United States: SEC Adopts Final Pay Ratio Disclosure Rules

The U.S. Securities and Exchange Commission (SEC) has adopted final pay ratio disclosure rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under the new rules, a covered registrant will be required to provide annually, as more fully discussed below, the following information:

(a) the median of the annual total compensation of all employees of the registrant (excluding the CEO);

(b) the annual total compensation of the registrant's CEO; and

(c) the ratio of the CEO's annual total compensation to the amount described in (a).

The following questions and answers discuss the most important provisions of the new rules. 

Which registrants are covered under the new rules?

A registrant is covered by the new rules unless it is:

  • an emerging growth company;
  • a smaller reporting company;
  • a foreign private issuer;
  • a registered investment company; or
  • a registrant that files reports and registration statements with the SEC pursuant to the U.S.-Canadian Multijurisdictional Disclosure System.

When will the new pay ratio disclosure be required in a registrant's filings?

A registrant's initial pay ratio disclosure will be required for its first full fiscal year beginning on or after January 1, 2017. Thus, for a registrant with a fiscal year ending on December 31, the disclosure initially will be required in the registrant's 2018 filings. Consistent with the initial reporting requirement applicable to an existing registrant, the first pay ratio reporting period for a new registrant will be its first fiscal year commencing on or after January 1, 2017, that is, after the date it first becomes subject to the requirements of Sections 13(a) or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act").

OBSERVATION: The delay of the date a registrant is first required to include in its filings pay ratio disclosure from that specified in the rules as originally proposed is in recognition of the fact that some registrants may require additional time to implement the systems needed to compile the required disclosure and verify its accuracy. Thus, a registrant should consider, early on, the time it will require, given its particular facts and circumstances, to establish and test the systems necessary to collect and analyze the data required to identify its median employee, make any necessary changes to its disclosure controls and procedures and put its system into operation.

In what documents will the new pay ratio disclosure be required?

The pay ratio disclosure must be included in any filing described in Item 10(a) of Regulation S-K that requires executive compensation disclosure under Item 402 of Regulation S-K, including annual reports on Form 10-K, registration statements under the Securities Act of 1933 or the Exchange Act (other than a registration statement relating to an initial public offering) and proxy and information statements, to the same extent these filings require compliance with the executive compensation disclosure requirements in Item 402.

OBSERVATION: Under the pay ratio disclosure rules, as adopted, a registrant is not required to provide the mandated pay ratio disclosure for a completed fiscal year (including an update of its pay ratio disclosure for the prior fiscal year) until it files its annual report on Form 10-K for that fiscal year or, if later (but in no event later than 120 days after the end of that fiscal year), it files the definitive proxy or information statement relating to its next annual meeting of shareholders or amends the previously filed annual report on Form 10-K, in either case, containing the required pay ratio disclosure.

What constitutes an "employee"?

For purposes of the pay ratio disclosure rules, an "employee" is defined to include any full-time, part-time, seasonal or temporary employee of the registrant or any of its consolidated subsidiaries, whether employed within or outside the United States. Independent contractors and leased workers are excluded from the definition, provided they are employed, and their compensation is determined, by an unaffiliated third party. Additionally, a registrant may exclude persons who become employees as the result of a merger or acquisition occurring in the most recently completed fiscal year for purposes of determining the employee population for that fiscal year, although such persons will need to be included for purposes of determining the employee population for subsequent fiscal years. In determining its employees for a fiscal year, a registrant may measure the employee population as of any date that is within three months of the end of that fiscal year, as long as that date is disclosed in the registrant’s pay ratio disclosure for that fiscal year.

Do any different rules apply with respect to a registrant's non-U.S. employees?

The short answer is, "Yes." The new rules include two key provisions: a "data privacy" provision and a de minimis provision, each discussed below, which are applicable only to non-U.S. employees.

The "Data Privacy" Provision

Under the "data privacy" provision, a registrant may exclude its non-U.S. employees in a foreign jurisdiction that has local data privacy laws or regulations that prevent it from obtaining or processing the information necessary to comply with the pay ratio disclosure rules despite "reasonable efforts" to do so. In order to satisfy the "reasonable efforts" requirement, a registrant will be required to seek an exemption or other relief from the applicable jurisdiction's data privacy laws or regulations. If any employee in a jurisdiction is excluded under the data privacy provision, all of the registrant's employees within that jurisdiction must be excluded. The registrant must identify in its pay ratio disclosure any jurisdictions where employees have been excluded in reliance on the data privacy provision. In addition, for each jurisdiction so identified, the registrant must include the following information:

  • the specific data privacy laws or regulations requiring the exclusion;
  • an explanation as to how complying with the pay ratio disclosure rules would violate those data privacy rules or regulations; and
  • the approximate number of employees in the jurisdiction that have been excluded based on the data privacy provision.

