On September 18, 2013, the U.S. Securities and Exchange Commission (the “SEC”) approved for public comment a proposed rule (the “Proposed Rule”) to implement Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act regarding CEO pay ratio disclosure. Under the Proposed Rule, public companies would be required to disclose the ratio of the annual total compensation of its CEO to the median annual total compensation of all the company’s other employees.

The Proposed Rule is set forth in Release No. 33-9452 (the “Release”), available here.

Disclosure Requirement

The Proposed Rule would require companies to disclose:

• the median of the annual total compensation of all employees of the company (excluding the principal executive officer),
• the annual total compensation of the company’s principal executive officer (the “PEO”), and
• the ratio between these two amounts (collectively, the “Pay Ratio Disclosure”).
  

Identifying the Median

One of the most contentious elements of the Proposed Rule relates to the identification of the median. Under the Proposed Rule, “all employees” includes any full-time, part-time, seasonal or temporary worker employed by the company or any of its subsidiaries as of the last day of the company’s prior fiscal year, including non-U.S. workers. In contrast, 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 covered. The potential burden associated with the identification of the median employee and related matters was a key area of concern in the comments received by the SEC prior to the release of the Proposed Rule.

In an attempt to alleviate those concerns, especially for those companies with a significant non-U.S. workforce, the SEC does not specify any required methods for identifying the median. As such, a company could use statistical sampling, estimates and any consistently applied compensation measure to identify the median. This would allow a company to choose which compensation amounts it uses to determine the median employee such as amounts reported in its payroll or tax records. A company would also be permitted to use the same annual period that is used in its payroll or tax records to identify the median employee and once the median employee has been identified, the company would only be required to calculate the annual total compensation for such employee and not for all employees. The company would need to briefly disclose and consistently apply the methodology and any material assumptions, adjustments or estimates used to identify the median.

Annual Total Compensation

The Proposed Rule defines “annual total compensation” to mean total compensation for the last completed fiscal year, and total compensation should be calculated in accordance with Item 402(c)(2)(x) of Regulation S-K as it currently is for the PEO. As discussed above, a company would be allowed to identify the median employee by reference to compensation amounts derived from its payroll or tax records using the same annual period that is used in the payroll or tax records from which the compensation amounts are derived, but each company would still be required to calculate the annual total compensation for the identified median employee for the applicable fiscal year, in order to maintain consistency with other Item 402 information. This creates many potential issues for companies, because most companies do not maintain the necessary information to calculate this amount for all of its employees. Accordingly, the proposed requirements permit the use of reasonable estimates in determining any elements of total compensation under Item 402(c)(2)(x), including when disclosing the annual total compensation of the median employee. If a company were to use any estimates, it would need to include a brief description of its estimation methods, and any estimated amounts would need to be clearly identified as such.

Filing Requirements

In accordance with Section 953(b) of the Dodd-Frank Act, the Proposed Rule requires companies to include the Pay Ratio Disclosure in any filing described in Item 10(a) that requires executive compensation disclosure. Therefore, the Pay Ratio Disclosure would be required in registration statements and annual reports that require executive compensation information under Item 402 and in proxy and information statements relating to an annual meeting of shareholders or written consents in lieu of such a meeting. To align the Proposed Rule to the timing rules for providing Item 402 disclosure in annual reports and proxy and information statements, the Proposed Rule does not require a company to include Pay Ratio Disclosure with respect to its last completed fiscal year until the filing of its annual report for that last completed fiscal year or the filing of a definitive proxy or information statement relating to an annual meeting of shareholders (or written consents in lieu of such a meeting), provided that updated pay ratio information must, in any event, be disclosed not later than 120 days after the end of such fiscal year. As an example, a company that files its definitive proxy or information statement within 120 days after the end of its fiscal year 2015 would not be required to disclose pay ratio information relating to compensation for fiscal year 2015 until its definitive proxy or information statement for its 2016 annual meeting of shareholders. As provided by the JOBS Act, the Proposed Rule would not apply to emerging growth companies. In addition, the Proposed Rule would not apply to smaller reporting companies or foreign private issuers.

Effective Dates and Transition Period

The Release proposes a transition period once the final rules are adopted allowing companies to omit the Pay Ratio Disclosure for the first year. This means that if the final rules are adopted in 2014, a company would be first required to include the Pay Ratio Disclosure related to its 2015 compensation in its proxy or information statement for its 2016 annual meeting of shareholders. In addition, the proposed requirements include instructions that would permit new registrants to delay compliance, so that 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. Instead, such a registrant would be required to first comply with the Proposed Rule with respect to compensation for the first fiscal year commencing on or after the date the registrant becomes subject to the requirements of Section 13(a) or Section 15(d) of the Exchange Act.

The Proposed Rule will be open to public comment for a period of 60 days after it is published in the Federal Register.

If you have any questions about this topic, please contact a member of our Capital Markets and Securities Practice Group.