SEC adopts final rules on CEO pay ratio disclosures

Transcription

1 alert august 2015 SEC adopts final rules on CEO pay ratio disclosures Final rules mandate pay ratio disclosures that will require time-consuming and costly efforts for compliance. However, these disclosures will not be required until the 2018 proxy season. The Securities and Exchange Commission (SEC) on August 5, 2015 adopted final rules to implement the CEO pay ratio disclosure requirements of section 953(b) of the Dodd-Frank Act. While the new rules provide companies with some additional flexibility in complying with controversial disclosure requirements, they follow the basic approach of the 2013 proposals. The lengthy text of the final rules are available through this link. Overall, employers are likely to be disappointed by the SEC s failure to include many of the changes suggested to address the potential compliance costs imposed by the new rules. In particular, the final rules offer only limited relief regarding which employees need to be counted; employers with large workforces outside the U.S. will be especially frustrated. The final rules should prove burdensome in terms of compiling the information needed to accurately disclose what, to the general public, may appear to be a simple ratio. What is the CEO pay ratio disclosure requirement? Dodd-Frank section 953(b) directs the SEC to amend its current executive pay disclosure regulations to require companies to disclose: a. the median of the annual total compensation of all employees of the company except the CEO; b. the annual total compensation of the CEO; and c. the ratio of the amount in a. to the amount in b. The choices available to companies in presenting the pay ratio are described later in this alert under How must companies disclose the pay ratio? 1

2 When will a company first have to disclose its CEO pay ratio? Under the final rules, the first reporting period for a company that is subject to the CEO pay ratio disclosure requirements is its first full fiscal year beginning on or after January 1, Thus, at the earliest, a company will not have to disclose the pay ratio until its 2018 proxy statement. Where must a company disclose its CEO pay ratio? The CEO pay ratio and related disclosures must be made in a company s filings that require executive compensation disclosures, including annual reports (on Form 10-K), proxy or information statements, and registration statements. How does a company identify its employee population for purposes of determining the median employee? In the final rule the SEC provided that the term employee includes a company s full-time, parttime, seasonal, and temporary employees, including those employed by consolidated subsidiaries. Many employers will be disappointed that the SEC did not include a broad exemption of employees who are not employed full-time. Must non-u.s. employees be considered for median employee determinations? Are there any exemptions? Yes and yes. The final rules require the inclusion of non-u.s. employees in determining the median employee; however, there are two tailored exemptions. After considering the many comments received on the difficulties and costs attendant to the proposed rules inclusion of non-u.s. employees, the SEC crafted final rules that permit the use of two narrow, but potentially helpful, exclusions: non-u.s. employees where a foreign country s data privacy rules make the company unable to comply without violating those laws in spite of reasonable efforts to obtain the information (including a legal opinion supporting this determination); and a de minimis exemption of up to 5% of a company s non-u.s. employees, provided that (1) the 5% maximum include any non-u.s. employees excluded under the data privacy exemption and (2) if any employee(s) in a jurisdiction are excluded, all must be excluded. As of what date are a company s employees identified for median employee determinations? A company may choose any date within the last three months of its last completed fiscal year for purposes of identifying its employees. This is a most useful change from the proposed rule which required looking to the last day of the fiscal year. Thus, employers will be able to increase their workforces at year-end (such as commonly occurs for production and sales ramp-ups in connection with year-end holidays) without having to include these individuals in determining the median employee. However, if a company modifies the date used to identify its median employee, it must disclose the change and briefly describe why it was made. 2

3 How is a company s median employee determined? The final rules state that they provide a company with the flexibility to choose a method based on their own facts and circumstances. For example, the rules mention the ability to use: annual total compensation (as defined under the rules governing executive compensation disclosures); any other compensation measure that is consistently-applied to all included employees (such as information derived from tax or payroll records); and statistical sampling or other reasonable methods. The disclosure needs to include a brief description of the methodology used and any material assumptions, adjustments or estimates used to identify the median employee. Are cost-of-living adjustments permitted in identifying the median employee? Yes, the final rule reverses course from the proposals and allows companies to make cost-ofliving adjustments (COLAs) to the compensation of employees working in jurisdictions other than where the CEO resides, provided that the adjustment is applied to all such employees included in the median employee calculation. The adjustment would be made to reflect the cost-of-living in the CEO s country of residence. Companies are required to describe any COLAs they used and to also disclose the median employee s total annual compensation and the pay ratio both with and without the COLA. Does the median employee have to be re-determined each year? Not necessarily. The final rules, in a change from the 2013 proposals, permit a company to identify the median employee only once every three years, unless there has been a change in its employee population (or employee compensation arrangements) that likely would significantly impact its pay ratio disclosure. However, the median employee s total annual compensation (see next topic below) has to be determined each year. How does a company determine the pay ratio once the median employee is identified? After the median employee is identified, the company needs to calculate that employee s annual total compensation as determined in accordance with the SEC s rules regarding the disclosure of executive compensation. In this calculation, a company may include personal benefits totaling less than $10,000 and compensation under non-discriminatory benefit plans, provided that these then also are included in determining the CEO s annual total compensation. Reasonable estimates may be used in determining various items that comprise the median employee s annual total compensation, provided that such estimates are clearly described in the disclosure. The CEO s annual total compensation is calculated in a similar manner. How must companies disclose the pay ratio? Once the annual total compensation of each of the median employee and the CEO have been calculated, the pay ratio can be determined for the required disclosure. 3

