Should Pay Ratio Disclosure Be “Furnished” or “Filed”?

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.”[1]  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.”[2]  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.”[3]  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.”[4]  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.”[5] 

 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.”[6]  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.  



[1] See Release No. 33-9452, p. 75 and Note 138.

[2] See id at p. 75.

[3] See Form 8-K, General Instruction B.2.

[4] See Release No. 33-9452, pp 75-76.

[5] 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.

[6] See id.

Pay Ratio Rules to be Proposed this Week

On Wednesday, September 18, 2013 at 10:00 a.m. the SEC will hold an open meeting to consider whether to propose rules to require companies to disclose the median annual total compensation of all employees and the ratio of that median to the annual total compensation of the company’s chief executive officer as mandated by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Conflict Minerals Rules Survive Legal Challenge

Yesterday, the United States District Court for the District of Columbia rejected a summary judgment motion challenging the SEC’s conflict minerals rules.  (See our May/June 2013 issue of Up to Date which discussed the legal challenge to the conflict minerals rules.)  Accordingly, the conflict minerals rules remain in effect as adopted.  

The conflict minerals rules require all public companies that manufacture (or contract for the manufacture of) a product where conflict minerals[1] are necessary to the functionality or production of such product to file a report annually with the SEC.  The first report must be filed with the SEC on May 31, 2014 for the 2013 calendar year. 


[1] “Conflict minerals” currently include the following:

  • cassiterite (most commonly used to produce tin);
  • columbite-tantalite (the metal ore from which tantalum is extracted);
  • gold; and
  • wolframite (the metal ore that is used to produce tungsten).


No Rule 506 Offerings for Bad Boys: Felons and Other “Bad Actors”

On July 10, the SEC revamped the way private placements under Rule 506 of Regulation D can be conducted by permitting general solicitation and general advertising in offerings where all purchasers are accredited investors (see To Use or Not to Use General Solicitation and General Advertising in Private Placements?) and by disqualifying felons and other “bad actors” from all Rule 506 offerings (i.e., irrespective of whether the offering involves or does not involve general solicitation and general advertising).  New SEC “bad actor” rules, effective 60 days after publication in the Federal Register, implement Section 926 of the Dodd-Frank Act and were originally proposed two years ago (May 25, 2011).

Under new Rule 506(d), “Bad Actor” Disqualification, an issuer will not be able to rely on the Rule 506 exemption from registration under the Securities Act of 1933 if the issuer or any other “covered person” is or was involved in a disqualifying event.

Covered Persons

“Covered persons” under Rule 506(d) include:

  • the issuer, any predecessor of the issuer, or any affiliated issuer;
  • directors, executive officers, other officers participating in the offering, general partners or managing members of the issuer;
  • beneficial owners of 20% or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power;
  • promoters connected with the company at the time of such sale;
  • investment managers of a pooled investment fund;
  • persons compensated (directly or indirectly) for soliciting investors; and
  • directors, executive officers, or other officers participating in the offering, of any such investment manager or solicitor or general partner or managing member of such investment manager or solicitor.

Disqualifying Events

Rule 506(d) “disqualifying events” include the following:

  • criminal convictions, within ten years before the sale of securities (or five years, in the case of issuers, their predecessors and affiliated issuers) in connection with the purchase or sale of any security; involving the making of any false filing with the SEC; or arising out of the conduct of an underwriter, broker, dealer, or other financial intermediary;
  • court injunctions and restraining orders, entered within five years before such sale, in connection with the purchase or sale of any security; involving the making of any false filing with the SEC; or arising out of the conduct of an underwriter, broker, dealer, or other financial intermediary;
  • final orders of a state securities commission; a state authority that supervises or examines banks, savings associations, or credit unions; a state insurance commission; an appropriate federal banking agency; the U.S. Commodity Futures Trading Commission; or the National Credit Union Administration that: 

     (i)  bar the person from associating with a regulated entity; engaging in the business of  securities, insurance or banking; or engaging in savings association or credit union activities; or

     (ii)  are based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct entered within ten years before such sale;

  • SEC disciplinary orders suspending or revoking a person’s registration as a broker, dealer, municipal securities dealer or investment adviser; placing limitations on the activities of such person; or barring such person from being associated with any entity or from participating in the offering of any penny stock;
  • SEC cease and desist orders, entered within five years before such sale, that, orders the person to cease and desist from committing or causing a violation of any scienter-based anti-fraud provision of the federal securities laws (e.g., Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 or Section 5 of the Securities Act of 1933).
  • suspensions or expulsions from membership in, or suspension or a bar from association with a member of, a registered national securities exchange for any act or omission to act constituting conduct inconsistent with just and equitable principles of trade;
  • SEC stop orders in connection with a registration statement or orders suspending the Regulation A exemption, issued within five years before such sale; or investigation to determine whether a stop order or suspension order should be issued; or
  • U.S. Postal Service false representation orders, entered within five years before such sale, or being subject to a temporary restraining order or preliminary injunction with respect to conduct alleged by the U. S. Postal Service to constitute a scheme or device for obtaining money or property through the mail by means of false representations.


