The boss will always make more than the workers, but under a regulation recently adopted by the Securities and Exchange Commission (SEC), a company’s employees and investors will now be able to determine how much more. 

The rule, which the commission passed in a 3-2 vote on Aug. 5, requires public companies to make three additional disclosures in their annual filings: the median of the annual total compensation of all employees, excluding the CEO; the annual total compensation of the CEO; and the ratio between the two. Companies would have to report the information for their first fiscal year beginning on or after Jan. 1, 2017.

The provision had been included in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, but its final approval was subject to delays—as has often been the case with measures tied to the legislation. A progress report published this summer by the law firm Davis Polk & Wardwell LLP, marking the fifth anniversary of Dodd-Frank, found that, as of July 15, 21.3 percent of the law’s 390 total rulemaking requirements had not yet been proposed.

Still, the pay disclosure rule, which garnered more than 287,000 comment letters before it was passed, was particularly contentious. 

According to Douglas J. Beck, a member of the NYSSCPA’s Chief Financial Officers Committee and a CFO at a public company, the rule was ultimately the result of outcry from investors, who have been paying greater attention to executive compensation over the past few years. The push for the disclosures, he added, seems to point to a disconnect between investors and the entities they fund over what value the CEO brings to the company, and how that relates to the company’s overall health. 

But while investor and labor groups, such as the AFL-CIO, have argued that the ratio could be used to gauge how effectively a company is managing its human capital, business groups and executive associations said it provided little insight and would present significant compliance costs for companies. Furthermore, the provision left the SEC itself divided, with the final vote splitting along partisan lines. In language that echoed many of the more irate comment letters, Commissioner Michael S. Piwowar said that the measure was tantamount to bullying and was a “sad example of surrendering the Commission’s agenda to politically connected special interests.” 

Will flexibility aid compliance?

In terms of cost and complexity, Commissioner Kara M. Stein said that the final rule provides companies with enough flexibility that it would not present an undue burden for businesses. 

The rule does, in fact, allow significant wiggle room for companies to determine who will be counted when calculating median employee compensation. According to David M.
Rubenstein, a Chief Financial Officers Committee member who is a partner at WeiserMazars, LLP, and chair of its SEC Practice Group, an overly complicated mandate that proved difficult to follow wouldn’t serve businesses or the SEC itself. Instead, he said, the commission seemed to be open to any methodology that seemed reasonable. 

Indeed, according to an SEC fact sheet, companies can “select a methodology based on their own facts and circumstances.” For example, a company could choose to determine a median based on every employee, use a statistical sampling of its workers or employ any other method that would be viewed as justifiable. The company could also decide to apply a cost-of-living adjustment in identifying the median employee, but is not required to do so. 

There’s also some latitude in how entities determine who is an employee. While companies do have to include all full-time, part-time, temporary and seasonal workers, whether employed directly by the entity or any of its consolidated subsidiaries, they are allowed to exclude independent contractors or those employed by unaffiliated third parties. They will be able to exclude up to 5 percent of their non-U.S. workforce, including those who work in countries where data privacy laws would prevent them from obtaining the relevant information, and can also choose to annualize the total compensation for a permanent employee who didn’t work for the entire year, such as a new hire. 

In addition, they have a wide range of choices regarding over what time period this calculation is made. Under the rule, entities can select a date within the last three months of their last completed fiscal year to determine the employee population. The calculation only has to be updated every three years, unless the company experiences major changes in its employment base. 

The rule’s elasticity, however, generates its own concerns. Rubenstein pointed out that the very exceptions used to make the rule more flexible might be a source of complexity for certain companies. Although, on the surface, it would seem easy enough to extract data en masse directly from payroll, considering the types of workers who are excluded from consideration, calculations could prove trickier than they sound. 

For example, say a company works on a calendar-year schedule and has an employee who started on July 1. According to the exception, you can annualize his or her compensation when calculating the ratio. However, you can’t just pull data from payroll, or else you wouldn’t get the annualized figure. On the other hand, temporary and seasonal workers can’t be annualized when determining the ratio, so payroll figures would need to be used when factoring in their compensation. Then there’s the case of overseas workers—companies will need to grapple, individually, with who is in the 5 percent they want to exclude.  

Given all the exceptions, on top of the general differences in compensation structure from company to company, it may also be difficult to compare one entity’s ratio to another. Beck pointed out that pay structures can vary significantly, not just between companies but entire industries. Take, for example, a utility. Since it may be slower growing and have lower compensation levels than, say, a rapidly growing tech company, seeking comparability between the two, Beck said, “will be based on relative information and industry information.” 

What’s more, Beck added, at the executive level, compensation is usually closely tied to various performance incentives that, again, can differ significantly from company to company. Packages, he said, are often centered, not around salary, but stock-based compensation, and can “reflect someone who is not doing well, or someone who is.” The bottom line: The ratio might not be telling the whole story. 

Still, Rubenstein was confident that, while comparability will be a bit more difficult, it’s certainly possible, especially since companies also have the option of providing a narrative explanation of their ratios, which might help people understand the individual factors behind the calculations. 

“If I was an analyst, if I was a trader in stocks or anything relative to the market and performance for companies …  I would want to understand why this CEO makes so much more money relative to their employee base vs. this other one,” he said. “It may impact one’s desire or consideration to buy or not to buy.” 

cgaetano@nysscpa.org