SEC Corp Fin Staff Releases Guidance on CEO Pay Ratio Disclosure

C&DIs 128C.01 through 128C.05 address five topics: (1) the identification of a “consistently applied compensation measure” to identify the median employee; (2) the use of hourly or annual rates of pay as a “consistently applied compensation measure;” (3) the time period(s) that may be used in applying a “consistently applied compensation measure;” (4) the treatment of furloughed employees; and (5) the circumstances under which a worker’s compensation will be deemed determined by an unaffiliated third party.  In summary, the takeaways from the Staff’s new C&DIs are as follows: 

• Under the final pay ratio rule, companies are permitted to choose annual total compensation or any other compensation measure that is consistently applied to all employees to identify the median employee.  C&DI 128C.01 elaborates beyond what is in the adopting release on what measures can qualify as “consistently applied compensation measures.”  Specifically, under the Staff’s interpretation, a “consistently applied compensation measure” should "reasonably reflect[] the annual compensation of employees.”  The appropriateness of any measure as a “consistently applied compensation measure” will depend on the company’s particular facts and circumstances.  For example, total cash compensation could be an appropriate “consistently applied compensation measure” unless a company also distributed annual equity awards widely among employees, and Social Security taxes withheld would likely not be an appropriate “consistently applied compensation measure” unless all employees earned less than the Social Security wage base. 

• Use of an hourly or annual pay rate alone is not an appropriate “consistently applied compensation measure” because use of rates without regard to whether an employee worked the entire year and/or full time will have the effect of a full-time adjustment, which is not permitted under Item 402(u). 

• As set forth in the final pay ratio rule, to calculate the required pay ratio, a company must first select a date, which must be within three months of the end of its fiscal year, to determine its employee population. Once the employee population is determined, the company must then identify the median employee from that population using either annual total compensation or another “consistently applied compensation measure.”  C&DI 128C.03 states that when using a “consistently applied compensation measure” to identify the median employee, a company is not required to measure compensation across a time period that includes the date on which the employee population is determined.  Practically speaking, a company may use the compensation paid in its prior fiscal year so long as there has not been a change in the company’s employee population or compensation arrangements that would result in a significant change to its workforce pay distribution.

• Furloughed employees should be treated using the same methods used for non-furloughed employees (e.g., if they are employed as of the date the company determines its employee population, they should be included in the process for determining the median employee, and the analysis should account for whether they were full-time, part-time, temporary, or seasonal). 

• As set forth in the final pay ratio rule, companies may exclude any workers who are “independent contractors and ‘leased’ workers who are employed by, and whose compensation is determined by, an unaffiliated third party.”  C&DI 128C.05 states that when a company obtains the services of workers by contracting with an unaffiliated third party that employs the workers, the company will not be deemed as determining the workers’ compensation if, for example, the company only specifies that those workers receive a minimum level of compensation.  The Staff also stated that an individual who is an independent contractor and “determines his or her own compensation” need not be treated as an employee, although this statement leaves a number of unanswered questions regarding what degree of company involvement would result in that individual being treated as a covered company worker.

Special thanks to Sarah Fortt for compiling the summary above.