Posts Tagged ‘SEC’

FAQs on the New SEC Pay-Ratio Rule

August 7th, 2015 | By

On August 5, 2015, the Securities and Exchange Commission released its final pay-ratio rule under the Dodd–Frank Wall Street Reform and Consumer Protection Act (hereafter Dodd–Frank). The announcement comes more than five years after Congress passed Dodd–Frank in July 2010 and nearly two years after the SEC first proposed the pay-ratio rule in September 2013. The release describing the new rule is a 294-page document that will be analyzed and applied in the weeks and months to come. Meanwhile, here are some basic FAQs to help boards and compensation committees understand the implications of this much-anticipated development.

  1. What disclosure will the new rule require?

While the release explaining it demands further study, the new rule can be summarized as follows:

  • Companies will be required to disclose the ratio of the median pay of all employees, excluding the “principal executive officer” (in most cases, the CEO), to the total pay of that principal executive officer for the most recently completed fiscal year, as disclosed in that year’s summary compensation table. The calculation for median employee pay can be made for any time during the last three months of the year.

The final rule defines employees as “any U.S. and non-U.S. full-time, part-time, seasonal, or temporary worker (including officers other than the [CEO]) employed by the registrant or any of its subsidiaries as of the last day of the registrant’s last completed fiscal year” (p. 216). Like the proposed rule, the final rule allows statistical sampling and estimates as long as these are “reasonable” (p. 14). Although the word reasonable appears at least 100 times in the release announcing the rule, it is not defined because the SEC believes that “companies would be in the best position to determine what is reasonable in light of their own employee population and access to compensation data.”[1]The ratio would have to appear in any filing that requires executive compensation disclosure, including 10-K annual reports, registration statements, and proxy statements. The SEC final rule specifically mentions the compensation discussion and analysis (CD&A) and the summary compensation table. “In this manner, the pay ratio information will be presented in the same context as other information that shareholders can use in making their voting decisions on executive compensation” (p. 39).

  1. When will the new rule go into effect?

Companies must begin reporting the new data in the first fiscal year beginning on or after January 1, 2017. The pay ratio will appear in the 2018 proxy statement disclosing compensation for 2017. After that, companies will be required to update the disclosure at least once every three years.

  1. To whom will the new rule apply?

The new rule will apply to all U.S. public companies but exempts smaller reporting companies (defined as having a public float of less than $75 million) and emerging growth companies (defined as a having total annual gross revenues of less than $1 billion during their most recently completed fiscal year). It also exempts foreign companies (including Canadian companies listing in the United States) and investment companies (mutual funds). The rule also contains an exemption for U.S.-based global companies that cannot access the median pay data due to foreign data-privacy laws. New public companies would not need to comply with the new rule until their first annual report and proxy statement after they register with the SEC.

  1. What aspects of the rule are likely to raise concerns in boardrooms?

In a comment letter filed on December 1, 2013, NACD expressed concerns that the rule defined the term employees too broadly. We encouraged the SEC to increase the flexibility of the pay-ratio rule by permitting the use of industry averages, by defining employees as full-time U.S. employees, and by permitting supplemental notes to correct any distortions caused by the use of “total pay” figures. The SEC’s final rule does not specifically authorize the use of industry averages, although it appears to permit their use to supplement company-based data. Nor does the final rule exclude part-time workers or foreign workers, allowing an exclusion of only up to 5 percent of a non-U.S. workforce.

In combination, these factors in the final rule may cause the ratio of median employee to CEO pay to appear relatively small in industries that employ part-time or non-U.S. workers. Over time an industry pattern may emerge, but initially there could be a hit to reputation. Boards can start now in preparing for potential impact on company reputation and employee morale.

  1. What do boards and committees need to do in the short term?

First, board members should become familiar with the requirements of the new rule, with help from their compensation committees and their compensation advisor. Then they will be in a position to ask informed questions. Compensation committees can begin by asking their chief human resources officer (CHRO) and chief financial officer (CFO) the following questions:

  • Do we have the information available to calculate the two numbers required for the ratio so that the board can begin its analysis? What technical and definitional issues, if any, may arise in this calculation, and what support might you need to resolve those issues? What is your rough estimate of the cost of calculation (e.g., staff time, data systems requirements, and/or third-party analysis)?
  • Will you work with an external compensation firm or other external consultant (such as a payroll expert) to determine the ratio?
  • Can the external advisor estimate the ratios of peer companies on the basis of publicly available data? What are the pros and cons of having the company’s consultant collaborate with the board’s compensation advisor in calculating such estimates?

