Highlights of the Proposed Rules
The proposed rules would require companies to begin to comply with the new rule with respect to compensation for their first fiscal year commencing on or after the effective date of the rules. Disclosure of the pay ratio, however, would not be required until the annual report for that fiscal year or, if filed later, the proxy or information statement for the next annual meeting following the end of that fiscal year, subject to a requirement that the pay ratio be filed within 120 days after the end of the fiscal year. This means that, if the final rules become effective in 2014 (which we view as the likely scenario), a company with a fiscal year ending on December 31 would first be required to disclose the pay ratio in its proxy or information statement for its 2016 annual meeting, based on fiscal year 2015 compensation.
Recommended Actions for Publicly Traded Companies
Summary of the Proposed Rules
The rules as proposed would require U.S. issuers subject to the reporting requirements of the Securities Exchange Act of 1934, other than smaller reporting companies and emerging growth companies, to disclose the following items:
This disclosure would generally be required in proxy statements, information statements, annual reports and registration statements that require disclosure of executive compensation under Item 402 of Regulation S-K.
Both the Median Pay and the CEO Pay would be calculated based on the rules that a company currently uses to calculate total compensation for purposes of the Summary Compensation Table under Item 402(c)(2)(x) of Regulation S-K. Under these rules, total compensation is the sum of (1) base salary, (2) bonuses (both discretionary bonuses and those paid under a pre-established incentive plan), (3) grant date fair value of equity awards, (4) change in pension value and above-market or preferential nonqualified deferred compensation earnings and (5) all other compensation, including such items as perquisites, tax gross ups and severance.
Under the proposed rules, companies may, but are not required to, annualize the total compensation for all permanent employees who were employed for less than the full fiscal year. However, the proposed rules would not permit full-time adjustments for part-time workers, annualization for temporary or seasonal employees or cost-of-living adjustments for non-U.S. workers. A company may use reasonable estimates to determine the Median Pay, but not the CEO Pay.
In determining the Median Pay, the potential pool of employees will include all individuals employed by the listed company or any of its subsidiaries on the last day of the most recently completed fiscal year, including all full-time, part-time, seasonal or temporary worker employed on that day. There is no exclusion for non-U.S. employees or for employees who are subject to a collective bargaining agreement. However, independent contractors and leased workers employed by a third party would not be included as employees.
In determining the employees from whom the median employee is identified, companies will be permitted to use either their entire employee population or statistical sampling or other reasonable methods.
In identifying the median employee from the relevant group, companies will be permitted to use either (1) actual annual total compensation, calculated using the Summary Compensation Table rules, or (2) any other compensation measure that is consistently applied to all employees included in the calculation. The proposed regulations provide as examples of alternative compensation measures amounts derived from the company’s payroll or tax records. Such records may be used to identify the median employee even if they are kept on an annual basis other than the fiscal year of the registrant.
Companies will be required to disclose the methodology used to identify the median employee and disclose any material assumptions, adjustments or estimates that are used to identify the median or to determine any elements of total compensation. Estimated amounts will need to be clearly identified. A company will need to explain any change in methodology from year to year, including the reason for the change and an estimate of its impact on the median and the ratio.
The proposed rules include a one-year transition period for newly public companies and exempt emerging growth companies entirely from the pay ratio disclosure.
The proposed rules would treat the pay ratio disclosure as being “filed,” not merely “furnished,” for purposes of liability under the Securities Act of 1933 (Securities Act) and the Securities and Exchange Act of 1934 (Exchange Act). Filed information is subject to liability under Section 18 of the Exchange Act, which imposes liability for misleading statements in reports or documents filed with the SEC, and is subject to automatic incorporation by reference into the company’s Securities Act registration statements, which could give rise to liability under Section 11 of the Securities Act.
The comment period for the proposed rules will run for 60 days after the rules are published in the Federal Register. The SEC has asked for comments on, among other things:
Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues. If you have any questions about this Alert or would like to discuss the topic further, please contact your Foley attorney or the following:
Patrick G. Quick
Joshua A. Agen