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Pay-Ratio Disclosure Rule May Include Foreign Workers, Part-Timers

The SEC’s staff is finalizing a Dodd-Frank rule that will require companies to provide the ratio of the CEO’s total pay to that of the median employee. Regulators are still trying to determine if the requirement should include foreign employees of multinational companies and part-time workers. Investors generally believe that all employees have to be included for the disclosure rule to have any substance. Many companies say the larger the pool of employees the rule covers, the more costs they’ll incur following it.

As the SEC wraps up some remaining Dodd-Frank Act rules in 2015, the agency is trying to piece together a hotly contested provision on executive compensation so that it becomes easier to implement.

Business groups complain that the final version of the rule based upon the September 2013 proposal in Release No. 33-9452, Pay Ratio Disclosure, will impose heavy costs on the companies that have to follow it and provide no benefits to their shareholders. The rule calls for public companies to provide the ratio of the CEO’s total pay to that of a median employee.

Investors say the information is material to their investment decisions at a time when social and governance issues are taking on more prominence.

Trillium Asset Management LLC, an investment firm in Boston, wrote to the SEC in July that companies with good performance on governance pose less risk and offer higher returns to shareholders.

High pay disparities “can hurt employee morale and productivity and have a negative impact on a company’s overall performance,” wrote Trillium.

The proposal received more than 128,000 comment letters, the vast majority of them form letters. A common sentiment in the letters says, “Disclosing corporate pay ratios between CEOs and average employees will discourage the outrageous and reckless pay practices that fueled the 2008 crash.”

The substance of the final rule still has to be determined. Keith Higgins, the director of the SEC’s Division of Corporation Finance, said his staff is specifically looking at some concerns raised by businesses in the comment letters.

“The principal issues in the rulemaking revolve around all the employees, and the cost associated with including non-U.S. employees of multinational companies,” said Higgins during the AICPA’s National Conference on SEC and PCAOB developments in Washington on December 9, 2014. The “flip side of that is that investors [say], ‘Gee, we really wouldn’t be able to get a good picture of what compensation is across the company if you left out foreign employees.'”

The SEC is also trying to determine how it will convert part-time employee compensation to a full-time rate so that the final numbers are meaningful.

Companies view the proposed requirement as highly controversial. Many began challenging it before it was issued. In response to complaints about the difficulty of calculating the ratio, the SEC is allowing companies some flexibility in producing 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. Companies will still have to calculate annual total compensation, but the SEC will let them use “reasonable estimates” when making the calculation. They would be required to disclose the method used to determine the median employee pay, as well as the estimates used in calculating the ratio.

The SEC’s suggested alternatives didn’t mollify companies who want a much simpler rule. A May 2014 report from the U.S. Chamber of Commerce said the rule will impose “egregious costs” on businesses and challenged the need for the requirement.

The Center on Executive Compensation, whose advisory board includes executives from major public companies, wrote in September 2014 that the SEC should write the rule in a manner that will significantly reduce the burden on companies without negatively impacting the pay ratio disclosure.

The group said limiting the disclosure to U.S. employees only will cut the compliance costs by nearly half and eliminate the likelihood that the rule will violate foreign data privacy laws. The number will also be less volatile each reporting period because it won’t be subject to fluctuating exchange rates and the difficulty of finding consistent compensation measurements from one country to the next. Limiting the disclosure to full-time employees will reduce compliance costs by an additional 20 percent.

The Council of Institutional Investors, a pension fund coalition that often lobbies the SEC on corporate governance requirements, hasn’t formed a position on the issue, said Jeff Mahoney, the group’s general counsel. Representatives from three funds, one a corporate pension, the second a public employee retirement fund, and the third a union pension fund, told him they support a broader requirement that covers all employees, including foreign workers.

“Two of the three members noted that since many publicly traded companies employ a majority of international employees, or part-time employees, investors would receive an incomplete picture of a registrant’s practices if those employees were excluded from the calculation,” Mahoney said. Still, the fund representatives felt that contract workers and temps should probably be left out of the calculation because they’re not technically employees.