The Advisors' Blog

– Broc Romanek, CompensationStandards.com

Good stuff from Fred Whittlesey of Compensation Venture Group in his blog entitled “33 Reasons That Your Company’s Say-on-Pay Vote Might Go Sub-50% in 2013.”

– Broc Romanek, CompensationStandards.com

Here’s a year-end action item from this Wilson Sonsini memo:

Severance and other compensation arrangements that promise a payment only if a release of claims (or other employment-related obligations, such as non-solicitation or non-competition agreements) is signed should be reviewed by December 31, 2012, for compliance with Section 409A of the Internal Revenue Code.1 Failure to ensure that these documents are in compliance could result in substantial penalty taxes and administrative burdens in the future.

Arrangements Most Likely to Be Affected:

– Severance plans and agreements
– Change-in-control and employment agreements
– Certain restricted stock unit and other cash-settled equity compensation awards that contain a severance feature

Background

Section 409A generally prohibits employees from manipulating the acceleration or delay of compensation. The Internal Revenue Service (IRS) issued guidance in 2010 addressing the concern that a compensation arrangement that requires the execution of a release of claims may allow an employee to manipulate the year in which the payment is made by accelerating or delaying the employee’s execution and delivery of the release of claims.2 To prevent this, the IRS set forth timing rules specifying when a release of claims must be executed to prevent a Section 409A violation. Interestingly, the final Section 409A regulations issued in 2007 do not state this IRS position. Therefore, some change-in-control and severance agreements that were drafted to comply with the final Section 409A regulations may not account for this later-released IRS position.

Moreover, since 2009, the IRS has employed a Section 409A audit program, and a targeted area of noncompliance includes agreements conditioning payment on a release of claims. Accordingly, we recommend that employers review agreements that condition severance and other compensation on the signing of a release of claims.

Release Timing Rules

If an arrangement does not contain a compliant specified period for executing a release of claims, the employer must amend it to provide that payment will be provided or otherwise begin:

– on a fixed date either 60 or 90 days following the employment-related event that gave rise to the payment (e.g., termination of employment), or
– during a specified period no longer than 90 days following the employment-related event.

Payment must be made in the later year if the specified period could span two taxable years.
If a compensation arrangement contains a specified period for payment, the arrangement must be amended to provide that payment will be made on the last day of the period, or in the second taxable year if the designated period can begin in one year and end in the following year.

Compliance Deadlines

Compensation arrangements that condition compensation on executing a release of claims should be amended by December 31, 2012, to comply with the release timing rules described above. In addition, an employer may be required to file a statement of correction with the IRS and to correct all agreements containing improper release timing. Depending on the facts, however, an employer or a service provider under IRS examination may not be able to correct its noncompliant arrangements.

The IRS also provided a transition rule for arrangements that do not comply with the release timing rules but are corrected before December 31, 2012. If payments under these arrangements could be paid during a period that begins in 2012 and ends in 2013, the payments must be provided in 2013 and the arrangements must be amended no later than December 31, 2012, to be compliant with the Section 409A release timing rules described above. Tax and monetary penalties generally should not apply in these cases.

Section 409A Tax Penalties

The penalties for violating Section 409A largely fall on employees and include immediate income tax inclusion, an additional 20 percent federal penalty tax, and interest charges (and in California, an additional 20 percent state penalty tax). In most cases, amending an arrangement by December 31, 2012, to comply with the release timing rules should not result in any tax or monetary penalties.

Action Items

Employers should review compensation arrangements that condition severance and other compensation on the signing of a release of claims in order to identify and correct any noncompliant provisions in advance of the December 31, 2012, deadline for amendment.

– Broc Romanek, CompensationStandards.com

I’ve blogged a few times about these NY proposals that are a sleeper for many more companies than you would think. One of our members found it a bit challenging to try to explain in simple terms why this Executive Order and the promulgating agency regs are so problematic from the viewpoint of the corporate community – so she put together the Q&As below:

Q1. My company is incorporated in Delaware, and this is a New York Executive Order — so this does NOT apply to my company, right?

A1. Wrong. The Executive Order applies to service providers that receive NY state funds or NY state-authorized payments — regardless of where the companies are incorporated or headquartered.

Q2. But my company is public, and it does not provide health care or similar services — so this does NOT impact my company, right?

