The SEC s Final Pay Ratio Rule: Analysis and Implications

Transcription

1 The SEC s Final Pay Ratio Rule: Analysis and Implications Membership Discussion Call HR Policy Association August 18, 2015 Today s Discussion Leaders Charles G. Tharp Chief Executive Officer Center On Executive Compensation Timothy J. Bartl President Center On Executive Compensation Shelly Carlin Executive Vice President Center On Executive Compensation Henry Eickelberg General Counsel Center On Executive Compensation Ani Huang Vice President, Compensation Practice and Research Center On Executive Compensation 2

2 Today s Agenda Background on the Dodd-Frank Pay Ratio The Final Rule Key Differences from Proposed Rule Requirements Next Steps 3 Background On The Dodd-Frank Pay Ratio The Pay Ratio was added to Dodd-Frank during a 20-minute Senate Banking Committee markup; it became law without a hearing or other legislative debate As a result, there is no legislative record on Congressional intent Pay Ratio was one of several Dodd-Frank mandates (e.g., conflict minerals, resource extraction) to use SEC to pursue social agendas Requires SEC to draft rules requiring companies to calculate and disclose the summary compensation table compensation for the median employee globally, the CEO s pay and the ratio of the CEO s pay to that employee s pay Congress did not specify a deadline for the SEC to implement a rule 4

3 The Proposed Pay Ratio Rule In September 2013, the SEC adopted a proposed pay ratio rule The Proposed Rule attempted to provide significant flexibility to companies, but would have resulted in significant compliance burdens Employees defined to include all full-time, part-time, and seasonal employees worldwide employed on the last date of the fiscal year Companies allowed to use a two-step process: Identify the median employee using a consistently applied compensation measure or statistical sampling companies could create their own methodology Calculate total compensation for that individual using the Summary Compensation Table definition Pay Ratio considered Filed information subject to SOX CEO/CFO certifications 5 The Proposed Pay Ratio Rule - Comments The SEC received over 287,400 comment letters regarding pay ratio, most of which were union sponsored form write-in campaigns. Of those, approximately 1,500 were unique and contained mostly substantive comments The Center and other opponents highlighted the pay ratio s inability to provide any valuable information as well as the substantial compliance costs Proponents praised the rule, asking for no changes to the proposed rule while urging the SEC to keep all global employees in a final rule 6

4 The Final Pay Ratio Rule SEC Open Meeting On August 5, 2015 the SEC approved a final pay ratio rule by a 3-2 vote, after one of the most contentious and conflicted rulemakings in SEC history Republican Commissioners Gallagher and Piwowar broadly criticized the final rule - including the way the law was passed, the rulemaking process, and its content Democratic Commissioners Aguilar and Stein supported the rule Chair White declared her desire to finish the rule was tied to its being a Congressional-mandate The SEC s rationale for the rule: to further Congress s apparent goal of giving shareholders additional information to enhance the shareholder engagement envisioned by Say on Pay The final rule is largely similar to the Proposed Rule, with a few exceptions 7 The Final Pay Ratio Rule Highlights Effective date: effective the first fiscal year beginning after January 1, 2017 Frequency of identifying the median employee: companies may identify median employee once every three years Definition of employees: all employees must be included in determining the median employee, with two minor exceptions Measurement date flexibility: Companies have a 90-day window during which they can determine the measurement date to establish the employee population Consolidated subsidiaries: only employees of consolidated subsidiaries must be included Cost of Living Adjustment: May adjust compensation of median employee to the country where the CEO is located 8

5 Effective Date The first reporting period which will contain a pay ratio disclosure is the first fiscal year beginning on or after January 1, 2017 For a calendar year company, the first proxy statement containing a pay ratio disclosure will be in calendar year 2018 for fiscal year 2017 compensation 9 Identifying the Median Employee Companies are only required to find the median employee once every three years, so long as: The company has a reasonable belief that there is no change in its employee population or compensation arrangements that would significantly impact the pay ratio. Companies can use the same employee or a similarly situated one for the following two years after identification Company must disclose if it is using the same employee as last year and the basis for the reasonable belief Total Compensation still needs to be calculated and disclosed annually 10

6 Covered Employees Proposed Rule All Employees Subject to Pay Ratio Calculation Key point of debate during rulemaking Required companies to include all full- and part-time, and seasonal employees in a company s global employee population, without exception The Center requested a U.S.-only rule on the basis that having a U.S., full-time ratio would reduce compliance costs by up to 70% Final Rule is nearly the same as the proposed rule, excluding independent contractors or leased workers employed by and whose compensation is determined by an unaffiliated third party with two exemptions Data privacy exemption De minimis exemption 11 Covered Employees Data Privacy Exemption Companies can exclude non-us employees covered by foreign data privacy laws which would be violated by pay ratio compliance Must first make a reasonable effort to get the data (including seeking an exemption from host country) Must obtain opinion of home-country counsel acknowledging that compliance would be illegal Proxy disclosure obligations List excluded jurisdictions Identify privacy law/regulation and describe how compliance with pay ratio rule causes a violation Identify approximate number of employees excluded in each country File legal opinion described above as exhibit to proxy 12

