Last week, the Securities and Exchange Commission (SEC) issued new guidance under its rule implementing the pay ratio disclosure requirement mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The guidance provides needed assistance to issuers and confirms that there will be no further administrative delay in the effectiveness of the new rules.
As congressional action at this point is unlikely, issuers should begin preparing now to comply with the pay ratio disclosure requirements.
The rule provides that, starting with its first annual report, annual proxy or information statement filed for fiscal years beginning in 2017, each public company (other than smaller reporting companies, emerging growth companies and foreign private issuers) will need to disclose as a ratio or multiple how the annual total compensation of its principal executive officer (PEO) compares to the annual total compensation of its median employee.
For each non-exempt calendar-year issuer, the first required disclosure will accompany its annual report or annual proxy or information statement filed in 2018 for its 2017 fiscal year. See here for previous discussion of the final rule.
To assist issuers with their compliance efforts, the SEC provided interpretive guidance under the following aspects of the rule:
Reasonable Estimates, Assumptions and Methodologies, and Statistical Sampling
The rule provides for the use of reasonable estimates, assumptions and methodologies to determine the median employee, including statistical sampling or consistently applied alternative compensation definitions, and the median employee’s annual total compensation. In response to concerns that the use of such estimates, assumptions or methodologies could lead to compliance uncertainty and liability (due to any inherent imprecision), the SEC confirmed that pay ratio disclosures resulting from the use of reasonable estimates, assumptions or methodologies would not provide a basis for SEC enforcement action unless such disclosures were made or reaffirmed unreasonably or were not provided in good faith.
Use of Existing Internal Records
The guidance confirms that an issuer may use appropriate existing internal records (e.g., tax or payroll records) for (i) determining whether the 5 percent de minimis exemption for non-U.S. employees is available, and (ii) when such internal records reasonably reflect annual compensation, for identifying the median employee, even if those records do not include every element of compensation, such as equity awards widely distributed to employees.
Although the rule generally provides for the mandatory inclusion of all employees when determining the median of the annual total compensation of all employees of the issuer (subject to certain data privacy and de minimis exclusions for non-U.S. employees), independent contractors (and leased employees whose compensation is provided by a third party) are excluded. The guidance confirms that an issuer may apply a widely recognized test under another area of law that the issuer otherwise uses to determine whether its workers are employees, such as determinations made under employment law or for tax purposes. The guidance specifically cites the Internal Revenue Service’s Publication 15-A Employer’s Supplemental Tax Guide (2017) as one such example.
Use of Sampling and Other Reasonable Methodologies
In addition to the interpretive guidance discussed above, the SEC issued a set of examples and hypotheticals illustrating certain instructions under the rule permitting issuers to use (i) reasonable estimates in the methodology used to identify the median employee and in calculating the annual total compensation or any elements of total compensation for employees, and (ii) its employee population or statistical sampling and/or other reasonable methods in determining the median employee.
The guidance provides specific examples of permissible sampling methods, situations where the use of reasonable estimates are appropriate, and other reasonable methodologies an issuer may use. It emphasizes that the rule is intended to provide substantial flexibility in how the pay ratio is determined, but notes that the sampling or other methodologies used must be reasonable and tailored to the issuer’s particular set of facts and circumstances. The guidance concludes with three hypothetical examples illustrating these principles.
Updated Compliance and Disclosure Interpretations
In connection with the issued guidance, the SEC updated its compliance and disclosure interpretations under the rule:
- Adding Question 128C.06 to confirm that, given the significant flexibility provided to issuers to identify the median employee, the SEC would not object if an issuer states in any required disclosure that the pay ratio is a reasonable estimate calculated in a manner consistent with Item 402(u).
- Revising Question 128C.01 to reference the new guidance that another consistently applied compensation measure used to identify the median employee includes internal records that reasonably reflect annual compensation, even if those records do not include every element of compensation, such as equity awards widely distributed to employees.
- Withdrawing Question 128C.05, which related to the identification and treatment of independent contractors and certain leased workers. As mentioned above, the new guidance confirms that an issuer may apply a widely recognized test under another area of law that the issuer otherwise uses to determine whether its workers are employees, such as determinations made under employment law or for tax purposes.
For further information, please contact one of the authors of this article — Taylor Wedge French, G. William Tysse and Robert B. Wynne — or any other member of the McGuireWoods employee benefits team.