For those seeking deregulation, the Securities and Exchange Commission’s pay ratio rule certainly seems to be low-hanging fruit.

Unpopular rule? Check.

Ideologically motivated? Check.

Materiality? Questionable.

The rule requires public companies to disclose, in an SEC filing, the ratio of CEO pay to that of the median employee (globally, not just domestically). Proponents tout it as an added metric for investors to consider in an age of runaway executive pay. Critics view it as a deceptively complex rule rife with compliance costs and international headaches. The intent, they say, is merely to fuel “name and shame” campaigns that benefit activists, unions, the media, and very few others.

Amid the polarized opinions, a few facts are laid on the table. First: as part of the Dodd-Frank Act, the rule is a Congressional mandate. What Congress giveth, only Congress can taketh away.

Also, the rule is already in effect. The SEC’s final rule requires registrants to comply with the new requirements for their first fiscal year beginning on or after Jan. 1, 2017. Companies may already be knee-deep in their calculations, with money already spent, if the requirement was to be suddenly yanked. And, proponents say, wouldn’t it be shortsighted to revisit the rule before it has had a chance to provide the data it was created to provide?

If you are a public company, especially one opposed to the rule, you are certainly forgiven if you think its days may be numbered.

In February, SEC Acting Chairman Michael Piwowar announced that the pay ratio rule, which he says is causing “unanticipated compliance difficulties,” was under reconsideration.

“It is my understanding that some issuers have begun to encounter unanticipated compliance difficulties that may hinder them in meeting the reporting deadline,” he wrote.

In order to better understand the nature of these difficulties, Piwowar announced that the Commission was seeking public input on “any unexpected challenges that issuers have experienced as they prepare for compliance with the rule and whether relief is needed.”

The letters received during the reopened 45-day public comment process espouse the gamut of opinions regarding the controversial rule.

Among those writing in was Lucinda Antrim, presiding clerk for the New York Yearly Meeting of the Religious Society of Friends (the religious order commonly known as the Quakers).

At the beginning of the 1900s, she recounted, Quaker businessman Joseph Rowntree said: “The real goal for an employer is to try to seek for others the fullest life of which an individual is capable.” The Dodd-Frank Act, Antrim wrote, supports that goal.

“We believe disclosure of CEO-to-worker pay ratio is material to investors,” Antrim added. “High pay disparities inside a company can hurt employee morale and productivity and have a negative impact on a company’s overall performance.”

The Washington Legal Foundation, a non-profit legal organization that advocates pro-business and free-market positions, struck a much different posture.

The pay ratio rule, it says, offers no convincing evidence that “shaming” companies will cause them to cut CEO pay.” The SEC is also guilty of “rigging the rule to advance the pay-unfairness agenda” by requiring companies to include part-time and seasonal employees in their figures without annualizing the employees’ earnings. This “skews the median to a lower-level employee.”

“We believe disclosure of CEO-to-worker pay ratio is material to investors. High pay disparities inside a company can hurt employee morale and productivity and have a negative impact on a company’s overall performance.”
Lucinda Antrim, Presiding Clerk, New York Yearly Meeting of the Religious Society of Friends

The Society for Corporate Governance recognized that the SEC “has shown some flexibility through the final rule and associated guidance.” Nevertheless, it urged delay, reconsideration, and withdrawal.

Among the concerns it has gleaned, thus far, from its membership’s implementation efforts:

The rule does not provide material information to investors and obfuscates information that investors actually do deem material to their investment decisions.

The rule imposes significant direct and indirect costs to companies in the forms of data gathering and systems costs, legal expense, auditing expense, public relations expense, litigation risk, and other costs.

Another concern: An unanticipated ruling by the National Labor Relations Board that has “further complicated the already fraught process of distinguishing between ‘employees’ and ‘independent contractors.’ ”

The letter details how pending litigation stemming from the NLRB’s decision in a matter involving Browning-Ferris Industries creates uncertainty and confusion regarding the rule’s definition of “employee” or “employee of the registrant.”

In the NLRB case, the Bureau expanded its definition of “joint employment” creating uncertainty regarding the circumstances in which a registrant could be considered a joint employer with an entity that provides putative independent contractor labor to that same registrant.

The Bureau ruled that two or more entities are joint employers of a single workforce if they are both employers within the meaning of the common law. It went on to hold that “the right to control [essential terms and conditions of employment], in the common-law sense, is probative of joint-employer status, as is the actual exercise of control, whether direct or indirect.”

The practical impact of the decision could require companies reporting under the rule to consider themselves “joint employers” along with entities supplying putative independent contracting labor.

The expansion of who is (and who is not) an “employee” caused by the NLRB’s ruling “appears to contradict or at least confuse the SEC’s guidance,” the comment letter says. “The inconsistency between the rule and the NLRB ruling compounds the uncertainty registrants face in determining who precisely is an ‘employee’ under the rule. Requiring companies to include in their pay ratio calculation workers employed by previously ‘unaffiliated’ entities will further undermine the relevance of the rule in helping investors assess executive compensation.”


