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SEC Proposes Rule on Pay Ratio Disclosure

Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) requires public companies to disclose comparative information about the compensation paid to their principal executive officer (“PEOs”) in any filing in which executive compensation disclosure is required under Item 402 of Regulation S-K, including Annual Reports on Form 10-K filed pursuant to the Securities Exchange Act of 1934 (“Exchange Act”) and certain registration statements filed pursuant to the Securities Act of 1933. Congress conditioned the implementation of this requirement on rule-making efforts by the U.S. Securities and Exchange Commission (“SEC”) and, on September 18, 2013, the SEC finally published its proposed rule. The rule, if made final, would require the disclosure of:


  • The median of the annual total compensation for all employees of the public company other than the PEO for the company’s most recently-completed fiscal year;

  • The annual total compensation of the PEO for the most recently-completed fiscal year; and

  • The ratio of the first amount to the second amount.

The proposed rule contemplates that public companies would have to make these disclosures for fiscal years that begin after the effective date of the final rule. For example, if the effective date of the final rule is February 1, 2014, then a company with a calendar year end will make its first disclosures for 2015, either in its Annual Report on Form 10-K for the year ending December 31, 2015 or, if the company chooses to make executive compensation disclosures in its proxy statement (and files that proxy statement within 120 days of its fiscal year end), in its proxy statement to be filed in 2016.

Disclosures Would Require a Multi-Step Process

The SEC’s proposal makes it clear that public companies would need to employ a multi-step process to make the required disclosures.

Defining the Employee Group

The calculation of the median compensation for all employees would need to cover all employees of the company and its subsidiaries, including full-time, part-time, temporary, seasonal and non-U.S. employees, who were employed as of the end of the company’s prior fiscal year. Independent contractors and leased or other temporary workers employed by third parties would not be included in this employee group.

Identification of Median Employee; Methodology; Compensation Measure

Companies must determine the total annual compensation of employees in the employee group and select a median employee. The proposed rule does not require a company to use a specific methodology to identify the median employee, but the SEC takes the position that the company should consistently apply the methodology that it uses. The proposed rule provides that a company may (i) consider the entire employee population, (ii) use a statistical sampling of the employee population, or (iii) use any other reasonable method.

When calculating the compensation of the median employee, a company may calculate that compensation using total annual compensation as determined under Item 402 of Regulation S-K or any consistently applied compensation measure that would result in a reasonable estimate of the median employee’s compensation, such as compensation amounts reported in payroll or tax records. If a company uses amounts reported in payroll or tax records, then the company may use the same annual period used in those records regardless of whether that period is the same as the company’s fiscal year. In addition, a company may annualize the total compensation of permanent employees who were employed for less than a full year. However, a company may not (i) make full-time equivalent adjustments for its part-time employees, (ii) annualize compensation for temporary or seasonal employees, or (iii) make cost-of-living adjustments for non-U.S. employees.

    The exchange rates and conversion methodologies that a company uses to calculate the compensation paid to non-U.S. workers should be consistent with the rates and methodologies that it uses to calculate the compensation paid to its named executive officers, but, as a general rule, the company would not need to disclose the currencies, exchange rates and conversion methodologies that is uses.

    Compensation of Median Employee

    After a company identifies its median employee, the company would then need to calculate and report that employee’s total annual compensation using the definition of “total compensation” found in Item 402(c)(2)(x) of Regulation S-K. Companies will be allowed to use reasonable estimates when calculating any element of the median employee’s total compensation and determining his or her annual total compensation.
    Disclosure of Methodology

    Public companies would need to briefly disclose the methodology used to identify the median employee, including the compensation measure used and any assumptions, adjustments or estimates that were material to the determination. This disclosure would not need to include a technical analysis and discussion of the methodology or formulas used in the determination.

    Companies that estimate total annual compensation would need to clearly state in their disclosures that the amounts are estimated and would need to provide a brief description of those estimates. If a company makes material changes to its methodology from period-to-period, then the company would be required to describe the change, the reasons for making the change, and how that change is expected to impact the company’s disclosures.

    Excluded Companies and Transition Period for Newly-Public Companies

    The following public companies would be exempt from the disclosure requirements:


    • Smaller reporting companies

    • Emerging growth companies;

    • Foreign private issuers; and

    • Canadian issuers that file annual reports and registration statements on Form 40-F pursuant to the Multijurisdictional Disclosure System (or MJDS).

    The new disclosures would be phased in for companies that become subject to the reporting requirements of the Exchange Act after the effective date of the proposed rule. For these companies, the pay ratio disclosures would be required for the first time for the fiscal year commencing on or after the date that the company becomes subject to the Exchange Act reporting requirements. This means that such a company would not be required to include the disclosures in a registration statement that it files in connection with its initial public offering.

    Comment Period

    The SEC’s release solicits comments on various aspects of the proposed rule. Absent an extension, the comment period will end on December 2, 2013. You can view and obtain a copy of the SEC’s proposed rule release at: http://www.sec.gov/rules/proposed/2013/33-9452.pdf.

    If you have any questions about the proposed rule, please feel free to call or e-mail one of the following members of the Firm’s Securities Law Practice Group:

    If you have any questions about the proposed rule, please feel free to call or e-mail one of the following members of the Firm’s Securities Law Practice Group: Abba David Poliakoff, 410-576-4067 or Michele Bresnick Walsh, 410-576-4216 or Andrew D. Bulgin, 410-576-4280.