The final rule excludes from the definition of ``employee'' those
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. Although it is unclear whether Congress intended to include
these workers as ``employees of the issuer,'' or even considered the
issue, we believe, as a matter of policy, these workers should not be
included as ``employees of the issuer.''
    While one commenter stated that ``leased employees and other
workers employed by a third party are not ``statutory'' employees of a
registrant,'' \120\ some definitions of ``employee'' may include
workers who are not employed directly by the registrant or its
consolidated subsidiaries, such as independent contractors or
``leased'' or ``borrowed'' workers, if they are employed by a third
party.\121\ We note that the statute specifies employees ``of the
issuer,'' and in light of this, to the extent there is any ambiguity on
this point, we believe that the better reading of the statute is to
exclude from the final rule's definition of ``employee'' workers who
are not employed by the registrant or its consolidated subsidiaries,
such as independent contractors or ``leased'' workers, if they are
employed, and their compensation is determined, by an unaffiliated
third party.
---------------------------------------------------------------------------

    \120\ See, e.g., letter from ABA.
    \121\ See, e.g., Black's Law Dictionary 602 (9th ed. 2009)
(defining ``employee'' as a ``person who works in the service of
another person (the employer) under an express or implied contract
of hire, under which the employer has the right to control the
details of work performance,'' and defines a ``borrowed employee''
as an ``employee whose services are, with the employee's consent,
lent to another employer who temporarily assumes control over the
employee's work'').
---------------------------------------------------------------------------

    We believe excluding such workers is appropriate because
registrants generally do not control the level of compensation that
these workers are paid. Instead, the registrant provides a payment for
their services to an unaffiliated third party, which determines the
compensation for the employees. As one commenter noted, there can be no
assurance, therefore, that the registrant even has access to the
workers' compensation information, which could make it difficult or
impossible to obtain the information.\122\
---------------------------------------------------------------------------

    \122\ See letter from ABA.
---------------------------------------------------------------------------

    We do not believe it is appropriate for registrants to voluntarily
include workers employed by third parties in their required pay ratio
disclosure ``if such persons make up a significant portion of the
workforce,'' as one commenter suggested, even if doing so may add to
the ``flexibility'' of the final rule.\123\ For the reasons described
above, we have not included these workers within the definition of
employee, and we are concerned that allowing registrants the option to
elect to include them in their required disclosures would introduce the
potential for registrants to manipulate the pay ratio disclosure.
Registrants, however, may discuss their reliance on ``leased'' workers,
as suggested by another commenter, in their narrative disclosure.\124\
Also, they may provide additional ratios that factor in those workers,
as long as any additional ratios are not misleading and are not more
prominently displayed than the required ratio.
---------------------------------------------------------------------------

    \123\ See letter from Vectren Corp.
    \124\ See letter from LAPFF.
---------------------------------------------------------------------------

b. Employed on Any Date Within Three Months of the Last Completed
Fiscal Year
i. Proposed Rule
    The proposed rule would define ``employee'' as an individual
employed as of the last day of the registrant's last completed fiscal
year. We proposed this calculation date for determining who is an
employee because it is consistent with the one used for the
determination of PEO and principal financial officer and the other
three most highly compensated executive officers under Item
402(a)(3)(iii). In the Proposing Release, we noted that the composition
of a company's workforce typically changes throughout the fiscal year,
and in some industries and businesses, it can change constantly.
Although Section 953(b) requires the median calculation to cover ``all
employees,'' it does not prescribe a particular calculation date for
the determination of who should be treated as an employee for that
purpose.
    We reasoned in the Proposing Release that a single date for
determining who is an employee would ease compliance for registrants by
eliminating the need to monitor changing workforce composition during
the year, while providing a recent snapshot of the registrant's entire
workforce. Also, we indicated that a requirement to track which
employees have been continuously employed for the entire annual period
could increase costs for registrants, and suggested that the most
appropriate calculation date would be one that is consistent with the
calculation date for determining the named executive officers under
current Item 402 requirements.
    In proposing this approach, we assumed that the potential benefits
of the disclosure mandated by Section 953(b) would not be significantly
diminished by covering only individuals employed on a specific date

at calendar year-end, rather than covering every individual who was
employed at any time during the year. Although this approach could help
limit compliance costs for registrants, we acknowledged that it could
have other costs. For example, this approach would not capture seasonal
or temporary employees who are not employed at year end, with the
result that a registrant with a significant number of such workers
might identify a median employee from a pool that does not fully
reflect the workforce that it requires to run its business. This
approach might also cause the disclosure to be costlier for, and
thereby have an anti-competitive impact on, registrants whose temporary
or seasonal workers are employed at calendar year-end as opposed to
other times during the year because registrants with temporary or
seasonal employees at calendar year-end would have to include them in
their median calculations but other registrants with temporary or
seasonal employees at other times of the year would not have to do so.
Finally, we noted that it would be possible, but unlikely, that
registrants could try to structure their employment arrangements to
reduce the number of lower paid employees employed on the determination
date.
ii. Comments on the Proposed Rule
    Most commenters that discussed the issue agreed that registrants
should be permitted to identify the median employee based on the
composition of their workforce on a particular day of the year as
opposed to the workforce employed throughout the year.\125\ Only a few
commenters, however, supported using the last day of the fiscal year
calculation date.\126\ It seems that these commenters supported this
provision more to limit the calculation to a particular day of the
year, thereby limiting the need to monitor a changing workforce during
the year, than because they believed the appropriate date should be the
last day of the registrant's last fiscal year.\127\ A number of
commenters contended that the final rule should allow registrants the
flexibility to choose a calculation date within the registrant's last
fiscal year.\128\ As some of these commenters noted, requiring
registrants to use the last day of the fiscal year could adversely
affect retailers,\129\ may not allow enough time for registrants to
collect and report on their pay ratio information,\130\ and could make
it difficult for registrants that are not calendar year-end companies
to use information derived from its tax and/or payroll records to
calculate the ratio.\131\ Some commenters suggested that, if the final
rule permits registrants to choose a determination date other than a
registrant's fiscal year end, it should also require registrants to be
consistent from year to year and/or briefly explain the reasons for not
using the fiscal year-end date.\132\
---------------------------------------------------------------------------

    \125\ See letters from ABA, Capital Strategies, FEI, Hyster-
Yale, Johnson & Johnson, and NACCO.
    \126\ See, e.g., letters from CII and Vectren.
    \127\ Id.
    \128\ See, e.g., letters from ABA, Best Buy et al., Capital
Strategies, COEC I, COEC II, Corporate Secretaries, Davis Polk, FEI,
Hyster-Yale, Johnson & Johnson, Microsoft, NACCO, NAM I, PM&P, RILA,
SH&P, and WorldatWork I. See also letter from Brianne H. McCoy,
University of Idaho College of Law (Nov. 28, 2013) (``McCoy'')
(stating that a registrant should be required to choose a date that
``corresponds with the month in which the registrant had its highest
gross operating revenues from the previous year'').
    \129\ See letter from PM&P.
    \130\ See, e.g., letters from COEC I, Corporate Secretaries,
Davis Polk, Microsoft, and NAM I.
    \131\ See, e.g., letters COEC I, Microsoft, NAM I, and NAM II.
    \132\ See, e.g., letters from Capital Strategies, Microsoft, and
SH&P.
---------------------------------------------------------------------------

    One commenter suggested that the rule could allow registrants to
choose a calculation date within a designated time window, ``such as a
date occurring during the 90-day period preceding the fiscal year
end.'' \133\ Regarding the concern that allowing registrants to select
the calculation date would create the potential for manipulation of the
pay ratio, this commenter stated that the concern ``is unwarranted,
particularly if the choice is restricted to a limited time period (such
as the last fiscal quarter), since in general the employee population
of a registrant would not vary significantly over such a period.''
\134\
---------------------------------------------------------------------------

    \133\ See letter from Davis Polk.
    \134\ Id.
---------------------------------------------------------------------------

    Another commenter proposed that registrants should be required to
calculate the median annual compensation of all employees employed at
any time over the preceding 365 days to ensure accurate disclosure for
registrants that employ a high number of seasonal employees.\135\
---------------------------------------------------------------------------

    \135\ See letter from AFL-CIO II.
---------------------------------------------------------------------------

    One commenter recommended that the final rule permit registrants to
use different determination dates for different segments of their
workforce based on tax, payroll, and/or other established recordkeeping
systems, accompanied by a brief statement of the basis for the
different disclosure dates because a number of companies maintain their
human resource/payroll systems for U.S. employees on a calendar-year
basis, but do so for their foreign employees on a fiscal-year
basis.\136\ The commenter also noted that using the end of the second
or third fiscal quarter as a determination date would not be feasible
because most payroll systems are set up to collect information on
fiscal year-end or calendar year-end bases.
---------------------------------------------------------------------------

    \136\ See letter from ABA.
---------------------------------------------------------------------------

    Some commenters responded to the Proposing Release's request for
comment on whether the rule's definition of ``employee'' would cause a
registrant to change its corporate structure. Most of the commenters
that responded said that the definition would not cause registrants to
alter their corporate structure or employment arrangements,\137\
although one commenter disagreed.\138\
---------------------------------------------------------------------------

    \137\ See, e.g., letters from ABA, Capital Strategies, and
WorldatWork I.
    \138\ See letter from Prof. Ray.
---------------------------------------------------------------------------

iii. Final Rule
    After considering commenters' desire for flexibility in choosing
the median employee determination date, we are revising the final rule
from the proposal. Unlike the proposed rule, which would define
``employee'' as an individual employed as of the last day of the
registrant's last completed fiscal year, the final rule defines
``employee'' as an individual employed on any date of the registrant's
choosing within the last three months of the registrant's last
completed fiscal year. The final rule also requires registrants to
disclose the date used to identify the median employee.
    Some commenters recommended that the final rule require registrants
to explain the reason they selected a determination date other than the
last day of the fiscal year.\139\ We do not believe such an explanation
would lead to useful disclosure, as registrants would likely state that
they chose any date other than the end of the fiscal year to provide
more time to take the steps necessary to identify the median employee.
If, however, a registrant changes the determination date from the prior
year, we believe it should disclose the reason for the change. Under
the final rule, therefore, if a registrant changes the date it uses to
identify the median employee, the registrant must disclose the change
and provide a brief explanation about the reason or reasons for the
change.
---------------------------------------------------------------------------

    \139\ See, e.g., letters from Microsoft and SH&P.
---------------------------------------------------------------------------

    We note that allowing registrants to choose a determination date
within a defined window, rather than be required to use the last day of
the fiscal year, is a change from the proposal and differs from the
approach in determining the

three most highly compensated executive officers under existing Item
402(a)(3)(iii).\140\ We believe permitting registrants to choose a date
within the last three months of their last completed fiscal year, as
suggested by a commenter, is appropriate because it will provide
registrants with some flexibility and could permit them additional time
to identify their median employee in advance of their fiscal year
end.\141\ At the same time, establishing a particular date certain will
provide some consistency from year to year. We also note that this
change may help to avoid some of the unintended consequences identified
by commenters, such as anti-competitive effects on retailers with a
significant number of employees at year end or inefficient changes in
corporate structure made simply to avoid employing workers on the last
day of the fiscal year. Finally, as discussed in the Proposing Release,
we continue to believe that requiring the determination of the employee
to be made as of a specific date, rather than over the course of the
year, will ease compliance for registrants by eliminating the need to
monitor changes in their workforce composition throughout the year.
---------------------------------------------------------------------------

