In a rare piece of good news relating to Section 409A of the Internal Revenue Code, on October 4, 2013, California reduced its additional state tax on income failing to comply with Section 409A from 20 percent to 5 percent. This reduction is effective for taxable years beginning January 1, 2013 and later.
Section 409A was added to the Internal Revenue Code by the American Jobs Creation Act of 2004, and was intended to regulate deferred compensation — that is, compensation in which the right to payment arises in one year but the amounts are to be paid in a future year. Section 409A can apply to compensation arrangements as diverse as employment agreements, severance arrangements and equity awards, as well as to traditional deferred compensation plans. Violation of the provisions of Section 409A generally causes the amounts in question to be subject to accelerated income taxation and an additional 20 percent federal income tax under Section 409A.
California’s Revenue and Taxation Code incorporates a parallel income tax of 20 percent, thereby increasing the total additional income tax imposed on California taxpayers for violating Section 409A to 40 percent, double the rate applicable to taxpayers in other states. This newly announced rate change reduces the 409A income tax applicable to California taxpayers to a level much closer to that applicable to non-California taxpayers.
We encourage any companies that have experienced Section 409A violations giving rise to Section 409A income taxes in 2013 and later years to revisit their calculations to reflect the revised rates. We are available to discuss any questions you may have relating to this new development and to any general Section 409A compliance of your compensation arrangements.
Recently, Masimo Corporation became the 61st company to fail its say-on-pay in ’13 – see the Form 8-K – with 48% support (the company failed last year with only 37% support). And then we have Capstone Turbine, which was the 60th company with only 48% support – see the company’s Form 8-K. Note that both 8-Ks for these companies don’t quite characterize the votes as failures, as they just provide the share data. However, the proxy statements state that abstentions have the effect of an “against” vote – so when the math is done, they received less than majority support.
With 61 failures, this year now ties last year with the number of failures. Thanks to Karla Bos of ING for the heads up on these!
A few days ago, the Chamber of Commerce and 13 other organizations sent this letter to the SEC requesting a 60 day extension of the pay ratio comment deadline. A little early in the comment process in my opinion to seek an extension – but it’s not a surprise given how outspoken some of these groups have been about this provision of Dodd-Frank…
Meanwhile, Towers Watson has these survey results about how respondents felt would be the biggest challenges if the SEC adopted a pay ratio rule (56% concerned with complying; 31% concerned about where ratio stands compared to peers; 21% concerned about explaining process of determination).
Here’s news from Davis Polk’s Ning Chiu from this blog:
ISS received more than 500 responses on emerging issues that could make up its policy update for the 2014 season, with a total of 128 institutional investors and 350 corporate issuers. Over 90% of the issuers were based in the United States, compared to 66% of the investors.
Last year, ISS implemented a controversial policy that they will recommend against any board that fails to respond to a shareholder proposal that receives a majority of votes cast. Recognizing the flak that resulted, ISS included a question about the policy in this year’s survey. Only 36% of investors indicated that the board should implement specific actions, while 40% wanted the board to exercise its discretion freely. Another 24% of investors suggested it depended on the circumstances, including the level of shareholder support on the proposal. It is unclear whether these survey answers will change the policy.
Investors were more inclined to rally around concerns of director tenure, as more than 10 years would be deemed problematic by 74%, with concerns related to independence and limitations on the board’s ability to change its membership. Over half of investors encouraged rotation of key positions such as board chair, lead director and committee chairs.
Service on other public company boards is one way investors assess director performance, including positive factors such as a director’s breadth of experience and expertise, or negative aspects such as governance concerns at those other companies. Fifty-four percent of investors believe ISS should consider company performance, primarily TSR, when evaluating directors.
More than half of the investors indicated it would be appropriate for ISS to distinguish policies based on company size when it comes to equity compensation plans, but not as many investors supported differentiation for issues such as chair and CEO separation.
Performance conditions on equity awards in equity-based compensation plans seeking shareholder approval were considered very significant by 75% of investors if ISS moves to a holistic approach to equity plan evaluation, while the cost of the plan and other features such as vesting requirements were similarly viewed by a majority of investors.
For share authorizations, a large number of investors found the size of the requested increase, the ratio of outstanding compared to new potential shares and the use of the shares to be important. More than half indicated that a company’s governance structure was very important in these voting decisions.
The next step is for ISS to release draft policies for open comment, before issuing new policy updates in November.
Ahead of today’s webcast that will help you figure out how to do the math behind the SEC’s pay ratio proposals, take time to digest the numerous memos that I have posted – as well as this set of FAQs from this Davis Polk blog:
As companies begin digesting the SEC’s proposed pay ratio rule (which we discuss here) and analyzing its impact, here are answers to some frequently asked questions. Final rules may affect the responses.
Is there a safe harbor for the use of any particular method to identify the median employee?
No, the SEC specifically declined to establish any “safe harbor methodologies” or a “menu of alternatives” for determining the median employee.
Do the compensation measures used to identify the median employee need to meet any requirements?
The proposal requires the use of “any consistently applied compensation measure” and mentions several possibilities, such as total direct compensation (salary or wages and performance-based pay); annual cash compensation; or amounts reported in payroll or tax records such as W-2s. The compensation measure can be for a different time period than the company’s fiscal year.
How should different elements of compensation be calculated to arrive at the median employee’s total compensation?
