Ask and thou shalt receive. When the Securities and Exchange Commission proposed its controversial pay ratio disclosure rule in 2013, it included a list of nearly 60 questions for public comment.
The response: 287,547 letters and counting.
Granted, tens of thousands of those missives were form letters prodding for the SEC to hurry up and finish the rule, which would require public companies to disclose the ratio of CEO pay to that of the median employee. Many more, however, did include suggestions for making the rule workable and less of a compliance burden.
According to persistent rumors, a final version is due to arrive sometime later this summer (believe that when you see it)—but already the proposal is one of the most commented-upon in SEC history. We took a look at some of the more intriguing suggestions so far that might influence what arrives in final form.
Employee Exclusions?
A common concern has been the international scope of the rule. The lack of centralized payroll systems, differences in the cost of living among various countries, and currency exchange rate fluctuations all complicate the calculation. Companies with a large number of part-time, seasonal, and temporary employees worry that those populations will negatively skew their ratio.
In June, the SEC’s Division of Economic and Risk Analysis released a study on the potential effects of excluding various percentages of employees from the pay ratio calculation. The DERA research found that excluding 40 percent of an employee population would result in a decrease in the pay ratio of less than 11 percent.
That suggests the SEC should include a principles-based exclusion in the final rule and give companies the flexibility to exclude “substantial percentages of employees where the data is difficult to obtain and where the impact would not be significant,” wrote Timothy Bartl, president of Center on Executive Compensation.
“The potential for very large, very diverse companies to make innocuous mistakes in gathering and verifying this information is substantial, and subjecting issuers to liabilities for these mistakes is neither sensible nor reasonable.”
Kevin Burke, President, American Apparel & Footwear Association
“A reduction or increase in the ratio of these amounts has a negligible impact on the pay ratio, but has the potential to materially reduce the substantial direct and indirect compliance costs facing companies as a result of the disclosure,” he added. Using that 40 percent exemption threshold as a guide, “registrants could avoid engaging in extensive and costly data collection on employees in countries with strict data privacy laws or in areas where there are de minimis employee populations.”
Who Gets Counted?
The Center on Executive Compensation proposes that the Commission only require U.S. employees in the pay ratio calculation. It should also permit full-time equivalent adjustments for part time, temporary, and seasonal employees.
Bartl estimated that excluding foreign employees would reduce compliance costs by nearly half and remove issues associated with foreign data privacy laws, exchange rates, and the difficulty inherent in finding a consistent compensation metric across geographies. Excluding part-time employees would reduce costs by an additional 20 percent.
Manufacturers are concerned that the SEC has not, in their view, adequately considered the challenge posed by the varying types and standards of compensation in different countries, wrote Carolyn Holmes Lee, senior director of tax policy for the National Association of Manufacturers.
Even a suggested alternative from one NAM member, to consider using base salary as a consistent measure, is problematic because base salary is not defined the same among countries. “In India, for example, the usual measure of what we would call ‘base salary’ is really ‘guaranteed cash’ compensation, which includes several types of benefits including car, cell phone, and housing allowances,” she wrote.
The following is an overview of the Securities and Exchange Commission’s proposed pay ratio rule.
As required by the Dodd-Frank Act, the proposal would amend existing executive compensation disclosure rules to require companies to disclose:
• The median of the annual total compensation of all its employees except the CEO.
• The annual total compensation of its CEO.
• The ratio of the two amounts.
The proposed rule would not specify any required calculation methodologies for identifying the median employee in terms of total compensation for all employees. Instead, it would allow companies to select a methodology that is appropriate to the size and structure of their own businesses and the way they compensate employees.
For example, a company would be permitted to identify the median employee based on total compensation using either its full employee population or a statistical sample of that population.
A company could, for example, identify the median of its population or sample:
Using annual total compensation as determined under existing executive compensation rules.
Using any consistently used compensation measure such as compensation amounts reported in its payroll or tax records. A company would then calculate the annual total compensation for that median employee in accordance with the definition of total compensation set forth in the SEC’s executive compensation rules.
The proposal would allow companies to use reasonable estimates when:
Calculating the annual total compensation.
