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Final and Proposed SEC Rules Target Executive Compensation

August 25, 2015

The Securities and Exchange Commission (SEC) is bringing additional transparency to the ever-controversial topic of executive compensation. One finalized and two proposed rules would require publicly traded U.S. companies to be more forthcoming with data related to the pay of their top employees.

The recently finalized pay ratio disclosure asks that publicly traded companies, with the exception of smaller firms, foreign private issuers, emerging growth companies and registered investment companies, include information about the difference between the CEO's total compensation and the average worker's total compensation. A proposed rule on pay versus performance disclosures would require public companies to disclose the relationship between executive compensation and shareholder return. A proposed "clawback" rule would require public companies, in the event of a restatement, to recover any incentive-based compensation that was incorrectly distributed.

All of the changes come via the direction of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Should the two proposed rules become finalized, the SEC would have fulfilled all of its mandates with respect to executive compensation.

Companies should examine how they disclose and report on executive pay to prepare for the changes. With compliance concerns will also come increased scrutiny on their compensation practices.

Pay Ratio Disclosures

Public companies currently disclose information about top officer compensation in proxy filings prior to annual stockholders' meetings. The pay ratio disclosure is in addition to current requirements and shall include:

  • The median of the annual total compensation for all employees, less the chief executive officer;
  • The annual total compensation of the CEO, following the existing guidance in Item 402(c)(2)(x) of Regulation S-K.; and
  • The ratio of those two amounts.

The SEC voted 3-2 to adopt the Dodd-Frank requirements during an August 5, 2015, meeting. The issue has been divisive because opponents of the measure say complying with the new requirements would cost public companies a cumulative $1.3 billion and that the change was designed to name and shame CEOs.

Though the requirements will require some changes in reporting, they do allow for flexibility. Entities can select which way they calculate the pay ratio. They can use a statistical sample, evaluate the whole employee population or use another methodology to determine the median employee amount.

Certain employees can be excluded from the evaluation, including non-U.S. employees in jurisdictions where the sampling would violate data privacy laws. Companies with less than 5% of their workers overseas can exclude the non-U.S. based employees from calculations. Companies with a larger percentage of overseas employees can exclude up to 5% of their non-U.S. population.

As part of the requirements, companies have to disclose the methodology used to determine the average employee compensation and any estimates or material assumptions used as part of the process.

The pay ratio must be used in registration statements, proxy and information statements and annual reports that include executive compensation information for fiscal years beginning on or after January 1, 2017.

Pay Versus Performance

As another degree of transparency, the SEC proposed that companies disclose how total shareholder returns affect executive compensation. All public companies except for smaller firms, foreign private issuers, emerging growth companies and registered investment companies would be subject to the requirement.

Under the suggested changes, public companies would provide information about executive pay and performance in a peer group table in proxy statements for annual shareholder meetings and other statements that require executive compensation information. They would have to use interactive XBRL tagging of the disclosure.

The comment period for the proposed rule ended on July 6, 2015, and the effective date of the final rule has yet to be determined.

Clawback Policies

The SEC recently proposed that companies should have a policy to recover incentive-based compensation to executives in the event of a restatement if the incentive turns out to be miscalculated.

Public company executives would be required to pay back any incentive related to certain financial metrics, such as stock price or total shareholder returns, if the company had to issue an accounting restatement in that period. Executives would also have to pay back incentives earned in a three-year window prior to the issuance of the accounting restatement.

As part of the rule, entities would file their recovery policies as an exhibit to their annual SEC report. Should the policy be triggered, they would have to disclose their steps to get that excess compensation back as well as the outstanding amount the company needs to recover.

Public comment period on the measure ends on September 14, 2015.

Preparing for the Scrutiny

Public companies subject to the new requirements and proposed rules need to get a jumpstart on making the necessary changes. In addition to meeting their compliance burdens, companies will need to prepare for the increased access investors and the public will have to your company's compensation practices. By acting early, you have time to address any potential obstacles that may arise as you implement the standards.

For More Information

If you have specific comments, questions or concerns about the SEC requirements, please contact Brad Hale or Rich Howard of MHM's Professional Standards Group. Brad can be reached at bhale@cbiz.com or 727.572.1400. Rich can be reached at rhoward@cbiz.com or 949.450.4402.

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