Similarly, they might consider asking the following two questions of the independent firm that advises the board on CEO and senior management pay:

  • What information, if any, is currently available on estimated ratios of employee/
    CEO pay for our industry peers so we know where we stand?
  • If you will be working with the company’s external advisor in collecting relevant data and/or preparing estimated ratio information (if one is retained by CHRO/
    CFO), would such activity be perceived as compromising your independence under current SEC rules? If so, how can we proactively counteract such a perception?

Having gained insights from these initial questions, directors might want to consider the following:

  • How comprehensive and compelling are our current published disclosures about our pay philosophy? Have we clearly communicated the link between our strategy, pay plan design, and pay outcomes?
  • Does our pay philosophy include employee pay beyond the executive level? Are there opportunities to address this issue in a more detailed way? For example, does our published pay philosophy specifically discuss the issue of pay distribution patterns and/or “fairness”? If not, is this something we might consider addressing?[2]
  • What information, if any, have we received from surveys regarding employee satisfaction with compensation levels?
  • What feedback, if any, have we received from our major shareholders about our compensation plan and our pay-for-performance track record? If we have heard concerns, what have we done to resolve them?
  • If the early estimated ratio for total pay appears out of proportion to any available estimates for our peers and/or industry, how should we interpret this discrepancy? What would this tell us about the structure of our reward system?
  • What would be the impact of early voluntary disclosure?
  1. What implications might this new rule have for D&O liability?

Any new disclosure rule immediately triggers potential director liability, absent a safe harbor provision. Although shareholder lawsuits against companies are often triggered by weak stock prices, the putative grounds for lawsuits are usually based on alleged disclosure violations, particularly in changes-of-control.[3] For more on D&O litigation, see the May–June 2015 issue of NACD Directorship.

  1. Is the new rule likely to be challenged?

It is possible that trade groups such as the U.S. Chamber of Commerce may try to get the rule vacated by a federal court. In a statement released via e-mail on August 5, David Hirschmann, president of the Chamber’s Center for Capital Markets Competitiveness, stated,We will continue to review the rule and explore our options for how best to clean up the mess it has created.” In the past this type of cleanup has meant legal action. In July 2011, the Chamber joined the Business Roundtable to successfully vacate a proxy access rule under Dodd–Frank that would have mandated a particular form of shareholder access to director nominations via the proxy ballot. Similarly, in April 2014, the National Association of Manufacturers and others succeeded in getting a court to declare an aspect of the conflict minerals rule under Dodd–Frank to be a violation of free speech.

  1. What long-term impact might the new rule have on human capital at corporations?

Compliance with the new rule is important, but the core issue for companies remains the same: developing a pay structure, at all levels of the organization, that is aligned with the firm’s strategy and aimed at long-term value creation. Sustained corporate performance is based in large part on human talent, and compensation is one of the key factors in motivating employees. Furthermore, payroll and benefits represent a significant percentage of capital allocation at many companies. For these reasons, among others, many boards will likely take a greater interest in pay at lower levels, and they will want independent verification of a wider band of pay practices. More broadly, a growing number of boards are stepping up their oversight of management’s talent development activities across the organization. For guidance, directors can turn to the Report of the NACD Blue Ribbon Commission on Talent Development.

  1. What resources does NACD have to help compensation committees cope with this and other current compensation matters?

The following NACD resources may be helpful:

NACD will continue to monitor the pay-ratio disclosure issue and other Dodd–Frank compliance matters as they evolve, providing further guidance and perspective on these and related matters.


[1] “Consistent with the proposal, the final rule does not specify any required methodology for registrants to use in identifying the median employee. Instead, the final rule permits registrants the flexibility to choose a method to identify the median employee based on their own facts and circumstances“ (p. 113). “The proposed rule did not prescribe specific estimation techniques or confidence levels for identifying the median employee because we believed that companies would be in the best position to determine what is reasonable in light of their own employee population and access to compensation data” (p. 98).

