Rationalizing the SEC’s Pay Ratio Proposal
As at least 25 law firms and an unknown number of reporters and bloggers have noted, the SEC has finally proposed the much dreaded pay ratio disclosure rule. Required by the Dodd-Frank Act, the rule appears to have a social and political purpose. It would require a public company to disclose the ratio of the compensation of its CEO to the median compensation of its employees. Although the notion is simple, the execution, as noted by the 25 law firms and countless others, is not.
Virtually every law firm memo on the subject mentions the complexity and costs associated with the rule. Most urge their clients to prepare for the rule’s eventual adoption by collecting data and considering sampling methodologies now, well before the rule may become effective. And Squire Sanders notes an additional pitfall that may await the unwary: that the proposal requires issuers to “file” not “furnish” the pay ratio data. “As a result, the new disclosures would subject affected companies to additional securities law liability risk for those disclosures.”
Given the costs, complexities, and risks associated with the proposal, and its apparently social purpose, affected companies have been urged to submit comments. SEC Commissioners Daniel Gallagher and Michael Piwowar, who both voted against the rule’s proposal, urged the submission of detailed comment. Gallagher noted: “There are no – count them, zero – benefits that our staff have been able to discern.” And in his remarks Piwowar, donning sackcloth and ashes, exclaimed: “the shame from this rule should not be put upon CEOs. It should be put upon the five of us who will be voting on this proposal today. Shame on us for putting special interests ahead of investors. Shame on us for letting special interests distract us from our core mission. Shame on us for surrendering our rulemaking agenda to special interests.”
At least one law firm has taken up the call to comment. Morgan Lewis urged its clients “to determine the costs of implementing the SEC’s proposed amendments and submit comment letters to the SEC explaining any concerns about the proposed rule and suggesting any revisions that would reduce implementation costs.”
And the comments are indeed pouring in, but not perhaps of the type which had been anticipated. Even though the rule has yet to be officially published in the Federal Register, the Commission has so far received 17,242 “Type A” letters supporting the rule and encouraging the Commission to: “not give in. Instead, weigh your duty to protect investors and the American public against the self-serving interests of those seeking to undermine this rule.”
Unless Congress acts, and the House does have before it a bill that would repeal the pay ratio disclosure requirement, whatever rule the SEC ultimately adopts will most likely end up before the U.S. Court of Appeals for the D.C. Circuit. That Court will determine whether the pay ratio disclosure rule is arbitrary or capricious and whether the benefits outweigh the costs. But in considering the latter, the Court will have a very different cost-benefit analysis to perform. As the SEC apparently admits, there are no measurable economic benefits to the rule. Rather, the perceived benefits are social. It will be up to that Court to rationalize the economic costs against the social benefits.