New Guidance Eases—but Won’t Delay—CEO Pay Ratio Reporting

Public companies must begin disclosures with 2018 proxy statements

Stephen Miller, CEBS By Stephen Miller, CEBS September 28, 2017
New Guidance Eases—but Won’t Delay—CEO Pay Ratio Reporting

The U.S. Securities and Exchange Commission (SEC) published interpretive guidance in the Federal Register on Sept. 27, emphasizing that public companies have some flexibility to implement CEO pay ratio reporting, which they must begin doing next year. SEC staff also recently provided a corporate finance guidance memo for calculating the pay ratio and updated compliance and disclosure interpretations.

Public companies in the U.S. are required to disclose the ratio of CEO pay to median employee pay in their 2018 proxy statements—reporting on fiscal year 2017—under the Dodd-Frank financial reform law, passed in 2010. The SEC issued a final rule in 2015 and subsequent guidance last October (now revised). Most public companies have been working through the calculations involved for several months.

The new guidance, "to the extent practicable, allows companies to use operational data and otherwise readily available information to produce the disclosures," said SEC Chairman Jay Clayton in a statement.

In February, after President Donald Trump ordered federal agencies to look for ways to lessen burdensome business regulations, the SEC asked public companies for comments on any unexpected challenges they were facing as they prepared to comply with the pay ratio rule. The new guidance "reflects the feedback the SEC has received and encourages companies to use the flexibility incorporated in our prior rulemaking to reduce costs of compliance," Clayton said.

In particular, the interpretative guidance:

  • Explains the SEC's views on the use of reasonable estimates, assumptions and methodologies, and statistical sampling permitted by the rule.
  • Clarifies that a company may use appropriate existing internal records, such as tax or payroll documents, to identify the median employee and to calculate the median employee's annual total compensation.
  • Clarifies that appropriate internal records also can be used to determine if the company must include non-U.S. workers in pay ratio calculations (the SEC's final rule allowed companies to exclude non-U.S. employees if these employees account for 5 percent or less of the company's total workforce).
  • Provides guidelines on when a company may use widely recognized tests to determine whether its workers are employees for purposes of the rule, which will allow employers to exclude independent contractors from pay ratio calculations.

The additional staff guidance, which includes examples illustrating how reasonable estimates and statistical methodologies may be used, "is intended to assist companies with their compliance efforts and reduce the costs associated with preparing disclosures," noted Bill Hinman, director of the SEC's division of corporation finance. He encouraged companies to contact division staff if additional interpretive questions arise as the compliance date approaches.

[SHRM members-only toolkit: Designing Executive Compensation Plans]

No Implementation Delay

Under the Trump administration, many corporate chief financial officers had expected that the SEC's earlier guidance "would be either materially amended or that implementation would be delayed," Deb Lifshey, managing director of pay consultancy Pearl Meyer in New York City, wrote in an online post. However, she noted, "most of us gave up that last vestige of hope" last September when Hinman addressed the American Bar Association's business law section annual meeting and said that the SEC had no plans to delay implementation of the pay ratio rule. It is also unlikely that Congress will take steps to repeal the requirement before the compliance deadline, she said.

Compliance Flexibility

The new guidance "appears to be intended to mitigate the pain of compliance," Lifshey pointed out.

For instance, because computing the pay ratio involves a degree of imprecision, the interpretative guidance "states that if a company uses reasonable estimates, assumptions or methodologies, the pay ratio and related disclosure would not provide a basis for SEC enforcement action unless the disclosure was made or reaffirmed without a reasonable basis or was provided in bad faith," Lifshey explained. "So, if you get started early and do your due diligence by documenting all assumptions and methodologies, the risk of an SEC enforcement action is very low."

However, "it's unclear whether this guidance would impact private litigation," she added.

"Companies might now want to consider using statistical sampling to help determine the pay ratio, given that the SEC guidance should virtually eliminate data challenges for companies that choose this method," said Steve Seelig, senior regulatory advisor for executive compensation at Willis Towers Watson.

"With the SEC issuing very helpful guidance to help companies manage their data issues using statistical sampling, the clock is now ticking for companies to comply with the disclosure requirement," Seelig said.

Addressing Pay Fairness

In explaining the economics of setting CEO pay, "the disclosure is fraught with social justice questions," noted Steve Seelig, a senior executive compensation advisor with Willis Towers Watson and Jim Kohler, director of the consultancy's communication and change management practice, in a September blog post on the do's and don'ts of CEO pay ratio communications.

The disclosure was included in the Dodd-Frank Act "to create debate and hopefully foster changes in pay structures for the rank-and-file," they said. However, "for most companies, proxy disclosure is not the place to be relitigating the question of why CEOs are paid what they are."

They advised companies to prepare "robust communications about their employee value proposition to get ahead of the question of pay fairness" following the required disclosure. Aim to:

  • Help employees understand why their pay is fair and competitive, and that it's just one element of their total rewards.
  • Explain how pay ranges are set using a competitive analysis and how employees' positions within the ranges influence pay decisions.
  • Define what median means and how it affects calculation of the ratio.
  • Train managers to have effective pay discussions.
  • Help senior leadership know what the pay ratio means, how it compares to other organizations, and how to respond to questions without being defensive or dismissive.

"We have heard from many companies that given the flexibility provided in the regulations, they would rather find a median employee whose pay level is lower rather than seeking a higher median pay level that will yield a more favorable pay ratio," Seelig and Kohler said. "The logic is that they would prefer to have fewer workers find they are paid below that [median] level."

They added, however, that "the more important question will come even from those paid above median: am I being paid fairly when our pay ratio seems so large?"

Related SHRM Articles:

Preparing for CEO Pay Ratio Disclosures, SHRM Online Compensation, October 2016

How to Counter Employee Perceptions of Income Inequality, SHRM Online Compensation, May 2016


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