Key Developments in Executive Compensation: What Should a Public Company Do Now and in 2010? - 17 Dec 2009

Key Developments in Executive Compensation: What Should a Public Company Do Now and in 2010?

Author: Adam B. Cantor

Employee Benefits Alert

December 2009

 Printer Friendly

Both
the Internal Revenue Service (IRS) and the Securities and Exchange
Commission (SEC) have issued extensive guidance over the past two years
on executive compensation matters. Everything from “say on pay” to
Compensation Disclosure & Analysis (CD&A) disclosure to
clawbacks to proxy access to deductions of compensation paid to key
executives under Section 162(m) of the Internal Revenue Code (Code)
have been addressed. Although much of this guidance is proposed, there
are certain steps that public companies should be taking before the end
of this year or early in 2010 to address executive compensation issues.

What To Do by December 31, 2009

• Amend Employment Agreements To Ensure Section 162(m) Deduction for Performance-Based Compensation
  Section
  162(m) of the Code generally prohibits a public company from deducting
  compensation paid to a “covered employee” (generally the CEO and the
  three next highest paid officers) that exceeds $1 million. One of the
  major exceptions to this rule is if the compensation qualifies as
  “performance-based compensation.”The IRS ruled in 2008 that
  compensation does not qualify as “performance-based compensation” if,
  in addition to being payable upon the attainment of the performance
  target(s), such compensation also is payable upon an involuntary
  termination without cause, a good reason termination or a voluntary
  resignation by the employee. However, informal conversations with the
  IRS have indicated that a double trigger change in control provision
  still may qualify (depending upon the facts) as “performance-based
  compensation.” Under the IRS guidance, employment agreements that
  contain these provisions (single trigger payment upon involuntary
  termination without cause, termination for good reason or voluntary
  resignation by employee) generally must be amended to eliminate such
  provisions on or before December 31, 2009.¹


• Commence Review Compensation Committee Charters
  In
  July 2009, the Treasury Department proposed legislation to Congress on
  compensation committee independence and “say on pay,” generally
  requiring:
  
  
  
  • Except to the extent the SEC
    grants an exemption, each member of the compensation committee must be
    independent (that is, must not accept consulting, advisory or other
    compensatory fees from the issuer of the securities or qualify as an
    “affiliated person” with respect to the issuer or any of its
    subsidiaries);
  
  
  • Any compensation
    consultant, legal counsel or other advisor (presumably, meant to cover
    accountants and consulting firms other than compensation consulting
    firms) must meet standards of independence to be established to the SEC;
  
  
  • Each compensation committee must be allotted sufficient resources to retain a compensation consultant; and
  
  
  • Beginning
    one year after applicable legislation is enacted, each company must
    disclose whether its compensation committee has obtained the advice of
    an independent compensation consultant, and if not, explain the reason
    for not doing so. (This requirement appears to be designed to make the
    retention of a compensation consultant the “default” option.)
  
  
  
  

Legislation
is now pending in Congress, specifically, the Corporate and Financial
Institutions Compensation Fairness Act of 2009 (which has been passed
by the House), that would implement some or all of these requirements,
along with others. What’s the effect of noncompliance? Delisting of the
securities on the applicable exchange, a truly ugly outcome. Even if
the legislation is not passed this year, the handwriting appears to be
on the wall regarding the direction in which public company
compensation committee independence is moving. Further, a public
company that moves in the direction of enhanced compensation committee
independence certainly would be engaging in “best practices.”

What To Do in Early 2010

• Get Ready for “Say on Pay”
  In
  the same proposal,Treasury proposed requiring public companies to
  afford shareholders with an annual opportunity to make nonbinding votes
  on executive compensation matters:
  
  
  
  • Any
    proxy or consent solicitation material for a meeting of the
    shareholders (or a special meeting in lieu of the annual meeting) that
    concerns an acquisition, merger, consolidation or proposed sale or
    other disposition of all or substantially all of the assets of the
    issuer must disclose, in a clear and simple tabular format, any change
    in control-related agreements or arrangements providing for present,
    deferred or contingent compensation to executive officers; and
  
  
  • Shareholders
    must be provided with an opportunity to vote separately on such
    agreements or arrangements; however, the vote is not required to be
    binding.
  
  
  
  

The Treasury’s concern is
with the approval of so-called “golden parachutes.” Reflecting a
similar concern, “say on pay” provisions also appear in the legislation
that has made its way through the House on compensation committee
independence.The disclosure and voting requirements appear to apply
only to the company’s named executive officers

• Get Ready for the New CD&A Disclosure and Proxy Solicitation Rules
  In
  July 2009, the SEC issued proposed CD&A and proxy solicitation
  rules relating to executive compensation.The material changes include
  the following:
  
  
  
  • The CD&A must
    include a discussion of any company compensation practices that may
    materially adversely affect the financials of the company;
  
  
  • The aggregate fair value of the stock and equity-based awards granted during the fiscal year must be disclosed in the Summary Compensation Table and the Director Compensation Table; and
  
  
  • The
    role of compensation consultants must be disclosed, if such role
    materially affects the compensation of executives or directors.
  
  
  
  

Conclusion

Attention
to changes in IRS and SEC guidance on executive compensation practices
matters more to public companies now than perhaps at any time in recent
memory. Action is required by the end of this year to avoid potential
losses on tax deductions and to set the stage for compensation
committee practices that reflect not only “best practices” but also the
direction in which the IRS, SEC and Congress clearly are proceeding.

Action
is required early next year to address “say on pay” concerns, which
have become much more important to shareholders seeking to align
executive pay with company results, and the direction in which the SEC
is moving on enhanced disclosure in proxy statements.

For more information, please contact Adam B. Cantor at 212.878.7978 or acantor@foxrothschild.com or any member of the firm’s Employee Benefits and Compensation Planning Practice Group.

Notes:
1
- The IRS ruling applies only to performance periods beginning on or
after January 1, 2009. In addition to pre-2009 performance periods, the
ruling does not apply to payments made pursuant to employment contracts
in effect (without regard to renewals) on February 21, 2008.