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Early Comments on Pay-Ratio Proposal Reveal a Sharp Divide Between Companies and Investors

November 14, 2013

The comments that have come in ahead of the deadline for a recent SEC proposal include tens of thousands from investors who submitted form letters that back the required disclosures of chief executive pay and the ratio of the CEO’s compensation to the median for all employees.At the same time, companies are complaining that gathering and reporting the data will impose too high a cost on them.Some business groups feel that regulators haven’t done enough to hear their views.

Judging from comment letters that have come in ahead of the deadline for a recent SEC proposal, many investors are pushing for more public disclosures about corporate pay practices, while companies are complaining that gathering and reporting the data would impose too high a cost on them.

To meet a Dodd-Frank Act requirement, the SEC proposed Release No. 33-9452,Pay Ratio Disclosure,to call upon public companies to report the ratio of their CEO pay to median employee pay.The rule was proposed on September 18, 2013, with a comment deadline of December 2. If finalized, the proposal will amend the reporting provisions for executive compensation in Item 402 of Regulation S-K.

According to the AFL-CIO’s calculation, the ratio between the pay for CEOs of U.S. companies and the average worker was 354-1 at the end of 2012.Some investor groups say disclosing the pay ratios will discourage the type of pay practices they blame for the 2008 financial crisis.

Americans for Financial Reform said the pay ratio disclosures are only a modest response to the crisis.

Business groups began challenging the underlying Dodd-Frank provision before the SEC proposed the rule.In response to complaints about the difficulty of calculating the ratio, the SEC is allowing companies some flexibility to produce the data.

The proposal doesn’t specify a single method for calculating the median, but public companies can choose a process that fits their structure and compensation programs.For example, the proposed rule lets a large company use a statistically representative sample of its workforce rather than the entire population.

Companies also won’t have to calculate the exact compensation when identifying the median.Instead, a company could apply any “consistently used compensation measure,” such as the amounts reported in payroll or tax records.While companies would still have to calculate annual total compensation, the SEC would allow them to use “reasonable estimates” when making such a calculation.They would be required to disclose the method used to determine the median employee pay, as well as estimates used in calculating the ratio.

The changes don’t appear to have mollified the proposal’s critics, who say the information won’t provide much benefit to investors but impose significant costs on more than 3,800 companies.The National Investor Relations Institute (NIRI) added in an October 17, 2013, letter that the SEC’s proposal will lead to ratios that are “likely to be misleading or inconsistent or both, with a high probability that the disclosures would confuse most investors and not contribute to their understanding of corporate pay practices.”

Even with flexibility, the group said compliance costs will be “exorbitant, especially for those firms with overseas employees” and asked the SEC to limit the disclosure to full-time U.S. employees and let companies rely on existing industry-specific employee compensation data from the Department of Labor’s Bureau of Labor Statistics.

NIRI said a company’s use of contract workers, employment of workers from low-wage states or countries, or the increased use of low-paid seasonal employees could cause the ratios to differ significantly.In a hypothetically extreme case, a company, under pressure to maintain a low pay ratio, could decide not to expand business operations in lower cost regions.

The group also said the lack of clearly defined calculation standards could increase compliance costs.Some companies may ask their auditors to review the data and verify that they used appropriate calculation methods.

“It will be costly for auditors to do this work, given the lack of clear-cut standards to guide these reviews,” NIRI said.

McGuireWoods LLP said in a November 7 letter said that the most costly and time consuming calculations usually are the changes in pension value and perks.The law firm asked the SEC to allow companies to identify the median employee by using statistical sampling based on a definition of compensation other than “annual total compensation” under Item 402.

The proposed rule’s supporters include 32,000 individuals who signed form letters that have been submitted to the SEC.

“Knowing which corporations heap riches upon their executives while squeezing struggling employees also will be a useful factor for me when considering which businesses to support with my consumer and investment dollars,” says a form letter signed by 20,000 people.

“Fairer pay structures mean stronger companies and a stronger economy, both of which are important to me as a consumer and as an investor,” says a second letter signed by more than 8,100 people.

SEC officials say they consider form letters from organized campaigns as a valid source of opinion when they review the responses to a proposal.

Despite having no formal position on the proposal, the Council of Institutional Investors submitted a comment drawn from discussions with some of its members.

“The members generally agreed that the commission has done an admirable job… in a flexible manner that attempts to strike an appropriate balance between providing potentially useful information to investors and limiting company compliance costs,” wrote CII’s general counsel Jeff Mahoney on November 6.

In addition to the sharp differences between business groups and investors, the proposal faces other hurdles before it’s finalized.

Fourteen groups representing businesses, including the U.S. Chamber of Commerce and American Insurance Association, requested a 60-day extension of the comment deadline, citing the rule’s complexity.The groups said they were disappointed that the SEC didn’t do more analysis of the rule’s costs and give companies more of an opportunity to present their views, such as by holding a public roundtable.

The trade groups also said Dodd-Frank doesn’t impose a deadline for finalizing the rule.