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Firms Must Report CEO-to-Worker Pay Ratio Under New SEC Rule

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Public companies will now have to disclose how much their CEO’s pay differs from the company’s workers under a rule passed by the Securities and Exchange Commission Wednesday.

The highly controversial rule, required under Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, mandates that public companies disclose the ratio of the annual total compensation of a public company’s CEO to the median of the annual total compensation of the company’s employees.

SEC Chairwoman Mary Jo White stated at the open meeting at SEC headquarters in Washington to vote on the rule the many “divided thoughts and heated dialogue” on the “controversial, contentious” rule, which garnered a whopping 287,400 comment letters to the agency.

The agency voted 3-2 to pass the rule, with the agency’s two Republican commissioners casting dissenting votes. Commissioner Daniel Gallagher called the pay ratio rule “the most useless of all our Dodd-Frank mandates,” adding that “shaming” companies into lowering CEO pay “is not the province of the securities laws.” He added that “reasonable investors” will not find the rule “useful.”

As White explained, the pay ratio disclosure “will provide shareholders with additional company-specific information that they can use when considering a company’s executive compensation practices, an important area of corporate governance on which shareholders now have an advisory vote.”

The final rule would also allow companies to choose any date during the last three months of a company’s fiscal year to determine the median employee, and, to further reduce costs, would permit companies to use the same median employee for three years unless there has been a change in the employee population or employee compensation arrangements that the company reasonably believes would result in a significant change in the pay ratio disclosure, White stated.

The final rule also provides companies with “substantial discretion to use estimates and sampling as a means to determine the median employee and the employee’s compensation,” and as required by the JOBS Act, the final rule excludes emerging growth companies,  smaller reporting companies, foreign private issuers, registered investment companies and registrants filing under the U.S.-Canadian Multijurisdictional Disclosure System.

The U.S. Chamber of Commerce is already threatening action against the SEC.

“Congress added this [pay ratio] disclosure to Dodd-Frank as a favor to union lobbyists who misguidedly think it will help their organizing efforts,” said David Hirschmann, president and CEO of the Chamber’s Center for Capital Markets Competitiveness. “When disclosure is used to advance special interest agendas rather than provide investors with better information, it is a step in the wrong direction.”

Pay ratio “is a misleading, politically inspired, and costly disclosure that fails to provide investors with useful, comparable data,” Hirschman continued. For instance, he said, “a domestic company might have a better pay ratio than a multinational company due to legal, currency or cost of living differences, creating a situation that is like trying to compare baseball to basketball stats when it’s a whole different ballgame.” Hirschman argued the rule “makes the public markets less attractive to investors and companies” and that Chamber would “continue to review the rule and explore our options for how best to clean up the mess [the SEC] has created.”

But Americans for Financial Reform said the rulemaking was long overdue, and that “out-of-control compensation played a conspicuous part in the cycle of reckless lending, opaque securitizing and systematic offloading of responsibility that led to the financial and economic meltdown of 2008.”

“Runaway pay,” AFR said, “repeated studies have shown, inhibits teamwork, reduces employee morale and productivity, and encourages executives to make dangerous short-term bets.”

Of the hundreds of thousands of comment letters, AFR said, “the messages and comments were overwhelmingly positive,” adding that the new rule will give investors and the public “an important set of new data points.”

Now that the SEC “has met this requirement,” AFR said, regulators must move ahead on a “strong rule” implementing Section 956 of Dodd-Frank, “which prohibits compensation for executives at big banks that encourages excessive risk taking, putting the public at risk.”

House Financial Services Committee Chairman Jeb Hensarling, R-Texas, called the SEC’s rule “disappointing,” stating that the pay-ratio rule “is the latest example of the SEC squandering its resources on rulemakings that do nothing to help small-business startups and will instead harm U.S. companies and investors.”

The SEC, he added, “has devoted thousands of man-hours and millions of dollars to finish rules mandated by the Dodd-Frank Act that neither address the causes of the financial crisis nor advance the SEC’s statutory mission. Chair White prioritized this rulemaking to appease those that want a government regulator-controlled economy.”