In August 2015, the SEC adopted its final pay ratio disclosure rules, implementing the pay ratio disclosure requirement in the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Rules"). SEC Release No. 34-75610. Commencing in early 2018, public companies, other than companies not subject to the Rules (i.e., emerging growth companies, smaller reporting companies, foreign private issuers, MJDS (or multijurisdictional disclosure system) filers, and registered investment companies), will have to disclose, at a minimum, (i) their CEO's total annual compensation, (ii) the median total annual compensation of all of their employees (other than the CEO), and (iii) a ratio comparing the two compensation amounts. More likely, certain additional disclosure will be required under the Rules or desirable at the issuer's discretion in connection with various aspects of the pay ratio calculation.
The provision has generated its share of controversy. In commenting on this provision, Senator Robert Menendez wrote to then SEC Chair Mary Schapiro that: "I wrote this provision so that investors and the general public know whether companies' pay practices are fair to their average employees, especially compared to their highly compensated CEOs. . . . Such information is highly material to investors who have the right to know about companies' policies and practices on compensation before they invest." Certain state government agencies, unions and pension funds likewise weighed in supporting the proposed rules, including the New York State Comptroller at the time, Thomas DeNapoli, the AFL-CIO and the Washington State Investment Board.
On the other hand, there was ample criticism of the usefulness and costs associated with the proposed rules. Former SEC Commissioner Michael Piwowar commented that: "The pay ratio rule will harm investors. . . . [A]ny investor that uses pay ratio disclosures to compare companies will be at best distracted from material information and at worst misled about the investment itself." The U.S. Chamber of Commerce's Center for Capital Markets Competitiveness submitted a comment letter on the proposed rules in which it stated that the "SEC likely underestimated costs [to comply] by more than 870 percent and underestimated compliance time by 560%," with annual costs to the private sector of over $700 million versus $72.7 million estimated by the SEC. The Chamber's view was echoed by others, including organizations like the American Benefits Council and corporations such as ExxonMobil. These comments were merely representative of the dialogue surrounding the proposed rules.
While compliance is not required for some time, the work required to make the calculation is likely to be time consuming, expensive and complex. To undertake this effort as efficiently as possible and achieve as favorable a ratio as permissible under the Rules, issuers need to engage in thorough advance planning taking into account the various options and considerations raised by the Rules. This article explains step-by-step how to prepare for compliance and then comply with the Rules, including identifying the median employee and computing total annual compensation; describes the advantages and disadvantages associated with the various options that need to be weighed along the way; summarizes the required and/or potential disclosures that need to be made; and includes model disclosure.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
