When Will Compliance With the Pay Ratio Rules Be Required?
Issuers will be required to comply with the new rules with respect to compensation for full fiscal years beginning on and after January 1, 2017. Disclosure of the pay ratio will first be required in the annual report covering 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, in the normal course for calendar year issuers, the pay ratio will first be required in the proxy or information statement for the 2018 annual meeting, based on 2017 compensation.
Are the Final Rules Similar to the Proposed Rules Issued in 2013?
Several aspects of the final rules are unchanged from the proposed rules:
What Are the Most Significant Differences in the Final Rules Compared to the Proposed Rules?
Although the overall framework of the final rules is similar to the proposed rules, the final rules include a number of changes, most of which provide additional flexibility to issuers:
What Should Companies Do to Prepare for the Pay Ratio Disclosures?
Detailed Summary of the Final Rules
A detailed summary of the final pay ratio rules follows below.
Components and Scope of the Required Disclosure. The rules will require U.S. issuers subject to the reporting requirements of the Securities Exchange Act of 1934, other than smaller reporting companies, emerging growth companies, foreign private issuers and U.S.-Canadian Multijurisdictional Disclosure System filers to disclose the following items:
This disclosure will 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.
Calculation of Pay for Purposes of the Ratio. Both the Median Pay and the CEO Pay will be calculated on the same basis as 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 final rules, companies may, but are not required to, annualize the total compensation for all permanent full-time and part-time employees who were employed for less than the full fiscal year. However, the rules will not permit full-time adjustments for part-time workers or annualization for temporary or seasonal employees. A company may use reasonable estimates to determine the Median Pay, but not the CEO Pay.
Personal benefits aggregating less than $10,000 and compensation under non-discriminatory benefit plans may be included in the median employee’s annual compensation so long as the items are also included in the CEO’s annual compensation. Any material difference between the CEO’s annual compensation used in the pay ratio disclosure and the compensation shown in the Summary Compensation Table will need to be explained.
Identifying the Median Employee. In identifying the median employee whose pay will be the basis for the Median Pay, the potential pool of employees will include all individuals employed by the listed company or any of its consolidated subsidiaries on a single date during the last three months of the most recently completed fiscal year. The listed company may identify any date during the three month period for purposes of identifying the median employee. If the date selected by the company changes from year to year, the company must explain the reason for the change.
The pool of employees will include all full-time, part-time, seasonal, or temporary workers employed on the day selected by the company, whether located in the U.S. or outside the U.S. (subject to limited exceptions for certain non-U.S. employees described below). There is no exclusion for employees who are subject to a collective bargaining agreement. However, the definition of employee would not include those workers who are employed, and whose compensation is determined, by an unaffiliated third party but who provide services to the company or its consolidated subsidiaries as independent contractors or leased workers.
Non-U.S. employees may be excluded in two limited circumstances:
Employees of an acquired business may be excluded from the determination of the median employee for the year in which the acquisition occurs, but the approximate number of employees omitted must be disclosed and the employees should be included in the total employee count for the triennial calculations of the median employee in the year following the transaction for purposes of evaluating whether a significant change has occurred. The company must identify any acquired business the employees of which are excluded under this rule.
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 annual compensation measure that is consistently applied to all employees included in the calculation. The 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.
In identifying the median employee, companies may (but are not required to) make cost-of-living adjustments to the compensation of employees in jurisdictions other than the jurisdiction in which the CEO resides so that the compensation is adjusted to the cost of living in the jurisdiction in which the CEO resides. If a cost-of-living adjustment is made to identify the median employee, and the median employee resides in a jurisdiction different from the CEO, then the same cost-of-living adjustment must be used in calculating the median employee’s annual total compensation. In this situation, the jurisdiction of the employee must be disclosed, along with a brief description of the cost-of-living adjustments used and the median employee’s annual total compensation and pay ratio without the adjustments.
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 median employee will need to be identified only once every three years, unless there was a change in the employee population or employee compensation arrangements during the company’s last completed fiscal year that the company reasonably believes would significantly affect the pay ratio disclosure. The median employee’s Median Pay, however, must be recalculated each year.
If the company uses the same median employee for multiple years, it must disclose that fact and describe the basis for its reasonable belief that no changes have occurred that would significantly affect the pay ratio disclosure. If there is a change in the median employee’s circumstances that the company reasonably believes would result in a significant change in its pay ratio disclosure, the company may use another employee whose compensation is substantially similar to the original median employee based on the compensation measure used to select the original median employee.
Transition Periods. The rules include a one-year transition period for newly public companies and companies that cease to be smaller reporting companies or emerging growth companies.
Status of Pay Ratio as Filed Rather Than Furnished. Under the final rules, the pay ratio disclosure will be considered “filed,” and 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.
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 update or would like to discuss the topic further, please contact your Foley attorney or the following:
Joshua A. Agen
Leigh C. Riley