    \140\ 17 CFR 230.402(a)(3)(iii).
    \141\ See letter from Davis Polk (noting that a ``90-day period
preceding the fiscal year end'' would permit ``a registrant [to]
begin the task of identifying its median employee in advance of its
fiscal year end, which is the most costly and time-consuming part of
the pay ratio calculation'').
---------------------------------------------------------------------------

c. Employees Located Outside the United States
i. Proposed Rule
    We proposed a definition of ``employee'' that would include any
U.S. and non-U.S. employee of a registrant. In the Proposing Release,
we acknowledged that the inclusion of non-U.S. employees raises
compliance costs for multinational companies, introduces cross-border
compliance issues, and could raise concerns about the impact of non-
U.S. pay structures on the comparability of the data to companies
without off-shore operations. We also recognized that differences in
relative compliance costs could have an adverse impact on competition.
We weighed these considerations and proposed that the disclosure
requirements would nonetheless cover all employees without exemptions
for specific categories of employees, including non-U.S. employees.
    Additionally, we were cognizant that data privacy laws in various
jurisdictions could have an impact on gathering and verifying the data
needed to identify the median of the annual total compensation of all
employees. Commenters in the pre-proposal period expressed concern
that, in some cases, data privacy laws of foreign countries could
prohibit a registrant's collection and transfer of personally
identifiable compensation data that would be needed to identify the
median employee. We also noted that some data privacy laws may make the
collection or transfer of the underlying data more burdensome, but do
not actually prohibit transfer of compensation data.
    For example, we indicated that multinational companies based in the
United States might need to ensure compliance with data privacy
regulations when taking certain actions to comply with the proposal,
such as transmitting personally identifiable human resources data
(``personal data'') of European Union (``E.U.'') employees onto global
human resource information system networks in the United States;
sending personal data in hard copy from the E.U. to the United States;
or making personal data ``onward transfers'' to third-party payroll,
pension, and benefits processors outside of the E.U.\142\ In some E.U.
countries, employee consent is required, while in other countries
consent may not be sufficient. We noted that other jurisdictions, such
as Peru, Argentina, Canada, and Japan also have data privacy laws that
could be implicated by the gathering of data for purposes of the
proposed pay ratio disclosure.
---------------------------------------------------------------------------

    \142\ The E.U. Directive 95/46/EC, 1995 O.J. L 281 (European
Union Directive on the Protection of Individuals with Regard to the
Processing of Personal Data and on the Free Movement of Such Data)
sets forth the regulatory framework governing the transfer of
personal data from an E.U. Member State to a non-E.U. country.
---------------------------------------------------------------------------

    Although we did not propose any specific accommodation to address
this concern, we stated our belief that the flexibility afforded to all
registrants under the proposed rule could permit registrants to manage
any potential costs arising from applicable data privacy laws. For
example, the proposed rule would permit registrants in this situation
to estimate the compensation of affected employees. We requested
comment on whether the proposed flexibility afforded to registrants in
selecting a method to identify the median, such as the use of
statistical sampling or other reasonable estimation techniques and the
use of consistently applied compensation measures to identify the
median employee, could enable registrants to better manage any
potential costs and burdens arising from local data privacy regulations
or if there are other alternatives that would be consistent with
Section 953(b).
ii. Comments on the Proposed Rule
    Many commenters agreed that non-U.S. employees should be included
in a registrant's pay ratio disclosure.\143\ Some commenters contended
that failing to include non-U.S. employees would cause the pay ratio
disclosure to be incomplete, less informative, and misleading.\144\
Some commenters stressed that Congress intended to include non-U.S.
employees because Section 953(b) refers specifically to ``all
employees.'' \145\ One commenter suggested that the exclusion of non-
U.S. employees would not reduce the regulatory burdens on registrants
because registrants with such employees would have substantial
flexibility in identifying the median employee.\146\
---------------------------------------------------------------------------

    \143\ See, e.g., letters from AFL-CIO I, AFL-CIO II, AFSCME,
Bricklayers International, CalPERS, Calvert, Chicago Teachers Fund,
Corayer, CT State Treasurer, Cummings Foundation, CUPE, Estep,
Fedewa, First Affirmative, Form Letter C, Gould, Douglas J. Matteson
(Oct. 5, 2013) (``Matteson''), ICCR, IL Bricklayers and Craftworkers
Union, Marco Consulting, McMorgan & Co., Novara Tesija, NY
Bricklayers and Craftworkers Union, NY State Comptroller, Oxfam, Pax
World Funds, Charmaine M. Phillips (Oct. 16, 2013) (``C.
Phillips''), Public Citizen I, Public Citizen II, Douglas C. Rand
(Sep. 26, 2013) (``Rand''), Sen. Menendez et al. I, Sen. Menendez et
al. II, Socially Responsive Financial Advisors, Stephen Spofford
(Sep. 24, 2013) (``S. Spofford''), Teamsters, Trillium I, Trustee
Campbell, US SIF, and Walden.
    \144\ See, e.g., letters from AFR, B[acirc]tirente et al., CII,
Domini, and FS FTQ.
    \145\ See, e.g., letters from AFL-CIO II, IPS, and Sen. Menendez
et al. II.
    \146\ See letter from AFL-CIO II.
---------------------------------------------------------------------------

    Many commenters, however, disagreed with the proposed rule and
contended that the final rule should include only the registrant's U.S.
employees because including non-U.S. employees would be very costly
and/or distort the pay ratio.\147\ A number of commenters asserted that
the costs to registrants of including non-U.S. employees would outweigh
any benefits of the disclosure to shareholders,\148\ and offered a
variety of different estimates of how greatly the inclusion of non-U.S.
employees would affect costs.\149\
---------------------------------------------------------------------------

    \147\ See, e.g., letters from Appleby, Avery Dennison, Chamber
I, Chesapeake Utilities, Dover Corp., FuelCell Energy, Garmin, Hay
Group, Meridian, NACD, PM&P, SH&P, Vectren Corp., Vivient,
WorldatWork I, and WorldatWork II.
    \148\ See, e.g., letters from ABA, American Benefits Council,
Business Roundtable I, Chamber I, Corporate Secretaries, ExxonMobil,
Frederic W. Cook & Co., Inc. (Nov. 29, 2013) (``Frederic W. Cook &
Co.''), RILA, Semtech, and Society for Human Resource Management
(Dec. 30, 2013) (``SHRM'').
    \149\ See, e.g., letters from American Benefits Council (stating
that costs could be 20 to 30 times higher if non-U.S. employees are
included and also that some of its ``member companies have estimated
that the annual cost to make the median employee determination on a
worldwide basis could be hundreds of thousands of dollars''),
Business Roundtable I (stating that costs could decrease by over 50%
in some cases if non-U.S. employees are excluded), ExxonMobil, and
FEI (stating that costs would decrease by 90% if the final rule
excluded non-U.S. employees).

---------------------------------------------------------------------------

    Additionally, commenters noted that companies with international
operations almost always have multiple payroll systems and databases
for their employees' compensation that are difficult, if not
impossible, to reconcile,\150\ with some of the commenters providing
the following examples:
---------------------------------------------------------------------------

    \150\ See, e.g., letters from American Benefits Council, Aon
Hewitt, BCIMC, Business Roundtable I, COEC I, COEC II, COEC III,
Cummins Inc., Eaton, ExxonMobil, Freeport-McMoRan, MVC Associates
International (Nov. 28, 2013) (``MVC Associates''), NIRI, Semtech,
SHRM, and Tesoro Corporation (Nov. 21, 2013) (``Tesoro Corp'').
---------------------------------------------------------------------------

     One commenter indicated that it has 15 payroll systems
that are not integrated, and those systems would have to be manually
reconciled with ``substantial costs'' and ``extensive staff hours;''
\151\
---------------------------------------------------------------------------

    \151\ See letter from Freeport-McMoRan.
---------------------------------------------------------------------------

     one commenter stated that it has 30 payroll systems that
do not interface; \152\
---------------------------------------------------------------------------

    \152\ See letter from Cummins Inc.
---------------------------------------------------------------------------

     one commenter cited a Human Resource Policy Association
survey concluding that 84% of respondents could not easily calculate
worldwide enterprise cash compensation for all their employees; \153\
---------------------------------------------------------------------------

    \153\ See letter from MVC Associates.
---------------------------------------------------------------------------

     one commenter cited its own survey finding that a
registrant on average maintains 46 different payroll systems in 34
different countries; \154\ and
---------------------------------------------------------------------------

    \154\ See letter from COEC I.
---------------------------------------------------------------------------

     one commenter stated that it does not have a single
payroll system.\155\
---------------------------------------------------------------------------

    \155\ See letter from Tesoro Corp.
---------------------------------------------------------------------------

    Several commenters stated that many countries have data privacy and
other laws that prevent registrants from transferring payroll data
outside that country's borders (even if the transfer would be within
the same company), which would make compiling the information necessary
for the pay ratio problematic or even illegal.\156\ One of these
commenters recommended that, if the final rule did not exclude all non-
U.S. employees, it should permit registrants to exclude from their
methodology for identifying the median employee the data for any
employees in a jurisdiction where such collection, analysis, and
transmission would violate a registrant's existing data privacy
obligations.\157\ A few commenters stated that the proposed rule's
flexibility afforded to all registrants could permit registrants to
manage any potential costs arising from applicable data privacy
laws.\158\
---------------------------------------------------------------------------

    \156\ See, e.g., letters from AAFA II, ABA, American Benefits
Council, BCIMC, Business Roundtable I, Chamber I, COEC I, COEC II,
Corporate Secretaries, Cummins Inc., Eaton, ExxonMobil, Freeport-
McMoRan, Hyster-Yale, IBC, NACCO, NAM I, NAM II, NIRI, RILA,
Semtech, SHRM, and WorldatWork I.
    \157\ See letter from ABA.
    \158\ See, e.g., letters from Capital Strategies (stating that
data privacy laws would not affect registrants because U.S. firms
must know their employee expenses and can use sampling techniques to
negate any data privacy effects) and WorldatWork I (stating that,
while data privacy laws will have a negative effect on some
registrants, others may be able to gather the required information
under existing waivers granted to them by the EU, and some
registrants can estimate total compensation of their employees in
countries with data privacy laws by placing employees in ``bands''
of similar compensation and benefits levels, and estimating total
compensation using those bands).
---------------------------------------------------------------------------

    One commenter contended that any data privacy concerns can be
addressed easily by anonymizing payroll data sets or conducting
statistical sampling.\159\ If, however, these privacy safeguards proved
insufficient, the commenter recommended that registrants be permitted
to exclude employees in such countries only if they disclose the number
of employees in the excluded countries and obtain and file as an
exhibit to the periodic report in which the pay ratio disclosure
appears a legal opinion by qualified outside counsel demonstrating that
the privacy safeguards are inadequate under local law.
---------------------------------------------------------------------------

    \159\ See letter from AFL-CIO II.
---------------------------------------------------------------------------

    Additionally, a number of commenters contended that including non-
U.S. employees in the final rule would distort the pay ratio because of
(1) differences in local pay practices,\160\ with some of these comment
letters stating that, unlike many U.S. companies, companies in other
countries include as ``compensation'' transportation, food, housing,
wedding, birth, education, and phone expenses, as well as profit-
sharing arrangements and government provided benefits; \161\ (2) the
exchange rates of foreign currencies; \162\ and (3) cost-of-living
differences among countries.\163\
---------------------------------------------------------------------------

    \160\ See, e.g., letters from AAFA I, ABA, Aon Hewitt, American
Benefits Council, Business Roundtable I, COEC I, Cummins Inc.,
Eaton, ExxonMobil, FEI, Freeport-McMoRan, Hyster-Yale, IBC, KBR,
NACCO, NYC Bar, Prof. Ray, RILA, Semtech, and SHRM.
    \161\ See, e.g., letters from Eaton, Freeport-McMoRan, and SHRM.
    \162\ See, e.g., letters from American Benefits Council, BCIMC,
Business Roundtable I, Cummins Inc., ExxonMobil, FEI, Freeport-
McMoRan, Prof. Ray, IBC, NAM I, NAM II, NYC Bar, Semtech, and SHRM.
    \163\ See, e.g., letters from AAFA I, American Benefits Council,
BCIMC, COEC I, Corporate Secretaries, Cummins Inc., ExxonMobil FEI,
Freeport-McMoRan, IBC, NAM I, NAM II, NYC Bar, and RILA.
---------------------------------------------------------------------------

    A few commenters argued that excluding non-U.S. employees was
supported by statutory construction. They contended that, despite
Section 953(b)'s reference to ``all employees,'' this statutory
reference does not require the final rule to include non-U.S.
employees.\164\ Some of these commenters asserted that excluding non-
U.S. employees would be consistent with Section 953(b) because the
statute is silent as to whether ``all employees'' means non-U.S.
employees.\165\ Others insisted that interpreting ``all employees'' to
exclude non-U.S. employees would be appropriate because of a
presumption against the extraterritoriality of U.S. laws.\166\
---------------------------------------------------------------------------

