SEC GUIDANCE REGARDING PAY RATIO OFFERS CLARIFICATION, BUT IS IT ENOUGH?

 

The Securities and Exchange Commission’s guidance regarding the pay ratio disclosure rule received a warm welcome because companies have discovered that the calculation isn’t so simple. While the new guidance is helpful, questions remain regarding the method used to calculate the ratio.

The SEC issued Oct. 18 the long-awaited guidance in the form of Compliance and Disclosure Interpretations (C&DIs).  The pay ratio disclosure rule requires public companies to calculate the ratio of the median employee’s annual total compensation and the chief executive officer’s annual total compensation.  The pay ratio must be expressed as a number compared to one or as a factor, such as X:1 or X times, which has been subject to criticism by the general public given that similar comparisons often demonstrate CEO pay is in excess of the median employee by the hundreds.  

The C&DIs regarding pay ratio provides guidance on the following topics:

  • how to select consistently applied compensation measures to identify the median employee, in lieu of using annual total compensation from Item 402(c)(2)(x) of Regulation S-K; 
  • how to factor furloughed workers given that the rule doesn’t define or address the term; and
  • how to differentiate between independent contractors and leased workers. 

Consistently Applied Compensation Measures

The SEC allocated three of the five C&DIs to provide additional guidance regarding the use of consistently applied compensation measures (CACMs) to identify the median employee, as opposed to annual total compensation from Item 402(c)(2)(x) of Regulation S-K.  The SEC defines CACM as any measure that reasonably reflects the annual compensation of employees.  The SEC permitted companies to use CACMs in response to concerns about compliance costs to calculate annual total compensation for all employees. 

Steve Seelig of Willis Towers Watson told Bloomberg BNA Nov. 3, “Using a ‘consistently applied compensation measure (CACM)’ is causing a bit of concern within the hi-tech industry.  Those organizations who were thinking of using a compensation definition like total cash compensation or W-2 compensation are now surprised to learn they would be required to include equity compensation values in their definition, to the extent equity is granted down to the median employee level, because excluding it does not ‘reasonably reflect the annual compensation of its workforce.’ The remainder of companies are left to ponder if they can use base pay as their CACM, particularly where a large swath of employees receive overtime or a bonus.  It is possible that they would conclude that they are required to include base and bonus if the latter was widely granted.”

The C&DIs “provide some helpful guidance for companies seeking more flexibility in applying the CACM, yet we think the rule could have gone much farther in permitting the use of prior-year data. We question whether permitting companies to use only prior year total compensation data will help many companies,” Seelig added.

Next Steps

Companies are required to comply with the pay ratio disclosure rule in their 2018 proxy statements using 2017 compensation data. 

Despite legislative efforts to repeal the pay ratio disclosure rule, practitioners are advising companies to start early. “We are strongly recommending that companies gear up to do a ‘dry run’ calculation using 2016 data as if they were required to disclose on the 2017 proxy.  This will permit companies to understand their data challenges, apprise their CEO and compensation committee on what the result will be, and to plan their internal and external communication approach well before the disclosure is required on the 2018 proxy,” Seelig said.

See related story, Companies Offered SEC Guidance on Pay-Ratio Disclosures.

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