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Just Compensation

Focusing on Issues and Trends in Corporate Governance and Executive Compensation

SEC finalizes CEO Pay Ratio Rules

Posted in Compensation Disclosure, Dodd-Frank Act

As noted in this McGuireWoods alert, the SEC recently finalized the CEO pay ratio disclosure requirements under Section 953(b) of the Dodd Frank Act. The biggest piece of news in connection with the final rules is the delayed effective date. Calendar year issuers will not have to comply with the new rules until their first annual report or proxy filing made in 2018. That should give folks plenty of time to digest some of the changes the SEC has made to the original proposal, summarized below:

  • Limited Exclusion of Non-U.S. Employees: Issuers will be allowed to exclude non-U.S. employees if either (i) foreign data privacy laws or regulations make issuers unable to comply with the final rule, despite their reasonable efforts, or (ii) non-U.S. employees account for 5 percent or less of the issuer’s total U.S. and non-U.S. employees, with certain limitations.
  • COLA Adjustment for Non-U.S. Employees: Issuers are permitted, but not required, to make cost-of-living adjustments for the compensation of employees in jurisdictions other than the jurisdiction in which the PEO resides to identify the median employee and calculate such employee’s annual total compensation.
  • Permissible Disclosure of Additional Pay Ratios: Issuers are permitted, but not required, to provide additional pay ratios (e.g., separate ratios for U.S. and non-U.S. employees) as long as any additional pay ratios are not misleading and are not presented with greater prominence than the required ratio.
  • Employees of Consolidated Subsidiaries: Issuers are only required to include their employees and the employees of their consolidated subsidiaries in determining the median employee. (The proposed rule had not restricted subsidiaries to consolidated subsidiaries for this purpose.)
  • Median Employee Determination Date: Issuers may use any date within three months prior to the last day of their last completed fiscal year to identify the median employee. (The proposed rule would have required issuers to use the last day of the fiscal year.) Issuers must disclose the date used for this purpose and, if the date changes from one year to the next, disclose the reasons for the change.
  • Three-Year Cycle for Median Employee Determination: Instead of every year as under the proposed rule, the final rule allows issuers to identify the median employee every three years, unless there has been a change in employee population or employee compensation arrangements that the issuer reasonably believes would result in a significant change in the pay-ratio disclosure. If an issuer relies on such a three-year cycle, it must disclose that it has done so and why it believes there has been no change in circumstances that would significantly change the pay ratio. The median employee’s annual total compensation must still be calculated each year, however. If the median employee leaves or changes position or otherwise experiences a material change in compensation during this period, the issuer may use an employee in a similarly compensated position instead.
  • Transition Period for New Issuers and Issuers that Lose their Exemption: A new issuer, like existing issuers, will not need to comply with the final rule before its first annual report or proxy or information statement for fiscal years beginning in 2017. In addition, an issuer that ceases to be a smaller reporting company or emerging growth company is not required to provide pay-ratio disclosure until it files a report for the first fiscal year commencing on or after it ceases to be a smaller reporting company or emerging growth company.
  • Transition Period for Mergers and Acquisitions: The final rule permits an issuer that engages in business combinations and/or acquisitions to omit the employees of a newly acquired entity from its pay-ratio calculation for the fiscal year in which the business combination or acquisition occurs


SEC proposes clawback rules

Posted in Clawbacks, Dodd-Frank Act

Yesterday, the SEC proposed the long-awaited executive compensation clawback rules under Section 954 of the Dodd Frank Act. Weighing in at over 100 pages, there is a lot to digest. This McGuireWoods client alert provides an in-depth summary, and includes some suggestions for what companies should be considering now that the proposed rules are finally out:

Consider New Arrangements. Companies should consider adding provisions to any newly entered incentive compensation arrangement that would subject the compensation payable under the arrangement to any clawback policy that may be adopted by the company in the future.

