SEC Adopts Divisive Pay Ratio Rule

After years of anticipation (and no small dose of dread) the Securities and Exchange Commission’s pay ratio rule is now final. The Commission approved the rule on Wednesday with a 3-2 vote, with Republican commissioners Daniel Gallagher and Michael Piwowar unsuccessfully swaying the majority.

The rule, a mandate of the Dodd-Frank Act and requirement to compare CEO compensation to the pay of the median employee, has lingered in the proposed rule stage since 2013. While proponents, many associated with shareholder activists and organized labor, have accused the SEC of foot-dragging, public companies covered by the rule have expressed fears that compliance will be daunting and expensive. A common concern has been the international scope of the rule and how the lack of centralized payroll systems, differences in the cost of living among various countries, and currency exchange rate fluctuations will complicate the calculation. Companies with a large number of part-time, seasonal, and temporary employees also worry that those populations will negatively skew their ratio.

“To say that the views on the pay ratio disclosure requirement are divided is an obvious understatement,” SEC Chairman Mary Jo White said prior to the vote. The final rule, she said, “provides companies with substantial flexibility in determining the pay ratio, while remaining true to the statutory requirements.” 

As with the 2013 proposal, the final rule provides companies with substantial discretion to use estimates and sampling as a means to determine the median employee and the employee’s compensation.  The final rule excludes emerging growth companies, smaller reporting companies, foreign private issuers, registered investment companies and registrants filing under the U.S.-Canadian Multijurisdictional Disclosure System.

Additional accommodations are also made in the final rule, including: an exemption for situations when foreign data privacy laws would prevent companies from being able to process or obtain the necessary compensation information to calculate the ratio; an ability to exclude a de minimis amount of non-U.S. employees (up to 5 percent) when determining the median employee; and allowing companies to use cost-of-living adjustments when determining the median employee and calculating the employee’s total compensation.

The rule also allows companies to choose any date during the last three months of a company’s fiscal year to determine the median employee and, to further reduce costs, would permit companies to use the same median employee for three years unless there has been a change in the employee population or employee compensation arrangements that the company reasonably believes would result in a significant change in the pay ratio disclosure.

 “These and other discretionary decisions were made to help ameliorate some of the complexities of implementing the statutory mandate while retaining the value of the disclosure to investors,” Commissioner Louis Aguilar said, adding that the new rule should “complement the Commission’s recently proposed rules that would require public companies to show the relationship between the executive compensation actually paid and the financial performance of the issuer.”

“The release does an impressive job of creating out of whole cloth a rationale for this rule: that it could help inform investors in their oversight of executive compensation, including say-on-pay votes,” Gallagher said. “But, to steal a line from Justice Scalia, this is pure applesauce.” In his view, the rule is a union-driven effort to “shame companies into lowering CEO pay. It is a “nakedly political rule that hijacks the SEC’s disclosure regime to once again effect social change desired by ideologues and special interest groups.”

Gallagher would have preferred to make the pay ratio rule the last piece of Dodd-Frank rulemaking, “in the year 2020 or so,” and limited its scope to full-time, U.S. employees.

Piwowar dismissed the Dodd-Frank requirement as “Saul Alinskyan tactics by Big Labor and their political allies.” He also expressed concern that the ratio could be the foundation of even more onerous business requirements, such as a CEO tax in the amount that annual wages could have been increased if the CEO’s pay had been instead divided up equally among the companies’ workers.

In California, a bill was introduced that would tie state corporate tax rates for publicly held corporations to its CEO pay ratio, he added. Also, in Rhode Island, the state senate has introduced a bill that would give preference in government contracting to firms whose highest paid executive does not receive more than 25 times the compensation paid to its median, non-executive employee.

The rulemaking also unfairly targets publicly traded companies that employ a large number of individuals in states with relatively lower costs of living, Piwowar said.