Pay ratio rule in SEC chair's sights

Sullivan & Cromwell partner Jay Clayton, President Trump's nominee for SEC chairman, last week testified at his hearing before the Senate Banking Committee.  Meantime, although the commission is currently operating with only two commissioners out of the full compliment of five, several contentious issues are being revisited, with their outcomes unpredictable. 

In August of 2015, the commission adopted a final rule that requires a public company to disclose the ratio of the compensation of its chief executive officer (CEO) to the median compensation of its employees.  Based on comments received during the rulemaking process, the Commission delayed compliance for companies until their first fiscal year beginning on or after January 1, 2017.  Issuers are now actively engaged in the implementation and testing of systems and controls designed to collect and process the information necessary for compliance.

However, Acting Chairman Michael Piwowar has become aware that some issuers have begun to encounter unanticipated compliance difficulties that may hinder them in meeting the reporting deadline.  He opposed the rule in 2015 when it was approved, calling it "a provision of the highly partisan Dodd-Frank Act that pandered to politically connected special interest groups."

Part of the 2010 Dodd-Frank law, the pay-ratio rule mandates that companies disclose median worker pay - the point on the income scale at which half their employees earn more and half earn less - and compare it with CEO compensation.  The rule could put pressure on corporate boards to slow pay increases for chief executives at companies with significant or widening gaps, proponents have said.

From the outset of the debate, years before the projected start of disclosure of the data, the requirement has been controversial because it could further embroil executive pay disclosure in divisive political debates about income inequality and its causes.  Companies complain the metric, which firms are set to begin reporting in 2018 for this year's pay, is expensive to calculate and not informative to shareholders.  "Industry has fought it tooth and nail because the contrast between worker pay and CEO pay is stark," said Lisa Gilbert, a director of Public Citizen, an ardent supporter of the pay rule.

The SEC could encounter difficulty attempting to delay the rule outright, because of the commission's depleted ranks.  With just two sitting commissioners - Mr. Piwowar and Kara Stein, a Democrat - the SEC is likely politically deadlocked on most matters.  In response to the directive to reconsider it, Ms. Stein signaled opposition to efforts to ease the pay ratio rule.  "It's problematic for a chair to create uncertainty about which laws will be enforced," she said.

Congressional Republicans have indicated opposition to the pay ratio rule and are expected to try to spike it legislatively, though those efforts could be stymied in the Senate, where Democrats have more leverage than in the House.  Senator Elizabeth Warren (D, MA) said yesterday that the Acting SEC Chair may be exceeding his powers by ordering 1) the Enforcement Division’s investigative powers scaled back and 2) two Dodd-Frank Act mandated final rules, on disclosure of use of  "conflict minerals" and CEO-worker pay ratio, reconsidered.

The pay ratio rule reconsideration under way doesn't immediately relieve companies of the need to comply in the coming year.  It is somewhat unusual for the SEC chief to seek new comments on a closed regulatory matter.  Willis Towers Watson was one of myriad entities submitting suggestions to the SEC during the recently-closed comment period.  In its letter, WTW proposed:

• Narrowing the definition of “employee” and “employee of the registrant.”
• Clarifying that prior-year data can be used to identify the median employee. 
• Clarifying that companies can use base pay as a consistently applied compensation measure (CACM).
• Making clear that the disclosure can be a “reasonable estimate.”
• Allowing registrants to use readily accessible records to determine employee classifications.
• Permitting broader use of “reasonable estimates” as part of statistical sampling to greatly reduce the effort required for companies with global workforces.

We'll keep a close eye on the regulatory and legislative proceedings, which could modify the rule, perhaps postpone its effective date, or conceivably do away with it altogether.

Robert Stead