Summary: At an open meeting on September 18, 2013, by a 3-2 vote, the Securities and Exchange Commission proposed a new rule,1 as mandated by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, to require companies to disclose (i) the median of the annual total compensation of all company employees (excluding the company's principal executive officer), (ii) the annual total compensation of the company's principal executive officer and (iii) the ratio between the two. A summary of the proposed rule is set forth below.
Proposal for Pay Ratio Disclosure Rules
The SEC proposed an amendment to Item 402 of Regulation S-K and a
conforming amendment to Form 8-K under the Securities Exchange Act
of 1934 to implement the pay ratio disclosure requirements mandated
by Section 953(b) of the Dodd-Frank Act.
The proposal would amend Item 402 of Regulation S-K by adding a new
paragraph (u) to Item 402 requiring companies to disclose:
- the median of the annual total compensation of all company employees except the company's principal executive officer;
- the annual total compensation of the company's principal executive officer; and
- the ratio of the median of the annual total compensation of all company employees (except the company's principal executive officer) to the annual total compensation of the company's principal executive officer.
Under current SEC rules, companies are required to provide
extensive information about the compensation of their principal
executive officer and other named executive officers identified
pursuant to Item 402(a) of Regulation S-K, but are generally not
required to calculate or disclose detailed compensation information
regarding other employees. The proposing release stated that the
proposed rule is designed to lower the potential costs of
compliance with the pay ratio disclosure requirements while
remaining consistent with the statutory mandate in Section 953(b)
of the Dodd-Frank Act.
Methodology for Identifying the Median Employee
The proposed rule would not require companies to adhere to a
particular methodology or specific computation parameters to
identify the median employee, but rather companies would have the
flexibility to choose from several options, including using
reasonable estimates of annual total compensation or any other
compensation measure that is consistently applied to all employees
included in the calculation (such as amounts derived from company
payroll or tax records). Companies would be permitted to identify
the median employee by using their full employee population or a
statistical sample of the full employee population appropriate to
the size and structure of the company's business and the
company's method for employee compensation or other reasonable
methods.
When a compensation measure other than annual total compensation is
used to identify the median employee, the proposed rule would
require companies to calculate the annual total compensation for
the median employee. For instance, the proposed rule would permit
companies to use the same annual period that is used in their
payroll or tax records from which the compensation amounts are
derived to identify the median employee, so long as the total
compensation of the median employee so identified is ultimately
calculated and disclosed pursuant to Item 402(c)(2)(x) of
Regulation S-K. The proposing release acknowledged that the
identification of a median employee through sampling does not
necessarily require a determination of exact compensation amounts
for every employee paid more or less than the median employee
included in a sample and that the proposed rule would only require
companies to actually calculate and disclose total compensation
pursuant to Item 402(c)(2)(x) of Regulation S-K for its median
employee. The proposed rule would not prescribe specific estimation
techniques, confidence levels for an estimated median or what
constitutes reasonable estimates or appropriate compensation
measures. Rather, these determinations would depend on the
company's particular facts and circumstances, which, as stated
in the proposing release, may vary depending on the size and nature
of the company's workforce, the complexity of the company's
organization, the stratification of pay levels across the
company's workforce, the types of compensation the
company's employees receive, the extent that different
currencies are involved, the number of tax and accounting regimes
involved, the number of payroll systems the company has and the
degree of difficulty involved in integrating payroll systems to
readily compile total compensation information for all company
employees.
Determination of Covered Employees
For purposes of the proposed rule, "employee" would
include an individual employed by the company or any of its
subsidiaries as of the last day of the company's last completed
fiscal year, including full-time, part-time, seasonal or temporary
workers employed by the company or any of its subsidiaries on that
day (including officers other than the principal executive
officer). Workers who are not employed by the company or its
subsidiaries, such as independent contractors or "leased"
workers or other temporary workers who are employed by a third
party, would not be considered "employees" under the
proposed rule.
Determination of Total Compensation
As mandated by Section 953(b) of the Dodd-Frank Act, the proposed
rule would require the "total compensation" of the median
employee (identified in the manner described above) to be
determined according to Item 402(c)(2)(x) of Regulation S-K.
"Annual total compensation" would mean the total
compensation for the company's last completed fiscal year,
consistent with the calculation date used for determining the three
most highly compensated executive officers under current Item
402(a)(3)(iii) of Regulation S-K.