Consider Existing Arrangements. With respect to existing arrangements, the proposed rules state that clawback policies would need to apply to any incentive compensation received with respect to a fiscal period ending on or after the effective date of the proposal, including compensation payable pursuant to pre-existing arrangements. In addition, the proposed rules further state that it would not be considered impracticable to recover compensation under existing contracts and arrangements merely because recovery might violate the terms of those arrangements, at least to the extent the arrangements could be amended to accommodate recovery. Issuers should therefore consider whether it is possible and, if possible, whether it is appropriate at this time to amend the terms of existing incentive compensation arrangements to subject compensation payable under the arrangements to any clawback policy that may be adopted by the issuer in the future.

Review Bylaw Provisions.If a company’s bylaws prohibit recovery of compensation that would be required to be recovered under the proposed rules, the company should consider whether it is appropriate at this point to amend its bylaws to allow such recoveries.

Review Indemnification Provisions. Similarly, if a company’s articles or bylaws, or if individual indemnification agreements with executive officers or a company’s D&O insurance policies provide for indemnification of executive officers for loss of erroneously awarded compensation, companies should consider whether it is appropriate at this point to amend these arrangements to eliminate these indemnification rights.

Review Compensation Committee Charters. Companies should consider whether it would be appropriate at this point to amend their compensation committee charters to address the new duties regarding clawback policy administration that would be imposed on compensation committees under the proposed rules.

Consider Clawback Policy Design Changes. Finally, companies that do not have clawback policies in place face the choice of whether to adopt a policy now that reflects the requirements of the proposed rules, or alternatively to wait until the SEC proposal and the exchange standards have been finalized. While the answer to this will depend on each company’s individual situation, consideration should be given to the fact that the rules are only proposed, are likely to receive substantial comment and may undergo substantial changes before being finalized. Similarly, companies with existing clawback policies will face the same choice regarding whether to amend the policies now or to wait and see, and their decisions should be informed by the same considerations.

DOL Weighs in on Top Hat Plan Dispute

Posted in Deferred Compensation/409A, Executive Compensation Litigation, Top-hat plans

For years courts have struggled with defining what qualifies as a “top hat plan.” The stakes in these cases are often high, as top hat plans are exempt from most of ERISA’s substantive requirements, including from its funding requirement which is necessary for the plan to be tax efficient, and from its minimum vesting requirements which is frequently necessary for the plan’s design objectives to be achieved. For example, non-qualified deferred compensation plans must be unfunded to avoid participants from being currently taxed on their benefits until those benefits are actually paid. In addition, many plans are designed to promote employee retention and to enforce non-competition and other post-termination restrictions by using vesting and forfeiture provisions that generally are not permissible under ERISA.

Part of the difficulty in this area has been the absence of interpretive standards, either in ERISA, its legislative history or in regulations. ERISA defines the exemption as covering a plan that “is unfunded and is maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.” There is very little in ERISA’s legislative history to help interpret this “select group” requirement, and the U.S Department of Labor (DOL) has never issued regulations. Instead, the DOL has issued a handful of advisory opinions on this topic over the past 41 years. The early advisory opinions, and the courts that drew from those opinions, focused on various objective factors to determine top hat plan status. Factors frequently considered by the courts were the percentage of the employer’s workforce covered under the plan, how the average compensation of plan participants compared with that of the rest of the employer’s workforce and the compensation levels of participants in absolute terms.

Beginning in 1990, the DOL adopted two additional interpretations narrowing the scope of top hat plan the exemption (see DOL Advis. Op. 90-14A). First, the DOL adopted the position that a select group is limited to persons who “by reason of their position or compensation level, have the ability to affect or substantially influence, through negotiation or otherwise, the design and operation of their deferred compensation plan.”  This bargaining power factor has since been accepted by a number of courts as one, but not the exclusive, means of evaluating a plan’s status. In addition, the DOL adopted the position that the word “primarily” relates solely to the purpose of the plan and not to the determination whether the plan covers a select group. In the DOL’s view, the exemption applies to a plan if the primary purpose of the plan is to provide deferred compensation; not to a plan that “primarily covers” of select group of management or highly compensated employees.

