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Severance Arrangements

  1. Why Severance Arrangements are Under Fire
  2. Essential Practice Tips: "How to Now Disclose Change-of-Control and Severance Arrangements"
  3. Mock-Up: Termination/Change of Control Table and Related Disclosure
  4. Disclosing Health Care Benefits
  5. Practice Pointers
  6. Media Articles
  7. Litigation/Court Decisions
  8. Firm Memos
  9. Video Webcast Panel (2005 Compensation Conference)
  10. Video Webcast Panel (2005 Compensation Conference)
  11. Tallying Up Total Compensation Practice Area
  12. Companies That Limit Severance
  1. Why Severance Arrangements are Under Fire

    This is the component of CEO compensation that is getting the most attention from investors these days – but yet is often overlooked and, as a result, is not factored into the full compensation equation is severance payouts under varying scenarios. These are payments beyond the SERP payments that executives will receive as part of their retirement benefits. To illustrate the point about investor activism, note that the California State Treasurer has announced that severance pay issues will be a key focus for CalPERS and CalSTERS in 2005 and the numerous shareholder proposals on this topic get strong shareholder support each year.

    From a litigation perspective, it is noteworthy that the Disney and Cendant complaints both alleged that the compensation committee did not discuss the size of potential payments in the event of the exiting executive’s termination. Also recall how this issue was a bone of contention in the recent MONY merger litigation as discussed in a practice pointer below.

    And all of this ties to the information contained in the "Tallying Up Total Compensation" Practice Area.

    Here is what the Council of Institutional Investors included in its recently updated executive compensation policy:

    Structure

    • Employment contracts:  Companies should only provide employment contracts to executives in limited circumstances, such as to provide modest, short-term employment security to a newly hired or recently promoted executive.  Such contracts should have a specified termination date (not to exceed three years); contracts should not be "rolling" on an open-ended basis. 
    • Severance payments: Executives should be entitled to severance payments in non-control change situations only in the event of wrongful termination, death or disability.  Termination for poor performance, resignation under pressure or failure to renew the contract should not qualify as wrongful termination. 
    • Change-in-control payments.  Any provisions providing for compensation following a change-in-control event should be "double-triggered," stipulating that compensation is payable only (1) after a control change actually takes place and (2) if a covered executive's job is terminated because of the control change. 

    Limitations

    • Gross-ups:  Companies should not compensate executives for any excise or additional taxes payable upon the receipt of severance, change-in-control or similar payments. 

    Proxy Statement Disclosure

    • Transparency: The compensation committee should fully and clearly describe the terms and conditions of employment contracts and any other agreements/arrangements covering the executive oversight group and reasons why the compensation committee believes the agreements are in the best interests of shareowners. 
    • Tabular disclosure: The compensation committee should provide tabular disclosure of the dollar value payable, including gross-ups and all related taxes payable by the company, to each member of the executive oversight group under each scenario covered by the contracts/agreements/arrangements, including change-in-control, death/disability, termination with/without cause and resignation. 
    • Timely disclosure: New executive employment contracts or amendments to existing contracts should be immediately disclosed in 8-K filings and promptly disclosed in subsequent 10-Qs. 
       
  2. Essential Practice Tips: "How to Now Disclose Change-of-Control and Severance Arrangements"

    Below are tips from our Conference, "Implementing the SEC's New Executive Compensation Disclosures: What You Need to Do Now!":

    By Scott Spector, Fenwick & West and Mike Kesner, Deloitte Consulting

    1. We suggest that a table be used to supplement the narrative explanation of benefits and assumptions. The inclusion of a table makes it easier for the reader to understand exactly what benefits an executive is entitled to receive upon a termination or a change of control.  The inclusion of a table will also aid the reader in making comparisons between executives, factual situations, and across companies.
       
    2. Appropriate cross references should be made to the Company’s CD&A discussion of employment, severance and change of control agreements, as well as other narrative or footnote discussions throughout the tables. Having cross references will help ensure that the description of arrangements is consistent, complete and accurate throughout the filing.  In addition, including footnotes to the tables will allow the information contained in the tables to be easily understood at a glance while still providing detailed and complete information.
       
    3. Care should be taken to disclose all of the definitions and all material operative assumptions and conditions that relate to triggering events for severance and change of actual payments. The definition of terms such as "Cause", "Good Reason" and "Change of Control" can have a impact on the amount of benefits to which an executive will be entitled in the event a change in control or termination occurs.
       
    4. Consider stating that the reasonable estimate (or range) of costs of Section 280G gross-up payments does not take account of mitigation for payments being paid in consideration of non-competition agreements or as reasonable compensation. The amount of a potential 280G gross-up payment can be significantly reduced by assuming that a portion of the compensation is either reasonable compensation or attributable to a non-competition agreement.  By stating that the 280G gross-up amount estimate is not reduced by these factors provides investors with the maximum cost exposure the company would be subject to in the event of a change in control.  It also avoids providing details to the IRS of the company’s ultimate tax position but preserves the company’s ability to take such positions.  In addition, the assumptions used in calculating the 280G gross-up amount should be described (for example, tax rates, option assumptions, and discount rates).
       