    \164\ See, e.g., letters from COEC I, ExxonMobil, Frederic W.
Cook & Co., Freeport-McMoRan, NIRI, and NYC Bar.
    \165\ See, e.g., letters from Freeport-McMoRan, and NIRI.
    \166\ See, e.g., letters from COEC I and ExxonMobil.
---------------------------------------------------------------------------

    Some commenters advocated for a de minimis exemption for non-U.S.
employees \167\ because, as one of these commenters stated, excluding a
small number of employees is unlikely to affect ``in a material way''
the pay ratio and the nominal differences in ratios would be outweighed
by the cost savings to registrants.\168\ Commenters provided a number
of suggestions for a de minimis exemption. One commenter suggested
that, if non-U.S. employees make up less than 20% of all a registrant's
employees, the registrant should be permitted to exclude all non-U.S.
employees.\169\ Another commenter stated that registrants should be
permitted to exclude non-U.S. employees in any foreign country that
comprises less than 5% of the registrant's aggregate global
workforce.\170\
---------------------------------------------------------------------------

    \167\ See, e.g., letters from American Benefits Council (arguing
in the alternative to excluding non-U.S. employees), Corporate
Secretaries, ExxonMobil, Financial Services Institute (Dec. 2, 2013)
(``FSI''), FSR, NACCO (arguing in the alternative to excluding non-
U.S. employees), NYC Bar (arguing in the alternative to excluding
non-U.S. employees), and PNC Financial Services.
    \168\ See letter from PNC Financial Services.
    \169\ See letter from NACCO.
    \170\ See letter from American Benefits Council.
---------------------------------------------------------------------------

    A different commenter recommended that a registrant be permitted to
exclude non-U.S. employees if they account for less than 5% of the
registrant's total workforce because they would represent a de minimis
number of employees.\171\ Also, according to that commenter, if the
registrant's foreign employees account for more than 5% of all
employees, this commenter recommended that the registrant should be
permitted to exclude employees in any single foreign jurisdiction if
they comprise less than 2% of total

employees, with an aggregate cap of 5%, and that the registrant be
allowed to choose which country's employees to exclude.\172\ Another
commenter noted that a registrant should be permitted to exclude non-
U.S. employees in a foreign country if the number of employees in that
country is less than 1% of the registrant's total workforce.\173\
---------------------------------------------------------------------------

    \171\ See letter from FSR.
    \172\ See id.
    \173\ See letter from ExxonMobil.
---------------------------------------------------------------------------

    One commenter recommended that a registrant be able to exclude non-
U.S. employees if its CEO is based in the United States and more than
50% of the registrant's employees also are based in the United
States.\174\ Conversely, a different commenter contended that we should
use our discretion to limit the scope of the term ``all employees'' to
only U.S. employees if ``most of the registrant's employees'' and its
principal executive officer ``work primarily outside the United
States.'' \175\ Alternatively, the commenter suggested that, if the
final rule includes non-U.S. employees, the rule should not include as
``compensation'' the value of pension accruals, employer matching
contributions for 401(k)s, and non-cash benefits. The commenter also
advocated that, if non-U.S. employees are included, the final rule
should exclude from the median identification employees who work in any
E.U. jurisdiction that has strict data privacy rules and employs fewer
than 50 people.
---------------------------------------------------------------------------

    \174\ See letter from NYC Bar.
    \175\ See letter from ABA. See also letter from NACCO
(suggesting that, if non-U.S. employees make up more than 80% of a
registrant's employees, the registrant should be exempt from the
rule entirely).
---------------------------------------------------------------------------

    Another commenter contended that the final rule should include a
principles-based exclusion that would permit companies the flexibility
to exclude substantial percentages of employees if their compensation
data is difficult to obtain and the impact would not be
significant.\176\ The commenter cited the two memoranda analyzing the
potential effects of excluding different percentages of employees on
the pay ratio calculation that the staff from the Division of Economic
and Risk Analysis (``DERA'').\177\ According to the commenter, these
memoranda concluded that excluding a ``large share'' of employees from
the pay ratio calculation would ``not have a significant impact'' on
the ratio. As an example, the commenter noted that the June 30
Memorandum states that excluding 40% of a registrant's employee
population could reduce the pay ratio by 10.77% or increase it by
12.08%. The commenter asserted these amounts would be ``negligible,''
and therefore registrants should be permitted to exclude these
employees from their pay ratio calculations under the principles-based
exclusionary approach advocated by the commenter. Additionally, the
commenter noted that the average respondent to a survey it conducted
indicated that 40% of its employees are located overseas and excluding
these employees would decrease the compliance costs of the rule by 47%.
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    \176\ See letter from COEC III.
    \177\ See Memorandum of the Division of Economic and Risk
Analysis regarding the potential effect on pay ratio disclosure of
exclusion of different percentages of employees at a range of
thresholds (Jun. 4, 2015) (``June 4 Memorandum'') available at
http://www.sec.gov/comments/s7-07-13/s70713-1556.pdf and Memorandum
from the Division of Economic and Risk Analysis regarding an
extension of the analysis of the potential effect on pay ratio
disclosure of exclusion of different percentages of employees at a
range of thresholds (Jun. 30, 2015) (``June 30 Memorandum'')
available at http://www.sec.gov/comments/s7-07-13/s70713-1559.pdf.
When the June 4 Memorandum was placed in the public comment file, we
provided a press release announcing it was issued and an electronic
alert through our RSS feed. The press release expressly advised that
additional staff analyses might be placed in the comment file.
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iii. Final Rule
(a) Non-U.S. Employees Generally
    After considering the comments, we have determined to include in
the final rule's definition of ``employee'' a registrant's U.S. and
non-U.S. employees, as proposed. We believe that the inclusion of non-
U.S. employees is the policy choice that most closely captures what
Congress directed us to do in stating that the ratio should reflect
``all employees.'' As noted above, we believe that the use of the word
``all'' provides a general direction in favor of inclusion rather than
exclusion of broad categories of employees. Although we recognize that
our reading may impose more costs on registrants than if we excluded
non-U.S. employees, given that Congress is undoubtedly aware that many
U.S. registrants operate globally, we think Congress's use of ``all
employees'' without any territorial limitation is a strong indication
that Congress did not want us to categorically exclude non-U.S.
employees. Further supporting our conclusion is the fact that,
historically, the disclosures that are required of registrants under
the securities laws apply to events, assets, conduct, or persons
irrespective of whether those are located in the United States or
abroad, and there is no indication that Congress intended to depart
from this historical approach. However, as discussed below, we are
adopting several tailored exemptions to address specific concerns
raised by commenters.
    With respect to the assertion by some commenters that the rule
should exclude non-U.S. employees because there is a presumption
against the extraterritoriality of U.S. laws,\178\ we do not believe
that including foreign employees within the ``employee'' definition
constitutes an extraterritorial application of the statute. Generally,
whether a particular application of a statute is ``extraterritorial''
turns on an analysis of whether the conduct that is the Congressional
focus of the statute occurs here or abroad.\179\ The Congressional
focus of Section 953(b) is disclosure by registrants that avail
themselves of the U.S. public markets and thereby submit to U.S.
law.\180\ As discussed above, Section 953(b)(1) directs us to amend
Item 402, ``to require each issuer to disclose'' the pay ratio
information ``in any filing'' described in Item 10(a). Companies are
only required to provide a ``filing'' with us if they offer and/or sell
securities in the United States and become subject to the our
registration and filing requirements. Therefore, the final rule affects
only registrants that come under the umbrella of United States laws.
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    \178\ See, e.g., letters from COEC I and ExxonMobil.
    \179\ See Morrison v. Nat'l Australia Bank Ltd., 561 U.S. 247
(2010).
    \180\ In this regard, we note that it is important that
shareholders have access to information about both the domestic and
foreign operations of a registrant given that a shareholder's
investment in a U.S. registrant is typically exposed to the risks
of, and the returns generated by, the global operations of the
registrant.
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    Our exemptive authority under Section 36 of the Exchange Act and
Section 28 of the Securities Act would allow us to exempt registrants
from including non-U.S. employees in the median employee determination
required by Section 953(b).\181\ However,

after careful consideration, we decline to exercise our discretion to
grant a wholesale exemption for non-U.S. employees. As we understand
Section 953(b), Congress thought that it was important for shareholders
to have pay ratio disclosure that reflects ``all employees'' of a
registrant when making their say-on-pay votes. We do not believe it
would be appropriate to second-guess Congress by granting a wholesale
exemption for non-U.S. employees in a manner that we believe could
fundamentally change the pay ratio information that Congress directed
be provided to shareholders.\182\
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    \181\ Section 36(a) of the Exchange Act and Section 28 of the
Securities Act afford us general exemptive authority to
conditionally or unconditionally exempt any person, security, or
transaction, or any class or classes of persons, securities, or
transactions, from any provision or provisions of this title (i.e.,
the Exchange Act and the Securities Act, respectively) or of any
rule or regulation thereunder, to the extent that such exemption is
necessary or appropriate in the public interest, and is consistent
with the protection of investors. Although Section 953(b) was not
expressly incorporated into either Act, our view is that, to the
extent that the statutory criteria for invoking exemptive authority
under these sections are met, the exemptive authorities afforded by
Section 36(a) and Section 28 are available here. We construe Section
953(b) as a Congressional directive to us to rely on our Exchange
Act and Securities Act rulemaking authorities to amend Sec.  229.402
of title 17, Code of Federal Regulations to require the pay ratio
disclosure. The pay ratio amendments that we are adopting,
therefore, are rules or regulations under the Exchange Act and the
Securities Act and, thus, fall within the express terms of Section
36(a) and Section 28.
    \182\ Our use of exemptive authority where foreign data privacy
laws are involved (as discussed below) may result in different pay
ratio disclosure in certain instances, but we believe the use of
exemptive authority is appropriate because it reflects a carefully
tailored accommodation necessary to address a situation (i.e.,
foreign data privacy laws) that Congress may not have contemplated.
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    While the final rule does not exclude non-U.S. employees, in
response to concerns that the inclusion of non-U.S. employees could
raise compliance costs for multinational companies, introduce cross-
border compliance issues, and have an adverse impact on competition, we
are exercising our exemptive authority to provide two tailored
exemptions that we believe will alleviate some of these concerns: (1)
an exemption that applies when a foreign jurisdiction's data privacy
laws or regulations are such that, despite its reasonable efforts to
obtain or process information necessary to comply with the rule, a
registrant is unable to do so without violating those laws or
regulations, and (2) a de minimis exemption. These exemptions are
discussed in detail below.
(b) Foreign Data Privacy Law Exemption
    The first instance in which we believe it is appropriate to provide
an exemption to the general requirement that non-U.S. employees be
included in the pay ratio disclosure is when a jurisdiction's data
privacy laws or regulations are such that, despite a registrant's
reasonable efforts to obtain or process information necessary to comply
with the rule, it is unable to do so without violating those laws or
regulations. A number of commenters noted that many countries have data
privacy and other laws that prevent registrants from transferring
payroll data outside that country's borders (even if the transfer would
be within the same company), which would make compiling the information
necessary for the pay ratio disclosure illegal.\183\ For example,
commenters noted that the E.U. prohibits the transfer of personal data
to a third country that does not ensure an adequate level of privacy
protections (the United States is considered not to ensure adequate
privacy protections) and that China, Japan, Mexico, Canada, Peru,
Australia, Russia, Switzerland, Argentina, and Singapore have adopted
or are considering similar rules.\184\
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    \183\ See, e.g., letters from AAFA II, ABA, American Benefits
Council, BCIMC, Business Roundtable I, Chamber I, COEC I, Corporate
Secretaries, Cummins Inc., Eaton, ExxonMobil, Freeport-McMoRan,
Hyster-Yale, IBC, NACCO, NAM I, NAM II, NIRI, RILA, Semtech, SHRM,
and WorldatWork I.
    \184\ See, e.g., letters from ABA, American Benefits Council,
Business Roundtable I, COEC I, Cummins Inc., NAM I, NAM II, RILA,
and WorldatWork I.
---------------------------------------------------------------------------