Calculating any element of total compensation.
Determining the annual total compensation of the median employee.
All employees of the registrant” would include:
All employees (including full-time, part-time, temporary, seasonal and non-U.S. employees)
Those employed by the company or any of its subsidiaries.
Those employed as of the last day of the company’s prior fiscal year.
Companies would be required to disclose the methodology used to identify the median, and any material assumptions, adjustments or estimates used to identify the median or to determine total compensation.
Source: SEC.
Applauding the SEC’s willingness to exclude leased workers, Catherine Dixon, chairman of the American Bar Association’s Federal Regulation of Securities Committee, suggested excluding foreign employees if a majority of the registrant’s employees, as well as its principal executive officer, work in the United States.
If the SEC determines it does not have the statutory authority for a full exclusion, it should instead consider a de minimis safe harbor where a company could exclude those non-U.S. employees working in any foreign country in which less than 5 percent of the company’s aggregate global workforce is employed, wrote Lynn Dudley, senior vice president for the American Benefits Council. At a minimum, she suggested, the SEC should allow companies to annualize the pay of part-time employees and seasonally hired or temporary employees.
Statistical Sampling
As for the SEC’s plan to allow statistical sampling, Lee fears it “is not a panacea” and doesn’t ease the main costs and burdens of determining the pay ratio. Sampling would only be helpful if an organization already has an expensive process in place, she explained. Costs are heavily weighted to the beginning of the process, when a company is trying to assemble either a list of employees for the sample, or trying to stratify and segment the employee population.
“To create a statistically viable random sample of their workforce, most companies would still have to obtain much of the same information and engage in similar data-gathering processes as those calculating pay for the entire employee population,” Bartl added.
More Suggestions
Among NAM’s suggestions for a final rule: allowing use of an algorithm designed to estimate the median employee’s compensation using salary data and statistics for each business location; the ability to use the previous year’s data; and a safe harbor that allows companies to use the ratio for domestic employees to estimate a final ratio that includes non-U.S. workers.
Several commenters argued that the disclosures be “furnished” and not “filed” with the SEC because the ratio will be based on an estimate, thereby making Sarbanes-Oxley certification inappropriate. “The potential for very large, very diverse companies to make innocuous mistakes in gathering and verifying this information is substantial, and subjecting issuers to liabilities for these mistakes is neither sensible nor reasonable,” wrote Kevin Burke, president of the American Apparel & Footwear Association.
As long as each registrant accurately describes the calculation it used, is consistent year-to-year, and discloses whether and how it chose to deviate from the previous year’s methodology, the SEC should allow registrants to develop a process for collecting, verifying, and aggregating the needed data that is the most cost-effective for them, the ABA’s Dixon wrote.
She, along with a comment letter from the National Association of Corporate Directors, recommends that companies be permitted to supply a supplemental pay ratio using solely Form W-2 wages, tips, and other compensation. This would provide additional information to investors if there are concerns that using the total compensation of the principal executive officer would distort the ratio.
With many of its members expressing concern that they would not have ready access to compensation data from partially owned subsidiaries and joint ventures, the American Benefits Council asked the SEC to consider excluding those entities.
A joint letter on behalf of 33 companies—among them Best Buy, Bristol-Myers Squibb, Cigna, Eli Lilly, Mondelez International, and Xerox Corp.—urged the SEC to allow companies discretion when choosing the reference date they use when identifying the median employee for a given year.
The Ubiquitous Concern
Tom Quaadman, vice president of the U.S. Chamber Center for Capital Markets Competitiveness, was among the many expressing concerns about compliance costs.
The SEC estimates that the rule would impose 545,792 annual hours of paperwork, which works out to 190 hours per company, and $72.7 million in costs. The Chamber’s efforts to “derive a number based on more than mere whimsy” led to a survey of 118 companies where respondents estimated an average of 952 hours per year, with average labor cost of $185,600. That extrapolates to an annual cost to the private sector of $710 million and 3.6 million man-hours a year. “The SEC likely underestimated costs by more than 870 percent and underestimated compliance time by 560 percent,” Quaadman wrote.
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