The Five Most Important Things Companies Need to Know and Do About the SEC’s Proposed CEO Pay Ratio Rules
By Jim Barrall, Partner, Latham & Watkins LLP
Last Wednesday the SEC met and issued 162 pages of proposed rules and commentary under Section 953(b) of the Dodd Frank Act, which requires U.S. public companies to disclose the ratio of the total compensation of the their median compensated employee to that of their CEO. Here is Latham’s Corporate Governance Alert describing the rules.
As all who work on U.S. executive compensation and corporate governance matters know, Section 953(b) is very poorly drafted and poses formidable challenges for the SEC and its staff in trying carry out the statutory mandate (without any clear statement of the objectives or intended benefits of the statute, as noted by the SEC) while also attempting to control the costs and burdens of compliance which would be substantial if the terms of the statute were literally and narrowly construed. (See my Wall Street Journal CFO Report opinion, which was published on the eve of the SEC’s meeting, which describes the problems with the statute).
While the SEC’s final rules will hopefully be more workable, the SEC and staff are to be commended for the very heavy lifting they have already done in considering more than 22,000 comment letters filed even before rules were proposed, forthrightly identifying problems with the statute and potential problems with the rules and inviting company and investor comments to improve them.
Here are the five most important things that companies should now know and do about the rules, as they have been proposed:
- The rules do not apply to emerging growth companies, smaller reporting companies, or foreign private issuers, leaving nearly 4,000 companies subject to the rules. Further, disclosure is only required for those companies in those SEC filings that require executive compensation disclosure under Item 402 of Regulation S-K. No disclosure would be required in IPO registration statements, 8-Ks, and other filings that could have been subjected to the statute. These rules are far better than they could have been.
- The rules would first apply in a company’s first fiscal year beginning on or after the final rule becomes effective and, in general, the disclosure would be required to be made in the first annual proxy after that year. Given the SEC’s 60 day comment period (which starts when the proposed rules are published in the Federal Register this coming week) and the large number of open issues and comments likely to be filed with respect to the proposed rules, it is not likely that final rules will take effect this year. If the final rules take effect in 2014, as is reasonably likely, calendar year companies first would become subject to the rules in 2015 and would need to make their first required disclosures in their 2016 proxies.
- In addition to proposing helpful rules on companies not subject to the statute and on its effective date, the SEC has provided companies with substantial flexibility in permitting the use of statistical sampling or reasonable estimates for determining employee compensation and has allowed the use of simplified compensation measures to identify the company’s median employee, without requiring companies to determine the Summary Compensation Table compensation of every employee, as some feared might be the case.
- The rules are most inflexible and administratively expensive and burdensome in requiring that all employees of a company and its subsidiaries (broadly defined) be taken into account in identifying the median employee, including part-time, seasonal, and temporary employees, no matter where in the world employed. Unless these rules are liberalized, they will impose substantial costs and administrative burdens on companies with large numbers of employees, especially if they are employed around the world and in different lines of business with high pay variances.
- During the next 60 days, companies should determine how they would go about gathering and analyzing the information necessary to comply with the rules and should file comments with the SEC discussing the costs and burdens of doing so, using the SEC’s 69 requests for comments as a guide. Fruitful areas for companies to address are:
- the broad classifications of employees that need to be taken into account
- the data bases that would need to be built and analyzed
- the information and technical difficulties of using statistical samplings or other reasonable estimation techniques and consistently applied compensation measures to identify the median compensated employee (even using simplified definitions of compensation) and
- the impact of data privacy laws.
It is clear from the rules and commentary that these are key areas where the SEC and its staff would benefit from unemotional, concrete, and granular input from companies and their advisors.
Given the statute’s uncertain and unquantifiable benefits and very substantial doubts as to the value to investors of CEO pay ratio disclosures, no matter how constructed, there is room to believe that shining bright lights on the administrative costs and burdens of the rules will improve them. As has been said about compensation disclosure rules in other contexts, sunlight indeed is the best disinfectant.
About the Guest Blogger:
James D. C. Barrall is a partner in the Los Angeles office of Latham & Watkins LLP and is the Global Co-Chair of the firm’s Benefits and Compensation Practice. Mr. Barrall specializes in executive compensation, corporate governance, employee benefits, and compensation related disclosure and regulatory matters.
Mr. Barrall is a frequent author, contributing editor, and lecturer on executive compensation, corporate governance, disclosure, and other regulatory matters. He is a co-author of the chapter on extensions of credit to directors and officers in the American Bar Association’s Practitioner’s Guide to the Sarbanes-Oxley Act.
Mr. Barrall has lectured at the UCLA Law School, the UCLA Anderson School of Management, and the Aresty Institute of Executive Education at the Wharton School, University of Pennsylvania. Mr. Barrall is a member of the Board of Advisors of the UCLA School of Law and the Lowell Milken Institute for Business Law and Policy.