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Some Comments on the SEC's Proposed Pay Ratio Disclosure Rules

(The following post originally appeared on ONSecurities, a top Minnesota legal blog founded by Martin Rosenbaum to address securities, governance and compensation issues facing public companies.)

September 26, 2013

Last week, the SEC issued its long-awaited proposed pay ratio disclosure rules (PDF), required by Section 953(b) of the Dodd-Frank Act. As has been widely reported, the rules will adopt new Item 402(u) of Regulation S-K, requiring public companies to disclose the ratio of the median annual total compensation of all employees to the annual total compensation of the CEO. The public comment period for the rules expires on December 2, 2013.

The SEC’s fact sheet on the proposed rules gives a helpful summary. I also saw an especially helpful posting on The Conference Board Blog: “The Five Most Important Things Companies Need to Know and Do About the SEC’s Proposed CEO Pay Ratio Rules” by Jim Barrall of Latham & Watkins. To paraphrase:

  • The rules don’t apply to smaller reporting companies or certain other categories.
  • The rules will likely take effect in 2014, first applying to 2015 for calendar year companies, with the first report likely due in the proxy statement (or Form 10-K if no proxy statement is filed) in early 2016.
  • The proposal allows substantial flexibility in complying with the rules, including permitting statistical sampling or reasonable estimates. Issuers can also use simplified measures to identify the median employee.
  • The most burdensome and costly aspect of the rules is the inclusion of part-time, seasonal, temporary and non-U.S. employees in determining the median employee.
  • During the next two months, companies should start to determine how to gather and analyze the necessary information, and should consider filing comments with the SEC about the burdens of doing so.

Here are a few more points:

  • In a commentary on (subscription site), Mark Borges speculates that most companies will include the disclosure somewhere in Compensation Discussion and Analysis in the proxy statement – in the executive summary, in the discussion of internal pay equity or benchmarking, or in a separate subsection of CD&A.
  • Borges also points out that the SEC’s Proposing Release allows the company to supplement the required disclosure with a narrative. The company may also include additional ratios, as long as they are clearly identified and not misleading, and not presented with greater prominence than the required ratio. So companies will have a chance to tell their own story.

Commentary. The disclosures will be a pain to deal with, and will be expensive for global companies in particular. But it looks like the rule is here to stay. During 2015 in preparation for the first disclosures, companies will spend a lot of time and resources determining the best method for determining the median employee and that employee’s total compensation as calculated under Item 402(c)(2)(x) of Regulation S-K. But life will go on, and after the first year, the process should get easier.

As been stated in many other commentaries, the benefit of the disclosure to investors is uncertain at best. I agree with Borges’ statements, reported in this Wall Street Journal article, that company-to-company comparisons won’t be all that meaningful, but the ratio will be most useful in assessing pay equity over time as it grows or shrinks. But regardless of the utility of the required disclosures themselves, hopefully compensation committees will ultimately view the new requirement as an opportunity to communicate their policies in a positive way.

The Ratio

[Disclaimer: An attempt at Item 402(u)-related humor follows. Because sometimes we just have to laugh.]

Soon a public company will be required to identify its median compensated employee and compare that employee’s compensation to that of the CEO. What if a company took this disclosure to the next level: don’t we want to learn something about the employee? Maybe you could see something like this in a future proxy statement:

After a careful study utilizing its proprietary statistical sampling analysis, the Company has determined that its median compensated employee (“MCE”) is Ralph Snowden, age 37, pictured below. Since 2008, Mr. Snowdon has served as a senior fry cook at the Company’s West Des Moines, Iowa restaurant. Prior to that time, he held a wide variety of kitchen positions with companies in the fast food industry. As shown in the Summary Median Compensation Table (“SMCT”) below, in 2015, our MCE’s total annual compensation was $37,440. In 2015, the mathematical ratio of the total annual compensation of Ralph Snowden to that of our CEO, Ruth Swenson (the “Ralph to Ruth Ratio”) was one-to-238, or 0.0042016-to-one.

Wouldn’t that be more fun? But now that I think about it, I’m not sure any part of Item 402(u) will work in Minnesota, where all the employees are above average.

Thanks to my partner, Alan Gilbert, for the concept for "The Ratio."


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