Both of these interpretations recently have been reiterated by the DOL in an amicus brief filed in a top hat plan case on appeal to the Fourth Circuit Court of Appeals. The case, Bond v. Marriott International, Inc., involves a plan that provided deferred stock bonus awards to participants that vested on a pro rata basis between the date the award was granted to the date on which participant attained age 65. A group of former participants who did not vest in their awards under the plan because they left employment before age 65 asserted that the plan did not qualify as a top hat plan because it covered a large number of employees that was not a “select group” within the meaning of the ERISA exemption, and that the plan violated ERISA’s minimum vesting requirements. The plan covered up to 2500 participants until it was amended in the late 1980’s to limit participation, which resulted in participation dropping to less than 100.

The district court agreed with the employer that the plan was in fact a top hat plan and thus was exempt from ERISA’s minimum vesting requirements, and dismissed the former participants’ claims. The court reached this conclusion on the basis of objective criteria, noting that only 2% of the employer’s workforce and 20% of all of the employer’s management employees participated in the plan, and that the employer sufficiently disclosed to plan participants that the plan was a top hat plan. The court refused to apply the DOL’s “bargaining power” requirement, referring to it as “a fairly significant expansion upon the perceived scope of the top hat exemption.” In addition, the court also did not apply the DOL’s view that the statute’s use of the word “primarily” refers only to the purpose of the plan. Instead, the district court concluded that the inclusion of certain participants who were not management or highly compensated did not preclude the plan from qualifying as a top hat plan so long as the plan was “principally intended” for the benefit of such persons.

Following appeal, the DOL submitted an amicus brief in support of the plaintiffs. The brief reiterates the DOL’s commitment to both its “bargaining power” and “primarily” standards. The brief argues that both standards are supported by ERISA’s legislative history and other federal court decisions. In addition, the brief emphasizes that the Fourth Circuit has previously observed that ERISA’s substantive requirements were enacted to help persons who “lacked sufficient economic bargaining power to obtain contractual rights to nonforfeitable benefits” (see Darden v. Nationwide Mut. Ins. Co., 796 F.2d 701 (4th Cir. 1986)).

The Bond case is worth watching. While the DOL’s “bargaining power” standard has been adopted by some courts as one factor that should be considered along with other objective criteria, it is inherently difficult to apply in cases that involve plans covering a group of participants, as opposed to individually designed and negotiated compensation arrangements. On the other hand, the DOL’s narrow view of the “primarily” requirement has not been widely accepted by the courts. In fact, the Second Circuit Court of Appeals in an oft-cited decision rejected the DOL’s interpretation and concluded that a plan could still be a top hat plan even if it included only a “very small number” of participants who were not part of a select group of management of or highly compensated employees (see Demery v. Extebank Deferred Compensation Plan (B), 216 F.3d 283 (2d Cir. 2000)). The Fourth Circuit now has an opportunity to further refine the law in this area.

IRS rules retention arrangement violates 409A

Posted in Executive compensation

In a Chief Counsel Memorandum issued last month, the IRS concluded that an executive retention arrangement violated Section 409A despite the employer’s efforts to correct the arrangement before the retention bonus vested.

The arrangement in question provided for a retention bonus that vested after 3 years of employment and was then payable over the two years after vesting. However, under the terms of the arrangement, the employer had the discretion to accelerate the payments and pay them in a lump sum on the first anniversary of the vesting date. The employer, recognizing that the arrangement failed to comply with Section 409A’s anti-acceleration rule, attempted to correct the arrangement by amending it to remove the employer’s ability to accelerate the payments. The amendment was made in the same taxable year in which the retention bonus vested, but before the actual vesting date.

