On September 21, 2017, the SEC approved new interpretive guidance designed to aid companies in their compliance with the pay ratio disclosure rules under Item 402(u) of Reg. S-K, as most companies are required to comply with these regulations in early 2018. The SEC guidance encourages companies to use the flexibility incorporated in the rules to reduce the cost of compliance.
Use reasonable estimates, assumptions, methodologies and sampling
The pay ratio rule provides flexibility in identifying the “median employee” and calculating his or her annual total compensation. Companies are encouraged to use reasonable estimates, assumption, methodologies, and statistical sampling and to use reasonable efforts in preparing disclosure. The key is to use reasonable assumptions and consistently applied measurements (such as payroll or tax records). The SEC confirmed that because the pay ratio measurements and disclosures involve a degree of imprecision, “if a registrant uses reasonable estimates, assumptions or methodologies, the pay ratio and related disclosure that results from such use would not provide the basis for Commission enforcement actions unless the disclosure was made or reaffirmed without a reasonable basis or was provided other than in good faith.” As usual, companies should carefully consider their disclosure of these assumptions and any changes in methodology.
Use existing, internal records
A company may use appropriate existing internal records, such as tax or payroll records, to identify the median employee and determine whether exclusion of non-U.S. employees is allowed by the 5% de minimis exception. According to the SEC guidance, the internal records that are useful for determining the median employee should be those that “reasonably reflect annual compensation… even if those records do not include every element of compensation, such as equity awards widely distributed to employees.” Further, the SEC noted that if the selected internal measure resulted in a median employee with “anomalous characteristics… that have a significant higher or lower impact on the pay ratio,” then the company may select another employee with “substantially similar compensation” to the initially identified employee. Note however, that companies must determine their own median and cannot rely on industry estimates, such as employee earnings estimates provided by the Bureau of Labor Statistics.
Employee v. independent contractor status
The SEC clarified that the statement in the rule allowing companies to exclude “workers who are employed, and whose compensation is determined, by an unaffiliated third party” is an example of one class of non-employee that may be excluded, but it is not the sole means for exclusion. Rather, companies may also exclude workers from the pay ratio calculation based on widely recognized tests under other areas of law that the registrant otherwise uses to determine whether its workers are employees, such as employment law or tax law.
Finally, the SEC issued additional guidance from the Commission staff that provides hypothetical examples and FAQs illustrating how reasonable estimates and statistical methodologies may be used. Please find below links to the SEC’s news release, interpretive guidance, and staff guidance.
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