Tag Archive: Comment letter

Applying the SEC’s Newest Guidance on Pay Ratio Disclosures

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alexandralajoux

  Alexandra R. Lajoux

“It ain’t over ‘til it’s over.” Truer words were never spoken when it comes to the new pay ratio rule.

A key chapter in pay regulations closed August 5, 2015 when the U.S. Securities and Exchange Commission (SEC) issued its final rule on the pay ratio disclosure mandated by the Dodd–Frank Wall Street Reform and Consumer Protection Act. This final rule capped a two-year comment period intended to resolve many thorny issues around exactly when and how to calculate the two numbers involved in the rationamely median employee compensation/CEO compensation. (To see NACD’s comment letter, visit the NACD Resource Center on Corporate Governance Standards and click on our Comment on Pay Ratio.)  The NACD comment letter, like some others, noted that the “annual total compensation” figure can be misleading, and suggested solving this problem by asking the SEC to permit the use of industry averages, to limit employees to full-time domestic employees, and to permit supplemental notes. In its final rule, the SEC did not make these changes but did address concerns about total annual pay by allowing companies to use any “consistently applied compensation measure” (CACM) to calculate median annual compensation for employees.

This concept of a CACM led to questions, however. So on October 18, 2016, the SEC’s Division of Corporation Finance addressed them by updating its C&DI for Regulation S-K, one of the 32 “Compliance and Disclosure Interpretations” (C&DIs) the staff maintains on its most complex regulations. Although the five questions raised are technical rather than strategic, and represent only a tiny fraction of the many issues raised by the final rule overall, they still merit board attention. Therefore, this blog presents, in simplified English, the five ratio-relevant Q&As in the newly updated C&DI (codified under Section 128 C) and provides a key question and a final “takeaway” for boards.

Summary of the SEC’s Five Questions and Answers

Summary of Question 1: If a company does not use annual total compensation to identify the median employee, how should it choose another consistently applied compensation measure (CACM) to do so?

Summary of Answer 1: SEC’s updated C&DI assures companies that a CACM can be any measure that “reasonably reflects the annual compensation of employees,” but asks that companies explain their rationale for the metric they choose. An appropriate CACM will depend on “particular facts and circumstances,” says the SEC. For example:

  • Total annual cash compensation can work as a CACM, unless the company has also made a wide distribution of annual equity awards for the same period.
  • Social Security taxes withheld would likely not be an appropriate CACM unless all employees earned less than the Social Security wage base.

Summary of Question 2: May a registrant exclusively use hourly or annual rates of pay as its CACM?

Summary of Answer 2: No. Although an hourly or annual pay rate may be a component used to determine an employee’s overall compensation, the use of the pay rate alone generally is not an appropriate CACM to identify the median employee.

Summary of Question 3: When a registrant uses a CACM to identify the median employee, what time period may it use?

Summary of Answer 3: The SEC’s answer to this question says that the company must select a date within three months of the end of its most recent fiscal year to determine the population of employees from which to identify the median employee. The CACM need not be contemporaneous. In fact, it can come from the prior fiscal year, as long as there has not been a material change in the registrant’s employee population or employee compensation arrangements—that is, a change that would “result in a significant change of its pay distribution to its workforce.”

Summary of Question 4: What about furloughed employees?

Summary of Answer 4: The SEC’s response clarifies that the final rule identifies four classes of employees: full-time, part-time, temporary, and seasonal. It does not define or even address furloughed employees, because a furlough could have different meanings for different employers. It is a matter “facts and circumstances” and provides additional guidance on the matter.

Summary of Question 5What about independent contractors? Under what circumstances can their pay be included in the CACM for the employee?

Summary of Answer 5: The final rule had stated that “leased” workers are excluded from the definition of employees “as long as they are employed, and their compensation is determined, by an unaffiliated third party.” The SEC’s answer preserves this distinction, and gives some flexibility. In determining when a worker is an “employee,” the company “must consider the composition of its workforce and its overall employment and compensation practices.” So a company should include workers whose compensation it (or a subsidiary) determines “regardless of whether these workers would be considered ‘employees’ for tax or employment law purposes.”

NACD Takeaway
Are you familiar enough with compensation patterns in your company to know whether a chosen CACM “reasonably reflects” the compensation in your company? If not, you may wish to meet with the officer responsible for employee pay below the executive level to get a better sense of this important issue.

Compensation committees have traditionally focused on executive compensation, leaving employee compensation to management. In the past few years, however, several factors have combined to broaden the committee’s purview, including concerns about pay disparity, and the new requirement to disclose compensation risk. Therefore, more compensation committees are overseeing enterprise-wide pay. For example, in its 2016 proxy statement, WPX Energy disclosed that in the past year “With the oversight of our Compensation Committee, we conducted a risk assessment of the Company’s human capital with a focus on enterprise-wide compensation programs.” (Emphasis added.)

The key word in all of these questions and answers is “reasonably.” It is exactly the right word for compensation committees to use as they oversee this disclosure, as well they should.