The IRS ruled that the correction was ineffective because it occurred in the same year in which the retention bonus vested. The ruling is consistent with the IRS’s proposed Section 409A income inclusion regulations, which provide limited relief for corrections of Section 409A errors that occur before the year in which the deferred compensation vests, provided the correction is not part of pattern or practice to avoid Section 409A. Interestingly, the employer in question may have been able to correct the error in this case under the more formal correction procedure for 409A document failures set forth in Notice 2010-6.

The memorandum is a reminder that the options for correcting Section 409A problems after arrangements have been put in place are limited and few, and therefore retention agreements, long-term incentive agreements, employment agreements, severance agreements, change in control agreements and the like, all of which may be subject to Section 409A, should be reviewed for Section 409A compliance issues prior to adoption.

Final 162(m) rules have a surprise for newly public companies

Posted in 162(m)

The final Section 162(m) regulations issued by the IRS last week have a small but welcome surprise for companies that have recently become public. As explained in this McGuireWoods client alert, the rules exempt RSUs, phantom units and other similar awards from the $1 million deduction limitation if the awards were granted during a newly public company’s transition period and before April 1, 2015, even if the awards are paid out after the end of the transition period. The expectation based on the proposed regulations had been that RSUs and other similar awards paid out after the end of the transition period would be subject to the limitation, regardless of when granted.

Congressional report takes aim at nonqualified deferred compensation

Posted in Deferred Compensation/409A, Legislation

A recent report from ranking member Sen. Ron Wyden and the Democratic staff on the Senate Finance Committee indicates that nonqualified deferred compensation plans continue to be in the crosshairs of potential tax reform efforts.

The report, which characterizes the longstanding and widespread use of supplemental retirement and other deferred compensation plans as a “tax avoidance” scheme on par with the latest in esoteric financial derivative transactions, does not offer new proposals but instead lends its support to previous proposals to tax nonqualified deferred compensation when it vests, to limit the total amount of nonqualified deferred compensation to, e.g., $1 million per employee and to close the Section 162(m) “loophole” that only takes current compensation into account when applying the $1 million deduction cap.

While the near-term propsects for comprehensive tax reform are uncertain at best, the ongoing focus by congressional policymakers, and in paticular the Joint Committee on Taxation, on the treatment of nonqualified deferred compensation arrangements suggests that, sooner or later, changes in this area are likely to come.

ISS Equity Plan Scorecard – First Results In

Posted in Equity Plans, ISS/Institutional shareholders

According to ISS, Emerson Electric (the Fergusson, Mo. – based electrical equipment manufacturer) was the first U.S. company to which ISS applied its new Equity Plan Scorecard policy.  On February 3rd, Emerson held its shareholder meeting, at which time, it put its 2015 Incentive Shares Plan up for shareholder approval.  Based on a recently filed Form 8-K, Emerson’s shareholders resoundingly approved the plan.

In general, the new ISS policy analyzes equity plan proposals pursuant to three pillars:

  • Estimated Cost  – total potential cost relative to industry/market cap peers, measured by estimated Shareholder Value Transfer in relation to peers.
  • Plan Features – review of problematic plan terms (e.g., single-trigger change in control vesting, discretionary vesting authority, liberal share recycling, minimum vesting periods).
  • Equity Grant Practices – relative burn rate, vesting terms in most recent CEO grants, estimate plan duration, portion of CEO’s most recent equity grants subject to perfomance conditions, clawback policy, post-exercise/vesting holding requirements.

Emerson’s shareholder proposal to approve the plan, which can be found here, seems drafted with an eye to the Equity Plan Scorecard.  In particular, the proposal points out that:

  • The plan will have enough shares to last through the next two performance cycles (October, 2015 and October, 2018).
  • The company has reduced it’s weighted average diluted shares via share repurchases.
  • The plan incorporates key ISS best practices concerning minimum vesting periods, clawbacks, double-trigger change in control provisions.
  • The plan does not allow liberal share counting or contain a liberal change in control definition.
  • The company’s grant practices should be viewed favorably under ISS standards.

