CEO Pay Ratio Rule: New SEC Advice Helps Companies Prepare to Comply

Having recently affirmed that there will be no postponement of the 2018 effective date for CEO pay ratio disclosure, the U.S. Securities and Exchange Commission on Sept. 21 issued interpretive guidance to assist companies in their efforts to comply with the pay ratio disclosure requirement comparing the compensation of the company’s CEO to that of the company’s “median employee.” The guidance is helpful in several meaningful ways and comes in time to meet upcoming deadlines.

Independent Contractors

First, and most importantly, the SEC provides guidance as to when a company may use widely recognized tests to determine whether its workers are employees or independent contractors. Using this guideline, companies should be able to utilize methodologies that they otherwise would use to determine which workers are employees or independent contractors in other legal and regulatory contexts, such as for employment law or tax purposes. Such a test might, for example, be drawn from guidance published by the Internal Revenue Service with respect to independent contractors. This should vastly simplify the process used by companies. It should be noted, however, that whether or not independent contractors are included or excluded may not “move the needle” very much in determining the “median employee” for purposes of the pay ratio disclosure.

Use of Reasonable Estimates & Statistical Sampling

Second, the SEC guidance provides that the use of reasonable estimates, assumptions and methodologies, and statistical sampling permitted by the rule, may include the use of appropriate existing internal records, such as tax or payroll records, in determinations identifying the median employee. This guidance may be helpful because of the numerous examples that it contains. While many companies have determined that they will not use statistical sampling (and to our knowledge most mid-sized technology and biotech companies are not in fact using reasonable estimates, assumptions and methodologies, or statistical sampling, because they believe that their pay data is easily obtainable), it may result in some compensation consultants advising companies to consider statistical sampling in light of this guidance without fear of receiving an adverse comment from the SEC Staff or risking liability.

Use of Internal Records

Third, the SEC guidance states that a company may use internal records that reasonably reflect annual compensation to identify its median employee, even if those records do not include every element of compensation, such as equity awards widely distributed to employees. To a large degree, this reaffirms what the SEC said in one of its prior CD&Is, but with more clarity.

New CD&Is

Fourth, the SEC issued one new CD&I, revised one CD&I and withdrew one CD&I on pay ratio disclosure. Read more about new and revised CD&Is.

Next Steps

As we noted in our prior alerts (see “CEO Pay Ratio Rule – Start Preparing Now ” and “Executive Compensation Alert: SEC Issues Final CEO Pay Ratio Rule ”), compensation consultants will and must be the key resource to companies as they prepare for their 2018 CEO pay ratio disclosure. Companies should connect with their compensation consultants to assess the complexity of their pay ratio analysis based on the composition of their workforce (e.g., domestic vs. international employees, significant number of consultants, etc.) and to create a timeline to complete the analysis. We suggest that companies complete this analysis prior to Dec. 1, 2017, so that they will have sufficient time to run models and analyze the potential internal impact of the methodology used by them for determining the pay ratio. It will also provide companies time to draft—and test with internal focus groups—any internal PR and HR material that the company feels will be valuable in communicating with employees who will have an elevated interest in where they stand relative to the company’s median employee, an area we believe will be of much more concern to most employees than their comparison to the company’s CEO.