SEC Issues Pay-Ratio Disclosure Rule

Gap Accounting: Some five years and 287,000 comments after the pay-ratio disclosure rule was included in the Dodd-Frank Wall Street Reform and Consumer Protection Act, the US Securities and Exchange Commission issued the final regulation in August.

Starting in January 2017, many large US public companies will have to disclose the median annual compensation of all employees other than their CEOs, the total compensation of their chief executives, and the ratios between the two.

The regulation comes amid growing controversy over income inequality. Critics say the massive gap between senior executive compensation and worker pay is growing—and unjustified. Many corporations opposed the rule. Labor unions, on the other hand, backed it.

Andrew Liazos, a US-based partner with law firm McDermott Will & Emery, says corporate finance professionals will need to devise effective controls around these disclosures. “If you’re a CFO, you want to be very comfortable that the process put in place to create disclosures for this rule will pass muster,” he says.

Most companies are likely to rely on statistical sampling, rather than try and tally the pay stubs of every employee. “They’ll need to make sure they’re using a valid method,” Liazos cautions.

To comply with the rule, many larger companies will need to gather data from multiple payroll systems. The average annual cost of doing so, as estimated by 118 respondents to a US Chamber of Commerce survey, topped $185,000.

Because the rules prohibit companies from annualizing or adjusting the wages of temporary or part-time workers, the ratios at firms with many part-time and temporary or seasonal workers are likely to look worse than those at other businesses.

The regulations do allow exceptions for employees who work in jurisdictions in which data privacy laws render a company unable to comply with the rule. However, the company has to obtain a legal opinion attesting to the difficulty of compliance.

Companies can also exclude up to 5% of non-US employees. If a company excludes any non-US employee in a jurisdiction, though, it must exclude all of them.

Although the rule is final, changes are possible. “The big wild card in this is judicial and legislative challenges,” Liazos says.

That uncertainty shouldn’t, however, be a temptation to adopt a wait-and-see attitude. “It’s hard to sit on the sidelines because it may take a year to prepare to do it,” Liazos says.