The proposed rule would allow companies to use reasonable estimates
when calculating the annual total compensation or any element of
annual total compensation for the median employee. In using an
estimate for annual total compensation or for an element of total
compensation, the company should have a reasonable basis to
conclude that the estimate approximates the actual amount of
compensation under Item 402(c)(2). For instance, a company would be
permitted to use reasonable estimates in determining an amount that
reasonably approximates the aggregate change in actuarial present
value of an employee's defined pension benefit under a union
members' multi-employer defined benefit pension plan for
purposes of Item 402(c)(2)(viii), since employers generally do not
have sufficient access to information from the plan administrator
to calculate the aggregate change in actuarial present value of the
accumulated benefit of an individual employee under such a plan. A
reasonable basis would depend on the facts and circumstances of the
company. Where companies determining the pay ratio choose to
include certain personal benefits and perquisites in the
calculation of total compensation for employees that would
ordinarily be excluded from the calculation of a principal
executive officer's total compensation, companies would be
required to use the same approach to such items when calculating
the principal executive officer's total compensation for the
pay ratio disclosure. Any difference between the principal
executive officer's total compensation used in the pay ratio
disclosure and the total compensation amounts reflected in the
summary compensation table would need to be explained.
Companies would be permitted, but not required, to annualize the
total compensation for all permanent employees (other than
temporary or seasonal employees) that were employed by the company
for less than the full fiscal year, such as new hires or permanent
employees on an unpaid leave of absence. If a company elects to
annualize the total compensation for employees, it must do so for
all eligible employees. In contrast, the proposed rule would not
permit full-time equivalent adjustments for part-time workers,
annualizing adjustments for temporary and seasonal workers or
cost-of-living or other adjustments for non-US workers.
Disclosure of Ratio, Methodology, Assumptions, Adjustments and
Estimations
Under the proposed rule, the appropriate form of disclosure for the
pay ratio would be as a ratio in which the median of the annual
total compensation of all employees except the principal executive
officer is equal to one or, alternatively, the ratio may be
expressed narratively as the multiple that the amount the annual
total compensation of the company's principal executive officer
bears to the median of the annual total compensation of all company
employees. The proposing release provided an example of a company
with an annual total compensation of $45,790 and $12,260,000 for
its median employee and principal executive officer, respectively.
In this instance, the pay ratio disclosed would be "1 to
268" or, as expressed narratively, "the principal
executive officer's annual total compensation is 268 times that
of the median of the annual total compensation of all
employees."
In addition, the proposed rule would require companies to briefly
disclose the methodology used to identify the median and any
material assumptions, adjustments or estimates used to identify the
median or to determine total compensation or any elements of total
compensation. In addition, companies would be required to
consistently apply such methodology, assumptions, adjustments or
estimates and to clearly identify any estimated amounts in their
disclosure. Such disclosure should consist of a brief overview
containing sufficient information for a reader to be able to
evaluate the appropriateness of the methodology, assumptions,
adjustments or estimates, but does not need to provide technical
analyses or formulas.
The proposing release provided an example of appropriate disclosure
where statistical sampling is used. Companies using statistical
sampling should disclose the size of both the sample and the
estimated whole population, any material assumptions used in
determining the sample size, which sampling methods are used and,
if applicable, how the sampling method deals with separate payrolls
such as geographically separated employee populations or other
issues arising from multiple business or geographic segments. Also,
if a company changes the methodology, material assumptions,
adjustments or estimates used for the prior fiscal year and the
effects of any such change are material, the company must provide a
brief description of the change, the reasons for the change and an
estimate of the impact of the change on the median and the
ratio.
Voluntary Additional Disclosure
Other than the required brief description of methodology, material
assumptions, adjustments or estimates and the expression of the pay
ratio described above, the proposed rule would not require
companies to provide a narrative discussion of the ratio, the
median or any supplemental information. However, companies would be
permitted to voluntarily supplement the required disclosure with a
narrative discussion or additional ratios so long as any additional
ratios are clearly identified, are not misleading and are not
presented with greater prominence than the required ratio.
Companies Subject to the Proposed Rule
The pay ratio disclosure requirements proposed by the SEC would
apply to only those companies that are required to provide summary
compensation table disclosure pursuant to Item 402(c) of Regulation
S-K. Consistent with Section 102(a)(3) of the Jumpstart Our
Business Startups Act, the proposed rule would not apply to
emerging growth companies. In addition, the proposed rule would not
apply to smaller reporting companies, since such companies are not
required to calculate compensation in accordance with Item
402(c)(2)(x) or to include all of the types of compensation
required to be included in total compensation under Item 402(c)(2).