    One of these commenters acknowledged, however, that ``it would be
reasonable to expect that registrants which employ workers abroad
already have an understanding of their obligations under the data
privacy laws of each jurisdiction in which they operate, and have
undertaken to comply with those laws,'' but the commenter was concerned
that existing actions taken by registrants to comply with those laws
may not be sufficiently flexible to facilitate compliance with the
rule.\185\ In this regard, the commenter noted that, under the E.U.
Directive, data may be exempt from the dictates of the Directive if it
is truly anonymous such that the data cannot be attributed to any
identifiable person. It would seem, therefore, that a registrant
employing hundreds or thousands of employees in an E.U. jurisdiction
could collect compensation data for purposes of complying with Section
953(b) in a way that would preserve employee anonymity while a
registrant that employs only a handful of employees in an E.U.
jurisdiction may not be able to collect the data in such a manner.\186\
The commenter therefore recommended that, if the final rule did not
exclude all non-U.S. employees, it should permit registrants to exclude
from the definition of ``employee'' any employee in a jurisdiction
where such collection, analysis, and transmission would violate a
registrant's existing data privacy obligations.\187\
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    \185\ See letter from ABA.
    \186\ In such situations, we recognize that the de minimis
exemption may be available.
    \187\ See letter from ABA (recommending that we consider
permitting registrants to exclude from the identification of the
median employee those employees who work in an E.U. jurisdiction
that maintains strict data privacy laws and in which the registrant
employs fewer than 50 employees).
---------------------------------------------------------------------------

    After considering the comments received, we are persuaded that a
tailored exemption from the definition of ``employee'' is appropriate
where a foreign country's data privacy laws or regulations are such
that a registrant is not able to comply with the rule without violating
those laws or regulations in spite of its reasonable efforts to obtain
or process the necessary information.\188\
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    \188\ As required by Section 28 of the Securities Act and
Section 36 of the Exchange Act, we find that the exemption here is
consistent with investor protection and is necessary or appropriate
in the public interest. We make these findings based on the fact
that, without the exemption, registrants operating in countries with
applicable privacy laws could be forced into the difficult situation
of violating either that country's laws or U.S. law, and we believe
that because of the limited and tailored nature of the exemption, it
will not materially impact the pay ratio disclosure.
---------------------------------------------------------------------------

    Although, as noted above, we believe the inclusion of non-U.S.
employees is consistent with the Congressional directive and is
important for providing pay ratio information that reflects a
registrant's overall employment practices, we do not have any
indication that Congress intended that a registrant should have to
choose between complying with our disclosure rules and violating the
laws of a foreign jurisdiction. We believe that, on balance, providing
an accommodation in such situations would not substantially affect the
utility of the Section 953(b) disclosures for shareholder say-on-pay
votes.
    To prevent any potential manipulation, the rule requires the
registrant to exercise reasonable efforts to obtain or process the
information necessary for compliance with the final rule. As part of
its reasonable efforts, the registrant must seek an exemption or other
relief under the applicable jurisdiction's governing data privacy laws
or regulations and use the exemption if granted.
    If a registrant excludes any non-U.S. employees in a particular
jurisdiction under the data privacy exemption, it must exclude all non-
U.S. employees in that jurisdiction. Additionally, the registrant must
list the excluded jurisdictions, identify the specific data privacy law
or regulation, explain how complying with the final rule violates the
law or regulation (including the efforts made by the registrant to use
or seek an exemption or other relief under such law or regulation), and
provide the approximate number of employees exempted from each
jurisdiction based on this exemption.
    Also, the registrant must obtain a legal opinion that opines on the
inability of the registrant to obtain or process the information
necessary for compliance with the final rule without violating that
jurisdiction's laws or regulations governing data privacy, including
the registrant's inability to obtain an exemption or other relief under
any

governing laws or regulations. The legal opinion must be filed as an
exhibit with the filing in which the pay ratio disclosure is included.
For filings other than proxy or information statements, the legal
opinion must be filed as an exhibit under Exhibit 99.\189\
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    \189\ See Item 601(b)(99) of Regulation S-K [17 CFR
229.601(b)(99)]. The exhibit must be filed with proxy or information
statements pursuant to Item 25 of Schedule 14A.
---------------------------------------------------------------------------

(c) De Minimis Exemption
    The second instance in which we believe it is appropriate to
provide an exemption from the general requirement to include non-U.S.
employees in identifying the median employee is when a de minimis
number of a registrant's employees work outside the United States. The
de minimis exemption is a change from the proposed rule. Under this
exemption, registrants whose non-U.S. employees make up 5% or less of
their total U.S. and non-U.S. employees may exclude all of them when
identifying their median employee. If such a registrant chooses to
exclude any non-U.S. employees under this exemption, it must exclude
all of them. A registrant with more than 5% non-U.S. employees may also
exclude non-U.S. employees up to the 5% threshold; provided that, if
such a registrant excludes any non-U.S. employees in a particular
foreign jurisdiction, it must exclude all the employees in that
jurisdiction. The registrant may not pick and choose which employees to
exclude in any one jurisdiction.
    We believe a de minimis exemption provides flexibility in a manner
that will not meaningfully alter the pay ratio disclosure. We are
persuaded that a de minimis exemption is appropriate after considering
the potential cost savings to registrants and the small effect it would
have on the pay ratio, as discussed below. The final rule establishes
the de minimis threshold at 5%. The commenters that suggested specific
de minimis thresholds did not provide reasons why the particular
thresholds they suggested were suitable, but several of these
commenters suggested a threshold of 5%.\190\ We believe the 5%
threshold will both limit the exemption to an amount that is, in fact,
de minimis and help address the payroll or other data challenges that
may arise for registrants with a small percentage of non-U.S.
employees.
---------------------------------------------------------------------------

    \190\ See letters from PNC Financial Services (suggesting 5% as
the de minimis threshold) and FSR (recommending a registrant be
permitted to exclude non-U.S. employees if they account for less
than 5% of the registrant's employees, but, if the registrant's
foreign employees account for more than 5% of all employees, the
registrant may exclude employees in any single foreign jurisdiction
if they comprise less than 2% of total employees, with an aggregate
cap of 5%).
---------------------------------------------------------------------------

    Although commenters did not provide data about the effect on the
pay ratio of potential de minimis thresholds, staff in DERA performed
an analysis of the potential effect on pay ratio disclosure of
excluding different percentages of employees at a range of thresholds
and posted to the comment file two memoranda containing the
analysis.\191\ As discussed in further detail both in the memoranda and
in the Economic Analysis section below, under such analysis and based
on the assumptions set forth in the analysis, the exclusion of 5% of
employees may cause the pay ratio calculation to decrease by up to 3.4%
or to increase by up to 3.5%. We believe such analysis confirms that
the effect of the 5% threshold on the pay ratio disclosure will be de
minimis. We note that one commenter observed that under one of the
scenarios analyzed in the June 30 Memorandum, excluding 40% of a
registrant's employees may cause the pay ratio calculation to decrease
by up to 10.77% or to increase by up to 12.08%.\192\ The commenter
called this impact ``not significant'' and ``negligible'' and, based on
this impact, contended that the final rule should permit registrants to
exclude up to 40% of their non-U.S. employees. We are not adopting this
suggestion. We believe that the exclusion of 40% of employees would be
a fundamentally different type of exclusion than the one we adopting
here--that is, a de minimis exclusion designed to allow companies to
exclude employees in jurisdictions where there are only a limited
number of employees and where the costs of including such employees may
be disproportionately greater than the incremental information they
would add to the disclosure. The exclusion of 40% of employees is not a
de minimis amount of employees, and, in contrast to the assertions of
the commenter, we believe that a decrease in the pay ratio calculation
of up to 10.77% or increase by up to 12.08% is significant and more
than negligible, and we do not believe that it is de minimis.
Additionally, as the commenter acknowledges, under other scenarios in
the memorandum, exclusion of up to 40% of a registrant's employees
could have an even greater effect on the pay ratio (e.g., by causing it
to decrease by up to 25.06% or to increase by up to 33.43%). In
contrast, the 5% de minimis threshold both results in the exclusion of
a de minimis number of employees and has a de minimis effect on the pay
ratio, regardless of which scenario is considered. Accordingly, the
final rule's de minimis threshold for non-U.S. employees does not
exceed 5%.
---------------------------------------------------------------------------

    \191\ See the June 4 Memorandum and the June 30 Memorandum. See
also, Section III.D.2.c.vi below.
    \192\ See letter from COEC III.
---------------------------------------------------------------------------

    As one commenter warned, there is a possibility for intentional
manipulation in identifying the median employee when a de minimis
exemption is provided and a registrant is permitted to choose which
jurisdictions to exclude.\193\ To provide safeguards against any
potential manipulation, the final rule requires that, if a registrant
with 5% or fewer non-U.S. employees chooses to exclude those employees
from the calculation of its median employee, it may not pick and choose
which of the 5% to exclude and must exclude all of its non-U.S.
employees. Similarly, if a registrant with more than 5% non-U.S.
employees excludes any employees in any jurisdiction, it must exclude
all the employees in that jurisdiction. In this regard, we recognize
that this requirement could prevent some registrants with more than 5%
non-U.S. employees from excluding any of its foreign employees. A
purpose of the de minimis exemption is to provide relief from the need
to determine how to integrate payroll systems and compensation
arrangements in jurisdictions where the number of employees may not
justify the effort, and we believe that setting the threshold at 5%
establishes an appropriate measure of relief.
---------------------------------------------------------------------------

    \193\ See letter from FSR.
---------------------------------------------------------------------------

    The final rule also requires a registrant using the de minimis
exemption to provide certain disclosures. If the registrant excludes
any non-U.S. employees under the de minimis exemption, it must disclose
the jurisdiction or jurisdictions from which employees are being
excluded, the approximate number of employees excluded from each
jurisdiction under the de minimis exemption, the total number of its
U.S. and non-U.S. employees irrespective of any exemption (data privacy
or de minimis) and the total number of its U.S. and non-U.S. employees
used for its de minimis calculation.
    In calculating the number of non-U.S. employees that may be
excluded under the de minimis exemption, a registrant must count any
non-U.S. employee exempted under the data privacy exemption against the
availability. A registrant may exclude any non-U.S. employee that meets
the data privacy exemption, even if the number of excluded employees
exceeds 5% of the registrant's total employees. If, however,

the number of employees excluded under the data privacy exemption
equals or exceeds 5% of the registrant's total employees, the
registrant may not use the de minimis exemption to exclude additional
non-U.S. employees.
    For example, a registrant has non-U.S. employees located in two
foreign jurisdictions. One of the jurisdictions has 10% of the
registrant's total employees who are non-U.S. employees and has data
privacy laws that, despite its reasonable efforts to obtain or process
the information necessary for compliance with the final rule, the
registrant is unable to do so without violating those data privacy laws
or regulations. The other jurisdiction has an additional 5% of the
registrant's total employees who are non-U.S. employees and has no such
data privacy laws or regulations. The registrant may exclude all the
non-U.S. employees in the first jurisdiction, which has 10% of the
registrant's total employees. In that situation, however, the
registrant may not exclude the non-U.S. employees in the second
jurisdiction, which has the additional 5% of the total employees, even
though the 5% would otherwise constitute a de minimis amount of non-
U.S. employees, because the registrant is already excluding over 5% of
its employees under the data privacy exemption.\194\
---------------------------------------------------------------------------

    \194\ We do not envision a scenario in which a registrant can
forgo the data privacy exemption in favor of the de minimis
exemption in the above or similar situations. The data privacy
exemption is permitted only for circumstances in which a foreign
jurisdiction's laws or regulations governing data privacy are such
that a registrant is unable to comply with the final rule without
violating the that jurisdiction's laws or regulations. If a
registrant is in a position to forgo the data privacy exemption, it
would not be considered eligible for the exemption.
---------------------------------------------------------------------------

