The SEC recently adopted interpretive guidance to assist companies in their efforts to make the pay ratio disclosures mandated by the Dodd-Frank Act. The pay ratio rule requires issuers to disclose 1) the median annual total compensation of all employees, except the chief executive officer, 2) the annual total compensation of the CEO, and 3) the ratio of those two amounts in any annual report, proxy, or registration statement that requires disclosure of executive compensation pursuant to Item 402 of Regulation S-K. The rule is effective for issuers with fiscal years beginning on or after January 1, 2017, which means that issuers will begin making the pay ratio disclosures in early 2018.
As the pay ratio rule permits the use of estimates, assumptions and statistical sampling to determine the median employee, some constituents expressed concern about the compliance uncertainty and potential liability associated with the required disclosures. The SEC’s interpretive guidance was partly issued to alleviate these concerns and states that the Commission will not take an enforcement action that challenges a registrant’s pay ratio disclosures if the estimates have a reasonable basis and are made in good faith. The interpretive guidance also clarifies that:
- The consistently applied compensation measure used to calculate the median employee may be derived from existing internal, such as tax or payroll, records even if those records do not include every element of compensation, for example, equity awards.
- The determination of workers that meet the definition of an employee may be drawn from pre-existing published guidance under employment or tax laws.
The staff updated its compliance and disclosure interpretations to reflect the Commission guidance above and issued separate interpretive guidance to help registrants understand how they can utilize statistical sampling and estimates in making their pay ratio disclosures. The guidance provides hypothetical examples related to the use of sampling and other reasonable methodologies.
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