Lawsuit Likely Over SEC Pay Ratio Rule: Attorney

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By Michael Greene

Sept. 17 — The Securities and Exchange Commission's recently adopted pay ratio rule will likely be challenged in court, an attorney suggested Sept. 16 during a conference session.

“I predict we will see a challenge,” said Brian Breheny, a Washington-based Skadden, Arps, Slate, Meagher & Flom LLP partner and former deputy director in the SEC's Division of Corporation Finance. “I am not sure” if a challenge “will be successful,” he added.

However, Columbia Law School Professor Robert J. Jackson Jr. disagreed that the SEC will be sued over the rulemaking. “People like to say this is a challenge that they want to bring because this rule makes them mad,” he said. “I understand that, but I don’t think they will bring it.”

Breheny and Jackson spoke with others at a Practising Law Institute executive compensation conference.

Likely Challenge?

The rule, adopted by a divided SEC, requires companies to disclose the ratio of their chief executive's annual pay to the median annual pay of their employees. Republican SEC members Daniel Gallagher and Michael Piwowar voted against the rule, each issuing a dissenting statement.

At the PLI event, Breheny noted that the SEC has “not had the best track record” when it's been challenged on its Dodd-Frank Act rulemaking. Among other successful challenges, he cited the agency's conflict minerals disclosure requirements, resource extraction payment disclosure rule and proxy access.

According to Breheny, Piwowar's dissent clearly laid out why the SEC commissioner thought the pay ratio rule violates the Administrative Procedure Act, a major source of challenge for SEC regulations.

Breheny speculated that one of the reasons the SEC adopted a transition period—so that companies don't need to disclose until 2018—is because it likely anticipated a legal challenge.

Not Good Idea 

However, Jackson, co-director of Columbia Law School's Ira M. Millstein Center for Global Markets and Corporate Ownership, said there are several reasons why challenging the rule may not be a good idea.

For one, the SEC staff “did a pretty good job on a pretty hard mandate,” Jackson said. If the rule is successfully challenged, forcing the staff back to the drawing board may not make things any better for those impacted by the requirements, he said.

“If you read the statute,” the staff went “as far as I think you can get to be flexible,” Jackson added.

Should a court decide that the SEC was too flexible in its requirements, “what they will do next is cut and paste that awful statute in the Federal Register, and that will make your life a lot worse,” he said.

Supplemental Disclosures 

The panelists also discussed some practice tips for complying with the rule.

Breheny suggested that companies may have to give more consideration to what is not required under the rules. He noted that supplemental disclosures are permitted as long as they are clearly identified, not misleading and not presented more prominently than the required pay ratio.

Linda Rappaport, a New York-based Shearman & Sterling LLP partner, said there are different options available to companies, including alternative ratios and supplemental discussions.

“I think in different industries the issue is going to be more prevalent than you might think, retail being one of them because of things that cannot be excluded,” she said.

Rappaport said she expects that at least in the early years, companies will use supplemental discussions to try to illuminate what is seen or to give some context to their ratios. She cited industry peer groups as one method of doing so.

Jackson noted that the use of supplemental disclosures in tabular quantitative formats has become more common. He also agreed that companies likely will use industry-relative comparisons to explain their ratios. Industry comparisons, along with some narrative disclosures, “can probably be helpful in addressing some of those tough cases,” he said.

Unintended Consequences

Rappaport suggested that a possible unexpected consequence of the rule is that it may end up increasing employees' median pay. Some employees may be surprised that they make less than the median employee and companies may face internal pressure to raise worker pay, she said.

Although the SEC was very flexible in how companies can calculate median employee pay, Rappaport also suggested that companies be deliberate and careful about choosing one methodology and then sticking with it.

“This is not something you want to switch around,” she said.

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To contact the editor responsible for this story: Yin Wilczek at