Rule 506(d) disqualification does not apply if:

  • the triggering event occurred before the effective date of the new rules;
  • the SEC waives the disqualification;
  • before the relevant sale, the court or regulatory authority that entered the relevant order, judgment or decree advises in writing that Rule 506(d) disqualification should not arise as a consequence of such order, judgment or decree; or
  • the company establishes that it did not know and, in the exercise of reasonable care, could not have known that a disqualification existed.

 Disclosure of Pre-Existing Disqualifying Events

The company must furnish to each purchaser, a reasonable time prior to sale, a description in writing of any matters that would have triggered Rule 506(d) disqualification but occurred before the effective date of new rules.  The failure to furnish such information timely will not prevent a company from relying on Rule 506 exemption from registration if the company establishes that it did not know and, in the exercise of reasonable care, could not have known of the existence of the undisclosed matter or matters.

Reasonable Care

In connection with “reasonable care” requirements, a company will not be able to establish that it has exercised reasonable care unless it has made a factual inquiry into whether any disqualifications exist. The nature and scope of the factual inquiry will vary based on the facts and circumstances concerning, among other things, the company and the other offering participants.  For example, the SEC anticipates companies to have “an in-depth knowledge of their own executive officers and other officers participating in securities offerings gained through the hiring process and in the course of the employment relationship, and in such circumstances, further steps may not be required in connection with a particular offering.”

The SEC suggested that “factual inquiry by means of questionnaires or certifications, perhaps accompanied by contractual representations, covenants and undertakings, may be sufficient in some circumstances, particularly if there is no information or other indicators suggesting bad actor involvement.”  The SEC also clarified that for continuous, delayed or long-lived offerings, “reasonable care includes updating the factual inquiry on a reasonable basis,” which can be “managed through contractual covenants from covered persons to provide bring-down of representations, questionnaires and certifications, negative consent letters, periodic re-checking of public databases, and other steps, depending on the circumstances.”

Companies that are contemplating a Rule 506 private placement need to establish internal procedures for conducting a factual inquiry into whether “bad actors” may be involved in its offering.

When Do You Need to Start Complying With New NASDAQ and NYSE Compensation Committee Rules?

On January 11, 2013, the SEC approved proposed changes to the listing standards of the New York Stock Exchange LLC and NASDAQ Stock Market LLC related to compensation committees. Both exchanges created transition periods to comply with the new rules.

As of July 1, 2013, NASDAQ and NYSE listed companies will be required to comply with the new rules relating to the authority of a compensation committee to retain compensation consultants, legal counsel, and other compensation advisers; the authority to fund such advisers; and the responsibility of the committee to consider independence factors before selecting such advisers. The requirement that such authority and responsibilities of the compensation committee be included in the compensation committee’s written charter does not apply until a later date (see below) for NASDAQ listed companies and such companies should consider under state corporate law whether to grant such specific responsibilities and authority through a charter, resolution or other board action. In contrast, NYSE listed companies will have to amend their existing charters as of July 1, 2013 to address these additional rights and responsibilities of the compensation committee related to compensation consultants, legal counsel, and other compensation advisers. To the extent a NASDAQ listed company does not have a compensation committee by July 1, 2013, these requirements will apply to the independent directors who determine, or recommend for the board’s determination, the compensation of the CEO and other executive officers of the company.

The remaining new rules, for example, compensation committee charter and independence standards for compensation committee members, will not have to be complied with by NASDAQ listed companies until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014.

NYSE listed companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new standards for compensation committee director independence.

ISS Releases 2013 Updates to Proxy Voting Guidelines

On November 16, 2012, the ISS released its final 2013 Updates to its U.S. Corporate Governance Policy. ISS also will release a FAQ document in December 2012 for further guidance. The Updates will be effective for meetings on or after February 1, 2013.

Highlights of the 2013 Updates include:

• Stock Pledges/Hedges: In response to comments, ISS will be taking a case-by-case approach in determining whether pledging of company shares rises to a level of serious concern for shareholders. Also in response to comments, ISS is including significant pledging of company stock as a failure of risk oversight and thus considered a governance failure for which directors should be held accountable (rather than communicating concern through a say-on-pay recommendation as originally proposed). However, hedging of company stock, through covered call, collar or other derivative transactions, will be considered a problematic practice warranting a negative voting recommendation on the election of directors.

• Failure to Act on Shareholder Proposals: ISS will keep its current policy in effect for 2013, with some modifications: ISS will recommend a negative vote for individual directors, committee members or the entire board, if the board failed to act on a shareholder proposal that received the support of either (i) a majority of the outstanding shares or (ii) a majority of the votes cast in the last year and one of the two previous years. Beginning in 2014, ISS will recommend a vote negative vote if the board failed to act on a shareholder proposal that received the support of a majority of shares cast in the previous year. Under the Update, the ISS now has the flexibility to recommend a negative vote on members of the board as deemed appropriate, not necessarily the full board. The ISS also has included more guidance on the case-by-case examination of the sufficiency of a company’s action in response to a majority-supported shareholder proposal.