A2. Wrong. The problem with the Executive Order and the proposed regulations is that many terms are either undefined or ill-defined, and the scope is potentially broad enough to cover any entity — including public companies — that receive NY state funds to provide any services. For example, companies that provide technology services, energy services, consulting services or financial services to New York State could be impacted.

Q3. If this applies to my company, what does it mean?

A3. There are three major items that companies reviewing the Executive Order and proposed regulations are concerned about:

1. Limits on Executive Compensation: A service provider cannot use more than $199K of state funds or state-authorized payments to pay any employee in the company;

2. Limits on Administrative Expenses: A service provider must use at least 75% (increasing to 85% in 2015) of the state funds or state-authorized payments to provide program services — as opposed to administrative expenses such as compensation to staff that does not directly provide program services (including a CEO, CFO and controller), overhead expenses and office operating expenses; and

3. Disclosure Obligations: A service provider will be required to file certain reports but no specific information has been released yet about the contents of these disclosures.

Q4. You keep mentioning state funds and state-authorized payments – what do those terms mean?

A4. Wish we knew for sure. Like many of the provisions in the regulations, these terms are defined in a very convoluted manner. The definition of state funds refers to funds appropriated in the annual state budget – but excludes a limited subset of procurement contracts. State-authorized payments is very broadly defined, referring to any payments distributed upon approval by a NY state agency or a NY governmental unit (also excluding a limited subset of procurement contracts). As a practical matter, this would appear to pick up contract payments made by New York as a service customer to public companies for ordinary course business.

Q5. There must be some sort of an exemption for companies like mine, right?

A5. The rule applies to covered providers, and this definition has certain thresholds; if they are not met, then the company would be exempt from these provisions. An entity is a covered provider if it (1) receives state funds or state-authorized payments (as mentioned, not clearly defined) in an amount greater than $500K for at least 2 years and (2) at least 30 percent of the entity’s total annual in-state revenues (undefined) for the most recent calendar year were derived from state funds or state-authorized funds. Therefore, given these broad terms and ambiguities, it is difficult to conclude definitively that a company is not a covered provider.

Q6. Where can I learn more about this – and what can I do about it?

A6. Here is the (i) January 2012 Executive Order issued by Gov. Cuomo, (ii) draft regulation implementing the executive order (there were over a dozen nearly identical proposed regulations by the various NY state agencies) and (iii) a helpful Proskauer memo.

We are hoping that companies, as well as legal and business organizations, will share their concerns about these issues in Albany. Specifically, they should consider contacting Gov. Cuomo’s office to ask that the Executive Order be appropriately amended to clarify impacted entities (for e.g., it should not apply to public companies that are subject to SEC obligations, including Say on Pay votes). In addition, they should consider submitting a comment letter to the state agencies that have proposed these regulations. Even though over dozen state agencies have proposed implementing regulations, the proposals are virtually identical and therefore the same comment letter could be submitted to all the agencies. Also, even though the official comment period ends shortly, the Governor’s Office has indicated that the agencies will consider comments submitted after that time.

– Broc Romanek, CompensationStandards.com

In this podcast, Ruth Wimer of McDermott, Will & Emery explains the latest on personal use of aircraft, including:

– Have companies changed their use of personal aircraft practices since the FAA final guidance on reimbursement in 2010?
– How typical is it for companies to have personal use of aircraft policies? What typically is in those policies? Who approves those policies – full board or compensation committee?
– What are common snafus when it comes to personal use of aircraft disclosures?

Did you catch this recent CFO.com article entitled “New Threat to Personal Use of Corporate Jets?“?

– Broc Romanek, CompensationStandards.com

We have posted the transcript from the recent webcast: “Proxy Season Post-Mortem: The Latest Compensation Disclosures.”

Check out my night at the USA Men’s basketball game against Brasil…

– Broc Romanek, CompensationStandards.com

Here’s news from this Gibson Dunn blog:

Glass Lewis & Co. has announced that, effective for annual meetings taking place after July 1, 2012, it has implemented a number of revisions to its proprietary pay for performance quantitative model. Glass Lewis uses the quantitative model to analyze the degree of alignment between corporate performance and named executive officer compensation. When making voting recommendations to its subscribers on say-on-pay proposals, Glass Lewis analyzes both the quantitative analysis and a qualitative analysis of the company’s named executive officer compensation program.

