Take 5 steps to prepare for pay ratio disclosure rules

Compensation Benefits: Pay ratio disclosure rulesThe SEC has finally adopted the long-awaited pay ratio disclosure rules requiring public companies to disclose the median of the annual total compensation for all employees except the CEO, the annual total compensation of the CEO and the ratio of the CEO’s annual total compensation to median employee annual total compensation. Companies aren’t required to comply with the rules until their first fiscal year beginning on or after Jan. 1, 2017, but they should start preparing now by understanding the disclosure requirements and the steps they’ll need to take.

The SEC released a proposed rule in 2013 to implement Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which requires U.S. public companies to disclose CEO total annual compensation, total annual compensation of the median employee and the ratio between these two items. After receiving comments during the rule-making period, the SEC Commission voted 3-2 to approve pay ratio rules, which included modifications to increase flexibility and reduce the costs and burdens of compliance.

Final rule highlights
Highlights of the final rule include the following:
  • The disclosure requirements don’t apply to emerging growth companies, smaller reporting companies, registered investment companies or foreign private issuers.
  • The new disclosures are required to be filed in a company’s annual report, proxy or information statement, or registration statement that requires executive compensation disclosures under Item 402 of Regulation S-K.
  • When identifying the median employee, consider all employees: full-time, part-time, seasonal or temporary employees, including non-U.S. employees, of the company and consolidated subsidiaries.
    • The final rule allows you to exempt non-U.S. employees when foreign data privacy laws make it impossible to comply. (You must obtain a legal opinion to qualify for exclusion.)
    • The final rule also permits a company to exempt non-U.S. employees when they account for 5% or less of the company’s total employees (U.S. and non-U.S.)
    • Compensation of part-time employees cannot be annualized to treat them as full-time equivalents; on the other hand, compensation of permanent employees who are hired midyear is allowed to be annualized.

  • When determining the median employee, cost-of-living adjustments are allowed for employees who live outside the CEO’s jurisdiction. However, the median employee’s annual total compensation and pay ratio without the cost of living adjustment must be disclosed.
  • When identifying the median employee, companies can choose a reasonable method that works best for them based on their own facts and circumstances.

    • Companies may use total compensation or other compensation measures that apply to all employees (i.e., taxable wages, cash compensation).
    • Companies may use statistical sampling or other reasonable methods.
    • Reasonable estimates may be used to calculate total annual compensation for employees other than the CEO.

  • Companies may identify the median employee once every three years and then calculate that individual employee’s annual total compensation each year for three reporting periods unless there’s a change in the employee population or compensation arrangements.
  • Companies may use any date within three months before the last day of the fiscal year to identify the median employee.
  • Companies can supplement the disclosure with additional ratios to provide shareholders with additional context.

5 steps to take now
Consider taking the following steps now:
  1. Create a team. Determine who should participate in preparing the pay ratio disclosures (for example, HR, finance and legal).
  2. Gather necessary compensation data. Start a dialogue with your payroll provider to devise a plan to collect compensation data. This is especially important for multinational companies whose employee compensation data may be housed on multiple systems and administered by multiple individuals or teams. Companies with foreign operations should also start to research privacy laws and identify countries from which they’ll be unable to retrieve data.  
  3. Determine the best method to identify the median employee. As previously stated, you have the flexibility to choose a method based on your own facts and circumstances; however, you must apply the method consistently every year. Determine the compensation measure and sampling procedures you’ll use to identify the median employee. The selected method should have longevity and not be chosen to achieve favorable ratios in the short term.
  4. Consider which date to use for the ratio (within three months of the fiscal year end). If you have a seasonal workforce, date selection could affect the ratio.
  5. Develop a communication strategy. You’ll need to find a way to tailor your message both internally and externally. Be proactive in determining what, if any, extra communication, disclosure and additional ratios will be appropriate. All employees will now see how their pay stacks up against employees at other companies. Companies need to start considering how they will handle the inevitable questions.

Now that the pay ratio disclosures have been finalized, companies and boards of directors must start preparing for their 2017 disclosures.

Brian Martin
+1 214 561 2289

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