United States: Looking Ahead To The 2018 Proxy Season: Preparing For CEO Pay Ratio Rules Disclosure Requirements

As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in July 2010, Congress directed the Securities and Exchange Commission (SEC) to adopt pay ratio disclosure requiring public companies to disclose the ratio between the annual total compensation of the median employee and the company's principal executive officer (PEO), generally the company's chief executive officer (CEO). The Pay Ratio rules required the SEC to amend Item 402 of Regulations S-K, related to company compensation disclosures. Item 402(u) requires companies to disclose:

  1. the median of the annual total compensation of all employees of the company (excluding the company's PEO);
  2. the annual total compensation of the company's PEO; and
  3. the ratio of the two amounts.

The SEC adopted final Pay Ratio rules in August 2015, released additional interpretive guidance in October 2016, and solicited additional comments for consideration in February 2017. All public companies except smaller reporting companies, foreign private issuers, US-Canadian Multijurisdictional Disclosure System filers, emerging growth companies and registered investment companies will be subject to the Pay Ratio rules. The Pay Ratio rules are effective for fiscal years beginning on or after January 1, 2017, and, thus, absent repeal by Congress or delay by the SEC, most public companies will need to comply with the rules beginning with the 2018 proxy season.

Determining the Median Employee

Much of the difficulty of preparing for the Pay Ratio disclosure is the need for companies to identify their median employees. In performing this analysis, a company generally is required to consider all individuals employed by the company or any of its consolidated subsidiaries, including its full-time, part-time, seasonal and temporary workers. However, independent contractors whose compensation is determined by an unaffiliated third party are not required to be included in the overall analysis. In addition, employees acquired through a business combination or acquisition may be omitted for the fiscal year in which the transaction becomes effective, but the approximate number of employees omitted must be disclosed and those employees must be considered in the following year when determining the median employee.

In determining the median employee, companies can also make a cost of living adjustment for employees who do not reside in the same jurisdiction as the PEO. However, if a company chooses to apply a cost of living adjustment, it must separately determine the median employee without applying a cost of living adjustment. Additionally, the ratio without the adjustment must still be disclosed and each jurisdiction in which an adjustment was applied must be disclosed, including the methodology of the adjustment.

Generally, all workers, including those outside of the US, must be included in the median employee analysis, with two limited exceptions. First, the SEC allows companies to exclude employees in foreign jurisdictions where, due to applicable data privacy laws or regulations, companies are unable, after reasonable efforts, to obtain or process the necessary information to conduct the analysis. The data privacy law exclusion requires that companies use or seek exemption or other relief from the applicable laws and regulations, and must obtain a legal opinion from local counsel as to the legal or regulatory limitations (including efforts to obtain relief) that is filed as an exhibit to the applicable disclosure statement. Secondly, the SEC rules also provide for de minimis exceptions that would allow companies to exclude all employees in foreign jurisdictions under certain circumstances, including where the total number of non-US employees is less than 5% of the company's total employees. This exception also allows companies to exclude all employees in individually selected foreign jurisdictions if the total number of employees excluded – together with employees excluded under the data privacy law exception – is less than 5% of the company's total employees. Any de minimis exclusion requires disclosure identifying the applicable jurisdiction(s) excluded and quantifying the number of excluded employees relative to the company's total number of US and non-US employees.

The SEC rules require that a median employee be chosen to represent the employee workforce on a date within the last three months of the most recently completed fiscal year. Once the median employee is determined, the median employee may be used for three years, provided that (i) the company's employee compensation arrangements or employee population does not change in a way that could significantly impact the Pay Ratio disclosure and (ii) there has not been in a change in the median employee's circumstances. Any change – or lack of change – from year to year must be described.

Determining the Median Employee's Annual Total Compensation

In determining the annual total compensation for both the median employee and the PEO, companies are directed to the rules provided for preparing the Summary Compensation Table. However, for employees other than the PEO, companies may use another consistently applied compensation measure ("CACM"), such as information derived from the company's tax or payroll records. In interpretive guidance added in October 2016, the SEC explained that any measure that "reasonably reflects the annual compensation" would be an acceptable CACM; however, the appropriateness of a measure is dependent on each company's facts and circumstances.

Certain adjustments may be applied to make the annual total compensation more comparable to that of the PEO's compensation. First, companies may annualize the annual total compensation of full-time and part-time employees who have not been with the company for the full fiscal year, but this adjustment is not permitted for seasonal or temporary employees. Finally, rather than analyzing all employees, companies may use a statistical sampling of its employee population.

Preparing the Disclosure

There is some flexibility as to where and how the Pay Ratio is disclosed in the proxy statement. The SEC rules do not require that the disclosure be made in the Compensation Discussion & Analysis ("CD&A") section or under a separately captioned section. However, if the CD&A includes a discussion of internal pay equity, companies may wish to specifically address the Pay Ratio disclosure.

Once the ratio is determined, companies will need to decide how they include the ratio in the proxy – numerically or narratively (or both). Item 402(u)(1)(iii) provides that the Pay Ratio can be expressed as a numerical ratio where the median employee's compensation is "one," or as a narrative about how a multiple of the PEO's compensation relates to the median employee's compensation. In addition to the ratio, companies must also disclose the methodology they applied in making all the determinations associated with the calculation of the ratio, which would include material assumptions, adjustments, estimates and any changes in the methodology from the prior year's Pay Ratio disclosure.

In addition to the disclosure of the ratio and the methodology used in determining it, companies may choose to provide some additional contextual or explanatory disclosure related to the ultimate ratio, as long as any such additional disclosure is clearly identified, not materially misleading and not more prominent than the required Pay Ratio.

Next Steps

In preparation for the Pay Ratio disclosure requirements for the 2018 proxy season, companies must assemble the appropriate internal teams and external advisers. Not only will companies need assistance from their accounting firms, compensation consultants and outside counsel, companies will also require support and coordination from their HR, IT, payroll, finance, accounting, legal and communications teams. In preparing the methodologies to be used to identify their median employees and their annual total compensation, companies should consider the implications on the required Pay Ratio disclosure and the potential reactions of their workforces and their shareholders.

Looking Ahead To The 2018 Proxy Season: Preparing For CEO Pay Ratio Rules Disclosure Requirements

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.