4 The rules provide that a company may disclose pay ratio using one of two alternatives: a ratio in which the median employee s annual total compensation is equal to 1 and the CEO s annual total compensation is the number compared to 1 (e.g., 50 to 1 or 50:1); or narratively, by stating how many times higher the CEO s annual total compensation is to that of the median employee (e.g., the CEO s annual total compensation is 50 times that of the annual total compensation of the median employee). The final rules make clear that a company may supplement the required disclosures with additional information, such as other pay ratios or narrative discussions. Any supplemental disclosures must be clearly identified, not misleading, and of no greater prominence than the required pay ratio. Depending on a firm s CEO pay ratio as compared to its peers or to a broader group of reporting companies, the company may find it useful to explain why its pay ratio is so high (e.g., it has a relatively small executive population with a largely minimum wage workforce in a very competitive industry). What companies are exempt? While the CEO pay ratio disclosure requirements generally apply to reporting companies, there is an exemption for emerging growth companies, smaller reporting companies, and foreign private issuers. In addition, the final rules contain transition rules for business combinations or acquisitions as well as for newly public companies. Is the CEO pay ratio treated as filed for federal securities law purposes? Does this affect potential liabilities under such laws? Under the final rules, the pay ratio disclosure is filed (rather than merely furnished ) for purposes of the 1933 and 1934 securities acts. By treating these disclosures as filed, potential liability can arise under the Securities Exchange Act of 1934 in the event that these disclosures are determined to be false or misleading, unless it can be established that such actions were in good faith with no knowledge that the disclosure was false or misleading. What should a company do now? While there are more than two years before any CEO pay ratio information will need to be disclosed, a first step is to understand what may be required, given the company s particular facts and circumstances. Accordingly, we suggest that a working timeline now be developed withaction steps, responsible parties, and target completion dates. In this process, companies may need to balance (i) potential consequences of the disclosure of its pay ratio among various audiences (e.g., investors, proxy advisors, the press, the general public, employees) and (ii) cost considerations (i.e., what costs might a company incur to examine and make determinations under all potential alternatives in an effort to reduce its pay ratio to as low as possible?). An understanding of the permissible approaches will be needed, followed by some preliminary estimates under different methodologies. 4

5 The identification of a company s median employee is central to the process, which necessarily involves a consideration of the various alternatives and areas of flexibility in the final regulations. Questions to consider include: to what extent is the workforce part-time or seasonal? what testing date should be used? will statistical sampling be helpful (from cost and presentation perspectives)? what reasonable assumptions should be considered? if virtually all of the company s workforce is in the U.S., might the 5% de minimis exemption enable the company to avoid having to consider any non- U.S. employees? if non-u.s. employees constitute a significant portion of the overall workforce, are there any countries where data privacy laws may apply? These are just a few of the many questions that a company may need to address in preparing for any ultimate disclosures. In addition, the new rules are likely to have various indirect (and often unintended) consequences. For example, when the disclosures are made, half of the employee population will learn that they are paid below that of the median employee; human resources should be prepared to address questions from those employees who had not already realized that fact. Similarly, some boards may encounter arguments from CEOs that their low pay ratios demonstrate that they are underpaid. The compensation committee and human resources, in particular, need to understand the potential implications of the new rules. Responsibilities and due dates will have to be determined, allowing for timely analyses, discussions, and decisions. is the ability to use cost-of-living adjustments (for those residing in a different jurisdiction from the CEO) worth the additional complexity it may entail? what adjustments to payroll and other systems will be needed to implement the relevant determinations, calculations, and disclosures? what other information may be helpful? 5

6 for more information: Please contact the nearest member of your Hay Group team. Irv Becker US leader, board solutions Bill Gerek Regulatory expertise leader Board solutions US Steve Sabow Director of research Board solutions US Jim Otto Southeast regional leader Board solutions Atlanta Brian Tobin Midwest regional leader Board solutions Chicago Cory Morrow Southwest regional leader Board solutions Dallas Brian Holmen West coast regional leader Board solutions Los Angeles Greg Kopp Northeast/Mid-Atlantic regional leader Board solutions NY Metro/DC Metro Christine Rivers Board solutions Boston Dana Martin Board solutions Chicago Tim Bartlett Board solutions Kansas City Dan Moynihan Board solutions NY Metro Marty Somelofske Board solutions NY Metro Dave Wise Board solutions NY Metro Matt Kleger Board solutions Philadelphia Brandon Cherry Board solutions San Francisco w b blog.haygroup.com We believe that it s people who make change happen. So, while we operate on a global scale, we keep the individual at the very center of our thinking. We re world-sized: 4,000 employees, 86 offices, 49 countries. We draw on management data from over 125 national centers. We work alongside more than 8,000 organizations in the private, public and not-for-profit sectors, across every major industry, in virtually every corner of the earth. We re focused: on people who they are, why they do what they do, and how they can be inspired and enabled to perform better at every level. Confident of the knowledge and methods we ve originated over 70 years in business, we remain enthusiastic about new ideas that prove their worth. We transform: we help managers to become leaders, and leaders to perfect their skills. Because when people are at their best, your strategic vision is ready to grow into business reality. 6