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Just Compensation

Focusing on Issues and Trends in Corporate Governance and Executive Compensation

ISS Benchmark Policy Survey Looks At Pay Equity

Posted in Compensation Trends, Executive compensation, ISS/Institutional shareholders

The annual ISS Benchmark Policy Survey has a significant portion devoted to executive compensation topics.  In the several questions on Pay for Performance, one focuses on the issue of pay equity.

Is there a threshold at which you consider that the magnitude of a CEO’s compensation should warrant concern even if the company’s absolute and relative performance have been positive, for example outperforming the peer group?

If the survey taker answers yes, the survey asks about their view on three possible “tools for determining excessive pay magnitude“.

  • Comparison to median CEO pay at peer companies
  • Comparison of CEO compensation to pay of other named executives
  • Excessive proportion of corporate earnings or revenue

In prior years, the ISS survey questions have often portended changes in policies.  Survey results are expected in late September.  The results could be interesting this year.

IRS issues “stock right” guidance under 457A

Posted in Deferred Compensation/409A, Stock Options

On June 10, the IRS issued a revenue ruling confirming that a nonstatutory stock option or stock-settled stock appreciation right (SSAR) that is exempt from Section 409A is also exempt from Section 457A.

As most readers will know, Section 457A is a special regime for certain “tax-indifferent” entities (entities such as corporations located in offshore tax havens or domestic partnerships substantially owned by tax-exempt organizations) that generally subjects such entities’ nonqualified deferred compensation arrangements to tax on vesting, rather than on payment as under Section 409A.

Previously, despite guidance in Notice 2009-8 exempting 409A-exempt stock options and SSARs from Section 457A, the IRS’s position had been in some doubt, given language in Section 457A that exempts 409A-exempt stock rights other than any “right to compensation based on the appreciation in value of a specified number of equity units of the service recipient.” It wasn’t entirely clear how the “other-than” language in the statute and the IRS’s guidance in Notice 2009-8 could be squared, since the “other than” language appears to refer to all stock appreciation rights. The revenue ruling addresses this apparent discrepancy by citing to legislative history indicating that the “other than” language was specifically not intended to apply to stock options, and holding that if stock options are exempt, SSARs should also be exempt, given the economic equivalence between net-settled stock options and SSARs.

Thus, the only difference in coverage of stock rights between Section 409A and Section 457A is with respect to stock appreciation rights that are or may be settled in cash (CSARs), which are subject to Section 457A but may still be exempt from Section 409A if certain conditions (FMV exercise price, etc.) are met.

Some may recall that the IRS originally intended to cover CSARs under Section 409A as well. Notice 2005-1 created an exemption only for SSARs of publicly traded companies, based on concern that CSARs or private company SSARs could resemble other nonqualified deferred compensation arrangements that were not exempt. Eventually, however, the IRS recongized that all SARs, public and private, cash and stock settled, were functionally equivalent and exempted them all in the final 409A regulations. Given they produce identical payouts, it’s still unclear as a policy matter why CSARs and SSARs should be treated differently under Section 457A, but the statutory language is what it is, and the revenue ruling does at least offer a welcome confirmation of the IRS’s guidance from 2009.

Virginia court case supports enforceability of restrictive covenants in online equity awards

Posted in Restricive Covenants, Stock Options

Recently, a Delaware court case (Newell Rubbermaid v. Storm) drew notice for enjoining the breach of a noncompete agreement contained in an equity award that had been delivered to and accpeted by the employee online.

As discussed in this recent McGuireWoods news item, the court in a recent Virginia case (MeadWestvaco Corp. v. Bates) also granted temporary injunctive relief to an employer to enforce restrictive covenants contained in equity award documents that an employee had acknowledged online.  The facts in MeadWestvaco are similar to the facts in Newell Rubbermaid in that the evidence showed that the employee had agreed to online acceptance of the stock award, required by “log-in” and specific “click” to accept the grant (including terms and conditions). What makes the MeadWestvaco case even more interesting, however, is that the equity award documents in question did not even include any language identifying temporary injunctive relief as a potential remedy for breach. In fact the only remedy referenced in the documents was forfeiture of the equity compensation. The court granted the injunctive relief anyway, holding that the failure to include injunctive relief language wasn’t fatal.

Together, the MeadWestvaco and Newell Rubbermaid cases illustrate that narrowly drawn restrictive covenants in employee equity awards can, in appropriate circumstances, be enforced through the full set of available remedies (including injunctive reief), not just forfeiture of the award, even where the agreement has been accepted online and even where the award documents don’t specifically refer to remedies other than forfeiture.