The rule permits the use of “reasonable estimates” that are disclosed, and companies must have a “reasonable” basis to conclude that the estimate for any compensation component, or total compensation, approximates the actual amount of compensation. This includes benefits provided to non-U.S. employees that are not provided to U.S. employees. Personal benefits that are less than $10,000 in the aggregate may be excluded.
When can a full-time employee’s pay be annualized?
A full-time employee’s pay may, at the company’s option, be annualized if that employee did not work the entire fiscal year. This might apply to an employee who was hired during the course of the year, or who was on unpaid leave during part of the year.
When can a part-time employee’s pay be annualized?
A permanent part-time employee’s pay, may at the company’s option, be annualized if that employee only worked part of the fiscal year. However, companies cannot adjust the part-time schedule to a full-time equivalent schedule.
What other adjustments are not permitted?
Companies cannot annualize pay for temporary or seasonal employees or make cost-of-living adjustments for non-U.S. workers.
What if more than one CEO is reported in the summary compensation table?
As a technical matter, the proposed rule requires a ratio using “principal executive officer” as defined in Item 402(a)(3) of Regulation S-K, which could be more than one individual.
Are directors included as employees for purposes of calculating the ratio?
No, directors are not included. Neither are independent contractors or leased employees.
Can we disclose more than one pay ratio?
Yes. As with the non-GAAP disclosure rules, the required ratio must be the most prominent. Companies can disclose one or more other ratios as supplemental information if they are clearly identified and not misleading. For example, if the supplemental ratio excludes the effect of non-U.S. employees, it should be explained as such.
Tune in tomorrow to this webcast at noon eastern – “Doing Your Pay Ratio Homework Now: A Roadmap” – to hear Compensia’s Mark Borges, Deloitte Consulting’s Mike Kesner and Towers Watson’s James Davies, Paul Platten, Steve Seelig and Dave Suchsland get into the nitty gritty of how to do the math in the SEC’s pay ratio proposal. Here’s a set of Course Materials that you should print in advance.
This program will not be an overview of the SEC’s new proposal on pay ratio disclosures–we have posted plenty of memos to get you up-to-speed. Rather, this program will drill down to see where you stand if the proposal was adopted–and to help you decide whether you should consider submitting a comment letter to the SEC using hard facts. So this program will help you evaluate how to choose a compensation definition; how to conduct statistical sampling in this area; how to access the right data and calculate the median.
Had a blast at our week of conferences last week! The speakers did a great job. Interviewing Congressman Mike Oxley was a career highlight (and luckily, my days as ‘Billy Broc’ Oxley never came up). I’m particularly thankful to Faruqi & Faruqi’s Juan Monteverde for coming and being willing to answer many direct questions about the motivations and nature of his proxy disclosure lawsuits (stay tuned for more from Juan). Juan is a character and definitely added spice to the conference (next year’s conference? Vegas in late September!). Here is a pic of us together:
Squeezed in just before the government shutdown – the Federal Register site indicates they are now severely restricting what is being published – the SEC’s pay ratio disclosure proposal was published on Tuesday in the Fed Reg. So the comment period has officially started – even though a number of comments have already been submitted. It ends in 62 days – on December 2nd.
SEC Chair Mary Jo White, speaking Sept. 26 at the Council of Institutional Investors’ fall conference, told attendees the commission was pushing forward on governance-related rulemaking despite challenges faced by the resource-strained agency. In a question and answer session following a speech to attendees touting the agency’s enforcement record, White was noncommittal on when draft rules on clawbacks, pay-for-performance disclosures, and hedging and pledging of shares by executive–as mandated by the Dodd-Frank Act–would be put out, though stressed the agency’s commitment to deliver as quickly as possible.
Telling attendees the biggest surprise she faced upon assuming the chairmanship this spring was the “massive obligations and responsibilities” engendered by Dodd-Frank and the JOBS Act, which, she said, necessitated the creation of “parallel workstreams” to allow for the staggered and timelier roll out of draft rules. Speaking about specific rulemaking, White said she couldn’t predict when commissioners would approve a final rule on pay disparity ratio disclosures, now out for public comment, noting the agency “took seriously” all comments and reviewed them in “real time,” while cautioning that many comments are filed close to the end of 60 day rulemaking deadlines, which would draw out the process.
White also said the agency was focused on investors’ call for stronger clawback policies though noted the complexity of related rules “takes more bandwidth,” suggesting SEC staff remain months away from providing a draft rule to commissioners for consideration.
Notably, White also told attendees the agency was focused on and planned to “effect change” on mandatory arbitration provisions adopted by a growing number of companies. According to White, resolution of the issue would be dictated to some extent by state law, but the SEC does have authority to examine limits placed on the rights of shareholders through such provisions and would explore avenues for redress.
On matters related to ESG reporting, White told the largely public and labor pension fund delegates that Division of Corporation Finance staff are now focused on what may lie ahead for non-financial reporting, in response to a question regarding how the agency will address the matter as ESG reporting gains momentum.
“I worry about whether we’re doing the right disclosures,” White said. “One of things we must do is [ensure] for meaningful disclosures.” White also acknowledged questions over corporate political spending disclosures, pointing to a petition for rulemaking on the matter that at one point appeared close to being ready in draft rule form. “Given all of our mandated rulemakings, we don’t have bandwidth” to address issues beyond that which are Congressionally decreed, White suggested, noting the staff had yet to provide for any recommendations on the matter.