OBSERVATION: For a registrant with employees in foreign jurisdictions, a timely evaluation should be undertaken to determine what, if any, jurisdictions have data privacy laws or regulations that may conflict with the use of the data of employees in those jurisdictions to comply with the new pay ratio disclosure requirements. If there are such jurisdictions, the registrant must take the steps required by the new data privacy rules to seek an exemption or other relief and to obtain and provide with its SEC filings the necessary legal opinions required by the rules when employees are excluded pursuant to the data privacy exception.

The De Minimis Provision

A second basis for a registrant's exclusion of foreign employees is a de minimis provision, which permits a registrant to exclude up to five percent of its non-U.S. employees, subject to the following specific limitations:

  • Any non-U.S. employees excluded pursuant to the data privacy provision, discussed above, must be counted toward the five percent de minimis limit.
  • In the case of a registrant whose non-U.S. employees represent five percent or less of its total employees, if it chooses to exclude any non-U.S. employees under this provision, all of its non-U.S. employees must be excluded.
  • In the case of a registrant with more than five percent of its total employees being non-U.S. employees, and consistent with the data privacy provision, if it chooses to exclude any employee in a particular jurisdiction, all of its employees in that jurisdiction must be excluded.

If any employee is excluded under the de minimis provision, the registrant must disclose the jurisdiction or jurisdictions where its non-U.S. employees are being excluded, the approximate number of employees from each jurisdiction that have been excluded under this provision, and the total number of its U.S. and non-U.S. employees used for its de minimis calculation.

How is the median employee to be identified?

The final rules provide a registrant with flexibility in determining its median employee, permitting the use of its entire employee population, a statistical sample or other reasonable methods for this purpose. In making the determination, a registrant may use annual total compensation or another measure of compensation that is consistently applied, such as information derived from payroll or tax records. A registrant's pay ratio disclosure must include a brief description of the methodology used in identifying the median employee, as well as any material assumptions, adjustments or estimates that are used. If applicable, the disclosure must also note any changes from the methodology used in the prior year and the purpose of the changes.

OBSERVATION: In a statement reflecting the complexity some registrants will encounter in determining a median employee, the adopting release observes that, in determining the methodology to be used, a registrant may consider, among other factors, the following:

  • the size and nature of the workforce;
  • the complexity of the registrant’s organization;
  • the stratification of pay levels across the workforce;
  • the types of compensation the employees receive;
  • the extent different currencies are involved;
  • the number of different tax and accounting regimes involved;
  • the number of payroll systems involved; and
  • the degree of difficulty involved in integrating the registrant's payroll systems to compile total compensation information for all employees.

In determining the median employee, may a registrant make cost-of-living adjustments to the compensation levels of its employees in order to reflect the value of compensation paid to individuals in other countries?

A registrant may make cost-of-living adjustments to the compensation of its employees that are located in jurisdictions other than the jurisdiction where the CEO resides when identifying its median employee, provided the adjustment is applied to all such employees included in the pay ratio calculation. If a registrant chooses to use a cost-of-living adjustment to identify its median employee, and the median employee identified is an employee in a jurisdiction other than the one in which the CEO resides, the registrant must use the same cost-of-living adjustment in calculating the median employee's annual total compensation and disclose the median employee's jurisdiction. Finally, a registrant electing to present the pay ratio using a cost-of-living adjustment must disclose its median employee's annual total compensation and the pay ratio calculated both with and without the cost-of-living adjustment, with the pay ratio that reflects the cost-of-living adjustment constituting the pay ratio required by Item 402, as amended by the new rules.

How often must a new median employee be determined?

Under the new rules, a registrant need only identify the median employee once every three years, unless there is a change to its employee population and/or employee compensation arrangements that it reasonably believes would significantly change its pay ratio disclosure.

OBSERVATION: If a registrant determines that there have been no changes that it reasonably believes would significantly affect its pay ratio disclosure, the registrant must include in its pay ratio disclosure a statement to the effect that it is using in the current-year pay ratio calculation the same median employee used in the prior year and a brief description of the basis for its reasonable belief that it is entitled to do so.

How must the pay ratio be expressed?

The pay ratio is required to be expressed as a ratio in which the annual total compensation of the median employee is set at one (for example, 162 to 1), or in a narrative describing the CEO's compensation as a multiple of the median (for example, 162 times that of the median employee). The median employee's annual total compensation may not be expressed as a percentage of the CEO's annual total compensation.

The preceding discussion is but a brief summary of some of the key provisions of the new pay ratio rules. Accordingly, registrants are urged to undertake an early, detailed review of the pay ratio provisions, as adopted, in order to timely identify and address all of the obligations imposed under the new provisions.

If you have any questions about this Alert, please contact Darrick M. Mix, Howell J. Reeves, any of the attorneys in our Capital Markets Group or the attorney in the firm with whom you are regularly in contact.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

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