November 11, 2019

November 11, 2019

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Pay Ratio Disclosure And The Sometimes Mythical Median Employee

Most, but not all, publicly traded companies are, or soon will be, drafting the disclosures required by Section 953(b) of the Dodd Frank Wall Street Reform and Consumer Protection Act.  That statute requires the Securities and Exchange Commission to amend Item 402 of Regulation S-K to require three disclosures:

  • the median of the annual total compensation of all employees of a registrant (excluding the chief executive officer),
  • the annual total compensation of that registrant’s chief executive officer, and
  • the ratio of the median of the annual total compensation of all employees to the annual total compensation of the chief executive officer.

The SEC duly responded to Congress’s mandate and issuers are required to make these disclosures for their first fiscal year beginning on or after January 1, 2017.

The SEC’s approach in Item 402(u) of Regulation S-K assumes the existence of a “median employee”.  For example, Instruction #1 begins “Registrants may use reasonable estimates both in the methodology used to identify the median employee . . .”.  But what if there is no “median employee”?  Is that even possible?

As discussed in the adopting release, a median is not the same thing as an average.  The median is the middle number in a sequence of numbers.  For example, the median in the a sequence of 10, 20 and 30 is 20 (the average of the sequence is 30 (10+20+30/3)).  Some sequences, however, contain an even number; for example 10, 20, 30 and 40.  In this sequence there is no middle, but there is a median.  It is 25, or the average of the two middle numbers in the sequence.  The average of the sequence is 20 (100/4).

The SEC knows what a median is and even explains the concept in footnote 314 of the adopting release.  The SEC, moreover, knows the problem with even numbered sequences:

Another commenter suggested that, where a registrant has an even number of employees and, therefore, is unable to select one median employee, the registrant should be permitted to select and disclose an average of the compensation of the two employees nearest the median.

Knowing that in some cases there will be no middle person, the SEC nonetheless persists in the fiction that the median employee is an actual person and not sometimes an average.  For example, the adopting release states:

For example, if the median employee identified in year one is no longer employed by the registrant in years two or three . . . the registrant is permitted to identify its median employee in each of the following two years from among employees that had similar compensation to the median employee in year one.

At least one issuer has recognized that there will not always be a real, live median employee: “since we have an even number of employees when not including the CEO, determining the average of the annual total compensation of the two employees ranked sixth and seventh on the list (“Median Employee”).”  Novagold Resources Inc. (filed 3/23/2017).

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About this Author

Keith Paul Bishop, Corporate Transactions Lawyer, finance securities attorney, Allen Matkins Law Firm
Partner

Keith Paul Bishop is a partner in Allen Matkins' Corporate and Securities practice group, and works out of the Orange County office. He represents clients in a wide range of corporate transactions, including public and private securities offerings of debt and equity, mergers and acquisitions, proxy contests and tender offers, corporate governance matters and federal and state securities laws (including the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act), investment adviser, financial services regulation, and California administrative law. He regularly advises clients...

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