The SEC released interpretive guidance on compliance with the pay ratio disclosure rule, which mandates that companies begin filing reports in early 2018 (for fiscal year 2017). Under the pay ratio disclosure rule, a public company is obligated to disclose (i) the median of the annual total compensation of all its employees, except that of the CEO, (ii) the annual total compensation of its CEO, and (iii) the ratio of those two amounts.
As explained in the guidance, a company has “significant flexibility” in determining the appropriate methodology to identify its median employee. The SEC acknowledged that industry members expressed concerns about compliance and liability due to the imprecision that could arise from estimation. The guidance states that “if a registrant uses reasonable estimates, assumptions or methodologies, the pay ratio and related disclosure that results from such use would not provide the basis for Commission enforcement action unless the disclosure was made or reaffirmed without a reasonable basis or was provided other than in good faith.”
The guidance also details how a company is permitted to use payroll or tax records to (i) identify a median employee and (ii) make a determination about the inclusion of non-U.S. employees. Under the rule, non-U.S. employees representing up to 5% of the company’s total personnel generally are exempted from calculations.
In separate staff guidance, SEC Division of Corporation Finance Staff outlined important information regarding reasonable methodologies for calculations as required by the pay ratio disclosure rule.
Lofchie Comment: Given the absence of any specific requirements as to how the compensation calculation should be made and the complete absence of any reasonable policy rationale for this rule (after all, the CEO’s salary is disclosed), issuers have significant flexibility as to how to comply with this rule. Don’t waste resources overthinking the reporting methodology. The important compliance rules are (i) choose a methodology (doesn’t really matter what it is), (ii) fully document it, and (iii) stick to it rigidly.