• Peer Groups: The new methodology incorporates information from companies’ self-selected pay benchmarking peer groups in order to identify and prioritize Global Industry Classification Standard (GICS) industry groups beyond the subject company’s own GICS classification. The methodology draws peers from the subject company’s GICS group as well as from GICS groups represented in the company’s peer group, while maintaining the approximate proportions of these industries in the final peer group where possible. The methodology additionally focuses initially at an 8-digit GICS resolution to identify peers that are more closely related in terms of industry. Finally, when selecting peers, the methodology prioritizes peers that maintain the company near the median of the peer group, are in the subject company’s peer group, and that have chosen the subject company as a peer. The peer group methodology maintains its focus on identifying companies that are reasonably similar to the subject company in terms of industry profile, size, and market capitalization. Other changes to the peer group methodology include using slightly relaxed size requirements, especially at very small and very large companies, and using revenue instead of assets for certain financial companies.

• Realizable Pay: Realizable pay is being added to the research report for large capitalization companies. Realizable pay will consist of the sum of relevant cash and equity-based grants and awards made during a specified performance period being measured, based on equity award values for actual earned awards, or target values for ongoing awards, calculated using the stock price at the end of the performance measurement period. Stock options or stock appreciation rights will be revalued using the remaining term and updated assumptions, as of the performance period, using the Black-Scholes Option Pricing model. The realizable pay consideration may mitigate or exacerbate the CEO’s pay for performance concerns.

• Voting on “Say on Golden Parachute” Proposals: The Update will (i) include existing change-in-control arrangements maintained with named executive officers rather than focusing only on new or extended arrangements and (ii) place further scrutiny on multiple legacy problematic features (e.g. single trigger equity, tax gross –ups, etc.) in change in control agreements.

SEC Issues Letter to New Investment Advisers Regarding Presence Exams

On October 9, 2012, the Office of Compliance Inspections and Examinations (OCIE) of the SEC issued a letter directed to senior officers of newly registered investment advisers that manage private equity funds introducing them to the National Exam Program (NEP). The letter explains that the NEP is launching an initiative to conduct Presence Exams, which are focused, risk-based examinations of investment advisers to private funds.  In the letter, the SEC explains that the Presence Exams initiative will take place over the next two years and will be comprised of three phases: engagement, examination and reporting. 

Engagement Phase.  The NEP is currently engaged in an outreach program to inform newly registered investment advisers about their obligations under the Advisers Act.  As part of such outreach, the NEP has published various materials, including staff letters, risk alerts, special studies and speeches.  The letter contains a list of some of these resources and their reference links. 

Examination Phase.  The letter states that the NEP staff will contact advisers separately if and when they are selected for an examination.  If an adviser is selected for examination, the NEP staff will review one or more of the following higher risk areas: marketing, portfolio management, conflicts of interest, safety of client assets and valuation.   Upon completion of an on-site examination, the NEP staff may send the investment adviser a letter (i) indicating that the exam has concluded without findings, or (ii) describing the deficiencies identified and asking the firm to take corrective action.  Serious deficiencies may be referred to the Division of Enforcement of the SEC or other regulators.

Reporting Phase.  Upon completion of the examination phase, the NEP will report its observations, such as common practices and industry trends, to the SEC and the public.

NYSE Amends its Compensation Committee and Committee Adviser Independence Proposed Rules

Yesterday the NYSE filed an amendment to its proposed compensation committee and committee adviser independence rules.  According to the rule filing, the amendment corrects an error in the rule text under the heading “Transition Periods for Compensation Committee Requirements.”  According to the amended rule text, listed companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new director independence standards with respect to compensation committees.  The other proposed rules, including those related to compensation committee advisers, will become effective on July 1, 2013.

SEC to hold Sunshine Act Meeting

The SEC announced yesterday that on August 22, 2012 at 10:00 a.m. it will hold an open meeting to consider:

  • whether to adopt rules regarding disclosure and reporting obligations with respect to the use of conflict minerals;
  • whether to adopt rules regarding disclosure and reporting obligations with respect to payments to governments made by resource extraction issuers; and
  • rules to eliminate the prohibition against general solicitation and general advertising in securities offerings conducted pursuant to Rule 506 of Regulation D under the Securities Act of 1933, as amended and Rule 144A promulgated thereunder.

SEC Extends Compliance Date for Third-Party Solicitor Provisions of Advisers Act Pay-to-Play Rule

On June 8, 2012, the SEC extended the compliance date for the third-party solicitor provisions of Rule 206(4)-5 of the Advisers Act (the “Pay-to -Play Rule”). The Pay-to-Play Rule, among other things, prohibits an adviser from providing or agreeing to provide, directly or indirectly, compensation to any person to solicit a government entity for investment advisory services on behalf of such adviser unless the person is an executive officer, general partner, managing member or employee of the adviser, or such person is a registered investment adviser, a registered broker-dealer, or a registered municipal adviser. 

The SEC extended the compliance date for the third-party solicitor provisions of the Pay-to-Play Rule until nine months after the compliance date of a final rule adopted by the SEC related to the registration of municipal advisor firms. Once the final rule regarding the registration of municipal advisor firms is adopted, the SEC will issue the new compliance date for the ban on third-party solicitations.