It will be intersting to see if companies use the ISS Equity Plan Scorecard as a rubric of sorts when drafting equity plan shareholder proposals.  Emerson’s proposal certainly touched on many ISS key issues and appears to have been embraced by shareholders.


CD&A Disclosure

Posted in Compensation Committee, Compensation Disclosure, Executive compensation

The CD&A is a required part of a public company’s annual proxy statement. Its stated purpose is to give shareholders material information about a company’s compensation objectives and policies for the named executive officers (NEOs). It also provides perspective for investors about the compensation numbers and narrative that follow. As such, the CD&A’s real purpose is to explain the “compensation numbers.” As everyone knows, this has become increasingly important in the last few years, primarily due to the mandatory “say on pay” shareholder vote on executive compensation. While the vote is not binding, it can get very embarrassing if shareholders do not approve executive compensation practices and policies.

We believe the CD&A provides an excellent opportunity to educate shareholders about the company’s business strategy and to highlight how stated compensation practices best support the company’s goals.

So this year, let your CD&A tell your story by using some of these helpful tips:

Year in Review – explain the decisions made during the year and the resulting payouts, if any; describe the context for decision making;

Business Strategy — describe strategy and how compensation practices support it;

Executive Summary — include succinct “summary” of good governance and best practice policies upfront and early in the document;

Charts & Graphs — use lots of these to illustrate elements of pay, mix of pay, variable vs. fixed, and to chart performance against goals;

Simple Direct language — use simple plain English and write from the investor’s perspective; assume your reader knows nothing about executive compensation;

Financial Performance – ensure the company’s performance story frames the discussion of executive compensation; don’t keep the reader guessing how performance impacts executive pay – show them how through a chart or graph; and

Realized or Realizable pay – consider using if appropriate (e.g., if TSR or say –on- pay support are low)

Finally, keep it short (but be thorough) so that shareholders and proxy advisory firms may easily understand how your compensation programs support your business strategy.




Delay in Dodd-Frank Executive Compensation Rules

Posted in Clawbacks, Dodd-Frank Act

The Securities and Exchange Commission recently indicated that further rule-making would not likely occur until October of 2015 with respect to:

  • Pay for performance rules;
  • Compensation clawback requirements;
  • Hedging rules; and
  • CEO pay ratio rules.

You can access the SEC’s regulatory agenda here.

Previously, the SEC had targeted the end of this year for action in each of these areas.  Many issuers will likely be relieved by the delay of these Dodd-Frank requirements, especially the pay ratio rules, whose proposed regulations were the subject of significant comment.

In other areas of rule-making, such as compensation clawbacks and (to a lesser extent) hedging, market forces and institutional shareholder pressures have already led many publicly-traded companies to adopt policies that address these issues.

Of course, the SEC’s priorities may change at any time, but it appears that issuers will have a break from new proxy requirements related to these Dodd-Frank rules, at least for now.

Executive Compensation Shareholder Proposals Down in 2014

Posted in Clawbacks, Compensation Trends, Director Compensation

A new Conference Board report on proxy voting in 2014 reports a decline in shareholder proposals on executive compensation matters.  Among Russell 3000 and S&P 500 companies, the 70 compensation-related proposals was down from 86 proposals in 2013.  Almost 70% of the proposals involved either requiring equity retention periods or limits on golden parachute payments.   A couple of notes:

  • There was majority support for 5 of the golden parachute proposals and 1 of the equity retention proposals.
  • Support increased for clawback and SERP limit proposals, but measured on a small number of proposals (3 clawback and 2 SERP proposals).
  • 2014 saw a complete lack of proposals on tax gross ups (consistent with the decreased use of gross ups).
  • The major area of new proposals (6) related to director compensation, however, these were all part of a single director election proxy fight.