[2] Note: “Fairness” was one of the five principles of pay recommended by NACD in the Report of the NACD Blue Ribbon Commission on Executive Compensation (2003), and was also cited in the more recent Report of the NACD Blue Ribbon Commission on the Compensation Committee (2015).

[3] Josh Bradford, D&O Claims Trends: Q2 2015, Advisen Ltd., July 2015.

NACD BLC 2014 Breakout Session – Inside the SEC: Anatomy of an Agency

October 28th, 2014 | By

The Securities and Exchange Commission (SEC) is charged with maintaining fair and efficient markets, facilitating capital formation, and, like directors, protecting investor interests. This regulatory arm of the federal government has a significant impact on businesses, but many may not effectively understand the commission’s inner workings. Providing directors with an insider look at the SEC was a panel comprised of: Mark D. Cahn, former general counsel of the SEC’s Office of the General Counsel, and partner at WilmerHale; Thomas J. Kim, partner at Sidley Austin and former chief counsel and associate director of the SEC’s Division of Corporation Finance; Troy Paredes, senior strategy and policy advisor at PwC and former SEC commissioner; and moderator Kendra Decker, partner in Grant Thornton’s National Professional Standards Group.

The SEC has five commissioners, each of whom is selected by the president of the United States, and no more than three of them can be from the same political party. The president also selects one commissioner to serve as chair. The chair sets the agenda and makes senior hiring decisions; however, this does not create a hierarchy as that professional title might imply. The commissioners are like a board of directors, with each person maintaining their own, independent voice as they vote on the issues set before them.

“No one commissioner has the power to do anything,” Kim said. “They only have power by acting as a commission, just like a board must act as a collective body.” Although the SEC is generally thought of as a rulemaking entity, Cahn pointed out that it’s a relatively infrequent occurrence that commissioners actually cast a vote. The organization’s day-to-day workings are processed at the staff level—and, in turn, the division heads engage with the commissioners.

The panel also drew attention to challenges within the commission. For Cahn, the biggest challenge with regard to rulemaking is the Government in the Sunshine Act of 1976, which requires all commission deliberations to be carried out in public. “You end up with meetings of two commissioners with staff members to discuss issues when they could be much more productive to work out matters as a group.”

In addition, trying to pass a rule through a multi-member commission can turn into a game of chess, with each member making suggestions for changes up until the last minute. If a rule passes with a split vote, those dissenting opinions serve as a roadmap to potential litigants who want to challenge the rule—a factor that emphasizes the importance of unanimity within the commission. “I think it [speaks] well for the agency overall when there’s consensus,” Parades said. “But sometimes you can’t bridge those differences. Another aspect is, from time to time, chairs have had a norm where they wouldn’t go forward unless there was a norm of four. What that does, it forces people to compromise and it doesn’t allow those in the majority to say that ‘this is what we’re going to do, regardless.’”

Despite these complexities, Paredes stressed the critical importance of third-party engagement. “The SEC is able to better evaluate the consequences of their rulemaking if they are able to hear from the people their rules are going to impact,” he said. “If [SEC] folks aren’t hearing that through one mechanism or another, there are going to be serious blind spots.”

Current Efforts Toward Corporate Disclosure Reform

August 22nd, 2014 | By

The discussion surrounding corporate disclosure reform has consistently centered on the issue of how to provide sufficient levels of information to investors and other readers without overburdening those responsible for preparing the disclosures. On July 29, the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness (CCMC) hosted an event addressing corporate disclosure reform. A variety of issues involving disclosure reform were discussed in panels featuring general counsels from leading companies, former officials from the Securities and Exchange Commission (SEC), the current head of the SEC’s Division of Corporation Finance, and other stakeholders.

Corporate disclosure reform has also been a recurring topic of discussion among the delegates of NACD’s advisory council meetings. Delegates are committee chairs of Fortune 500 companies and, along with key stakeholders, they discuss the issues and challenges currently affecting the boardroom. In particular, NACD’s Audit Committee Chair Advisory Council has discussed this topic at length, and this issue featured prominently in the discussions at the June 2013, November 2013 and March 2014 meetings. In particular, the November meeting featured senior leaders from the Society of Corporate Secretaries and Governance Professionals to discuss their efforts to streamline disclosures, while the March meeting included analysts from Moody’s Analytics and Morgan Stanley to share how they use disclosures.

