- The proposed rules would require companies to disclose the "pay ratio" of the total annual compensation of their median employee to that of their CEO.
- The proposed rules permit flexibility in complying with the requirements in order to lower the costs of compliance, but they provide no apparent benefits to investors.
- Indeed, the SEC's acknowledgement that there are significant challenges in quantifying the potential economic benefits, if any, from the proposed pay ratio disclosures may signal an expectation of—or possibly even an invitation for—litigation challenging the rules.
- We encourage companies to submit substantive, "data-heavy" comment letters to the SEC to demonstrate that the perceived benefits of the rules—if any can be identified—cannot possibly outweigh the costs of compliance.
The SEC has proposed the pay ratio disclosure rules required by
Dodd-Frank, more than three years after the statute's enactment
and after its receipt of hundreds of substantive comment letters
from trade groups, companies, unions, and investors. The proposal
was accompanied by strongly worded dissenting statements from two
objecting Commissioners.
We agree with the dissenters. In our view, the pay ratio
disclosure rulemaking, like the provision of Dodd-Frank that
mandated it, merely panders to special interests without any
discernible investor benefits. Instead, the rules will only provide
unions, pundits, and other members of the chattering classes a
"shame card" to use to inflame employees and embarrass
corporate America. This is not an appropriate goal for federal
legislation, nor for the SEC's rulemaking efforts. At risk in
particular will be large, global companies whose worldwide
operations and sizeable workforces will drive ratios that may be
perceived as excessive and will have substantial compliance costs
notwithstanding the flexibility the SEC has proposed.
Some may argue that the pay ratios alter the total mix of
information available to investors, because they will be able to
analyze the ratios of comparable companies when making investment
decisions and considering compensation-related proposals. However,
the flexibility that the SEC has provided, and really had to
provide, to companies in producing their ratios will by its nature
make ratios impossible to compare across companies or industries.
The SEC acknowledged this in its proposing release: "Although
the proposed flexible approach could reduce the comparability of
disclosure across registrants, we do not believe that precise
conformity or comparability of the ratio across companies is
necessary." In essence, these ratios will be stand-alone
numbers that will be driven largely by the nature, size, and
location of a company's workforces, and will be essentially
meaningless to investors.
The SEC itself acknowledged, as it had to, that investor benefits
of the proposed disclosures are not possible to identify:
[T]here is limited legislative history to inform our understanding of the legislative intent behind [Dodd-Frank's mandate] or the specific benefits the provision is intended to secure. In particular, the lack of a specific market failure identified as motivating the enactment of this provision poses significant challenges in quantifying potential economic benefits, if any, from the pay ratio disclosure.
While we commend the SEC for striving to mitigate the effects of
a misguided Congressional directive, it is nonetheless troubling
that the SEC would undertake this rulemaking—legislative
mandate or not—without a clear idea of the benefits that it
would provide to investors.
If the rules are in fact adopted, there will certainly be
litigation challenging the SEC's underlying cost-benefit
analysis. In fact, perhaps the SEC's admission that neither the
objectives nor the intended benefits of pay ratio disclosures are
evident in Dodd-Frank's mandate or its legislative history
signals that the SEC is inviting—or, at the very least,
expecting—a challenge to the rules, if adopted, under the
Administrative Procedure Act. (Recall that the Commission's
universal proxy access rules were ultimately invalidated through a
successful challenge to its cost-benefit analysis in litigation
filed under the APA by The Business Roundtable and the U.S. Chamber
of Commerce.) While it is true that the flexibility afforded by the
SEC to companies in determining their ratios eliminates many
possible costs that could have been imposed by the rule,
it remains impossible to justify adopting rules that have no
discernible benefits. In the words of Commissioner Gallagher, who
voted against the proposal: "Putting the most positive face
possible on [the] proposal, then, its benefits are not so much
elusive as illusory.... It amounts to this: Congress told
us to do it, and since we could have done it in a more costly way
than we did, the result is an implicit net benefit."
Executive compensation has, of course, been a hot point for the
chattering classes—not really for investors—for many
years, and proxy statement disclosure requirements relating to
compensation matters have grown exponentially in response. The
proposed pay ratio disclosure rules, however, are a sizable
departure from past rulemaking efforts not only in their scope, but
also in their intent. Of course, partisan politicking often results
in legislation that serves neither its stated purposes nor
investors' interests. Further, it is not surprising that this
legislation—which was primarily designed to placate unions
and promote their interests—penalizes the interests of
corporate America and, consequently, investors. It is unfortunate
that the SEC has, to paraphrase dissenting Commissioner Piwowar,
surrendered its rulemaking agenda to special interests. Now that
the rules have been proposed, however, it is time to rally against
their adoption.
We plan to submit a comment letter to the SEC challenging the
proposed rules. We encourage our clients and friends to do the
same, and to include in their correspondence specific and realistic
analyses of the anticipated costs of complying with the rules as
proposed.
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.