Pay Ratio Rule Continues Down Slow Road After Public Senatorial Scolding

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Coins and Hourglass

On Friday June 5, 2015, the SEC made incremental progress toward finalizing the “pay ratio” rule required by the 2010 Dodd-Frank Act by publishing a memo from the Division of Economic and Risk Analysis (DERA memo) that addresses questions about how that pay ratio will be calculated for the purposes of the law.

Dodd-Frank requires the SEC to draft and enforce a rule requiring companies to disclose:

  • The “median” of the annual total compensation of all employees of the company, except the principal or chief executive officer of the company;
  • The annual total compensation of the CEO; and
  • The ratio of the “median” of the annual total compensation of all employees to the annual total compensation of the CEO.

But the SEC has been stalled trying to determine how to define those terms and whether to retain any flexibility in how companies are permitted to calculate key components of the ratio, which could have a significant difference in how the ratio appears the public.  Some companies had advocated for using statistical sampling or excluding certain workers when calculating the median.  They argued, for example, that part time employees or employees in developing countries would skew the calculation, creating a ratio that was an unfair representation of compensation distribution at the company.  The DERA memo explores the potential effect of excluding certain categories of employees from the calculation of the ratio, finding that the exclusion of anywhere between 5% and 20% of employees from the calculation can cause a change in the ratio by 3.4-15%.  The SEC is accepting comments in response to the DERA memo through July 6.

Based on the most current September 2013 version of the proposed rule, the pay ratio companies generate and disclose will be deemed “filed” not “furnished.”  Therefore, like other Item 402 information, the disclosed pay ratio would be subject to potential liabilities under the Securities Act and the Exchange Act.  The more flexibility companies retain in determining how the ratio is calculated, the better positioned they will be to avoid such liability.

Publishing the DERA memo seemed to be, at least in part, the SEC’s  response to political pressure, in particular from Senator Elizabeth Warren of Massachusetts, who sent a letter to SEC Chair Mary Jo White on June 2 criticizing the slow response of the SEC on this very issue.  When White took over as SEC chair in the fall of 2013, the commission indicated it would have a rule in place by October 2014.  When that date came and went, the commission projected it would implement the rule in October 2015.  Warren accused White of misleading her as to the commission’s timeline in finalizing the rule and asked for an explanation of the inconsistencies and a detailed timeline.  White said that Warren’s letter was a “mischaracterization” of her statements and the SEC’s accomplishments.