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Geithner announces support for executive compensation reforms, but Congress might have its own agenda

On Wednesday, June 10, Secretary of the Treasury, Timothy Geithner outlined the Obama administration’s new proposals on executive compensation. The proposals focused on greater independence of corporate compensation committees and giving shareholders a nonbinding vote on executive compensation, commonly known as ‘say on pay’ provisions. Geithner outlined five guiding principals for executive compensation, namely:

  1. compensation plans should properly measure and reward performance;
  2. compensation should be structured to account for the time horizon of risks by aligning executive (and highly compensated individual) pay with long-term value creation;
  3. compensation should be aligned with sound risk management;
  4. golden parachutes and supplemental retirement packages should properly align the interests of executives with the interests of shareholders; and
  5. the compensation setting process should promote transparency and accountability.

Geithner promoted the administration’s support for legislation requiring greater compensation committee independence for companies listed on the national securities exchanges. The proposed legislation would require compensation committee members to meet the stringent independence standards required of audit committee members under the Sarbanes Oxley Act. In addition, the proposed legislation would provide compensation committees with the right to (i) hire compensation consultants, (ii) hire legal counsel, and (iii) require each company to “appropriately” fund the compensation committee to allow it to execute its independent compensation oversight responsibilities.

In addition, Geithner promoted the administration’s support for legislation requiring non-binding ‘say on pay’ votes by shareholders. The legislation would require all public companies to include a proposal to allow shareholders to approve or disapprove of the compensation arrangements listed in a company’s …

Grant Thornton Executive Compensation Survey

Grant Thornton has a relatively recent (February 2009) survey on its website regarding executive compensation that reports 50% of companies surveyed are freezing executive base salaries for 2009 and 15% are reducing salaries. 227 companies responded to the survey, of which the “typical” company seems to be publicly traded with revenues below $100 million and 100-499 employees.

The numbers highlight a motivation problem for companies and their employees, namely how to structure a compensation program when bonuses, salaries, and stock prices are down. Companies that lower bonus targets, re-price options, and start “special retention programs” risk investor criticism for rewarding the executives who contributed to the company’s decline. Conversely, investors who recognize that a decline is not necessarily the result of poor executive performance often want to continue to motivate key employees.  …

New Executive Compensation Limitations

Yesterday, President Obama announced that the Treasury had adopted new guidelines for financial institutions that are receiving government assistance. The Treasury press release discusses these new restrictions.…

Teamsters Seek Executive Compensation Reform

According to RiskMetrics, the Laborers’ International Union of North America and the International Brotherhood of Teamsters don’t think Treasury’s bailout program does enough to curb executive compensation.

The unions want a number of reforms, including:

  • Incentive compensation not to exceed one times annual salary;
  • Stock option awards tied to increased company performance relative to a peer group;
  • Stock award holding requirements for the full term of an executive’s employment;
  • No accelerated vesting; and
  • Limits on severance payments.

The labor funds have submitted proxy statement proposals to JPMorgan Chase, KeyCorp, Bank of America, American Express, and SunTrust Banks, and plan to submit proposals to more than 45 other firms planning to participate in the Troubled Asset Relief Program (TARP).

Participation in the TARP requires some limits on executive compensation so companies may be able to argue exclusion of the labor union proposals from the proxy on the grounds they have “substantially implemented” the requests.

The debate continues as to whether executive compensation is a product of free market labor costs or the market is flawed and needs executive compensation regulation.  …

IRS Limits Scope of IRC Section 162(m) Performance-Based Compensation Deduction

The IRS issued Revenue Ruling 2008-13 to clarify what constitutes “performance-based” compensation under Internal Revenue Code Section 162(m).  This classification is important because Code Section 162(m) generally prohibits public companies from deducting compensation in excess of $1 million to the CEO and certain named executive officers.  If the compensation is performance-based, however, this deduction limitation does not apply.

Under prior guidance, an executive could receive a performance award (either cash or equity) upon involuntary termination without cause, termination for good reason, or retirement, without regard to whether performance goals were actually met. In Revenue Ruling 2008-13, the IRS reversed its position, holding that such an award will not be treated as performance-based compensation under Code Section 162(m). This ruling puts many executive compensation plans and employment agreements at risk in light of the new restrictions on deductions for non-performance-based compensation that exceeds $1 million.

For more information on this latest guidance, you may view our recent law alert.…

House Oversight Committee to Question CEO Termination Payments

Last week the House of Representatives Committee on Oversight and Government Reform rescheduled a hearing on CEO termination payments in connection with the mortgage lending crisis. In January, Committee Chairman Henry Waxman sent letters to Citigroup, Merrill Lynch and Countrywide Financial asking them to justify payments to outgoing CEOs despite significant subprime-related losses and decreasing stock values. The hearing follows a December 2007 hearing on the use of compensation consultants to determine CEO pay. Scheduled to testify, presumably to justify their compensation, are Angelo Mozilo, CEO of Countrywide, E. Stanley O’Neal, former CEO of Merril Lynch, and Charles Prince, former CEO of Citigroup.…

SEC Reports on Executive Compensation

The SEC has published its observations regarding executive compensation disclosure for the first round of proxy statements that were filed under the new executive compensation rules. In summary, two themes were the focus of the report:

  1. The Compensation Discussion and Analysis (CD&A) needs more attention to how and why compensation decisions are made; and
  2. Companies are encouraged to think about how they present information, including by use of plain English, tables, and graphs.