Alexandra R. Lajoux is chief knowledge officer emeritus at the National Association of Corporate Directors. 

SEC Roundtable on Conflict Minerals Regulations

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On Tuesday, the Securities and Exchange Commission (SEC) convened a roundtable for an area the Commission does not usually delve into: the humanitarian crisis in the Democratic Republic of Congo (DRC). As part of the Dodd-Frank financial reform legislation, the SEC was given the responsibility of drafting rules requiring publicly listed companies to disclose whether their products contain “conflict minerals.” In this context, the conflict minerals are tin, tungsten, tantalum, and gold produced in the DRC or adjoining countries, as well as any others the U.S. Secretary of State may designate as financing conflict in the DRC.

Although the SEC issued proposed rules on the disclosure in December 2010, it has since failed to meet its April deadline established for final rules, citing difficulties in drafting a rule that would not pose prohibitive costs of compliance for companies. To this end, the SEC convened a public roundtable representing corporations, investors and human rights advocates.

The first panel discussed what is covered by the rule, and what steps would be required to comply. Panelists included Sandy Merber, General Electric; Irma Villarreal, Kraft Foods Inc.; Yedwa Zandile Simelane, AngloGold Ashanti Ltd.; and Mike Davis, Global Witness. The panel discussed a series of questions the Commission had developed from the first round of comment letters including:

  • Should functionality be a test of whether a product is included in the report?
  • If the mineral is used as an ornament, should it be included?
  • Should rules include a de minimis point?
  • How to define “contract to manufacture” in rules

Unlike many of the rules to develop from Dodd-Frank, this did not trigger contention among those representing corporations, investors and advocacy groups. While the representatives from Kraft Foods and General Electric noted the practical impossibility of fully identifying the sources of all their products by the next reporting season, the other panelists, recognizing this, responded that they would be content with a “good faith” effort, improving year over year. Even so, the sheer scope of the rule’s potential impact demonstrates the difficulties the SEC faces in writing the rules, and for companies to comply. Villarreal noted that Kraft Foods has 40,000 different products with 100,000 suppliers.

The second panel continued to discuss the steps necessary for compliance as well as reporting. Panelists included Benedict S. Cohen, The Boeing Company; Jennifer Prisco, TE Connectivity; Darren Fenwick, Enough Project; Kay Nimmo, ITRI, Ltd.; and Darrel Schubert, Ernst & Young LLP and the Auditing Standards Board. Picking up where the first panel left off, the roundtable discussed further questions from the SEC, such as:

  • Should the disclosure be included in the annual report or in a separate report?
  • Should scrap and recycled minerals be exempt?
  • How should the country of origin be defined?
  • Who should conduct the audit? A Certified Public Accountant (CPA), or non-CPA?
  • Should the SEC specify a standard for the audit, and, if so, what standard?

The SEC faces a difficult task—draft rules that satisfy the Dodd-Frank requirements and advocacy groups, without imposing punitive costs or unattainable expectations on corporations. In light of the recent dismissal of proxy access rules from the U.S. Court of Appeals, the SEC must also create rules that will survive potential court challenges. As the voice of the director, NACD is currently drafting a comment letter. Stay posted for further developments in this area.

NACD Insight & Analysis: SEC Whistleblower Program

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In Thursday’s NACD Directors Daily, the Wall Street Journal reported on the actions large companies have taken in response to the SEC’s proposed whistleblower program. While the SEC has received hundreds of comment letters opposing various provisions of the proposed rules, the Journal reported on more than two dozen of the country’s largest companies that have asked the SEC to revise the proposed rules. One of the more contentious issues is the proposed “bounty” that would be rewarded to a whistleblower if the company receives a sanction of more than $1 million. That bounty could range between 10 and 30 percent of the penalty paid by the company.

The article covers both sides of the debate surrounding the new whistleblower program. Businesses fear that employees will bypass the internal compliance programs and whistleblowing hotlines mandated by Sarbanes-Oxley, and report directly to the SEC. On the other hand, attorneys defending whistleblowers argue that requiring the use of internal reporting channels prior to the SEC would discourage fraud reporters for fear of losing anonymity. The SEC has just weeks to issue final rules that balance the use of internal reporting systems with reporting fraud.

Since the SEC first proposed rules on the new program last fall, NACD has worked to amplify the voice of the director on this issue. In our comment letter, we voiced concerns similar to the reservations expressed by the companies in the Journal article. Our letter stressed that the SEC should work to enhance and strengthen the internal reporting channels already in place, rather than bypass those channels by going directly to the SEC with an issue. Encouraging internal reporting can help management address and solve issues in the early stages, which in many cases are best solved by internal human resources professionals.

In the past months, NACD has also met and discussed the possible consequences of the proposed whistleblower rules with key members of the regulatory and investor communities to discuss your concerns and suggestions as we heard them in our survey prior to submitting our comment letter. In addition, last week’s edition of NACD BoardVision features NACD’s Managing Director & CFO, Peter Gleason discussing the whistleblower provisions with PwC’s John Barry.