SEC Proposes New Pay Equity Disclosure Requirements for Reporting Companies

September 30, 2013

HSE LEGALcurrents

Recently the Securities and Exchange Commission (the “SEC”) released a highly anticipated set of proposed rules that would require disclosure of the ratio of the annual total compensation of a company’s median employee to the annual total compensation of the company’s Chief Executive Officer (the “Proposed Rules”). This mandate expands the existing SEC executive compensation disclosure rules, under which a reporting company must disclose extensive information about the compensation of its Chief Executive Officer (“CEO”), Chief Financial Officer, and certain other highly compensated executive officers.

Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) directed the SEC to amend its existing compensation disclosure rules to require companies to disclose:

  • the median of the annual total compensation of all employees of the company, except the CEO;
  • the annual total compensation of the CEO; and
  • the ratio of the annual total compensation of the median employee to the annual total compensation of the CEO.

Recognizing the difficulty of determining this information, the Proposed Rules: (1) exempt certain public companies from the disclosure requirement; (2) specify a flexible approach to identifying the median employee and calculating the median employee’s annual total compensation; and (3) provide a transition period to allow companies to implement the necessary systems to provide this disclosure.

Companies that are Exempt from the Proposed Rules

Under the Proposed Rules, certain public companies will not be required to make these additional disclosures. The Proposed Rules exempt emerging growth companies, smaller reporting companies (companies with a public oat of less than $75 million), and foreign private issuers from providing the disclosure mandated by the Proposed Rules.

Identifying the Median Employee

The Proposed Rules provide flexibility in determining the methodology used to identify the median employee. A company may use reasonable estimates to identify the median employee as well as reasonable estimates to calculate the annual total compensation or any elements of total compensation for any employee other than the CEO.

A reporting company may identify the median employee by calculating the compensation of all of its employees using the methodology under the existing executive compensation disclosure rules. Because of the potential complexity of such an approach, the Proposed Rules also permit a company to use any other measure of compensation that is consistently applied to all employees, such as amounts that are reported in payroll or tax records.

In a similarly flexible approach, a company may use its full employee population or a statistical sample of the employee population in determining the employees from which the median employee is identified. The Proposed Rules would require that the methodology be appropriate for the size and structure of the business and the company’s method of compensation. Along with disclosing the annual total compensation of the median employee, the company would also be required to disclose a brief overview of the chosen methodology and any key assumptions, adjustments, or estimates.

The Proposed Rules will require a company to include in its calculation, or base any statistical sample of its employee population on, “all employees” who are employed by the company on the last day of the company’s last completed ¬fiscal year, including those employed by any subsidiary. Thus, in addition to full-time permanent employees, companies would need to include any part-time, temporary, seasonal, and non-U.S. employees that meet such employment requirement. A company may annualize the total compensation for permanent employees who did not work the full year (i.e., new hires), but may not make annualizing adjustments for temporary or seasonal workers. Similarly, a company may not make full-time equivalent adjustments for part-time employees or cost-of-living adjustments for non-U.S. workers.

Calculating Annual Total Compensation

After identifying the median employee, a company would be required to calculate the annual total compensation for that employee. The Proposed Rules require the annual total compensation of the median employee to be calculated under the existing executive compensation disclosure rules, which are the same rules used to determine the annual total compensation of the CEO. Generally, the existing executive compensation disclosure rules de¬ne compensation to include salary, bonuses, stock awards, option awards, non-equity incentive plan compensation, changes in pension value, and other compensation. Companies may use reasonable estimates to calculate any element of annual total compensation, but would be required to disclose any such estimates.

Transition Period

The Proposed Rules will not become effective until the SEC adopts ¬final rules, which is not expected to occur until sometime in 2014. Once the Proposed Rules become effective, companies will have a transition period to comply with the new disclosure requirements. If the SEC adopts ¬final rules during 2014, then the new pay ratio disclosures will not be required until the 2016 proxy season.

What to Do Now

The adoption of the Proposed Rules begins a 60-day public comment period. When Dodd-Frank was enacted, there was a good amount of controversy surrounding this disclosure requirement. As such, numerous comments are anticipated during this 60-day comment period. It is also anticipated that the ¬final rules will include some changes from the Proposed Rules. Due to the extended transition period and the possibility of changes to the Proposed Rules, we recommend that companies that would be subject to this disclosure requirement take a “wait and see” approach by monitoring the comments that are submitted to the SEC, and consider submitting a comment letter if it feels its views are not adequately represented. Once the rules are finalized, companies should begin taking steps to enable it to provide this disclosure as early as the 2016 proxy season.

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