Foreign private issuers that file annual reports and registration
statements on Form 20-F and US-Canadian Multijurisdictional
Disclosure System filers that file annual reports and registration
statements on Form 40-F would also not be subject to the proposed
rule since Forms 20-F and 40-F do not require Item 402 disclosure.
Foreign private issuers that file annual reports on Form 10-K would
also not be subject to the proposed rule and would continue to be
able to satisfy Item 402 requirements by following the requirements
of Items 6.B and 6.E.2 of Form 20-F.
Filings Where Disclosure Is Required and Proposed Compliance
Date
The proposed rule would require companies subject to the rule to
include pay ratio disclosure in any filing described in Item 10(a)
of Regulation S-K to the extent such filing requires executive
compensation disclosure under Item 402 of Regulation S-K. This
includes registration statements under the Securities Act of 1933
and the Exchange Act, proxy and information statements and annual
reports on Form 10-K.
A company subject to the proposed rule would first be required to
report the pay ratio disclosure with respect to compensation for
its first fiscal year commencing on or after the effective date of
the final rule. If the final rule were to become effective in 2014,
a company with a fiscal year ending on December 31 would be first
required to include pay ratio disclosure relating to the 2015
fiscal year in its proxy or information statement for its 2016
annual meeting of shareholders (or written consents in lieu of such
a meeting). In the event the company does not file its proxy or
information statement within 120 days of the end of 2015, it would
be required to file its initial pay ratio disclosure in its Form
10-K for fiscal year 2015 or an amendment to that Form 10-K. A
company with a fiscal year ending on December 31 that is not
subject to the proxy rules or does not file a proxy or information
statement in connection with an annual meeting of shareholders
would also be required to include pay ratio disclosure relating to
the 2015 fiscal year in its Form 10-K for fiscal year 2015, which
would be due in the first quarter of 2016.
The proposed rule would provide a transition period for newly
public companies, requiring initial compliance with respect to
compensation for the first fiscal year commencing on or after the
date the company becomes subject to the requirements of Section
13(a) or 15(d) of the Exchange Act (pay ratio disclosure would not
be required in a registration statement on Form S-1 or S-11 for an
initial public offering or a registration statement on Form 10).
Companies would be permitted to begin compliance earlier on a
voluntary basis. The proposed rule would not contain any additional
transition period for compliance after a company ceases to qualify
as an emerging growth company.
For both companies that would be subject to the proposed rule and
newly public companies, the company would not be required to
disclose its pay ratio disclosure for a particular fiscal year in
any filing until the filing of its annual report on Form 10-K for
such fiscal year or, if later, the filing of a definitive proxy or
information statement relating to its next annual meeting of
shareholders (or written consents in lieu of such a meeting)
following the end of such fiscal year so long as such pay ratio
disclosure is filed not later than 120 days after the end of such
fiscal year.
A company that makes a filing after the end of its last completed
fiscal year and before the filing of its Form 10-K or proxy or
information statement must include or incorporate by reference the
pay ratio disclosure for the fiscal year prior to the last
completed fiscal year in such filing. In addition, the proposed
rule would provide that where a company omits summary compensation
table disclosure of the salary or bonus of the principal executive
officer because such information is not calculable as of the latest
practicable date, the company must also omit pay ratio disclosure
until those elements of the principal executive officer's total
compensation are determined and provide the pay ratio disclosure in
the same filing under Item 5.02(f) of Form 8-K in which the
principal executive officer's salary or bonus is later
disclosed. In such a case, the company must disclose that the pay
ratio disclosure is being omitted because the principal executive
officer's total compensation is not calculable until the
principal executive officer's salary or bonus is determined and
disclose the expected date that the total compensation for the
principal executive officer is expected to be determined. The Form
8-K disclosure regarding pay ratio would only be triggered once the
salary or bonus of the principal executive officer becomes
calculable in whole, not in part.
Consistent with other Item 402 information, the pay ratio
disclosure would be considered "filed" for purposes of
the Securities Act and Exchange Act and, as such, would be subject
to potential liability under both Acts.
The comment period for the proposed rule will be open for 60 days
from publication of the proposing release in the Federal
Register.
1
Release Nos. 33-9452; 34-70443; File No. S7-07-13 (hereinafter “proposed rule”) available at http://www.sec.gov/rules/proposed/2013/33-9452.pdf.
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