    Moreover, if the number of non-U.S. employees excluded under the
data privacy exemption is less than 5% of the registrant's total
employees, the registrant may use the de minimis exemption to exclude
no more than the number of non-U.S. employees that, combined with the
data privacy exemption, equals 5% of the registrant's total employees.
    For example, a registrant has non-U.S. employees located in two
foreign jurisdictions. One of the jurisdictions has 2.5% of the
registrant's total employees who are non-U.S. employees and has data
privacy laws that, despite its reasonable efforts to obtain or process
the information necessary for compliance with the final rule, the
registrant is unable to do so without violating those data privacy laws
or regulations. The other jurisdiction has an additional 2.5% of the
registrant's total employees who are non-U.S. employees and has no such
data privacy laws or regulations. The registrant may exclude the 2.5%
of total employees who are non-U.S. employees in the first jurisdiction
under the data privacy exemption. The registrant may also exclude the
additional 2.5% of the registrant's total employees who are non-U.S.
employees from the second jurisdiction because the total number of
exempted non-U.S. employees under both the data privacy and the de
minimis exemptions equal only 5% of the registrant's total employees.
    Alternatively, in the above example, if the number of non-U.S.
employees in the second jurisdiction was 3% of the registrant's total
employees, the registrant could not exclude the non-U.S. employees in
that jurisdiction because the registrant's number of excluded non-U.S.
employees in both jurisdictions would be over 5% of its total
employees.
(d) Cost-of-Living Adjustment
    In the Proposing Release, we requested comment on whether we should
permit cost-of-living adjustments for employees in different countries.
A number of commenters who addressed this issue contended that
unadjusted cost of living differences between countries would cause the
inclusion of non-U.S. employees to render the pay ratio disclosure
misleading.\195\ Accordingly, some of these commenters suggested that
the pay ratio disclosure could be more meaningful for some registrants
if the final rule permitted cost-of-living adjustments.\196\ However,
other commenters objected to permitting cost-of living-
adjustments,\197\ asserting that the compensation of a non-U.S.
employee ``is more directly comparable to the total compensation of a
registrant's [PEO] without a cost-of-living adjustment,'' \198\ and
that permitting cost-of-living adjustments could add a level of
subjectivity to the pay ratio disclosure.\199\
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    \195\ See, e.g., letters from AAFA I, American Benefits Council,
BCIMC, Corporate Secretaries, Cummins Inc., ExxonMobil, NAM I, NAM
II, and SH&P.
    \196\ See letter from ExxonMobil (``Example 2: Differences in
cost of living. Two employees hold similar jobs in two different
countries, C and D. The employee in Country C receives total annual
compensation of $100,000 and the employee in Country D receives
total annual compensation of $75,000. The cost of living in Country
D is approximately 50% of the cost of living in Country C. In real
economic terms, the employee in Country D enjoys significantly
higher pay than the employee in Country C. However, under the rules
as proposed the appearance is reversed.'') (Emphasis in original.).
See also, letters from NAM I, NAM II, and SH&P.
    \197\ See letters from ABA, Prof. Ray, and WorldatWork I.
    \198\ See letter from ABA (``We believe that the Commission
should not allow registrants to make cost-of-living adjustments for
non-U.S.-based employees (should the agency determine to include
them), other than the annualization and full-time equivalent
adjustments discussed above in our responses to Questions 23 and 24.
We believe the total compensation of such full-time employees is
more directly comparable to the total compensation of a registrant's
principal executive officer without a cost-of-living adjustment than
with it.'').
    \199\ See letter from Prof. Ray.
---------------------------------------------------------------------------

    We acknowledge that differences in the underlying economic
conditions of the countries in which registrants operate likely have an
effect on the compensation paid to employees in those jurisdictions. As
a result, requiring registrants to determine their median employee and
calculate the pay ratio without permitting them to adjust for these
different underlying economic conditions could result in what some
would consider a statistic that does not appropriately reflect the
value of the compensation paid to individuals in those countries. The
final rule, therefore, allows registrants the option to make cost-of-
living adjustments to the compensation of their employees in
jurisdictions other than the jurisdiction in which the PEO resides when
identifying the median employee (whether using annual total
compensation or any other consistently applied compensation measure),
provided that the adjustment is applied to all such employees included
in the calculation.\200\ If the registrant chooses this option, the
compensation of such employees will have to be adjusted to the cost of
living in the jurisdiction in which the PEO resides. Further, if the
registrant uses a cost-of-living adjustment to identify the median
employee, and the median employee identified is an employee in a
jurisdiction other than the one in which the PEO resides, the
registrant must use the same cost-of-living adjustment in calculating
the median employee's annual total compensation and disclose the median
employee's jurisdiction. If a registrant does not make cost-of-living-
adjustments to its employees when identifying the median employee, the
registrant is not permitted to make cost-of-living adjustments to the
median employee's annual total compensation if the median employee is
an employee in

a jurisdiction other than the jurisdiction in which the PEO resides.
---------------------------------------------------------------------------

    \200\ We are utilizing our authority under Section 28 of the
Securities Act and Section 36 of the Exchange Act to permit
registrants to elect to identify the median employee by first
adjusting the compensation of employees in jurisdictions other than
the jurisdiction in which the PEO resides to the cost of living in
the CEO's jurisdiction of residence. Moreover, for the reasons
described above, we believe that this conditional exemption is
consistent with the public interest and investor protection.
---------------------------------------------------------------------------

    In the Proposing Release, we said that we preliminarily believed
that certain adjustments, including cost-of-living adjustments, ``could
distort an understanding of the registrant's compensation practices.''
Based on our fuller understanding of the Congressional purpose
underlying the pay ratio disclosure and the comments received on the
proposal, however, we are persuaded that allowing registrants the
option of a cost-of-living adjustment for employees in jurisdictions
other than the jurisdiction in which the PEO resides could be useful to
investors as they make their say-on-pay votes. Put simply, a cost-of-
living adjustment could provide a more meaningful comparison of the
PEO's compensation to the actual value of the median employee's
compensation by effectively filtering out that part of the difference
in compensation that results from differences in the cost of living
between the PEO's place of residence (typically, the United States) and
the median employee's jurisdiction. For some shareholders making their
say-on-pay votes, we believe that what may matter is the value of
compensation received by the median employee, rather than the dollar
amount of the compensation paid. Although we are not mandating that
registrants adjust for these cost-of-living considerations, we believe
that it is appropriate to give them the option to make such adjustments
where they determine that doing so would provide more useful
information to their shareholders as they vote on executive
compensation.\201\
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    \201\ Although the final rule gives registrants the option to
make cost-of-living adjustments for employees in jurisdictions other
than the jurisdiction in which the PEO resides, we are not giving
registrants the option of adjusting part-time or seasonal employees'
compensation as though they were full time employees. For U.S. part-
time or seasonal employees, the unadjusted compensation reflects the
actual relative value of the compensation received by that employee,
unlike non-U.S. employees who may be working in countries with a
significantly lower cost of living. Moreover, adjusting the
compensation of part-time or seasonal employees to what they would
have received if they had been full time employees would cause the
median to not be reasonably representative of the registrant's
actual employment arrangements for its workforce during the period.
---------------------------------------------------------------------------

    We recognize that providing registrants the flexibility to make
cost-of-living adjustments could add a level of subjectivity to the pay
ratio disclosure, make compliance with the rule more burdensome, or
permit registrants to alter the reported ratio to achieve a particular
objective with the ratio disclosure.\202\ Registrants with a
significant number of employees in countries with higher cost-of-living
than the jurisdiction in which the PEO resides may be unlikely to
adjust those compensation figures downward, while registrants with a
sizable work force in countries with a lower cost-of-living may be
likely to adjust the compensation figures upward.
---------------------------------------------------------------------------

    \202\ See letters from Prof. Ray (stating that permitting cost-
of-living adjustments ``will only make the pay ratio more
subjective,'' because they ``add subjectivity'' to the disclosure)
and WorldatWork I (``Cost-of-living adjustments and full-time
compensation adjustments would make compliance more burdensome by
requiring more context in the explanation of how the ratio was
calculated.'').
---------------------------------------------------------------------------

    We believe, however, that the final rule mitigates these concerns
by requiring registrants to briefly describe any cost-of-living
adjustments they used to identify the median employee or to calculate
annual total compensation, including the measure used as the basis for
the cost-of-living adjustment, and disclose the country in which the
median employee is located. Additionally, the final rule requires that
any registrant electing to present the pay ratio using a cost-of-living
adjustment must also disclose the median employee's annual total
compensation and pay ratio without the cost-of-living adjustments. To
calculate this pay ratio, the registrant will need to identify the
median employee without using any cost-of-living adjustments. In this
way, shareholders would have pay ratio information both in terms of the
value of compensation received by the employee and in terms of the
compensation paid by the registrant.\203\
---------------------------------------------------------------------------

    \203\ We believe that requiring this disclosure of the
unadjusted pay ratio for those registrants who choose to include a
cost-of-living adjustment will help to mitigate the concerns noted
in the Proposing Release about the impact that a cost-of-living
adjustment could have on an understanding of a registrant's
compensation practices.
---------------------------------------------------------------------------

    For registrants who choose to present the pay ratio using a cost-
of-living adjustment, the pay ratio required by Item 402(u)(1)(iii)
will be the cost-of-living adjusted pay ratio. Disclosure of the
unadjusted pay ratio will be available to provide context for the
registrant's required pay ratio. Because the cost-of-living adjustment
will be optional for registrants, we assume they will choose to avail
themselves of this option only to the extent they believe the benefits
of doing so will justify any additional costs to make the adjustment.
d. Employees of Consolidated Subsidiaries
i. Proposed Rule
    The proposed rule would cover employees of both a registrant and
its subsidiaries, which is similar to the approach taken for other Item
402 information.\204\ In the context of Item 402, a subsidiary of a
registrant is an affiliate controlled by the registrant directly or
indirectly through one or more intermediaries, as set forth in the
definition of ``subsidiary'' under both Securities Act Rule 405 and
Exchange Act Rule 12b-2. Therefore, the proposal would cover an
employee if he or she was employed by the registrant or a subsidiary of
the registrant as defined in Rule 405 and Rule 12b-2.
---------------------------------------------------------------------------

    \204\ See Item 402(a)(2) and Instruction 2 to Item 402(a)(3).
---------------------------------------------------------------------------

ii. Comments on the Proposed Rule
    The majority of commenters that discussed this issue recommended
that the rule only require parent registrants to incorporate into their
pay ratio disclosure the employees of their consolidated
subsidiaries.\205\ One of the commenters claimed that there would be a
91% increase in compliance costs if the final rule included minority-
owned subsidiaries and joint ventures because registrants would
otherwise be required to ``engage in an extensive information gathering
process'' without ``access to the payroll and human resources
information needed for the pay ratio from subsidiaries or other
entities with a more tenuous connection, such as joint ventures.''
\206\ Another commenter claimed that registrants do not exercise much
influence on the compensation policies and practices of entities in
which they have only a minority or nominal interest.\207\ Only one
commenter asserted that the final rule should exclude compensation
information from all subsidiaries and be limited to only the
compensation of employees directly employed by the registrant.\208\
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    \205\ See, e.g., letters from ABA (limiting the requirement only
to employees of the registrant's wholly-owned or majority-owned
subsidiaries with consolidated financial statements, but not
subsidiaries that are portfolio companies of business development
companies), Best Buy et al., Business Roundtable I, COEC I, COEC II,
Corporate Secretaries, CT State Treasurer, Davis Polk, Eaton,
ExxonMobil, Mercer I, Meridian, NACCO, NAM I, and NAM II.
    \206\ See letter from COEC I.
    \207\ See letter from ABA.
    \208\ See letter from WorldatWork I.
---------------------------------------------------------------------------

    Some commenters suggested that the final rule require registrants
to incorporate only employees of their wholly-owned subsidiaries and
not employees of their joint ventures.\209\ Other commenters stated
that the final rule should allow a subsidiary to exclude its pay ratio
disclosure in its filings if the subsidiary's employees are
incorporated into its parent registrant's

pay ratio disclosure.\210\ One commenter asserted that the final rule
should require a registrant to include the compensation information of
its subsidiary only if the issuer has ``control'' over the subsidiary
(as ``control'' is defined in our rules).\211\ Another commenter
maintained that the final rule should require a registrant to include
its subsidiary only if the registrant has ``actual control'' over the
compensation decisions made at the subsidiary level.\212\ Finally, a
few commenters contended that the final rule should require registrants
to include the employees of their subsidiaries in their pay ratio
generally without specifying the types of subsidiaries.\213\
---------------------------------------------------------------------------

