New SEC Staff Guidance on Pay Ratio Disclosure: Guidance Reinforces Flexibility in Identifying the Median Employee While Maintaining Limits on Annualizing Compensation

Sullivan & Cromwell LLP - October 19, 2016
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The Securities and Exchange Commission’s Division of Corporation Finance has posted on its website five new Compliance and Disclosure Interpretations regarding the CEO pay ratio disclosure, which will be required for most U.S. public companies beginning with the 2018 proxy season. All of the new interpretations (which are set out in Annex A of this publication) relate to determining the median employee for purposes of the ratio. 
 

  • The guidance makes clear that a consistently applied compensation measure, or CACM, that is used to identify the median employee may cover less than an annual period, may cover a time period that does not include the date on which the employee population was determined, and may generally consist of annual total compensation from the registrant’s prior fiscal year.
  •  While reinforcing flexibility, the guidance notes examples of measures that would generally not be permissible CACMs because they do not reasonably reflect the annual compensation of employees, including the use of:
  • cash compensation when employees widely receive equity awards;
  • hourly or other rates of pay without factoring in time worked; and
  • Social Security taxes unless all employees earn less than the Social Security wage base.

Even though the new disclosure will not be required until the 2018 proxy season, companies may find it helpful to conduct dry-runs of the calculation based on past compensation data in order to develop an appropriate methodology, identify and resolve interpretive, practical or disclosure issues, and ensure that systems are in place to capture information necessary to support the chosen methodology.