Preparing for the Looming Reality of CEO Pay Ratio Disclosures and Other “Hot Topics”: The Latest from the SEC’s Division of Corporation Finance

As companies are trying to tackle the CEO pay ratio disclosure requirements that will be effective for the 2018 proxy season, as well as understand what additional rules may be on the horizon, David Fredrickson, Chief Counsel of the SEC’s Division of Corporation Finance, provided insight as to the SEC’s expectations for pay ratio disclosures and other items on the Division’s agenda during’s Pay Ratio & Proxy Disclosure Conference held last week in Washington D.C.

The New Pay Ratio Disclosures

Mr. Fredrickson emphasized several times that, consistent with the SEC’s recent Guidance on Pay Ratio Disclosure and Staff Interpretations, the CEO pay ratio rule affords significant “flexibility” to companies in determining appropriate methodologies to identify the median employee and calculate that employee’s annual total compensation for purposes of comparison, via the ratio, with the CEO’s compensation. Acknowledging that there had been some ambiguity regarding the regulatory treatment of independent contractors, he indicated that this issue has been resolved in the SEC’s Guidance on Pay Ratio Disclosure (“it would be consistent with Item 402(u) for a registrant to apply a widely recognized test under another area of law that the registrant otherwise uses to determine whether its workers are employees”). Mr. Fredrickson also made clear that the SEC staff does not intend to bring enforcement actions against companies for any pay ratio related disclosures unless the disclosures are made without a reasonable basis or are provided other than in good faith.

Some practice tips shared by panelists at the conference included:

  1. Avoid lengthy disclosures. The pay ratio rule provides that the disclosure should be “brief.”
  2. Institute an internal system to memorialize the steps taken and methodologies adopted to identify the median employee. This will encourage a consistent process in future years.
  3. Determine the audience for pay ratio disclosures (i.e., shareholders, employees, social change activists).
  4. Identify and work towards mitigating potential issues with employees arising from pay ratio disclosures.
  5. Each company is different, with its own unique structure. Companies should take comfort knowing that the SEC’s recent guidance emphasizes flexibility.
  6. The logical place for the pay ratio disclosure is after the executive compensation disclosure (but not within the CD&A).

During an institutional investor panel discussion in a companion conference, all three panelists (BlackRock, T Rowe Price, and Vanguard) agreed that CEO pay ratio will not be a significant factor in their compensation analysis for proxy voting purposes. According to one panelist, however, disclosure of a ratio that appears to be an “outlier” within a company’s peer group might be a trigger for engagement.

Other “Hot Topics” on the Division’s Agenda

In addition to discussing the new pay ratio disclosure requirements, Mr. Fredrickson highlighted the following topics:

  • In response to the recent suggestions for overhauling the shareholder proposal rule, Rule 14a-8,1 the Division is actively thinking about whether there is guidance it can issue and welcomes public feedback.
  • The SEC recently issued proposed rules based on the staff recommendations made in the Report on Modernization and Simplification of Regulation S-K2 and continues to focus on disclosure effectiveness in an effort to improve the quality and delivery of material information to investors. SEC Chairman Jay Clayton and Division Director William Hinman are also continuing to look at various work streams within the framework of this initiative.
  • Based on the significant number of comment letters the SEC has received from investors and others calling for better sustainability disclosure,3 the SEC is “wrestling” with how to be responsive to those seeking improved sustainability reporting. The Division recognizes there currently are some voluntary sustainability related disclosures and is considering various options, including encouraging voluntary disclosures, recognizing industry standards or adopting the Division’s own line-item disclosure requirements.
  • The SEC continues to look at ways to enhance the ability of shareholders to participate in the director selection process (i.e., universal proxies).
Endnotes    (≈ returns to text)

  1. See our earlier Alerts Treasury Recommends Overhaul of Many Disclosure and Shareholder Proposal Rules, available here and The Right CHOICE (2.0)? Bill Voted Out of Committee; SEC Chair Clayton Sworn In, available here.
  2. See our earlier Alerts SEC Open Meeting: Proposed Amendments to Regulation S-K Pass Unanimously, available here and SEC Open Meeting to Consider Proposing Amendments to Reg. S-K, available here.
  3. See the SEC Concept Release on the business and financial disclosure requirements in Regulation S-K, including disclosure of information related to sustainability matters (April 2016), available here.