    \209\ See, e.g., letters from AAFA I, Business Roundtable I,
Corporate Secretaries, NACCO, NAM I, NAM II, and PM&P.
    \210\ See, e.g., letters from FSI and FSR.
    \211\ See letter from Capital Strategies.
    \212\ See letter from Cummins Inc.
    \213\ See, e.g., letters from AFL-CIO I, Domini, and US SIF.
---------------------------------------------------------------------------

iii. Final Rule
    After considering these comments, we are revising the final rule
from the proposal. Unlike the proposed rule, the final rule defines
``employee'' to include only the employees of the registrant and its
consolidated subsidiaries rather than employees of subsidiaries that
were affiliates it controlled directly or indirectly through one or
more intermediaries, as set forth in the definition of ``subsidiary''
under both Securities Act Rule 405 and Exchange Act Rule 12b-2. This
change should reduce costs and burdens for registrants, while
maintaining the benefits of the pay ratio rule, as discussed below.
    Rule 12b-2 and Rule 405 define a ``subsidiary'' as ``an affiliate
controlled by [an entity] directly, or indirectly through one or more
intermediaries,'' while an ``affiliate'' is defined as ``a person that
directly, or indirectly through one or more intermediaries, controls or
is controlled by, or is under common control with, the person
specified.'' \214\ The term ``control'' (including the terms
``controlling,'' ``controlled by'' and ``under common control with'')
means the possession, direct or indirect, of the power to direct or
cause the direction of the management and policies of a person, whether
through the ownership of voting securities, by contract, or
otherwise.\215\ One commenter described this definition of
``subsidiary'' as ``very expansive'' because it includes not just
affiliates controlled directly by the registrant, but also those
controlled indirectly by the registrant through one or more
intermediaries or that are under common control with the
registrant.\216\ In the Section 16 context, we have noted that many
practitioners believe that individuals or entities holding as little as
10% or more of the voting equity securities of a registrant may likely
be considered an affiliate or control person.\217\ Further, whether an
affiliate is controlled by an entity is based on the facts and
circumstances of each situation, so whether a company should be
considered a ``subsidiary'' of a registrant is not always clear.\218\
Therefore, depending on the specific facts and circumstances of the
situation, if the rule used the term ``subsidiary'' as defined under
Rules 12b-2 and 405, a registrant could potentially be required to
include the employees of a company in which it holds as little as a 10%
ownership stake. As commenters noted, obtaining compensation and
payroll data from unconsolidated entities could be costly, burdensome,
or potentially impossible.\219\ Additionally, one commenter suggested
that, because compensation disclosure is designed to facilitate the
comparison of the PEO's pay to the performance of the company based on
its consolidated financial statements, the pay ratio should relate to
the same consolidated financial performance of the company and not to
non-consolidated entities and other factors if the purpose of the rule
is to enhance compensation disclosure.\220\
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    \214\ 17 CFR 240.12b-2 and 17 CFR 230.405.
    \215\ Id.
    \216\ See letter from ABA.
    \217\ See Revision of Rule 144, Rule 145 and Form 144, Release
No. 33-7391, Section III.B (Jun. 27, 1995) (``Under the proposal [to
make revisions to Rule 144, 145, and Form 144], the same criteria
used to determine those persons that are not `insiders' under
Exchange Act Section 16 would be used for Rule 144. Many
practitioners already used Section 16 criteria as a guide. The
Commission believes it is likely that most persons who are not
officers, directors, or 10% holders are not in a `control'
position.'').
    \218\ See, e.g., letters from ABA, Best Buy et al., Business
Roundtable I, COEC I, and Davis Polk.
    \219\ See, e.g., letters from ABA, Best Buy et al., Business
Roundtable I, COEC I, Corporate Secretaries, Davis Polk, Eaton,
ExxonMobil, NACCO, and NAM I.
    \220\ See letter from NAM II.
---------------------------------------------------------------------------

    In contrast, defining a ``subsidiary'' based on whether a
registrant consolidates a company in its financial statements likely
will decrease the costs and burdens on a registrant compared with the
proposal because most registrants consolidate based on their ownership
of over 50% of the outstanding voting shares of their subsidiaries and
more guidance is readily available on when consolidating subsidiaries
is appropriate than when an entity should be considered a
``subsidiary'' based on the concept of control. For example, the United
States generally accepted accounting principles (``U.S. GAAP'')
traditionally has required a company holding the ``controlling
financial interest'' of another company to consolidate that
company.\221\ The usual condition for consolidation is a controlling
financial interest through majority ownership of over 50% of the
outstanding voting shares.\222\ Determining whether a company is a
``subsidiary'' under the consolidated financial statement method, as
opposed to the using the definition of ``subsidiary'' under Rules 405
and 12b-2, generally will provide a higher quantitative threshold and
thus a smaller pool of employees to include in the median employee
determination, which should help to reduce costs associated with making
such a determination. Overall, the standard for consolidation and the
definition of ``control'' under Rules 405 and 12b-2 are both driven by
very similar concepts of control. Use of a consolidated subsidiary
standard will typically exclude employees of entities where a company
holds between a 10% to 50% voting interest in such entity.
---------------------------------------------------------------------------

    \221\ See Volume I, Section 1160.1.12 of PWC 2010 Accounting and
Reporting Manual.
    \222\ See ASC 810-10-15-8 (``The usual condition for a
controlling financial interest is ownership of a majority voting
interest, and, therefore, as a general rule ownership by one
reporting entity, directly or indirectly, of more than 50 percent of
the outstanding voting shares of another entity is a condition
pointing toward consolidation. The power to control may also exist
with a lesser percentage of ownership, for example, by contract,
lease, agreement with other stockholders, or by court decree.'').
---------------------------------------------------------------------------

    Although this change from the proposal generally will result in a
smaller pool of employees being used for the median employee
determination, we do not believe it will undermine the usefulness of
the required disclosures or conflict with the purposes of Section
953(b). As one commenter indicated, ``registrants do not exercise much,
if any, influence on the compensation policies and practices of
entities in which they have only a minority or nominal interest (unless
the employees of such entities provide services directly to the
registrant).'' \223\ According to the commenter, limiting the final
rule to employees of a registrant's consolidated subsidiaries,
therefore, ``would not deprive investors of useful information or
important insights into a registrant's compensation structure.'' We
believe that requiring registrants to consider only their employees and
the employees of their consolidated subsidiaries in identifying their
median employee should not limit the usefulness of the pay ratio
disclosure as a data point for shareholders to use in making their

voting decisions on executive compensation under Section 951 of the
Dodd-Frank Act in any significant way.
---------------------------------------------------------------------------

    \223\ See letter from ABA.
---------------------------------------------------------------------------

e. Any PEO Compensation in the Last Full Fiscal Year
i. Proposed Rule
    The Proposing Release did not discuss the compensation information
that would be required if one or more of a registrant's PEOs served
only part of a fiscal year.
ii. Comments on the Proposed Rule
    Some commenters suggested that a registrant should be required to
disclose the compensation information only for the PEO holding the
position at the end of the last completed fiscal year.\224\ One
commenter suggested an exception where the PEO has served for most of a
fiscal year but departs before the last day, in which case the
commenter recommended that we require compensation information
disclosure for the person who served as PEO for the majority of the
fiscal year.\225\ Another commenter suggested the use of the PEO as of
the last day of the most recently completed fiscal year and noted that
the issue of that person's annual total compensation representing less
than a full year's compensation ``could be addressed by requiring
registrants to annualize the annual total compensation for the chief
executive officer serving at fiscal year end.'' \226\
---------------------------------------------------------------------------

    \224\ See, e.g., letters from ABA, Corporate Secretaries, Davis
Polk, McGuireWoods, and PM&P.
    \225\ See letter from ABA.
    \226\ See letter from Davis Polk.
---------------------------------------------------------------------------

iii. Final Rule
    The final rule allows a registrant a choice of two options in
calculating the annual total compensation for its PEO in situations in
which the registrant replaces its PEO with another PEO during its
fiscal year. In these situations, the registrant must disclose which
option it chose and how it calculated its PEO's annual total
compensation. First, a registrant may take the total compensation
calculated pursuant to Item 402(c)(2)(x), and reflected in the Summary
Compensation Table, provided to each person who served as PEO during
the year and combine those figures. This figure would constitute the
registrant's annual total PEO compensation.
    Alternatively, a registrant may look to the PEO serving in that
position on the date it selects to identify the median employee and
annualize that PEO's compensation. For example, if the registrant
chooses October 15 as the date to determine its median employee, the
registrant would calculate the compensation of the person serving as
PEO on that date and annualize that PEO's compensation. If the person
was PEO for six months and received $100,000 of total compensation, the
registrant would use $200,000 as the annual total compensation of its
PEO. This approach is consistent with annualizing the total
compensation of permanent employees, discussed below, which is
permitted under the final rule. It is also similar to the approach
suggested by one commenter.\227\
---------------------------------------------------------------------------

    \227\ See id.
---------------------------------------------------------------------------

    We are not adopting the approach advocated by some commenters of
disclosing compensation information for the PEO holding that position
at the end of the fiscal year. Section 953(b) requires the disclosure
of the ``annual total compensation of the chief executive officer (or
any equivalent position) of the issuer,'' and we think the better
interpretation of that language is that it is intended to capture the
annual compensation paid for that position (regardless of the
individual who holds the position). Also, we believe that allowing the
disclosure of only partial year compensation would fundamentally alter
the pay ratio disclosure and would not capture the ratio of PEO
compensation to median employee compensation.
f. Additional Information Is Permissible
i. Proposed Rule
    In the Proposing Release, we noted that we received some comments
prior to the proposal suggesting that the rule should allow registrants
to present separate pay ratios covering U.S. and non-U.S. employees to
mitigate concerns that the comparison of the PEO to non-U.S. employees
could distort the disclosure.\228\
---------------------------------------------------------------------------

    \228\ See, e.g., letters from AFL-CIO (Dec. 13, 2010) (``AFL-CIO
pre-proposal letter''), Americans for Financial Reform (Mar. 23,
2011) (``AFR pre-proposal letter''), Walden Asset Management (Apr.
29, 2011) (``Walden pre-proposal letter''), and Social Investment
Forum (Apr. 21, 2011) (``SIF pre-proposal letter'').
---------------------------------------------------------------------------

    The Proposing Release stated that we did not believe that it was
necessary to include instructions in the new rule expressly permitting
registrants to add disclosure to accompany the pay ratio. We indicated,
that, as with other mandated disclosure under our rules, registrants
would be permitted to supplement their required disclosure with a
narrative discussion or additional ratios if they chose to do so. We
indicated also that, as with other disclosure under our rules,\229\ any
additional ratios should not be presented with greater prominence than
the required pay ratio. We requested comment on whether the final rule
should permit or require registrants to include two separate pay ratios
covering U.S. employees and non-U.S. employees.
---------------------------------------------------------------------------

    \229\ See, e.g., Exchange Act Rule 12b-20 and Commission
Guidance Regarding Management's Discussion and Analysis or Financial
Condition and Results of Operations, Release No. 33-8350 (Dec. 19,
2003) [68 FR 75056], at 75060.
---------------------------------------------------------------------------

ii. Comments on the Proposed Rule
    Some commenters opposed any requirement for two separate
ratios.\230\ Other commenters also opposed a requirement for two
separate ratios, but indicated that the final rule should permit
registrants to provide separate ratios if they chose to do so.\231\ One
commenter acknowledged that the Proposing Release permitted additional
ratios but suggested that we should indicate that any additional ratios
should not be misleading and not presented with greater prominence than
the required ratio.\232\
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    \230\ See, e.g., letters from American Benefits Council, Aon
Hewitt, Frederic W. Cook & Co., and WorldatWork I.
    \231\ See, e.g., letters from ABA, Capital Strategies, CII, COEC
I, CT State Treasurer, Cummings Foundation, Emergent, Hyster-Yale,
Johnson & Johnson, NACCO, Comptroller of the City of New York (Nov.
27, 2013) (``NYC Comptroller''), US SIF, and Vivient.
    \232\ See letter from E&Y.
---------------------------------------------------------------------------

iii. Final Rule
    After considering the comments, we have added an instruction to the
final rule stating expressly that registrants may present additional
ratios or other information to supplement the required ratio, but are
not required to do so. The instruction states also that, if a
registrant includes any additional ratios, the ratios must be clearly
identified, not misleading, and not presented with greater prominence
than the required ratio. Additional pay ratios are not limited to any
particular information, such as pay ratios covering U.S. and non-U.S.
employees.
g. Annualizing Permanent Employees is Permissible, but Other
Compensation Adjustments are Prohibited
i. Proposed Rule
    The proposed rule included an instruction permitting, but not
requiring, registrants to annualize the total compensation for
permanent ``employees'' who did not work for the entire year, such as
new hires, employees on leave under the Family and Medical Leave Act of
1993,\233\ employees called for active military duty, or employees who
took an unpaid

leave of absence during the period for another reason. We did not
propose to require registrants to perform this type of adjustment,
however, because we did not believe that the costs of requiring
companies to make this extra calculation would be justified. The
proposed rule applied to individuals who were employed on the last day
of the fiscal year because it referred specifically to an ``employee.''
---------------------------------------------------------------------------