7 Covered Employees De Minimis Exemption Companies can exclude up to 5% of their foreign employees with certain limitations: If one employee in a country is excluded, all employees in that country must be excluded Employees excluded as part of the Data Privacy Exception count towards the 5% limit Disclosure obligations List excluded jurisdictions Identify approximate number of employees excluded from each country Disclose total number of US/non-US employees without exemption Disclose total number of US/non-US employees used to determine 5% of employees 13 Measurement Date Proposed Rule: All employees employed at a company on the last day of that company s fiscal year were employees for the purpose of the pay ratio calculation The Center argued that using the end of the fiscal year as the Measurement Date made it difficult to calculate in time for publication in the proxy Final Rule: Companies may select a Measurement Date within 90 days prior to the end of the fiscal year, and use that date to establish the employee population and identify the median employee Must disclose whether using a different date than in prior year 14

8 Consolidated Subsidiaries Only employees of consolidated subsidiaries are required to be included in a company s pay ratio calculation The Proposed Rule left this as an open question and also asked whether employees of joint ventures and other unconsolidated arrangements should be included The Final Rule limits the employees to those of a consolidated subsidiary - those whose results are consolidated by the company in its financial statements On a related topic, the final rule allows companies to exclude employees of acquired companies in the year of acquisition 15 Cost of Living Adjustments In calculating median employee, companies can perform a cost of living adjustment to make the pay of employees located in different regions more comparable to that of the CEO s home country If the Company chooses to make an adjustment, it must be used both to identify the median employee and to calculate total compensation for that employee If a cost of living adjustment is made, the company must disclose the total compensation of the median employee and the pay ratio both with and without the adjustment 16

9 The Final Pay Ratio Rule The Have It Your Way Methodology to Finding the Median Employee As provided under the Proposed Rule, companies are afforded wide latitude to create a methodology for identifying the median employee Statistical sampling is expressly mentioned by the final rule. Does not prescribe any confidence intervals or sample sizes Customizable Methodology Companies are free to design any reasonable methodology to identify the median employee as suits their individual business Reasonable Estimates permitted The final rule notes that it purposefully does not provide any details on what would constitute a reasonable estimate 17 The Final Pay Ratio Rule The Have It Your Way Methodology to Finding the Median Employee Consistently Applied Compensation Measure Like the proposed rule, companies can use a consistently applied compensation measure to help identify the median employee A measure of compensation can qualify as a consistently applied even if defined differently across jurisdictions, so long as it is consistent internally for example, different definitions of taxable income Full-Time Equivalent Adjustments are Prohibited Companies cannot make full-time equivalent adjustments to parttime, seasonal or temporary employees However, a company can adjust the pay of full time employees who have only worked for part of a year to reflect a full year s pay 18

10 The Final Pay Ratio Rule Disclosure Requirements The Final Rule is considered filed not furnished Many of the disclosures required by our rules require complex calculations and estimates. Moreover, the fact that registrants will be required to provide disclosure about how they have arrived at their pay ratio calculations, and in particular the required disclosure about the assumptions and methodologies underlying the calculations, will permit registrants to clearly explain to shareholders where potential imprecisions may be introduced into the reported statistic. Section 18 of the Exchange Act states that a person shall not be liable for misleading statements in a filed document if it can establish that it acted in good faith and had no knowledge that the statement was false or misleading.. 19 The Final Pay Ratio Rule Economic Analysis The Final Rule does not attempt to ascribe any benefits to the pay ratio information Expressly admits that there is no value in comparing the pay ratio between companies Instead, the Final Rule states that Congress intended the pay ratio to supplement the information used in Say on Pay voting This theory is based on the pay ratio s location in Dodd-Frank among other executive compensation disclosures, including say on pay and pay for performance Nothing in the Congressional Record nor in any statements by the pay ratio s sponsor supports this rationale 20

11 The Final Pay Ratio Rule Notable Quotes In their dissenting statements on the Final Rule, SEC Commissioners Piwowar and Gallagher issued stinging rebukes of the pay ratio Both statements effectively outlined a strategy for a legal challenge of the rule Failure to follow the Administrative Procedure Act Failure to assess costs/benefits in determining 5% exclusion Arbitrary and capricious in defining employee to exclude contract workers Failure to consider academic studies on the effects of the disclosure on CEO pay 21 The Final Pay Ratio Rule Future Steps & Strategies Implementation support for Center Subscribers November Annual meeting discussion 2016 regional meetings Best practice collection and dissemination Institutional investor outreach Advocacy Explore legal challenge Appropriations strategy Repeal strategy 22

12 The SEC s Final Pay Ratio Rule: Analysis and Implications Membership Discussion Call HR Policy Association August 18, 2015