General:  The SEC recently released final pay ratio rules, which can be found here. As a new Item 402(u) of Regulation S-K, these rules codify the Dodd-Frank requirement for companies to disclose:

• The median annual total compensation of all employees, excluding the Principal Executive Officer (“PEO”),

• The annual total compensation of the PEO, and

• The ratio of (i) and (ii).

The rules provide that this pay ratio must be expressed in a way that uses the median compensation as a base factor (i.e. 10 to 1, 10:1 or “the PEO compensation is ten times the median compensation”).

Companies Affected: The rules apply to companies required to provide executive compensation disclosure under Item 402(c)(2)(x) if Regulation S-K, but do not apply to smaller reporting companies, emerging growth companies, foreign private issuers, MJDS filers, or registered investment companies. Companies will be required to provide this pay ratio disclosure in their executive compensation disclosures for the first fiscal year beginning on or after January 1, 2017 (i.e., in the 2018 or 2019 proxy statements, depending on the fiscal year).

Methodology: The total compensation for the median employee and the PEO will be calculated using Item 402(c)(2)(x). The rules generally require a company to identify its median employee only once every three years and calculate total compensation for that employee each year. The rules grant flexibility to select a methodology to identify the median employee using the total employee population, statistical sampling, or another consistently-applied compensation measure. A company also has flexibility as to when in the final 3 months of the fiscal year to identify the median employee and whether to retain the median employee for 3 years (recalculating the median employee’s compensation each year). The company is required to briefly describe the methodology used to identify the median employee and any material assumptions or adjustments.

Exclusions/Adjustments:  Generally, all employees (including non-US, part-time, temporary, and seasonal employees) of the company and its consolidated subsidiaries, except the PEO, must be included to determine the median employee. The rules provide for exemptions for a de minimis level of non-US employees and for non-US jurisdictions where data privacy laws prevent inclusion, as well as a cost of living adjustment for certain employees. Adjustments are also available for permanent newly-hired employees, including for part-year PEOs (although full-time equivalents for part-time, temporary, or seasonal employees are not permitted).

Additional Disclosure: The company may (but is not required to) supplement the pay ratio disclosure with narrative discussion or additional ratios, provided that any additional ratios are clearly identified, not misleading, and not presented with greater prominence than the required ratio.