Sunday, June 26, 2011

Legislation Repealing Pay Ratio Provision of Dodd-Frank Passed Out of House Financial Services Committee

Legislation repealing a provision of Dodd-Frank that would require public companies to disclose their median annual total compensation of all employees was reported favorably out of the House Financial Services Committee to the full House. The Burdensome Data Collection Relief Act, HR 1062, would remove Section 953(b) of Dodd-Frank, which directs the SEC to adopt rules requiring disclosure of the median of the compensation of the company’s employees and the ratio between the median of the annual total compensation of the employees and the annual total compensation of the issuer's chief executive officer. The vote was 33-21. The legislation has the support of the Society of Corporate Secretaries and Governance Professionals.

The Committee received testimony about the burden and complexity this provision poses to public companies, with very little, if any, corresponding benefit to investors. The draft legislation is sponsored by Representative Nan Hayworth (R-NY). At recent hearings, Rep. Hayworth questioned the usefulness of Section 953(b) and whether there were any reasonable changes Congress could make to the section to make it less burdensome. Corporation Finance Director Meredith Cross replied that the usefulness of the pay ratio is a call for Congress to make.

The SEC has yet to propose rules under Section 953(b) since Dodd-Frank set no deadline for SEC rulemaking. Director Cross allowed that the statute is fairly prescriptive and leaves no leeway for the SEC in the rulemaking process.

The Society of Corporate Secretaries and Governance Professionals supports the legislation. Testifying in favor of the legislation, Society President Ken Bertsch said that it will be virtually impossible for large global companies to comply with Section 953(b) and that its implementation will impose a substantial burden even on smaller issuers. While acknowledging a public policy concern on pay gaps in the United States, the Society believes that the required ratio will be neither material or nor meaningful to investors. At the hearing, Rep. Hayworth also said that the Section 953(b) mandates disclosure of information that is essentially immaterial.

According to the Society, the pay ratio under Section 953(b) will not provide useful information to investors because it is not comparable in any way across industries, companies, geographies, or employees. For example, companies located in certain areas of the country pay employees and executives more than others, given the cost of living in those areas. Moreover, some businesses have a large number of low-paid workers and some have a higher percentage of part-time employees or seasonal employees. These companies will likely have worse pay ratios.

In addition, companies with franchisees rather than company-staffed stores will also likely have a better pay ratio. Thus, the Society said that the pay ratio will not be a meaningful measure to compare to the CEO’s compensation, or to compare the pay practices compared within a single industry.

Given the definition of “annual total compensation” as set forth in Section 953(b)(2), said the Society, many companies would not be able to calculate the median of the annual total compensation of all employees of the issuer with the degree of precision required for information filed under the federal securities laws. Payroll systems are not set up to gather the kind of information required under this provision. This is especially the case for companies organized into multiple operating business units.

Those business units keep records and have internal controls over what each employee is paid, but they report aggregated figures to the parent company for inclusion in consolidated financial reports for public filings. Thus, the parent company that files SEC reports does not have direct access to the employee-by-employee data necessary to identify the median employee. This is complicated even further when operating business units are based outside the United States or employ people in multiple countries.

Moreover, the Society noted that Section 953(b) requires the issuer to disclose the median of all employees, using the same calculations as are used to determine total pay for named executive officers under the proxy rules. In other words, a company would have to convert the pay of each employee globally into the pay formula applicable to the named executive officers in the Summary Compensation Table. To the Society’s knowledge, no public company now calculates each employee’s total compensation in the way it is required to calculate total pay on the Summary Compensation Table for named executive officers (usually five individuals). Disclosure of executive pay has a different purpose than internal accounting.