The full report contains suggestions for improved disclosure and an explanation of the types of comments that the SEC issued. The following are some highlights:

  1. Emphasize material information and de-emphasize less important information;
  2. In the CD&A, emphasize the how and why of compensation levels and de-emphasize compensation program mechanics;
  3. Charts, tables, and graphs not required by the rules were almost always helpful (for example, tables that explain payments upon a hypothetical termination or change-in-control);
  4. Disclosure that is clear and concise does not have to be long;
  5. Disclose how decisions affecting one element of compensation affected other elements as well; and
  6. Explain how subjective performance targets translate into objective pay determinations.

The SEC isn’t the only one concerned with executive compensation. Executive compensation has been mentioned by some of the front-runner candidates for president and recently by President Bush. Specifically, compensation for CEOs of large companies may be a point of discussion in next year’s election. …

Proxy Statement Executive Compensation Disclosures

As the SEC continues to review the first round of proxy statements filed last spring under the new executive compensation rules, publicly traded companies should consider thinking about how to improve disclosures for next year.

The importance of analyzing compensation decisions, as opposed to merely stating what types of compensation are paid, is evident by the language of the rules for drafting the Compensation Discussion & Analysis (CD&A) section of the proxy statement. The rules require that the following material elements of compensation for named executive officers be discussed, described, and explained:

  1. the objectives of the compensation program;
  2. what the compensation program is designed to reward;
  3. each element of compensation;
  4. why the company chooses to pay each element;
  5. how the company determines the amount/formula for each element; and
  6. how decisions regarding each element fit into the compensation objectives.

 The following are suggestions for improved disclosure, as prompted by the new rules:

  • Keep detailed minutes throughout the year regarding not only what compensation decisions are made but why they are made. When compensation decisions are made, the compensation committee should articulate, in writing, as many aspects of elements (1) through (6) above as possible. This allows an understanding of compensation decisions to develop throughout the year as opposed to at the last minute when it comes time to draft the proxy.
  • Amend the compensation committee charter to state that the committee will review and discuss disclosures in the CD&A with management and recommend that such disclosures be included in appropriate filings.
  • Draft

First Backdating Guilty Verdict

Earlier this week former Brocade CEO Gregory Reyes was found guilty of all charges in connection with stock option backdating and failing to report such backdating to auditors, regulators, and investors. This is the first conviction of an executive in the government’s option backdating investigation, and it occurred despite the fact Reyes never cashed in on his backdated options.

Reyes faces years of prison time and significant fines. More convictions are expected in a post-Enron era where juries are willing to convict not only instigators of backdating plans, but those who go along with illegal practices as well.   …

IRS Targets Option Backdating

The IRS has issued a directive identifying backdated stock options as a Tier 1 Compliance Issue. The directive explains the tax implications of backdated options, including the fact that options backdated to produce a “build-in” profit do not qualify as incentive stock options (ISOs). Corporations that intended backdated options to qualify as ISOs may be required to withhold and pay income and employment taxes when the option is exercised, and the individual may owe additional taxes at the time of exercise. As the directive explains, there are also 162(m) and 409A issues.  

The designation of option backdating as a Tier 1 Compliance Issue means it is a mandatory examination item for taxpayers with backdated stock option grant and/or exercise prices. …

IRS redefines “covered employee”

The IRS has revised the definition of “covered employee” under Section 162(m) of the Internal Revenue Code. The old definition used to mirror the SEC’s definition of Named Executive Officer (officers for whom compensation must be disclosed), but the SEC’s recent changes to executive compensation disclosure rules caused the two definitions to be out-of-sync.

Under new guidance from the IRS, the text of which is not yet available on the IRS website, “covered employee” means any employee who is either the principal executive officer or whose total compensation is required to be reported by the SEC for being one of the three highest paid officers. This definition aligns 162(m) with the SEC’s new executive compensation disclosure rules. Interestingly, a corporation’s principal financial officer is excluded as a “covered employee” if his or her compensation disclosure required by the SEC is simply on account of he or she being the principal financial officer.  

Internal Revenue Code Section 162(m) restricts the amount of deductions a publicly held corporation may claim for compensation paid to a “covered employee” in excess of $1 million per year, unless such excess compensation is performance based and other requirements are met. As a result, many corporations ensure that an executive officer’s base salary (plus perks) does not exceed the $1 million threshold.…

Employer Action on Deferred Compensation Required by December 31, 2007

As our corporate department recently reported, the U.S. Treasury has issued final regulations under Internal Revenue Code Section 409A. The following includes a summary of actions that employers should take by December 31, 2007 to comply with the final regulations and to guard against taxation of nonqualified deferred compensation and a 20 percent excise tax:

  1. Review all types of compensatory arrangements to determine whether they are subject to Section 409A. Arrangements that create a legally binding right to compensation in one year that is payable in a later year are typically subject to Section 409A.
  2. Amend plan documents in writing to comply with Section 409A.
  3. Determine which nonqualified plan deferrals that are linked to qualified plans comply with Section 409A and which ones do not. The arrangements that are not in compliance with Section 409A should be unlinked from the qualified plans or amended.
  4. Consider amending plan documents to allow participants to change the time and form of payment of amounts subject to Section 409A.
  5. Consider whether stock rights that are not exempt from Section 409A should be replaced with stock rights that are exempt.
  6. Update severance and employment arrangements in light of the final regulations.

Click here for the full text of the Executive Compensation Law Alert.…