U.S. Securities and Exchange Commission Proposes New Rule on Pay Disclosure

    View Author 20 September 2013

    On Wednesday, September 18, 2013, the U.S. Securities and Exchange Commission (SEC) proposed a new rule that would require public companies to disclose the ratio of the compensation of its principal executive officer (PEO)[1] to the median compensation of its employees. Median pay is the point on the income scale at which half the employees earn more and half earn less.

    A divided SEC voted 3-to-2 in favor of the proposed rule, which is a less onerous measure than what the U.S. Congress ordered the SEC to adopt three years ago as part of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).  The pay ratio provision of the Dodd-Frank Act generated extensive debate while the SEC considered approaches for implementing the provision.  The SEC Chairwoman Mary Jo White noted that the Dodd-Frank Act proposal has “generated significant interest” evidenced by more than 22,000 public comment letters to date.

    Proponents of the pay ratio provision argued that the disclosure of this pay ratio will provide more transparency on the pay disparity and will help rein in what is perceived as bloated executive compensation.  Opposition to the provision maintained that the pay ratio calculation was onerous, unnecessary, complex and prohibitively expensive.

    As a result, the SEC’s proposed rule provides companies with significant flexibility in complying with the new pay ratio disclosure, as explained more fully herein, rather than stipulating a one-size-fits-all reporting regimen.  In explaining her support for the proposed rule, Chairwoman White stated that the proposed rule provides companies with the flexibility to control the costs of compliance, while fulfilling the statutory mandate of the Dodd-Frank Act.

    The two SEC commissioners that voted against the proposed rule cited, among other things, a concern that the rule does little to advance the SEC’s core mission of investor protection and is nothing more than a political attempt to shame companies into reining in executive pay by forcing methods of pay calculations that are designed to yield “eye-popping” results.

    The proposed rule will have a 60-day public comment period following its publication in the Federal Register.  The SEC will then vote on the proposed rule again before its provisions can go into effect.

    New Pay Ratio Disclosure Requirement

    As required by the Dodd-Frank Act, the proposed rule would amend existing public company executive compensation disclosure rules to require companies to disclose:

    • The median of annual total compensation of all employees, excluding the PEO.
    • The annual total compensation of the PEO.
    • A ratio of the median employee annual total compensation to the PEO’s annual total compensation.

    Identification of Employees Covered by the Proposed Rule

    The proposed rule clarifies that “all employees” includes:

    • all employees (including full-time, part-time, temporary, seasonal and non-U.S. employees);
    • who are employed by the company or any of its subsidiaries (including officers other than the PEO)[2]; and
    • who are employed as of the last day of the company’s prior fiscal year.

    Companies will be permitted but are not required to annualize the total compensation for a permanent employee who did not work for the entire year, such as new hires. 


    In order to allow the greatest degree of flexibility while remaining consistent with the requirements of the Dodd-Frank Act, the proposed rule does not specify any required calculation methodologies for identifying the median of the annual total compensation of employees.  Instead, companies would be allowed to select a methodology that is appropriate based on the size and structure of their business and the way the company compensates employees. Companies can identify the median using:

    • Their full employee population.
    • Statistical sampling.
    • Another reasonable method.

    For example, a company could identify the median by calculating annual total compensation of each employee using either its full employee population or a statistical sample of that population. Alternatively, the company could first identify a “median employee” based on any consistently applied compensation measure, such as amounts reported in payroll or tax records and then calculate that median employee's annual total compensation in accordance with Item 402(c)(2)(x) of Regulation S-K. If a company uses such an alternative approach to identify the median, it must:

    • Disclose and briefly describe the compensation measure used.
    • Calculate and disclose the annual total compensation for that median employee.

    Companies may use reasonable estimates in calculating the annual total compensation or any element of total compensation for employees other than the PEO. For example, companies would be permitted to use reasonable estimates when valuing elements of compensation where the company does not have access to information necessary for an actual valuation (for example, pension benefits under a multi-employer defined benefit plan).

    Disclosure of Pay Ratio

    The proposed rule requires that the ratio of the median employee annual total compensation to the PEO’s annual total compensation be expressed either:

    • as a ratio in which the median of the annual total compensation of all employees is equal to one; or,
    • narratively in terms of the multiple that the PEO total compensation amount bears to the median of the annual total compensation amount.

    For example, if the median of the annual total compensation of all employees of a company is $45,790 and the annual total compensation of a company’s PEO is $12,260,000, then the pay ratio could be disclosed as “1 to 268” or the ratio could be expressed narratively as “the PEO’s annual total compensation is 268 times that of the median of the annual total compensation of all employees.”

    Disclosure of Methodology, Assumptions, and Estimates

    The proposed rule provides that companies must briefly disclose and consistently apply any methodology used to identify the median of the annual total compensation of all employees and any material assumptions, adjustments or estimates used to identify the median or to determine total compensation or any elements of total compensation, and companies must clearly identify any estimated amount as such. 

    Filings Where Disclosure Is Required

    Companies subject to the rule would be required to describe the pay ratio disclosure in registration statements, proxy and information statements, and annual reports that must already include executive compensation information as set forth under Item 402 of Regulation S-K.

    Companies Subject to the Proposed Disclosure Requirement

    The proposed rule will apply to public companies that are required to provide summary compensation table disclosure pursuant to Item 402(c) of Regulation S-K.  Accordingly, this rule will not apply to smaller reporting companies, foreign private issuers or emerging growth companies as defined under the Jumpstart Our Business Startups Act (JOBS Act).  In addition, the proposed rule provides for a transition period for newly public companies[3] not otherwise exempt from the proposed rule under the JOBS Act.

    Proposed Compliance Date

    A company will be required to include the proposed rule’s pay ratio disclosure in the company’s first fiscal year commencing on or after the effective date of the rule and, as proposed, a company will be permitted to omit its pay ratio disclosure from its filings until the filing of its annual report on Form 10-K for that fiscal year or, if later, the filing of a proxy or information statement for its next annual meeting of shareholders following the end of such year. For example, if the final rule becomes effective in 2014, a company with a fiscal year ending on December 31 would be first required to include its pay ratio disclosure relating to compensation for fiscal year 2015 in its proxy information statement for its 2016 annual meeting of shareholders.

    [1]   For consistency with existing Item 402 requirements of Regulation S-K, the proposed rule uses the defined term “PEO” instead of the term “chief executive officer” used in the Dodd-Frank Act.

    [2]   “All employees” does not include workers who are not employed by the company or its subsidiaries, such as independent contractors.

    [3]   For new public companies, initial compliance will be required with respect to compensation for the first fiscal year commencing on or after the date the company becomes subject to the reporting requirements.