Heads Up — SEC issues final rule on pay ratio disclosure
The SEC recently issued a final rule on pay ratio disclosure in response to a mandate in Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Registrants must adopt the final rule for their first fiscal year beginning on or after January 1, 2017.
Scope and Exemptions
Under the final rule, a registrant must annually disclose (1) the median of the annual total compensation of all its employees (excluding the individual that the SEC describes as the principal executive officer (PEO) and that is referred to herein as the chief executive officer (CEO)), (2) the annual total compensation of its CEO, and (3) the ratio of the median of the annual total compensation of all its employees to the annual total compensation of its CEO.
If the median annual total compensation of a registrant’s employees is $50,000 and the annual total compensation of its CEO is $2,500,000, the CEO’s compensation is 50 times larger than the median employee’s compensation.
The pay ratio may be described numerically either as 50 to 1 or 50:1 or narratively (e.g., “the PEO’s annual total compensation is 50 times that of the median of the annual total compensation of all employees”).
The final rule adds paragraph (u) to Regulation S-K, Item 402, and requires registrants to disclose their pay ratio in any filing described in Regulation S-K, Item 10(a), for which executive compensation disclosure is required under Item 402 (e.g., an annual report on Form 10-K, registration statement under the Securities Act and Exchange Act, proxy and information statement). However, the disclosure requirement does not apply to emerging growth companies, smaller reporting companies, foreign private issuers, or U.S.–Canadian multijurisdictional disclosure system filers.
Definition of “Employee” Under the Rule
The final rule’s definition of “employee” encompasses all “full-time, part-time, seasonal, and temporary employees employed by the registrant or any of its consolidated subsidiaries.” Independent contractors or “leased” workers that provide services to a registrant or its consolidated subsidiaries, and whose compensation is determined by an unaffiliated third party, are not considered employees and must be excluded from a registrant’s identification of its median employee.
Editor’s Note: Employees hired as contractors and not employed by a third party appear to be part of the population a registrant uses to determine its median employee. This could be an unintended result of the rulemaking, and the SEC may need to release additional guidance to clarify this point.
The proposed rule defined an employee as an individual employed on the last day of the fiscal year; however, the final rule defines an “employee” as an individual employed on any date of the registrant’s choosing within the last three months of the registrant’s last completed fiscal year. Registrants must disclose the date used to identify the median employee but not the rationale for selecting that particular date.
Editor’s Note: The three-month rule may make it easier for employers to identify the median employee by eliminating part-time and seasonal employees hired in the fourth quarter of the fiscal year.
Although the final rule defines “employee” as a registrant’s U.S. and non-U.S. employees, the SEC provides two exemptions from this definition to alleviate potential difficulties associated with collecting global compensation data.
Data Privacy Exemption
he final rule’s definition of “employee” does not apply to workers in foreign jurisdictions in which a registrant cannot obtain the compensation data it needs to comply with the rule without violating local data privacy laws.
To qualify for this exemption, a registrant must first make “reasonable efforts” to collect the required compensation data. The rule states that such efforts would entail seeking an exemption under the applicable jurisdiction’s data privacy laws and using that exemption if it is granted. Registrants that use the data privacy exemption also must:
- Disclose each jurisdiction that was excluded.
- Identify the specific data privacy laws or regulations for each jurisdiction and explain how complying with the final rule violates such laws or regulations.
- Note any efforts to obtain an exemption under the data privacy laws.
- Exclude all non-U.S. employees in any jurisdiction in which the exemption is used
(i.e., registrants cannot choose to exclude only a subset of that jurisdiction’s employees from the definition of employee).
- Disclose the estimated number of employees from each jurisdiction that have been exempted as a result of data privacy laws.
- Obtain and file as an exhibit a legal opinion on the registrant’s inability to collect the compensation data necessary to comply with the final rule without violating the jurisdiction’s data privacy laws.
De Minimis Exemption
The final rule also contains a de minimis exemption for non-U.S. employees. To apply this exemption, a registrant must have a non-U.S. employee workforce that makes up 5 percent or less of the total employee population. Such a registrant may choose to exclude all of those non-U.S. employees when determining the median employee but is not permitted to exclude only a portion of its non-U.S. workforce. If more than 5 percent of a registrant’s workforce is composed of non-U.S. employees, the registrant may exclude up to 5 percent of these employees; however, it must exclude all employees located in a particular jurisdiction (i.e., it cannot exclude a subset of employees from one jurisdiction and employees from other jurisdictions to arrive at the 5 percent threshold).
A registrant using the de minimis exemption must disclose:
- The jurisdiction(s) of the excluded employees.
- The approximate number of employees excluded from each jurisdiction.
- The total number of its U.S. and non-U.S. employees before any exemption (data privacy or de minimis) is used.
- The total number of U.S. and non-U.S. employees used for its de minimis calculation.
Non-U.S. employees excluded from the determination of the median employee under the data privacy exemption count against the 5 percent de minimis threshold. Although a registrant may exclude any non-U.S. employee that meets the data privacy exemption, if the number of excluded employees under the data privacy exemption equals or exceeds 5 percent of total employees, the registrant may not use the de minimis exemption to exclude additional employees.
Editor’s Note: Although registrants can exclude up to 5 percent of their non-U.S. employees, they are still required to track and disclose the number of total employees that reside outside of the United States.
Furthermore, if 5 percent or more of a registrant’s non-U.S. workforce is located in a single country, it would not be able to exclude any of these employees from its median employee determination. This is because the final rule states that registrants must exclude all employees from the same jurisdiction, and excluding all of the employees from that country would violate the 5 percent de minimis cap.
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