    \233\ 29 U.S.C. 2601 et seq.
---------------------------------------------------------------------------

    In addition, the proposed instruction would prohibit a registrant
from annualizing some eligible employees and not others, and the
instruction prohibited adjustments that would cause the ratio to not
reflect the actual composition of the workforce, such as annualizing
the compensation of seasonal or temporary employees. A registrant could
annualize the compensation for a permanent part-time employee who had
only worked a portion of the year (such as an employee who is
permanently employed for three days a week and who took an unpaid leave
of absence under the Family and Medical Leave Act for a portion of the
year). In such a case, we explained that the adjustment should reflect
compensation for the employee's part-time schedule over the entire
year, but should not adjust the part-time schedule to a full-time
equivalent schedule.
    Although we proposed to permit the annualizing adjustments
described above, the proposed rule would not have permitted certain
other adjustments or assumptions, such as full-time equivalent
adjustments for part-time employees or annualizing adjustments for
temporary or seasonal employees. We believed such adjustments would
cause the median to not be reasonably representative of the
registrant's actual employment and compensation arrangements for its
workforce during the period and could diminish the potential usefulness
of the disclosure.
ii. Comments on the Proposed Rule
    Some commenters concurred that registrants should be permitted to
annualize the total compensation for all permanent employees (which
would exclude temporary and seasonal positions) that were employed by
the registrant for less than the full fiscal year.\234\ Some commenters
also agreed that registrants should not be permitted to adjust the
salaries of part-time, temporary, and seasonal employees to the
equivalent of full-time status contending that it would be misleading
to do so.\235\
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    \234\ See, e.g., letters from ABA, Intel, NACCO, PM&P, SH&P, and
WorldatWork I.
    \235\ See, e.g., letters from Domini, Capital Strategies, and CT
State Treasurer (stating that substantial reliance on non-full-time
employees is important for shareholders' understanding of a
company's workforce and pay structure).
---------------------------------------------------------------------------

    Many commenters, however, contended that the final rule should
permit registrants to provide full-time equivalent adjustments for the
salaries of part-time, temporary, and seasonal employees.\236\ Some of
these commenters asserted that not doing so would distort the pay
ratio.\237\ One of these commenters asserted that permitting full-time
equivalent adjustments would not undermine disclosure or make it less
accurate because any potential concern about shareholders'
understanding of the pay ratio would be mitigated by requiring
registrants to disclose their full-time equivalency and the approximate
number of part-time, seasonal, and temporary employees for which it
made the calculation.\238\ Another commenter indicated that, if the
final rule requires disclosure of any adjustment calculations, the
disclosure should be limited to brief statements.\239\
---------------------------------------------------------------------------

    \236\ See, e.g., letters from ABA, ASA, Business Roundtable I,
Chesapeake Utilities, COEC I, COEC II, Dover Corp., ExxonMobil,
Fedewa, FEI, Frederic W. Cook & Co., Johnson & Johnson, LAPFF,
McCoy, PM&P, SH&P, SHRM, TCA, and Vectren Corp.
    \237\ See, e.g., letters from ABA, ASA, Chesapeake Utilities,
COEC I, and COEC II.
    \238\ See letter from ABA.
    \239\ See letter from Corporate Secretaries.
---------------------------------------------------------------------------

iii. Final Rule
    After considering the comments, we are adopting the final rule as
proposed. Annualization and full-time equivalent adjustments are
separate concepts. Annualization involves taking the compensation of an
employee who worked for only part of the registrant's fiscal year and
projecting that compensation as if the employee worked the full fiscal
year at the schedule that the employee worked for the portion of the
year the employee worked. Annualization is allowed under the rule for
full-time and part-time employees who did not work for the registrant's
full fiscal year for some reason, such as they were employees who were
newly hired, on leave under the Family and Medical Leave Act of 1993,
called for active military duty, or took an unpaid leave of absence
during the period. Annualization is only allowed for permanent
employees; it is not allowed under the final rule for seasonal or
temporary employees. A full-time equivalent adjustment involves taking
the compensation of a part-time employee and projecting what the
employee would have made if the employee were employed on a full-time
basis. Full-time equivalent adjustments are prohibited under the final
rule under all circumstances.
    We are taking this approach in the final rule because we believe it
most accurately captures the workforce and compensation practices that
the registrant has chosen to employ. The limited ability to annualize a
permanent full-time or part-time employee reflects the fact that these
employees are a permanent part of the registrant's workforce despite
having only worked for part of that particular year. In contrast, a
temporary or seasonal employee is not a permanent part of the
registrant's workforce. Full-time equivalent adjustments of these
employees' compensation would reflect a different workforce composition
and compensation structure than used by the registrant. To the extent a
registrant believes that not making full-time equivalent adjustments
for temporary or seasonal employees might not provide shareholders a
complete understanding of the registrant's compensation practices as
they exercise their say-on-pay votes, the registrant is permitted under
the final rule to provide additional disclosure.
2. Identifying the Median Employee and Calculating Annual Total
Compensation
a. Identifying the Median Employee
i. Once Every Three Years
(a) Proposed Rule
    The proposed rule required registrants to disclose the ``median of
the annual total compensation of all employees of the registrant.''
\240\ The proposed rule defined ``annual total compensation'' to mean
``total compensation for the registrant's last completed fiscal year,''
\241\ and ``employee'' to mean ``an individual employed by the
registrant or any of its subsidiaries as of the last day of the
registrant's last completed fiscal year.'' \242\ Therefore, the
proposed rule suggested that registrants would need to undertake the
full process of identifying anew the median employee for each completed
fiscal year.
---------------------------------------------------------------------------

    \240\ See proposed Item 402(u)(1)(i) of Regulation S-K.
    \241\ See proposed Item 402(u)(2)(ii) of Regulation S-K.
    \242\ See proposed Item 402(u)(3) of Regulation S-K.
---------------------------------------------------------------------------

(b) Comments on the Proposed Rule
    A few commenters suggested that the final rule should allow
registrants to undertake the full process of identifying the median
employee periodically (such as once every three years) and use the

compensation of that same or a similarly situated employee during the
intervening two years as long as no material or substantial changes to
the workforce had occurred.\243\ These commenters indicated that, to
remain consistent with Section 953(b), a registrant should be required
to undertake the process to re-identify the median employee for any
year in which it has experienced a change in its employee population
which the registrant reasonably believes would result in a significant
change in the pay ratio disclosure. One of these commenters suggested
that the registrant should exercise ``requisite diligence'' annually to
determine whether such a material change had occurred.\244\
---------------------------------------------------------------------------

    \243\ See, e.g., letters from ABA, COEC I, and COEC II.
    \244\ See letter from ABA.
---------------------------------------------------------------------------

(c) Final Rule
    The final rule allows a registrant to identify the median employee
whose compensation will be used for the annual total compensation
calculation once every three years unless there has been a change in
its employee population or employee compensation arrangements that it
reasonably believes would result in a significant change in the pay
ratio disclosure. If there have been no changes that the registrant
reasonably believes would significantly affect its pay ratio
disclosure, the registrant must disclose that it is using the same
median employee in its pay ratio calculation and describe briefly the
basis for its reasonable belief. For example, the registrant could
disclose that there has been no change in its employee population or
employee compensation arrangements that it believes would significantly
affect the pay ratio disclosure. If the registrant is using the same
median employee, it must calculate that median employee's annual total
compensation each year and use that figure to update its pay ratio
disclosure each year.
    For example, the registrant is required to identify the median
employee and calculate that median employee's annual total compensation
in year one. In years two and three, however, the registrant may use
that same median employee (or an employee whose compensation is
substantially similar to the original median employee based on the
compensation measure used to select that median employee, as discussed
below) to re-calculate the annual total compensation for that employee
without re-identifying the median employee as would otherwise be
required under the final rule if it satisfies the above conditions.
    We believe this approach is appropriate because, as commenters
noted, it is consistent with the requirements of Section 953(b) to
provide annual pay ratio disclosure, while at the same time reducing
registrants' costs and burdens of re-calculating the median employee
more than once every three years unless there has been a change in the
registrant's employee population or employee compensation arrangements
that it reasonably believes would result in a significant change in the
pay ratio disclosure.\245\ Also, we note that the final rule permits
reasonable estimates in identifying the median employee. Permitting
registrants to identify the median employee once every three years,
absent a change in the registrant's employee population or employee
compensation arrangements that it reasonably believes would result in a
significant change in its pay ratio disclosure, is another way of
allowing an estimate of the median employee in a situation where it is
unlikely to result in a significant change to the pay ratio disclosure.
Therefore, this provision will help to minimize burdens and costs while
not significantly affecting registrants' pay ratios. We do not believe
that allowing this flexibility will limit the usefulness of the pay
ratio for shareholders as a data point in making their voting decisions
on executive compensation under Section 951 of the Dodd-Frank Act.
---------------------------------------------------------------------------

    \245\ See, e.g., letters from ABA and COEC I.
---------------------------------------------------------------------------

    Further, we note that allowing a registrant in appropriate
circumstances to go up to three years without engaging in the full
process to re-identify the median employee is consistent with the outer
limit established by Section 951 for a registrant's say-on-pay vote. In
our view, just as registrants must have a new say-on-pay vote three
years after the previous vote, we think it is reasonable and
appropriate that they engage in the process of re-identifying the
median employee no less frequently than every three years.
    Also, there may be situations in which there has been no change in
a registrant's employee population or employee compensation
arrangements but it is no longer appropriate for the registrant to use
the median employee identified in year one as the median employee in
years two or three because of a change in that employee's
circumstances. In such a situation, the registrant may use another
employee whose compensation is substantially similar to the original
median employee based on the compensation measure used to select the
median employee in year one. For example, if the median employee
identified in year one is no longer employed by the registrant in years
two or three or that employee's compensation significantly changed in
years two and three (for example, a promotion that significantly
increased his or her compensation), the registrant is permitted to
identify its median employee in each of the following two years from
among employees that had similar compensation to the median employee in
year one. If no other employee has similar compensation, however, the
registrant must re-identify the median employee as required under the
final rule.
ii. Using Annual Total Compensation, Another Consistently Applied
Compensation Measure, Statistical Sampling, Reasonable Estimates, or
Other Reasonable Methods
(a) Proposed Rule
    In the Proposing Release, we noted that Congress specifically chose
the ``median'' as the point of comparison for Section 953(b), rather
than the average or some other measure. Therefore, the proposed rule
required the median. Section 953(b) does not prescribe a methodology
that must be used to identify the median. To allow the greatest degree
of flexibility while remaining consistent with the statutory provision,
the proposed rule did not specify any required calculation
methodologies for identifying the median. Instead, we provided
instructions and guidance designed to allow registrants to choose from
several alternative methods to identify the median, so that they would
be able to use the method that worked best for their own facts and
circumstances.
    For instance, registrants would be able to provide the proposed
disclosure using total compensation for each employee under Item
402(c)(2)(x), statistical sampling, reasonable estimates, or the use of
any consistently applied compensation measures to identify the median.
Once the registrant identified the median employee based on the
selected compensation measure applied to each employee in the sample,
the registrant would calculate that employee's annual total
compensation in accordance with Item 402(c)(2)(x) and disclose that
amount as part of the pay ratio disclosure. The proposal did not
prescribe what a reasonable estimate would entail because that would
necessarily depend on the registrant's particular facts and
circumstances. In addition, the proposed rule did not