Many of the key takeaways from the CCMC’s July meeting have been echoed at NACD’s advisory council meetings. These include:

The “disclosure burden” is largely driven by a desire to reduce liability. The first CCMC panel focused on the perspectives of two former SEC commissioners: Roel Campos, who is currently a partner at Locke Lord; and Cynthia Glassman, now a senior research scholar at the Institute for Corporate Responsibility at the George Washington University School of Business. There was agreement that disclosures have become documents of litigation. The usefulness of many disclosures was called into question, and in fact, many of the disclosures found on today’s financial statements are not actually mandated. For example, while comment letters issued by SEC staff from the Division of Corporation Finance and the Division of Investment Management “do not constitute an official expression of the SEC’s views” and are “limited to the specific facts of the filing in question and do not apply to other filings,”[1] many companies include disclosures based on these comment letters, often aiming to reduce their company’s liability by accounting for every possible contingency.

What’s more, if one company is asked by the SEC to provide a particular disclosure, other companies may feel compelled to disclose the same information even though they may operate in different industries.

Nevertheless, elimination of unnecessary or outdated disclosures requires a lengthy review process. Without a champion for reform, disclosures can linger on financial statements in perpetuity. An advisory council delegate noted: “It’s possible to take the initiative and cut the 10-K down. But it’s a significant time commitment, so you need buy-in from the CEO, CFO, and audit committee.”

Technology provides promising solutions. It was also observed that many disclosures are mandated by laws and rules stemming from the 1930s to the 1980s, when corporate information was only accessible in a physical form. Today, company websites often provide more detailed, current information than the 10-K. One CCMC panelist suggested that the SEC should encourage companies to rely more on these websites for the disclosure of certain information, such as historical share prices.

CCMC panelists also discussed ways to take advantage of technology to redesign and standardize the financial statements themselves, which could make them searchable and allow investors to make comparisons over time or across companies more easily. One panelist suggested that disclosure transparency could be enhanced by creating a “digital executive summary” document. In this summary, new, newly relevant, and the most material disclosures could be grouped in one place with hyperlinks to more detailed information. A similar notion has been discussed at recent Audit Advisory Council meetings, as one delegate offered: “Perhaps we need a second document, aside from the 10-K, that provides a shorter, more meaningful narrative that’s focused on the material issues that investors are interested in.”

Disclosure reform involves multiple stakeholder groups. The second CCMC panel of the morning focused on balancing the disclosure needs of various stakeholders. The panel included the perspectives of several professionals whose work is heavily influenced by the disclosure regime. They included Julie Bell Lindsay, managing director and general counsel for capital markets and corporate reporting, Citigroup Inc.; Chris Holmes, national director of SEC regulatory matters, Ernst & Young; Flora Perez, vice president and deputy general counsel, Ryder System Inc.; and Ann Yerger, executive director, Council of Institutional Investors.

From the investors’ perspective, it was noted that because investors are voracious consumers of information, they will rarely say “no” if offered more information.

Several corporate counsels noted initiatives at their companies that are designed to increase disclosure transparency, including efforts to work directly with investors to determine the information that was the most important to them. In fact, nearly half of the respondents to the 2013–2014 NACD Public Company Governance Survey indicated that a representative of the board had met with institutional investors in the past 12 months:

survey graphic

The SEC is currently developing solutions. The final panel of the morning featured Keith Higgins, director of the SEC’s Division of Corporation Finance, who provided his views regarding the state of the disclosure system and described how the division is currently conducting its disclosure reform initiatives. More details regarding the division’s plans to tackle disclosure reform can be found in this speech by Higgins to the American Bar Association in April.

Throughout the morning’s discussions, there were also points of disagreement, such as the relevance of specific disclosures. Each session, however, provided evidence that on all sides of the issue there are those making good-faith efforts to improve the system.

[1] http://www.sec.gov/answers/commentletters.htm.