January 24, 2022

Volume XII, Number 24


January 21, 2022

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Securities and Exchange Commission (SEC) Proposes Pay Ratio Disclosure Rules

Last week, the Securities and Exchange Commission (SEC) proposed a new rule to implement a requirement of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposal would require a disclosure of our issuer’s median employee compensation and the ratio of that median to the compensation of the principal executive officer.

Under the proposed rule, issuers would need to add further information to the executive compensation disclosure in their filings:

  • The median of annual total compensation of all employees of the company, excluding the principal executive officer (PEO);

  • The annual total compensation of the PEO; and

  • A ratio of the median employee annual total compensation to the PEO’s annual total compensation.

Not all issuers would be required to comply with the SEC’s proposal. The pay ratio disclosure requirements would only apply to reporting companies that are already required to disclose executive compensation under Item 402(c) of Regulation S-K. Therefore, Emerging Growth Companies, Smaller Reporting Companies, Foreign Private Issuers and Multijurisdictional Disclosure System (MJDS) filers would be exempt from the proposed rule.

To elucidate the types of employees that are to be factored into the ratio, the SEC proposed rule clarifies “all employees” to include individuals employed by the reporting company or any of its subsidiaries as of the last day of the company’s last completed fiscal year. This incorporates all full-time, part-time, seasonal, temporary and non-US employees. However, independent contractors or “leased” workers, not employed by the reporting company, would not be covered. For employees who did not work the entire year, such as new hires or employees who took an unpaid leave of absence, reporting companies have the option of annualizing those employees’ annual compensation. However, those companies would not be permitted to make full-time adjustments for part-time workers, annualize adjustments for temporary and seasonal workers or make cost of living adjustments for non-US workers. The SEC acknowledges that those adjustments may present a distorted picture of the actual composition of a reporting company’s workforce or compensation practices.

In any event, large public companies have already voiced their concerns to the SEC that reporting a median annual compensation for all employees would be burdensome. To address those concerns, the SEC would provide flexible options aimed at lowering compliance costs and furthering the requirement’s objectives. Recognizing that a number of variables affect how a company could calculate median annual compensation, the SEC would propose that companies can identify the median using the full employee population, a statistical sampling or any other reasonable method. One reasonable method includes identifying a median employee based on consistent compensation measures (such as amounts reported in payroll or tax records), and then calculating that median employee’s annual total compensation. The proposed rule provides that alternative approaches or assumptions would be appropriate so long as companies disclose and briefly describe the compensation measure used.

In addition, the median and annual total compensation for all employees may amount to a reasonable estimate. Estimates are permitted since companies may not have access to certain information, such as pension benefits under a multi-employer benefit plan. Estimates or estimation methods used to identify the median employee or the total compensation would also be subject to disclosure. In addition, if a company changes methodology from year-to-year, that company would need to describe the change, the reason for the change and the impact the change had on the median and ratio. Narratives of these disclosures would be permitted.

The SEC’s proposed rules provide that the pay ratio required could be expressed in two different ways. First, the annual total compensation of all employees would be equal to one (1 to 250). Second, such ratio could be expressed narratively (the PEO’s annual total compensation is 250 times that of the median of the annual total compensation of all employees).

The SEC believes that this flexible approach will reduce the cost of compliance. It acknowledges this approach will limit the comparability of disclosure across reporting companies, noting that precise conformity of ratios across companies is not necessary because it believes the pay ratio is aimed at providing investors with a company-specific metric to evaluate the PEO’s compensation within the context of his or her own company.

Under the proposed rules, reporting companies would have to begin making the disclosure following the first fiscal year that begins on or after the effective date of the final rule. Those subject to the proposal would be required to disclose the pay ratio for a completed fiscal year in the same report (Form 10-K, proxy statement or registration statement) in which other executive compensation disclosure is made. Previously non-reporting companies would not be required to make pay ratio disclosures in the Initial Public Offering (IPO) registration statement. However, such disclosures would then need to be provided for the first fiscal year beginning on or after the date the company becomes a reporting company.

The proposal will have a 60-day public comment period following its publication in the Federal Register.

©2022 MICHAEL BEST & FRIEDRICH LLPNational Law Review, Volume III, Number 275

About this Author

Michael H. Altman, transactional lawyer, corporate mergers attorney, Milwaukee Law firm

Clients across multiple industries turn to Michael to coordinate their more complex business transactions. They value his quick assessment of issues and their implications, as well as his creative yet effective solutions to the many issues that arise during the course of a transaction.

Michael’s practice focuses on mergers and acquisitions, buyout transactions, securities regulation, and venture capital investment transactions. Both buyers and sellers, as well as issuers and shareholders, benefit from Michael’s counsel. Michael maintains a diverse business law practice, which...

Gregory Lynch, Michael Best Law Firm, Corporate and Energy Attorney

Greg Lynch is a partner in the firm’s Transactional Practice Group and Energy Industry Group. He also is the Co-Founder of the firm’s Venture BestTM venture practice. His principal experience has been in the following areas: 

  • Early-stage company formation

  • Angel and venture capital financing

  • Public and private placement of securities

  • Stock option and equity incentive plans

  • ...