The most significant revision Glass Lewis has made to its pay for performance model is a change in the manner in which peer groups are selected for use in compensation and performance comparisons. Prior to these revisions, Glass Lewis selected a company’s peer group (which included, on average, 100 peer companies) using a proprietary model that took into account the company’s GICS code, enterprise value and geographic location. From and after July 1, 2012, peer groups will contain no more than 30 companies and will be determined using a “market-based” approach developed by Equilar. This market-based approach takes into account a company’s self-disclosed peer companies, the peer companies disclosed by those self-disclosed peers and the relative strength of the relationships and connections between that universe of companies and the subject company. In its voting recommendation reports, Glass Lewis will now identify the Equilar-determined peer companies used in its analysis and highlight the differences between the Equilar-determined peer group and a company’s self-disclosed peer group.

Glass Lewis also has changed the manner in which it looks at named executive officer compensation for purposes of the quantitative analysis. Instead of focusing on total compensation paid in the last fiscal year, the new pay for performance model will use the three-year weighted average of total compensation paid to a company’s chief executive officer and other named executive officers for purposes of comparing compensation to the Equilar-determined peer group and the alignment of pay and performance.

Finally, Glass Lewis has modified the manner in which it assigns letter grade rankings to a company’s pay for performance alignment. From and after July 1, Glass Lewis will no longer force all companies into bell curve, but instead will focus on the actual gap between performance and compensation relative to peers in assigning letter grade rankings.

– Broc Romanek, CompensationStandards.com

Here is an excerpt from this Skadden Arps memo:

On June 25, 2012, the Internal Revenue Service issued Revenue Ruling 2012-19, clarifying that dividends and dividend equivalents relating to restricted stock and restricted stock units (RSUs) intended to qualify as performance-based compensation must themselves separately satisfy the requirements applicable to performance-based compensation under Section 162(m) of the Internal Revenue Code (Section 162(m)). These performance goals may, but need not be, the same performance goals applicable to the related stock-based award.

Section 162(m) generally does not permit a publicly held corporation to deduct, for federal income tax purposes, compensation in excess of $1 million per year paid to a “covered employee” (generally the officers named in the corporation’s proxy other than the chief financial officer). However, there are certain exceptions to this deduction limit, including an exemption for “qualified performance-based compensation,” which is compensation that meets a number of requirements set forth in the regulations under Section 162(m), including it be payable solely on account of attainment of pre-established performance goals.

The regulations under Section 162(m) provide that a grant of restricted stock or RSUs does not fail to satisfy the performance goal requirements solely because the related dividends or dividend equivalents are payable prior to the attainment of the performance goal applicable to the underlying restricted stock or RSUs. The revenue ruling clarifies, however, that because the related dividends or dividend equivalents are treated as separate grants under the Section 162(m) regulations, they must separately satisfy performance goal requirements to be considered qualified performance-based compensation.

– Broc Romanek, CompensationStandards.com

Recently, I blogged about some open issues in the wake of the SEC’s rulemaking, particularly when dealing with compensation advisors. Here is an excerpt from this Gibson Dunn memo (we have also posted oodles of other memos on this topic):

The independence assessment requirements of the rules are likely to be the most burdensome and controversial aspect of the SEC’s rulemaking under Section 10C. They require that a review and assessment of independence be conducted by the compensation committee prior to receiving advice from a compensation adviser, and that review must encompass relationships of both the individual providing advice to the committee and the entity that employs that individual. We expect significant interpretive issues to arise under this standard, some of which we expect will be addressed in the context of the stock exchanges’ proposal, review and adoption of listing standards implementing Rule 10C-1. Among those issues are the following:

– What does it mean to “provide advice” to a compensation committee? Is this only triggered when an individual appears before the compensation committee, or does it also encompass any work product that is presented to the committee, and, if so, is that only when the work product is attributed to an adviser?[20] Although the rules exclude in-house legal counsel, will other company employees such as human resources personnel, actuaries or accountants be deemed to be covered by the rules, or will they not be viewed as compensation advisers?

– How will the standard apply when advice is provided by a number of individuals? If an individual working for a compensation consultant makes a presentation to the compensation committee, must the assessment be performed only with respect to that individual, or also with respect to each individual at the compensation adviser that worked on or helped to develop the information contained in the presentation?