High TSR doesn’t save Chipotle from failed say-on-pay vote

Posted in ISS/Institutional shareholders, Say-on-Pay/Say-on-Frequency

Some companies think a high TSR is a panacea against negative say-on-pay votes, but the Chipotle 2014 say-on-pay vote proves otherwise. Despite 1, 3 and 5-year TSRs in the 83rd, 77th and 95th percentiles as compared to peers, over 75% of Chipotle’s shareholders voted against the say-on-pay proposal.

Although shareholder unrest appears to have existed quite apart from ISS, it’s interesting to think about how ISS arrived at its “no” vote recommendation, given Chipotle’s high TSR. Of the 3 quantitative “gating” factors used by ISS to screen company say-on-pay proposals, the only one that doesn’t take TSR into account is the multiple of CEO pay as compared to peer median. From ISS’s public statements, it appears that Chipotle’s multiple of 3.4 was indeed considered too high by ISS and a main factor in ISS’s “no” vote recommendation for Chipotle. Other, qualitative factors–such as top executives cashing out of their option positions shortly after exercising–are also cited by ISS, but of course ISS is only supposed to consider qualitative factors if one of the quantitative “gating” factors demonstrates a pay misalignment. Behind the scenes, the near 20% drop in Chipotle’s share price in the months leading up to the annual shareholder meeting may have contributed as well.

409A Audit Lucky Number Is . . . 50

Posted in Uncategorized

The IRS announced Friday that it has selected 50 companies to get a special 409A audit.  The lucky winners had already won the audit lottery by being selected for an employment tax audit.  In the 409A component, the IRS auditors will be looking at:

  • initial deferral elections;
  •  subsequent deferral elections; and
  • payments, including the six-month delay for specified employees.

The inclusion of the six-month delay indicates that all of the recipients of this IRS 409A review will be public companies.  The focus will be on the top 10 highest compensated employees.

There may be time for a quick self-audit of your 409A plans before the IRS information request hits your desk or maybe your good fortune will keep you off the list.  Feeling lucky today?

 

Contractual limitations periods for ERISA claims in executive plans

Posted in Uncategorized

In a recent case (Heimeshoff v. Hartford Life & Accident Ins. Co. 134 S. Ct. 604 (2013)), the US Supreme Court upheld a contactual limitations period inserted into an ERISA disability plan barring a lawsuit for benefits under the plan. As explained in further detail here, the ERISA plan included a three-year limitations period, running from the date of proof of loss. The Supreme Court ruled the limitations period was enforceable, even though it began to run before the participant’s cause of action accrued and was shorter than the limitations period that would have applied under ERISA (which generally looks to applicable state law).

Although the case involved a broad-based employee disability plan, it has important implications for executive retirement and severance plans (which are also generally governed by ERISA) as well. Disputes under these types of plans can sometimes arise, for example in the context of an employee termination that is less than amicable. If an employee feels he or she has been denied a benefit, the employee’s only recourse is to sue under ERISA. But before the employee can sue, he or she must exhaust his or her remedies under the administrative claims procedure set forth in the plan. Under many states’ laws, the limitations period for bringing a suit under ERISA would not start to run until the claim has been finally denied in the claims process — and might run for as long as six years after that point. However, on the basis of Heimeshoff, an employer may be able to limit the exposure to ERISA suits by inserting a shorter limitations period directly into the plan document.

Of course, a contractual limitations period must still be “reasonable” — and what is reasonable may depend on the facts and circumstances. Still, in the wake of Heimeshoff, adding a contractual limitations period to existing and new ERISA-based plans for executives would seem to be an easy decision for many employers.

Deadline for Nasdaq compensation committee charter amendments

Posted in Compensation Committee

For Nasdaq companies that have not yet held their 2014 annual meetings, just a reminder that the deadline for amending compensation committee charters to comply with the recent compensation committee independence rues is the date of a company’s 2014 annual meeting (or October 31, 2014, if earlier). Similarly, for NYSE companies, the deadline for complying with the director independence component of the rules is the same.

If Insider Trading Forfeitures Are Deductible, What About Clawbacks?

