Corp Fin has just issued several new CDIs regarding pay-ratio disclosure (S-K Item 402(u)). As you probably recall, the pay-ratio provision mandates that the SEC require most public companies to disclose, in a wide range of their SEC filings:

• the median of the annual total compensation of all employees of the company, except the CEO (that is, the point at which half the employees earn more and half earn less);
• the annual total compensation of the CEO; and
• the ratio of the two amounts above.

In adopting a rule to implement the provision, the SEC employed a flexible approach to identifying the median employee:  to determine the population of employees from which to identify the median employee, a company must consider all employees of the company and its consolidated subsidiaries, including non-US, part-time, temporary and seasonal workers (with two narrow exceptions), employed on any date within the last three months of the last fiscal year. However, a company is not required to calculate “annual total compensation” (as calculated under Item 402(c) of Reg S-K) for each employee in the population or sample, although that approach is certainly permitted. Instead, the rule allows companies to determine the median employee from among the entire employee population, a statistical sample or other reasonable method. In addition, the company may then identify the median employee in the population or sample using annual total compensation or any other consistently applied compensation measure (CACM), such as compensation amounts reported in its payroll or tax records (e.g., W-2 wages). Reasonable estimates may also be used in calculating the annual total compensation or any elements of compensation for employees other than the CEO.

The new CDIs relate, directly or indirectly, to the determination of the median employee.

• Appropriate CACM. If a company does not use “annual total compensation” to identify the median employee, the company may select any measure that “reasonably reflects” the annual compensation of employees. Whether any measure is appropriate depends on the company’s particular facts and circumstances. For example, total cash compensation could be an appropriate CACM unless annual equity awards were widely used to compensate employees. Social Security taxes withheld would likely not be an appropriate CACM unless all employees earned less than the Social Security wage base. However, the requirement that a CACM “reasonably reflect” annual compensation does not mean that the same median employee must be identified under the CACM  as would be identified using the S-K definition of annual total compensation. Any compensation measure used to identify the median employee must be briefly disclosed.
• Pay rates. Although an hourly or annual pay rate may be a component of an employee’s overall compensation, the use of the pay rate alone — without taking into account the number of hours actually worked — is generally not an appropriate CACM to identify the median employee. Corp Fin views use of an hourly rate alone to be comparable to making a full-time equivalent adjustment for part-time employees, which is not a permitted practice. Similarly, using an annual rate alone — without regard to whether the employees worked for the entire year and were actually paid that amount during the year — would be similar to annualizing pay, which is permitted only in limited circumstances (e.g., newly hired employees).
• Time periods. As noted above, to determine the population of employees from which to identify the median, the company must first use a date within three months of the end of its fiscal year. Then the company must identify the median employee from that population using either annual total compensation or another CACM.  However, in applying the CACM to identify the median employee, “a registrant is not required to use a period that includes the date on which the employee population is determined nor is it required to use a full annual period. A CACM may also consist of annual total compensation from the registrant’s prior fiscal year so long as there has not been a change in the registrant’s employee population or employee compensation arrangements that would result in a significant change of its pay distribution to its workforce.”
• Furloughed employees. Whether workers that are “furloughed” should be included in the employee population depends on the facts and circumstances.  Because the definition of “furlough” may vary, the company must first determine whether the furloughed worker is an “employee” of the company on the date the employee population is determined. If so, his or her compensation should be calculated by the same method as for any other employee. The company must determine the category in which the employee belongs: full-time, part-time, temporary or seasonal. Under Instruction 5 of Item 402(u), a company may annualize the total compensation for all permanent employees (full-time or part-time) who were employed by the company for less than the full fiscal year (e.g., newly hired employees, employees called for active military duty or on unpaid leaves of absence during the period). However, the rules do not permit full-time equivalent adjustments for part-time, seasonal or temporary employee compensation; that is, the total compensation for employees in temporary or seasonal positions may not be annualized nor may compensation for part-time employees be adjusted to reflect full-time equivalents.
• “Gig” economy. The application of the rule in today’s “gig” economy, in which many workers who provide services directly to or for companies are identified as “independent contractors,” has been an open question. In the CDI, Corp Fin observes that the SEC stated in the rule release “that the primary benefit of the pay ratio disclosure is to provide shareholders with a company-specific metric that they can use to evaluate the compensation paid to the PEO within the context of their company.” As a result, Corp Fin believes that workers who might otherwise be considered “independent contractors” may well, depending on the facts and circumstances, be “employees” for purposes of the rule: “in determining when a worker is an ‘employee’ of the registrant under the rule, the registrant must consider the composition of its workforce and its overall employment and compensation practices. In furtherance of this, a registrant should include those workers whose compensation it or one of its consolidated subsidiaries determines regardless of whether these workers would be considered ‘employees’ for tax or employment law purposes or under other definitions of that term.” [emphasis added] 

SideBar: But for many companies in the “sharing” economy, whether they “determine” the compensation of their workers may not always be clear, depending on the nature of the arrangements.

The rule excludes from the definition of employee “workers who are employed, and whose compensation is determined, by an unaffiliated third party but who provide services to the registrant or its consolidated subsidiaries as independent contractors or ‘leased’ workers.” In the CDI, Corp Fin indicates that, in that circumstance, Corp Fin does not believe the company to be determining the workers’ compensation for purposes of the rule if, for example, the company only specifies “a minimum level of compensation.” In addition, if the worker is determined to be an independent contractor, he or she may be the “unaffiliated third party” who determines his or her own compensation.

[View source.]