– What type of information constitutes “advice” that triggers the requirement? Does the standard apply only with respect to advice relating to executive compensation, or does it also apply with respect to advice on director compensation or broad-based employee benefit plans? Does it only apply with respect to individualized advice, or does it also apply to, for example, survey information compiled by a compensation adviser and sold on a subscription basis to a large number of companies?

– Broc Romanek, CompensationStandards.com

As noted in this Proskauer memo, pursuant to Executive Order 38 issued by Governor Cuomo, thirteen New York State agencies released very similar proposed regulations on May 16th, placing a limit on the funds that can be used for administrative expenses and executive compensation by entities, both for-profit and not-for-profit, that receive state funds or state-authorized payments to provide services. These regulations are available for comment to July 14th – and are scheduled to become effective on January 1, 2013. Pretty wild stuff…

– Broc Romanek, CompensationStandards.com

Probably fitting since I will be interviewing Nell during the plenary session of our “Say-on-Pay Workshop: 9th Annual Executive Compensation Conference” in October, Nell recently ran this interview of me in her blog:

Nell: What have shareholders learned from two years of “Say on Pay?”

Broc: It obviously will depend on each shareholder but the main lesson is how to manage the enormous logistical nightmare of voting on executive pay for the many portfolio companies they own. This was a sea change in responsibilities at a time when investors were cutting from a department that is not a profit center. Now that the concept of “shareholder engagement” being a year-long process, the proxy season has turned into a year-long event for those investors who take their voting responsibilities seriously. Some still don’t.

Nell: What have companies learned?

Broc:That say-on-pay isn’t the end of the world. Even in this era of intense anger over skyrocketing pay, only about 50 companies have failed say-on-pay in each of the first two years. Even for those that failed, the consequences have not been that extreme even though a spate of say-on-pay lawsuits threw a scare into a dozen companies. Given that those lawsuits aren’t failing that well, say-on-pay is well on its way to being a routine along with the rest of the proxy season action items. This was always my biggest beef with say-on-pay – it will cause boards to become complacent because they think they are doing a great job with CEO pay because the voter said so.

Companies have also begun to treat annual meetings like real campaigns. For the first time, they are willing to publicly battle a negative recommendation from the proxy advisors through the use of supplemental letters that rebut what the proxy advisor has said about them. This practice has grown like wildfire with nearly one-third of the companies receiving negative recommendations willing to go to the mat this proxy season.

Nell: What is more important in getting a majority “no” vote on pay — the make-up of the pay or the make-up of the shareholder base?

Broc: Probably the shareholder base.

Nell: How influential are the proxy advisors?

Broc: The proxy advisors – ISS and Glass Lewis being the primary ones in the US – are quite influential and have primarily been responsible for boards making changes to pay practices as their policies have pushed the envelope at times. However, their influence has often been overstated – as borne out by several recent studies – and they have been targets for criticism by quite a few corporate interests.

Surprisingly, at least one of these studies shows that management often benefits from proxy advisor influence – leading me to say “be careful what you wish for” for those managers who bash proxy advisors more out of a knee-jerk reaction to not wanting to make any changes to a broken executive pay process.

Nell: What should a company with a “no” vote do?

Broc: Schedule a series of compensation committee meetings to develop, approve and monitor an outreach plan to figure out why the vote was negative. Don’t wait for a lawsuit to be spurred into making real changes. And don’t rely solely on advisors – like proxy solicitors – for intelligence about why the vote came in the way it did. Directors should also participate in some of the research to get a firsthand feel of what shareholders are saying about the company’s pay program.

Nell: Do shareholders vote “no” on comp committee members when they don’t like the pay?

Broc: Sometimes, but less than they used to before say-on-pay became the law of the land. Note what happened at Cablevision Systems recently; the company did not have say-on-pay on its ballot this year because the frequency is triennial (triennial was the choice of shareholders last year) – but then the members of its compensation committee received less than majority support at this year’s annual meeting presumably due to pay issues. The company has a plurality vote standard so there is no direct impact from this vote – but I consider this to be a more serious failure than a nonbinding SOP vote.

Nell: Will binding “say on pay’ votes become law in the UK? In the US?

Broc: Yes, seems pretty close to a done deal in the UK. I’ll be shocked if it happens in the US but you never know…