SEC approves 'pay ratio' disclosure for CEOs

Kevin McCoy | USA TODAY

The Securities and Exchange Commission Wednesday narrowly approved a new rule requiring publicly traded U.S firms to disclose the gap between CEOs' annual compensation and the median compensation of other employees.

Handing a defeat to business opponents of the change, the 3-2 vote by the SEC's five commissioners capped a multi-year battle over the so-called "pay ratio" disclosure required by the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted after the national financial crisis.

The outcome came after more than 287,000 comment letters and related meetings as business and other groups called the rule unnecessary and said it would be expensive and difficult to implement, while supporters contended it would help investors make more informed evaluations of corporate governance and so-called say-on-pay initiatives.

What's not little dispute is that the new rule is likely to be a new feature in protests over U.S. income inequality.

"While there is no doubt that this information comes with a cost, the final rule recommended by the (SEC) staff provides companies with substantial flexibility in determining the pay ratio, while remaining true to the statutory requirements," said SEC Chair Mary Jo White.

Publicly traded U.S. firms already disclose compensation of their CEOs and other top executives in proxy filings submitted to the SEC before annual stockholder meetings. But those forms are often complex and can prove challenging to decipher. The new rule will require companies to:

Disclose the annual total compensation of the CEO

Report the median of the annual total compensation of all other employees — the level where half the workers earn more, and half earn less.

Provide the ratio of those two amounts.

Companies would be allowed to use total employee headcount, a statistical sampling of workers or other methodology to determine the median employee level. That could include applying cost-of-living adjustment to the compensation measure used to identify the median. However, the firm would be required to disclose the median employee annual total compensation and pay ratio without the cost-of-living adjustment.

In an effort to ease compliance, the rule allows companies to exclude non-U.S.workers from the methodology used to calculate the median employee level if the workers are based in a location where the disclosure would violate data privacy laws.

Firms whose overseas workers make up 5% or less of the total workforce may exclude all of them from the calculations. Companies with larger non-U.S. divisions may exclude them up to a 5% threshold. The percentages are lower than opponents had sought.

The disclosure requirement will apply to all companies currently required to provide executive compensation disclosure. Smaller firms, foreign private issuers, emerging growth companies and registered investment companies would be exempt.

Companies would be required to report the pay-ratio disclosure during their first fiscal year beginning on or after Jan. 1, 2017.

White joined SEC Commissioners Luis Aguilar and Kara Stein in voting for the new rule. Aguilar said the requirement gives companies "a great deal of flexibility" in complying, while Stein said the rule "should provide a valuable piece of information to investors and others in the marketplace."

Commissioners Daniel Gallagher and Michael Piwowar, the SEC's two Republican commissioners, voted "no" after arguing the rule had no evident benefits and would cost businesses an estimated $1.3 billion in initial compliance costs alone. They contended the change instead was designed to "name and shame" highly paid CEOs and their firms.

"To steal a line from (Supreme Court) Justice (Antonin) Scalia, this is pure applesauce," Gallagher said of the rule and its rationale.

Critics, such as the Business Roundtable, agreed. The association of major U.S. chief executives said most private-sector companies lack an easy way to gather compensation data from operating divisions around the world that often use different and incompatible payroll systems.

"The pay-ratio mandate has never been about actual CEO pay or the pay of average workers, for it is no secret that CEOs are paid significantly more than the average worker," said Timothy Bartl, president of the Center on Executive Compensation. He also warned about "unintended consequences of the pay-ratio requirement and the increased potential for confusion at a time when investors are already faced with complex pay disclosures."

But supporters of the rule predicted the change would benefit shareholders.

"In recent decades, CEO compensation overall has grown to nearly 300 times what typical employees earn," Americans for Financial Reform, a coalition of more than 200 civil rights, consumer, labor and other groups wrote in a letter to the SEC. "Investors should have the ability to consider whether a CEO provides hundreds of times the value of their employees as they weigh whether to invest in a particular firm."

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