Almost two years after its initial proposal, the United States Securities and Exchange Commission (SEC) has approved a rule that requires a public company to disclose the ratio of pay of the CEO to the median compensation of its employees.
The pay ratio rule implements section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which took effect on 21 July 2010. The SEC has stated that the rule will provide companies with flexibility in calculating the pay ratio, and helps inform shareholders when voting on the remuneration of executives.
Companies will be required to disclose the following:
- The median of the annual total compensation of all employees of the registrant (excluding the CEO) (amount a);
- The annual total compensation of the registrant’s CEO (amount b); and
- The ratio of amount b to amount a.
- The term “registrant” refers to companies that are required to provide executive compensation disclosure under Item 402(c) of Regulation S-K. As a result, the disclosure requirement does not apply to emerging growth companies, smaller reporting companies, or foreign private issuers.
- “Total annual compensation” has the same meaning that it is given in Item 402(c)(2)(x) in Regulation S-K.
- Employees are defined as:
- Full-time, part-time, seasonal, and temporary workers employed by the registrant or any of its consolidated subsidiaries; and
- Individuals employed as of the last day of the registrant’s last completed financial year.
- The rule does not extend to independent contractors and “leased” workers who are employed by, and whose compensation is determined by, an unaffiliated third party.
- There are no prescribed methodologies for calculating the median employee. Registrants can choose a method that is appropriate to the size, structure, and compensation practices of their business.
Modification to Proposed Rule
The SEC acknowledges that the final rule is generally consistent with the proposed rule, however, it has made a number of revisions in an effort to minimise the expected costs and unintended consequences of the disclosure. The final rule has been modified as follows:
- There are now exclusions for non-U.S. employees in circumstances where foreign data privacy laws make registrants unable to comply with the rule or where these employees account for 5% or less of total employees.
- Previously, the definition of “employee” applied on an enterprise-wide basis. It has since been narrowed to include only employees of the registrant and its consolidated subsidiaries.
- In relation to identifying the median employee:
- Registrants can use any date within three months prior to the last day of their completed fiscal year to identify the median employee.
- The median employee only needs to be identified every three years unless there has been a change in the employee population or employee compensation arrangements.
- The registrant can use another employee in subsequent years if the median employee’s circumstances have changed. However, this is only permitted where there has been no change in employee population or compensation arrangements.
- Cost-of-living adjustments for employees in other jurisdictions are permitted.
- In circumstances where a CEO is replaced within a fiscal year, the registrant may use either:
- the total compensation provided to each person and combine the figures; or
- The annualised compensation of the CEO serving on the date that the registrant uses to determine its median employee.
Registrants must comply with the rule for the first fiscal year beginning on or after January 1 2017. There are, however, transition periods for new companies, companies engaging in business combinations or acquisitions, and companies that cease to be small reporting companies or emerging growth companies.
The information is to be provided in annual reports, proxy and information statements, and registration statements that require executive compensation disclosure under Item 402 of Regulation S-K.