Preparing for the SEC’s New Disclosure Requirements on CEO/Employee Pay Ratios
January 24, 2017
The Securities and Exchange Commission (SEC) recently released five Compliance and Disclosure Interpretations Questions and Answers (Q&As) providing additional guidance about the required disclosure of the ratio of public companies’ Chief Executive Officers’ total annual compensation to the median total compensation of all employees.
In August 2015, the SEC adopted rules implementing requirements under the Dodd-Frank Act amending the executive compensation disclosure regulations under Item 402 of Regulation S-K. The rules require public companies to disclose the ratio of total annual compensation of the Chief Executive Officer (or Principal Executive Officer, as stated in the rules) to the median total compensation of all employees. The rules state that companies can determine the median employee compensation as determined either in the same manner as the CEO’s total annual compensation in the Summary Compensation Table, in another “consistently applied compensation measure” (CACM), by statistical sampling, by reasonable estimates, or by other reasonable methods.
While the rules do not designate a specific preferred CACM to determine the median employee, the rules do state that the CACM must reflect the facts and circumstances of the registrant’s workforce. The rules also state that the population from which the median employee is identified must include all full-time, part-time, temporary, seasonal, and foreign employees. The final rules implementing the disclosure requirements are effective for fiscal years beginning on or after January 1, 2017 (Generally, the 2018 Proxy Season).
The Median Employee
Three of the recently released Q&As focus on identification of the median employee through the use of a CACM. Two such Q&As addressed how a registrant would select a CACM. The SEC’s guidance confirmed that an appropriate CACM would be based upon a registrant’s facts and circumstances and specifically noted that total cash compensation may not be appropriate if the registrant also broadly provides equity compensation and that Social Security taxes withheld would be a CACM but only if all employees earned less than the Social Security Wage base. The SEC further clarified that the use of hourly or annual rates of pay without consideration of hours worked would not be a CACM.
In the third Q&A related to the selection of a CACM, the SEC explained that when applying a CACM to identify the median employee, a registrant does not have to use the period that includes the date on which the employee population is determined, so long as there has not been a change in the employee population or compensation arrangements that would result in a significant change in the pay distribution of the workforce such that the period utilized would no longer accurately reflect the registrants facts and circumstances. A CACM may also entail using compensation over a period other than a full annual period.
The Employee Population
The remaining Q&As address whether certain categories of employees should be included in the population from which the median employee is determined. For furloughed employees, the SEC guidance states that a registrant must determine whether a furloughed person is an employee based on the registrant’s facts and circumstances because companies define furloughed employees differently. If a furloughed worker is an employee on the date the employee population is determined, such worker’s compensation should be determined using the same methodology as a non-furloughed employee.
For independent contractors, such workers are not considered employees if an independent third party determines their compensation. The SEC’s guidance provides that registrants should consider the composition of their workforce and overall employment and compensation practices in making determinations regarding employee/contractor status. The guidance related to independent contractors also provides the insights that (i) registrants are not considered to determine compensation if the registrant only specifies minimum compensation levels for services provided by unaffiliated third party contractors and (ii) the individual contractor may be the “unaffiliated third party” who determines his or her own compensation.
The five Q&As recently released by the SEC provide additional guidance for companies preparing disclosures to comply with the rules, which are effective for compensation disclosures for fiscal years beginning January 1, 2017.
Fortis Law Partners LLC is a boutique Denver law firm that represents middle-market public companies on SEC compliance matters, in addition to being a full service corporate, commercial, tax, real estate, litigation, and employment law firm. Please contact us to schedule an introductory meeting to review your company’s disclosures to ensure compliance with this updated guidance or any other securities issues.
For more information or to discuss specific scenarios, please contact:
Julie Herzog, Partner