In the recently proposed pay ratio rules, the SEC acknowledged that some commenters had suggested that pay ratio information should be deemed “furnished” and not “filed” for purposes of the Securities Act of 1933 and Securities Exchange Act of 1934, and no commenters had asserted that pay ratio disclosure should be “filed.” However, the SEC rejected these suggestions based on an extremely literal reading of Section 953(b) of the Dodd-Frank Act, which mandates the SEC to amend Item 402 of Regulation S-K to require disclosure of the pay ratio in any filing of the issuer described in Item 10(a) of Regulation S-K. The SEC concluded that “the use of the word ‘filing’ in Section 953(b) is consistent with the disclosure being filed and not furnished” and proposed that “the pay ratio disclosure would be considered “filed” for purposes of the Securities Act and Exchange Act and, accordingly, would be subject to potential liabilities under such acts.” For additional information about the proposed pay ratio rules, see our September blog post.
Information Disclosed in a Filing Does not Have to be Filed with the SEC
I believe the SEC gave disproportionate weight to the use of the word “filing” in Section 953(b). “Filings” described in Item 10(a) of Regulation S-K include, without limitation, registration statements under the Securities Act and Exchange Act, annual and other reports under Sections 13 and 15(d) of the Exchange Act, and proxy and information statements under Section 14 of the Exchange Act. However, some of these filings include disclosures that are considered “furnished” and “not filed”. For example, a current report on Form 8-K is considered a “filing” described in Item 10(a) of Regulation S-K. However, information included in a Form 8-K pursuant to Item 2.02 (Results of Operations and Financial Condition) or Item 7.01 (Regulation FD Disclosure) is not “deemed to be ‘filed’ for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section, unless the registrant specifically states that the information is to be considered “filed” under the Exchange Act or incorporates it by reference into a filing under the Securities Act or the Exchange Act.” Therefore, it seems that the legislative mandate to disclose the pay ratio in any filing described in Item 10(a) of Regulation S-K does not mean that such disclosure cannot be afforded the furnished status. I believe, Section 953(b) of the Dodd-Frank Act only prescribes the type of documents in which pay ratio disclosure should appear and does not dictate whether such disclosure should be furnished or filed.
The Proper Response is the Ballot, not Litigation Challenging the Disclosure
The proposed pay ratio rules are very flexible and allow a registrant to use (i) a methodology that uses reasonable estimates to identify the median and (ii) reasonable estimates to calculate the annual total compensation or any elements of total compensation for employees other than the PEO. Moreover, in determining the employees from which the median is identified, the registrant may use not only its total employee population, but also statistical sampling or other reasonable methods. The ability to use various estimates and statistical sampling for a complex analysis required by the proposed pay ratio rules leads to potentially subjective disclosure that may be difficult to verify and that should not serve as potential grounds for shareholder litigation.
In contrast, the SEC views the flexibility of identifying the median and the ability to use reasonable estimates as arguments against the pay ratio disclosure being furnished. The SEC believes that the proposed transition periods, flexibility of identifying the median and the ability to use estimates should mitigate registrants concerns about compiling and verifying the pay ratio disclosure.” Such argument contradicts the SEC’s original rationale for granting other compensation-related information “not filed” status. In1992, the SEC issued Release No. 33-6962, Executive Compensation Disclosure, which adopted amendments to the executive officer and director compensation disclosure requirements (the “1992 Release”). The 1992 Release recognized that the newly adopted Compensation Committee Report on Executive Compensation and Performance Graph raised significant concerns about the potential for litigation and increased an issuer’s exposure to liability with respect to these disclosures. To accommodate these concerns, the SEC stated that the information required by the Compensation Committee Report on Executive Compensation and Performance Graph “shall not be deemed to be ’soliciting material’ or to be ’filed’ with the Commission or subject to Regulations 14A or 14C …, or to the liabilities of Section 18 of the Exchange Act …, except to the extent that the registrant specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act.”
The SEC’s reasoning in connection with the “not filed” status of the Compensation Committee Report was that “[i]f shareholders are not satisfied with the decisions reflected in the report, the proper response is the ballot, not resort to the courts to challenge the disclosure.” This same reasoning should apply to pay ratio disclosures. Instead of treating the disclosure that most companies will base on subjective estimates and statistical sampling as “filed” and thus subject it to the liability provisions of the Exchange Act and Securities Act, this disclosure should be afforded the “furnished” status and shareholders should use voting as the venue for objecting to a specific ratio.
It will be interesting to see whether after the comment process the final SEC release would still support the “filed” status of pay ratio disclosure.
 See Release No. 33-9452, p. 75 and Note 138.
 See id at p. 75.
 See Form 8-K, General Instruction B.2.
 See Release No. 33-9452, pp 75-76.
 See 1992 Release, Item 402(a)(9). Both the Compensation Committee Report and Performance Graph have retained this “not filed” status in SEC Regulation S-K. See Item 402(e)(5), Instructions to Item 407(e)(5) and Item 201(e), Instruction 8 of Regulation S-K.
 See id.