    5. We recommend that the Committee review a "dry-run" of this table before year end, and consider modifying these arrangements, as appropriate. This will enable the company’s compensation committee to consider whether changes to agreements are necessary or appropriate before the effective date of the new rules.
     

  3. "Mock-Up: Termination/Change of Control Table and Related Disclosure" — Scott Spector and Mike Kesner from Executive Compensation Disclosure Conference (9/06)
     
  4. Disclosing Health Care Benefits - from Mark Borges' Blog (9/28/06)

    As part of the disclosure of potential payments to a named executive officer upon termination of employment or following a change in control, a company is required to estimate, among other things, the health care benefits that would be received by the NEO (see Item 402(j)(1) and (2)). As explained in the Adopting Release, these benefits are to be quantified based on the assumptions used for financial reporting purposes (as required under SFAS 106) (see Instruction 2 to Item 402(j)).

    This requirement may be a challenge for some of us. First, it's a new disclosure item and one that requires essentially an actuarial calculation - what's the estimated value of the health care benefits that the company has agreed to provide to each NEO over his or her remaining life? In talking to some of our actuaries, I've gotten the impression that this may require some work to determine, along the lines of the calculations for the Pension Plan Table.

    The good news is that the disclosure isn't required if coverage is pursuant to a company contract, plan, or arrangement that is non-discriminatory and available generally to all salaried employees of the company (see Instruction 5 to Item 402(j)). So if your NEOs simply participate in the company's general health care plans, I don't expect that a benefit amount needs to be estimated. However. if like many companies, you provide additional or supplemental health care coverage to your executives, it seems to me that this additional benefit falls within the disclosure rules and an estimated value is required.

    So, when contacting your retirement people to get them started on the pension and deferred compensation disclosure, don't forget to also get in touch with your health and welfare plan people as well. You may need some information from them to complete this particular disclosure item.
     

  5. Practice Pointers

  6. Media Articles

  7. Litigation/Court Decisions
    • SEC v. Gemstar-TV Guide International
      Ninth Circuit En Banc Opinion  (3/22/05)
      (holding that severance payments - at least those in the 5 time base salary range - are "extraordinary payments" within the meaning of Section 1103 of SOX).
      Ninth Circuit Opinion (5/12/04)
      (holding that the $37.6 million payment to two terminated officers, along with 6.7 million shares of stock, was not shown to involve "extraordinary payments" within the meaning of Section 1103 of Sarbanes-Oxley)
      SEC's Litigation Release: Former Gemstar-TV Guide CEO Ordered to Pay $22 Million (5/10/06)
       
    • CalPERS v. Coulter
      Delaware Court of Chancery opinion, 2002 Del. Ch. LEXIS 144 (12/18/02)
      (denying motion to dismiss)
      CalPERS v. Coulter
      Delaware Court of Chancery opinion (4/21/05)

     
  8. Firm Memos
  9. Video Webcast Panel: The Inside Scoop – Red Flags – Revealing Questions to Ask (2004 Compensation Conference)
    • What the compensation consultants have wanted to tell the compensation committee
    • How to understand the common – but often confusing – components of executive compensation
    • What you need to know (and haven’t been told) about Perks, Severance, Deferred Compensation, SERPs, 162(m), Surveys, and more
    • How to get a true handle on the CEO’s and NEO’s total compensation
    • How to factor in accumulated option and restricted stock gains when making current compensation decisions
    • Tally Sheets – what they are, how to use them – why every compensation committee needs to tally up all the components in one place
       
  10. Video Webcast Panel: "The Consultants Speak" on What You Need to Do Now (2005 Compensation Conference)
    • Where we have gone astray – and how to make the necessary fixes
    • Changes you can implement to restore integrity to the process
    • How to avoid liability for directors and their advisors.
       
    Speakers: Pearl Meyer, Steven Hall & Partners; Mike Halloran, Mercer Consulting; George Paulin, Frederic W. Cook & Co.; Douglas Friske, Towers Perrin
     
  11. Tallying Up Total Compensation Practice Area

  12. Companies That Limit Severance
    The following companies have policies that require shareholder approval before entering into severance agreements with greater than 2.99 multipliers:
    • American Electric Power Co.
    • Apartment Investment and Management Co
    • AutoNation
    • Electronic Data Systems
    • Hewlett Packard
    • Union Pacific Corp.
    • Brightpoint Inc. announced in May 2005 that it had capped the severance payments due for three executive officers if (i) in breach of the applicable employment agreement, the company terminates the employee's employment other than for disability or Cause, or (ii) the employee terminates his employment for Good Reason or at any time within twelve months after a Change of Control. Any accelerated vesting of annual equity awards upon a Change of Control will also count toward, and be subject to, the severance cap.  Pursuant to severance cap, the severance total may not exceed $9 million, $4.5 million and $2.25 million for the three officers. Any gross-up payment designed to cover extra income or excise taxes owed by the employee if the severance payments or benefits paid are deemed to constitute "parachute payments" as defined in Section 280G(b)(2) of the Internal Revenue Code of 1986, and any acceleration of the restricted stock granted to the employees on April 7, 2005, will not count toward or be subject to the Severance Cap.
 

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