SEC Issues Additional Guidance on CEO Pay Ratio Rules
The SEC recently released additional guidance to companies related to the CEO pay ratio requirements in Item 402(u) of Regulation S-K and the relevant methodologies required for its calculation. For further information on CEO pay ratio disclosure, please see our analysis of the final rules here.
Companies will be required to disclose the pay ratio starting in their 2018 proxy statements. The additional guidance offered is as follows:
Method of Calculation
- Determination of median employee
- If a company is unable to use total annual compensation to determine the median employee, it may use a different method, referred to as a consistently applied compensation measure (“CACM”). The SEC provided additional insight on the usage of a CACM in that any measure that reasonably reflects the annual compensation of employees may serve as one. The appropriateness of the measure as a CACM will depend on the company’s particular facts and circumstances.
- Rates of pay
- Companies may not exclusively use hourly or annual pay rates as a CACM to determine the median employee. Rates of pay may still be used as a component to determine an employee’s overall compensation.
- Time period
- When a company determines the median employee, it must be done from an employee population selected at a point in time that is within the last three months of its fiscal year. The additional guidance clarifies that, if using a CACM to determine the median employee, the company does not have to apply the CACM in the specific time period that includes the date on which the employee population was determined, nor is it required to use a full annual period. A CACM could use annual compensation from the previous year, as long as the use of the prior year data does not result in a significant change in pay distribution to the workforce.
- The original regulations did not address furloughed workers. The additional guidance observes that a furlough could have different meanings for different employers and thus firms will need to determine whether furloughed workers should be included in the employee population based on its own set of facts and circumstances. Further, if furloughed workers are included they then must be classified as one of the four classes of employees: full-time, part-time, temporary or seasonal. Once classified, the company should then determine furloughed employees’ annual compensation. Companies may annualize compensation for furloughed workers classified as full- or part-time. However, compensation cannot be annualized for furloughed workers classified as temporary or seasonal.
- A company should include any worker for whom the company (or one of its subsidiaries) determines the compensation, even if the worker is not considered an “employee” for tax or employment law purposes or under other definitions of that term. If a company is obtaining the services of workers by contracting with an unaffiliated third party that employs the workers, the SEC does not believe the company is determining the workers’ compensation for purposes of the rule.
Although not required for the 2017 proxy season, we recommend companies begin to prepare for implementation and familiarize themselves with the calculations and methodologies required. Companies should ensure that the necessary data to calculate the ratio is available. This may require the creation of a multi-disciplinary project team, including members of the Human Resources, Finance, and Legal departments.
Due to the flexibility of the rules in determining the median employee, companies should consider the various approaches it may use and model out the results under each to help determine the most appropriate method of calculation.
As the approach is finalized and anticipated values are calculated, determine those details which might be most helpful in providing context, and how to incorporate that information in public disclosure, including the CD&A, shareholder outreach efforts, the media and elsewhere.
Due to the complicated nature of the rules, we expect the SEC to provide further guidance over the course of 2017. We will keep you updated as the SEC releases additional direction. As always, we stand ready to assist with any questions that may arise in the implementation of this rule or the crafting of the required disclosure.