the same median employee in all three fiscal years, it must disclose that it has done so and the basis for its reasonable belief that the changes in its employee population and employee compensation arrangements have not significantly altered its pay ratio disclosure.24


The pay ratio disclosure rule, which passed by a 3-2 vote in the SEC, has faced significant scrutiny and opposition. Although the SEC takes the position that the objective of the rule is to enable shareholders to better evaluate executive compensation practices and assist shareholders in their exercise of say-on-pay rights,25 dissenters argue that it creates an added costly burden on companies who must invest time and resources to effectuate the disclosure, without providing useful information to investors.

Some have noted that Section 953(b) does not even require a statutory deadline to implement the rule—which may explain why this rulemaking has occurred several years after the Dodd-Frank Act's enactment—but not why the SEC chose a later date towards the tail end of the queue of all Dodd-Frank Act rulemaking (which is still expected in the years to come).

Despite the controversy, companies must comply with the rule beginning after January 2017, and it remains to be seen how the rule will shape investors' voting and investment decisions. Companies will need to collect the information necessary to complete their disclosure and may want to start preparing, if they have not already started. Now public companies, along with automobile drivers, will need to literally watch out for the median.


1. SEC Release Nos. 33-9877; 34-75610; File No. S7‑07-13 (hereinafter, "SEC Release"), p. 9.

2. A company with a fiscal year end of November 30, however, will be required to first provide the pay ratio disclosure as part of its executive compensation disclosure in proxy statements or Form 10-Ks filed in 2019.

3. SEC Release, pp. 35-36.

4. SEC Release, pp. 37-39.

5. SEC Release, p. 40, n. 74.

6. SEC Release, p. 43.

7. SEC Release, p. 160.

8. SEC Release, p. 163.

9. SEC Release, pp. 165-66.

10. See SEC Release, pp. 52-53. The SEC "acknowledged in the Proposing Release that the inclusion of non-U.S. employees would raise compliance costs for multinational companies, would introduce cross-border compliance issues, could raise additional comparability concerns, and could have an adverse impact on competition. [The SEC] indicated, however, that the inclusion of non-U.S. employees in the calculation of the median is consistent with the 'all employees' language of the statute." SEC Release, p. 26.

11. Additionally, if a company's non-U.S. employees exceed 5% of the company's total employees, it may still exclude up to 5% of its total employees who are non-U.S. employees. See SEC Release, pp. 28-29.

12. SEC Release, p. 28. In order to better assess an employee's compensation as compared to the CEO, the rule also permits companies to make cost-of-living adjustments either when identifying the median employee or calculating the median employee's total compensation, for employees that work in foreign jurisdictions (other than the jurisdiction in which the CEO resides). If the company uses cost-of-living adjustments to identify the median employee, it must use the same cost-of-living adjustment to calculate the median employee's total compensation. It must also disclose the country in which the median employee resides, and briefly describe the method it used to make the cost-of-living adjustments. Finally, for context, the company must also disclose what the pay ratio would be if it had not used cost-of-living adjustments. See SEC Release, pp. 29-30.

13. See Item 402(a)(3)(iii) of Regulation S-K. See also, SEC Release, p. 58.

14. SEC Release, pp. 58-59.

15. SEC Release, pp. 87-89.

16. The rule specifies that total compensation should be determined in accordance with Item 402(c)(2)(x) of Regulation S-K, as in effect on the day before the date of enactment of the Dodd-Frank Act. See, SEC Release, p. 8, 134, and Section 953(b)(2) of the Dodd-Frank Act.

17. SEC Release, pp. 91-93.

18. In this situation, the company must also explain, if material, the difference between the CEO's total compensation reflected in the Summary Compensation Table and the total compensation used for purposes of the pay ratio disclosure. See SEC Release, p. 133.

19. The use of statistical sampling would enable companies to avoid calculating the compensation of every employee. The SEC guidance indicates that a company could, without specific calculations, rule out as the median employee those employees that have extremely low or extremely high pay and as such, fall on either end of the spectrum. The company could focus on calculating the compensation of the employees whose salaries fall closer to the middle of the range. SEC Release, p. 119.

20. The SEC Release notes that the SEC is "not specifying the 'other reasonable methods' that may be appropriate because [they] seek to allow each company the flexibility to determine the method that best suits its own facts and circumstances." SEC Release, p. 116.

21. SEC Release, p. 113.

22. SEC Release, pp. 97-124.

23. SEC Release, p. 98.

24. SEC Release, pp. 32-33, 94-97.

25. SEC Release, p. 10.

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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