prescribe specific estimation techniques or confidence levels for
identifying the median employee because we believed that companies
would be in the best position to determine what is reasonable in light
of their own employee population and access to compensation data. We
proposed to require registrants to briefly describe and consistently
use the methodology and any material assumptions, adjustments, or
estimates applied to identify the median employee, and for any
estimated amounts to be clearly identified as such.
    We proposed this flexible approach because we believed that the
most appropriate and cost effective methodology would necessarily
depend on a registrant's particular facts and circumstances, including,
among others, such variables as: The size and nature of the
registrant's workforce; the complexity of its organization; the
stratification of pay levels across the workforce; the types of
compensation paid to employees; the extent that different currencies
are involved; the number of tax and accounting regimes involved; and
the number of payroll systems the registrant has and the degree of
difficulty involved in integrating payroll systems to readily compile
total compensation information for all employees. We believed that
these likely are the same factors that would cause substantial
variation in the costs of compliance.
    In the Proposing Release, we stated our belief that the proposed
rule's flexibility would enable registrants to manage compliance costs
more effectively. We also stated that, by allowing registrants to
better manage costs, a flexible approach could mitigate, to some
extent, any potential negative effects on competition arising from the
mandated requirements. We recognized, however, that a flexible approach
could increase uncertainty for registrants that would prefer more
specificity on how to comply with the proposed rule, particularly for
those registrants that do not use statistical analysis in the ordinary
course of managing their businesses.
    In the Proposing Release, we offered guidance on two permissible
methodologies under the proposal: (1) Statistical sampling and (2) use
of a consistently applied compensation measure. The variance of
underlying compensation distributions (that is, how widely employee
compensation is spread out or distributed around the mean) could
appreciably affect the sample size needed for reasonable statistical
sampling. We conducted an analysis about sample size that we described
in the Proposing Release. Our analysis used mean and median wage
estimates from the U.S. Department of Labor's Bureau of Labor
Statistics (``BLS'') at the 4-digit North American Industry
Classification System (``NAICS'') industry level (290 industries) and
assumed a lognormal wage distribution, a 95% confidence interval with
0.5% margin of error. The analysis focused on the registrants that have
a single business or geographical unit. The analysis also assumed that
the sampling method would be a true random sampling because it would
not be biased by region, occupation, rank, or other factor. In our
analysis, the appropriate sample size for the registrants with a single
business or geographical unit varied between 81 and 1,065 across
industries, with the average estimated sample size close to 560.
    We acknowledged, however, that variation in the types of employees
at a registrant across business units and geographical regions would
add complexity to the sampling procedure. While we generally agreed
that a relatively small sample size would be appropriate in some
situations, a reasonable determination of sample size would ultimately
depend on the underlying distribution of compensation data. We noted
that reasonable estimates of the median for registrants with multiple
business lines or geographical units could be arrived at through more
than one statistical sampling approach. All approaches, however, would
require drawing observations from each business or geographical unit
with a reasonable assumption on each unit's compensation distribution
and inferring the registrant's overall median based on the observations
drawn. Certain cases may not easily generate confidence intervals
around the estimates or prescribe the appropriate minimum sample size.
As a result, compliance costs would vary across registrants according
to the characteristics of their compensation distributions.
Nevertheless, we concluded that permitting registrants to use
statistical sampling could lead to a reduction in compliance costs as
compared with other methods of identifying the median.
    Additionally, we noted that the identification of a median employee
would not necessarily require a determination of exact compensation
amounts for every employee included in the sample. A registrant could,
rather than calculating exact compensation, identify the employees in
the sample that have extremely low or extremely high pay that would
fall completely on either end of the pay spectrum. Since identifying
the median involves finding the employee in the middle, it might not be
necessary to determine the exact compensation amounts for every
employee paid more or less than the employee in the middle.
    In addition to statistical sampling, the Proposing Release also
highlighted the use of a consistently applied compensation measure. We
recognized concerns about expected compliance costs arising from the
complexity of the ``total compensation'' calculation under Item
402(c)(2)(x) and, in particular, the determination of total
compensation in accordance with Item 402(c)(2)(x) for employees when
identifying the median. To address these concerns, the proposed rule
would allow companies to use total direct compensation (such as annual
salary, hourly wages, and any other performance-based pay) or cash
compensation to first identify a median employee and then calculate
that median employee's annual total compensation in accordance with
Item 402(c)(2)(x). We noted that this approach would provide a workable
identification of the median for many registrants, and we expected that
the costs of compliance would be reduced if registrants were permitted
to identify the median using a less complex, more readily available
figure, such as salary and wages, rather than total compensation as
determined in accordance with Item 402(c)(2)(x).
    This approach could also reduce costs for registrants that are
unable to use statistical sampling techniques, as registrants would be
permitted to use a consistently-applied compensation measure to
identify the median employee regardless of whether they use statistical
sampling. Further, because of concerns that using cash compensation
could be just as burdensome to calculate for registrants with multiple
payroll systems in various countries, we did not propose to require
companies to use a specific compensation measure like cash compensation
or total direct compensation when they were identifying the median
employee. Instead, we believed that registrants would be in the best
position to select a compensation measure that was appropriate to their
own facts and circumstances and that a consistently applied
compensation measure would result in a reasonable estimate of a median
employee at a substantially reduced cost. Therefore, the proposed rule
permitted a registrant to identify a median employee based on any
consistently applied compensation measure, such as information derived
from its tax and/or payroll records, as long as the registrant briefly
disclosed the measure that it used.

    We also recognized that the annual period used for payroll and/or
tax recordkeeping could sometimes differ from the registrant's fiscal
year. For purposes of calculating the annual total compensation amounts
when using a consistently applied compensation measure, the proposed
rule permitted registrants to use the same annual period that was used
in the payroll and/or tax records from which the compensation amounts
were derived. We did not propose to define or limit what would qualify
as payroll and/or tax records. We noted, however, that the proposed
accommodation was intended to be construed broadly enough to allow
registrants to use information that they already tracked and compiled
for payroll and/or tax purposes. We thought that permitting registrants
to use compensation information in the form that it was maintained in
their own books and records would reduce compliance costs without
appreciably affecting the quality of the disclosure.
    Additionally, although our proposed flexible approach could reduce
comparability of the pay ratio disclosure across registrants, we stated
our belief that precise conformity or comparability of the ratio across
companies was not necessary and indicated that a possible benefit of
the pay ratio disclosure would be providing a company-specific metric
that shareholders could use to evaluate the PEO's compensation within
the context of his or her own company. Accordingly, we did not believe
that improving the comparability of the disclosure across companies by
mandating a specific method for identifying the median would be
justified in light of the costs that would be imposed on registrants by
a more prescriptive rule.
    Also, even assuming the benefits of comparability across
registrants as a desirable goal, we did not believe that mandating a
particular methodology would necessarily improve comparability because
of the numerous other factors that could also cause the ratios to be
less meaningful for company-to-company comparison, such as differences
in industry and business type; variations in the way companies organize
their workforces to accomplish similar tasks; differences in the
geographical distribution of employees (domestic or international, as
well as in high- or low-cost areas); degree of vertical integration;
reliance on contract and outsourced workers; and ownership structure.
We also note that some commenters asserted that disclosing the pay
ratio could potentially increase the likelihood that a registrant's
competitors could infer proprietary or sensitive information about the
registrant's business, which could cause a competitive disadvantage for
registrants.\246\
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    \246\ See, e.g., letters from Huan Lou (Dec. 2, 2013) (``Lou'')
and Prof. Ray.
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    Finally, we recognized that allowing registrants to select a
methodology for identifying the median, including identifying the
median employee based on any consistently applied compensation measure
and allowing the use of reasonable estimates, rather than prescribing a
methodology or set of methodologies, could potentially permit a
registrant to alter the reported ratio to achieve a particular
objective with the pay ratio disclosure, thereby potentially reducing
the usefulness of the information. But, as we explained, we believed
that requiring the use of a consistently applied compensation measure
should lessen this concern.
(b) Comments on the Proposed Rule
(i) Flexibility
    A large number of commenters indicated that they supported the
flexibility permitted in the proposed rule generally, or more
specifically supported the flexibility of the proposed rule in
permitting registrants to choose a methodology for calculating the
median.\247\ Some commenters contended that the flexibility would
lessen the costs and burdens of the proposed rule without reducing the
rule's benefits.\248\ A few commenters suggested that the proposed
rule's flexibility would not undermine the rule and would be consistent
with the directives of Section 953(b).\249\ Other commenters indicated
that, although the proposed rule's flexibility might alter pay ratio
disclosures, any distortion would be minimal.\250\ One commenter
claimed that the proposed rule was not flexible enough because
Instruction 2(iii) to Item 402(u) would permit a registrant to identify
the median employee only using ``compensation'' measures, whereas the
commenter advocated for use of a ``job-level'' measure.\251\ Despite
the permitted flexibility, another commenter remained concerned about
the complexity of finding the median employee.\252\
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    \247\ See, e.g., letters from Prof. Angel, Aon Hewitt,
B[acirc]tirente et al., Best Buy et al., CalSTRS, Capital
Strategies, CEG, Chicago Teachers Fund, Corporate Secretaries,
Cummings Foundation, Cummins Inc., CUPE, Davis Polk, E&Y, First
Affirmative, Freeport-McMoRan, FS FTQ, ICCR, IL Bricklayers and
Craftworkers Union, Intel, Johnson & Johnson, Marco Consulting,
McMorgan & Co., Mercer I, Meridian, Microsoft, Novara Tesija, NSFM,
NY Bricklayers and Craftworkers Union, NYC Bar, OCP, Oxfam, PGGM,
Public Citizen I, Quintave, Rep. Ellison et al. II, SEIU, Sen.
Menendez et al. II, Socially Responsive Financial Advisors,
Teamsters, Trillium I, Trustee Campbell, UAW Trust, Vectren Corp.,
WA State Investment Board, and WorldatWork I.
    \248\ See, e.g., letters from ABA, AFSCME, Barnard, Bricklayers
International, CII, LIUNA, Fowler, Mirczak, PNC Financial Services,
Sen. Menendez et al. II, US SIF, Vivient, and Walden.
    \249\ See, e.g., letters from Domini and PM&P.
    \250\ See, e.g., letters from Capital Strategies and WorldatWork
I.
    \251\ See letter from Towers Watson. According to the commenter,
in a job-level approach, a global company assigns all jobs in its
organization to one of X number of job levels (determined by how the
particular job role contributes to the organization based on tasks,
skills, expertise, leadership, functional strategy and business
strategy). The company would readily be able to determine the job or
job family that would fall at the median of skill levels within the
company based on a ratio that compares the total number of employees
at each job level to the total employee population. The job or job
family in the median of skill levels would be where the median-level
employee resides and, once it is determined that the median employee
resides at a particular level, the company would then be able to
apply a statistical sampling approach to that job level, taking into
account compensation earned in different locations or countries, to
further reduce the number of payroll files that will need to be
examined. The commenter indicated that more details of this approach
can be found at: http://www.towerswatson.com/en/Services/Tools/job-leveling-global-grading-and-career-map.
    \252\ See letter from Vectren Corp.
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    One commenter contended that a registrant should be permitted to
develop its own methodology for identifying their median employee to
mitigate costs \253\ if the rule required the registrant to accurately
describe its methodology, perform consistent calculations each year,
disclose when and how it chose to deviate from the prior year's
methodology, select the methodology in good faith, and make reasonable
assumptions, adjustments, and estimates. Some commenters recommended
that, once a registrant chooses its methodology for identifying the
median employee, the registrant should be required to use that
methodology going forward.\254\ Other commenters supported the proposed
rule's flexibility in allowing registrants to choose a methodology for
identifying the median employee, provided that registrants are required
to disclose the methodologies they used.\255\ One commenter suggested
that the final rule provide some type of check generally on a
registrant's methodology.\256\
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    \253\ See letter from ABA.
    \254\ See, e.g., letters from PGGM and RPMI.
    \255\ See, e.g., letters from Australian Council of
Superannuation Investors (Dec. 2, 2013) (``ACSI'') and IPS.
    \256\ See letter from Mirczak.
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    Some commenters were opposed to the proposed rule's flexibility.
Most of these commenters were individuals who claimed that the proposed
rule's flexibility would allow registrants to reduce the ratio in
inappropriate

ways.\257\ Other commenters contended that the permitted flexibility
would decrease the ratio's utility, especially for comparing the ratios
of different companies.\258\ A few commenters maintained that the
proposed rule would still lead to high costs, even taking into account
its flexibility.\259\
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    \257\ See, e.g., letters from Bupp, Corayer, Fedewa, Fox,
Friend, Grotzke, Hlodnicki, Kizzort, Maly, Petricoin, and Van Pelt.