The U.S. Chamber of Commerce is pushing for a repeal of the SEC’s pay ratio rule, calling it a “misguided mandate.”
Since such a repeal is by no means certain, and could take a long time even if it was going to happen, the Chamber’s Center for Capital Markets Competitiveness offers the following recommendations for how the current rule could be fine-tuned to lessen what it considers to be the rule’s burden:
Exclude all non-U.S. employees as well as seasonal and part time employees from the median employee calculation.
Create a safe harbor to allow issuers the option of using industry median compensation data compiled by the Bureau of Labor Statistics.
The SEC should rely on and adopt prevailing standards regarding the definition of independent contractors.
The SEC should exclude employees who are on a leave of absence or have been furloughed from the median employee calculation.
In light of “pay ratio tax” proposals cropping up in various jurisdictions across the country, the SEC should conduct a new cost-benefit analysis of the pay ratio rule that takes into account the costs such taxes would impose upon issuers, investors, and the capital markets.
As per the last bullet point, several “pay ratio tax” bills have been introduced in various state and municipal jurisdictions around the country. For example, the city council of Portland, Oregon recently voted to tax companies doing business in Portland if such companies have a pay ratio that the council considers to be too high.
Source: U.S. Chamber of Commerce Center for Capital Markets Competitiveness

Another comment letter was penned by Jeffrey Shuman, senior vice president and chief human resources officer of Quest Diagnostics. His company’s initial difficulties are related to systems and data issues.

The company relies on the extensive use of a non-employee contingent workforce, he explained. “These contingent workers can be employed as contractors directly, or, more typically, through temporary staffing agencies it contracts with. The company pays the staffing agencies based on hours worked by their employees, an hourly rate (which it helps determine), and a “mark-up” charged by agencies.

The staffing agencies are responsible for paying the employees and issuing associated tax documentation. “We therefore do not have access to full data necessary to take account of the compensation of such workers in the determination of the median employee; nor can we fully audit how these contingent workers are actually paid,” Shuman wrote. “Collating

and analyzing such information from several systems (our HR system/payroll, our accounts payable system, and the staffing agencies) is proving complicated and expensive. Setting up supporting auditing structures for the calculation is also challenging.”

The inclusion of non-U.S. employees in the pay ratio determination “creates immense compliance complications,” wrote the American Benefits Council, a public policy organization representing Fortune 500 companies. Among the issues:

Foreign data privacy laws can change and complicate the process of obtaining compensation from non-U.S. jurisdictions.

In some countries, it is not possible to get compensation data without explicit employee consent.

In the non-U.S. employee context, companies cannot rely on straight salary data for identifying their median employees, due to, for example, currency exchange issues.

Many companies have multinational operations with multiple payroll systems in the various countries in which they operate.

Chesapeake Utilities Corp., a Delaware-based energy company that provides service to over 230,000 customers, lamented “counterintuitive messaging and unintended consequences.”

At its company, the CEO typically has a “substantially larger portion of his pay at risk,” which is linked to performance metrics, such as Total Shareholder Return (TSR), Earnings Per Share (EPS) and Return on Average Equity (ROE), than that of the “median employee.”

“Performance metrics … are intended to measure shareholder value or lead to creation of such value,” wrote James Moriarty, senior vice president, general counsel, and corporate secretary. “The result of this rule will be counterintuitive. In strong performance years, a company’s ratio would go up, and be subject to criticism, while in poor performance years the ratio would go down, and be subject to praise. Reactions to the higher or lower ratio numbers are contradictory to long-term value creation for shareholders.”

In terms of legal hurdles, companies with international operations face data privacy laws in some countries that could make it extremely difficult, if not impossible, for them to identify the median employee, said the National Association of Manufacturers.

“The barriers to sharing this information are not limited to Europe,” it wrote. “Indeed, a NAM member operating in Russia found that, according to that nation’s data privacy laws, the company will need to get the personal sign-off from every Russian employee to share the data with the corporate headquarters. The final SEC rule does allow issuer companies to exclude non-U.S. employees where the data privacy laws would not allow compliance, but the issuer would still need to obtain legal opinion from counsel in these cases, adding additional man hours to the already burdensome requirement.”

Manufacturers are also concerned that obtaining the written opinion of counsel in foreign jurisdictions with respect to this issue “will be extremely difficult, if not impossible,” it added, expressing concern that the SEC has not adequately considered the challenge posed by the varying types and standards of compensation in different countries.”

The American Federation of Labor and Congress of Industrial Organizations defended the rule as providing “investors with an alternative metric to assess the reasonableness of CEO pay within each particular company.”

Currently, CEO pay levels are set based on a peer group analysis of what other CEOs are paid. Over time, the use of peer group analysis leads to a ratcheting up of CEO pay levels, it claimed.

“Pay ratio disclosure will encourage consideration of internal compensation practices rather than relying on peer group analysis alone,” the AFL-CIO letter says.

It added that, as permitted by the SEC’s rule, “boards of directors can disclose supplemental information to provide context and explain to shareholders why their company’s pay ratio is appropriate…Shareholders could then take a more informed view on whether pay levels are proportionate and reasonable.”

Pay ratio disclosure will also provide investors “with greater insight into the human capital management strategies of their portfolio companies.”

“For many companies, employee compensation is frequently the single largest expense,” the letter says. “Yet few companies provide meaningful disclosure of how this asset is managed, including how employee compensation is allocated over their workforce.”