Posted in Bonuses, Clawbacks, Executive compensation, Executive Compensation Litigation

There is little guidance about whether and how an executive who has compensation clawed back can take a tax deduction for the amount repaid.  A new case reported by BNA today involving an insider trading forfeiture may show one path to a deduction for claw backs too.  The case involves Joseph Nacchio, the former CEO of Qwest.  After being convicted of insider trading, Nacchio forfeited $44.6 million in 2007 that he had realized from the insider stock sales in 2001.  He amended his 2007 return to deduct the $44.6 million under Code Section 165 as a loss and also claimed a credit of $18 million under Code Section 1341 for the taxes originally paid on the stock sales.  In denying summary judgment for either side, the Court of Federal Claims held that Nacchio might be entitled to the credit under Code Section 1341 if he subjectively believed that he had a claim of right to the forfeited gain.

Applying Code Section 1341 to a compensation claw back, most executives would have had a subjective belief that the incentive compensation was appropriately payable in the original year of payment.  The IRS might challenge that belief in some cases, such as a claw back due to an accounting restatement based on actions by the executive.

The ability to get a credit for taxes paid in an earlier year on income that has been clawed back would soften the blow of the claw back to an executive.  This also seems like the right tax result.

Is the Reign of 409A Waning?

Posted in Uncategorized

In the comprehensive tax reform proposal by Representative Camp issued yesterday, Section 409A would be repealed.  Instead, essentially the Section 83 rules would be applied to all compensation.  Tax would be imposed when a substantial risk of forfeiture ends.  This would eliminate voluntary deferrals for all practical purposes.  Based on enactment in 2014 (which won’t happen), any compensation earned in 2015 or later would be subject to these rules.   Prior deferrals under existing plans would have to be paid out within 10 years.

The revenue estimate for this change is more than $9 billion over 10 years.  The basic tax policy argument for the proposal is that 409A is too complicated and is only used by highly paid taxpayers.  While you can make other arguments for deferring compensation, it is hard to disagree with those two points.

We can expect that deferred compensation will be in play if there is comprehensive tax reform next year and Camp’s proposal may be the starting point for the discussion.

IRS releases final Section 83 regulations

Posted in Uncategorized

Today the IRS released final regulations under Section 83 of the Internal Revenue Code, substantially as proposed last year. The regulations are in effect for transfers of property on or after January 1, 2013.

The regulations make some relatively minor adjustments to the definition of “substantial risk of forfeiture,” which is a key concept under Section 83. As long as property (such as stock) that is transferred to an individual in connection with the performance of services is nontransferable and subject to a substantial risk of forfeiture, it is not taxable to the individual unless the individual files a special election (an 83(b) election) at the time of the transfer.

The regulations clarify that lock-up periods, insider trading policies, and potential liability under Rule 10b-5 under the Securities Exchange Act of 1934 (Exchange Act) do not create a substantial risk of forfeiture for purposes of Section 83. Thus, for example, if an employee exercises a stock option during a period when the employer’s insider trading policy prohibits the employee from selling the shares purchased under the option, the fact that the employee cannot sell the shares until the trading window opens does not constitute a substantial risk of forfeiture and therefore does not delay the taxable event for the employee. The employee must recognize taxable income at the time of exercise, even if he or she can not sell the shares at that time.

This is in contrast to how Section 83 works in the context of potential liability under Section 16(b) of the Exchange Act. Under Section 16(b), a non-exempt purchase and sale (or sale and purchase) of stock by an officer, director or 10% shareholder of a public company during a six-month period may result in the insider being liable to the company for disgorgement of any profit realized in the transaction. The Section 83 regulations provide that if an insider may not sell shares of stock previously acquired in a non-exempt transaction within the past six months due to potential liability under Section 16(b), the stock is subject to a substantial risk of forfeiture and (unless the taxpayer makes an 83(b) election) is not taxable until six months after the acquisition has passed.

Importantly, for Section 83 purposes, the six-month period is measured from the original acquisition date of the stock in question, and isn’t tolled if there is a subsequent non-exempt acquisition during this period. Thus, for example, if an insider receives a fully vested option grant on June 1, 2014 in a non-exempt transaction, and exercises the option on September 1, 2014, the shares acquired upon exercise will remain subject to a substantial risk of forfeiture until (about) December 1, 2014. However, if the insider purchases additional shares on the open market on November 1, 2014, the substantial risk of forfeiture on the option shares still lapses, and the option shares are still taxable, on December 1, 2014, even though the insider may have liability under Section 16(b) if he sells any of the shares within 6 months after the subsequent purchase on November 1.

Although most compensatory stock grants are designed to be exempt from Section 16(b), the special forfeiture rule governing sales which involve potential Section 16(b) liability may create some traps for the unwary in unusual circumstances, and should be observed whenever there has been a non-exempt transfer of stock for services.