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New SEC Pay Ratio Disclosure Guidance

    Client Alerts
  • September 25, 2017

As everyone knows by now, the SEC amended Item 402 of Regulation S-K, as required by the Dodd-Frank Act, to state that all companies required to provide executive compensation disclosure under Item 402(c) of Regulation S-K must also provide new executive compensation disclosure regarding:

  • the median of annual total compensation of all employees,
  • the annual total compensation of the CEO, and
  • the ratio of those two amounts.

Companies must provide the pay ratio disclosure for their first fiscal year beginning on or after January 1, 2017.

There had been a chance, albeit dwindling, that the new rules might somehow be repealed or delayed before the 2018 proxy season. Recent statements by the SEC staff, followed by last week’s barrage of staff guidance on pay ratio disclosure, now make it clear that the rules will go into effect as written.

The new guidance.

A September 21 interpretive release “… reflects the feedback the SEC has received and encourages companies to use the flexibility incorporated in our prior rulemaking to reduce costs of compliance,” according to SEC Chairman Jay Clayton. As summarized in the accompanying press release, the guidance:

  • States the SEC’s views on the use of reasonable estimates, assumptions and methodologies, and statistical sampling permitted by the rule;
  • Clarifies that a company may use appropriate existing internal records, such as tax or payroll records, in determinations about the inclusion of non-U.S. employees and in identifying the median employee; and
  • Provides guidance as to when a company may use widely recognized tests to determine whether its workers are employees for purposes of the rule.

Of particular note is the staff’s articulation of a reassuringly low standard for determining whether a company is in compliance with the new rules:

“… if a registrant uses reasonable estimates, assumptions or methodologies, the pay ratio and related disclosure that results from such use would not provide the basis for Commission enforcement action unless the disclosure was made or reaffirmed without a reasonable basis or was provided other than in good faith.” (emphasis added)

Then, in separate supplemental guidance, the staff addresses various questions and provides illustrative examples regarding how reasonable estimates and statistical methodologies may be used to satisfy the rule’s requirements. Here is a brief summary derived from, or quoting the language of, the guidance itself:

  • Companies may combine the use of reasonable estimates with the use of statistical sampling or other reasonable methodologies. For instance, a company with multinational operations or multiple business lines may use sampling for some geographic/business units and a combination of other methodologies and reasonable estimates for other geographic/business units.
  • Companies may use a combination of sampling methods, including, for example, simple random sampling, stratified sampling, cluster sampling and systematic sampling (each of which is described in the guidance).
  • Examples of situations where companies may use reasonable estimates include but are not limited to:
    • analyzing the composition of the company’s workforce (by geographic unit, business unit and employee type);
    • characterizing the statistical distribution of compensation of the company’s employees and its parameters;
    • calculating a consistent measure of compensation and annual total compensation or elements of the annual total compensation of the median employee;
    • evaluating the likelihood of significant changes in employee compensation from year to year;
    • identifying the median employee;
    • identifying multiple employees around the middle of the compensation spectrum; and
    • using the mid-point of a compensation range to estimate compensation.
  • Examples of common statistical techniques and methodologies that registrants may consider include but are not limited to:
    • making one or more distributional assumptions;
    • reasonable methods of imputing or correcting missing values; and
    • reasonable methods of addressing extreme observations, such as outliers.
  • Examples of the use of reasonable estimates, statistical sampling and other reasonable methods are provided for in multiple hypothetical scenarios involving companies with various combinations of employees and business units within and outside of the U.S.

It is clear that the staff is trying to demonstrate the rule’s flexibility, within reason. The staff also seems to be attempting to reduce anxiety about compliance, at least in the near term as companies continue to figure this out.