With the 409A documentary compliance deadline fast approaching (December 31, 2008), companies are under the gun to complete the arduous process of identifying and analyzing all arrangements (written and unwritten) that might possibly entail “deferred compensation” as expansively defined under Section 409A. There are many rocks to look under! Don’t overlook some of the less obvious sources, such as:
– informal offer letters to employees that may promise severance pay, equity grants or accelerations, post-termination health insurance, continuation of other employee benefits, or reimbursements of various types
– “informal” bonus arrangements that may need to be reduced to writing and contain a payment deadline to assure the availability of the short-term deferral exemption
– stock unit awards or performance shares (as opposed to restricted stock grants), which are not categorically exempt from 409A but can often be drafted to comply with 409A or meet the short-term deferral exemption
– reimbursement arrangements, which turn up in all types of unexpected contexts – such as, to list just a few: (a) an agreement to reimburse the expenses of an employee for cooperating with the company after employment as to lingering litigation matters, (b) agreements to reimburse legal expenses incurred by an employee in seeking to enforce an agreement with the company, or (c) even a monthly car allowance or payment of club dues
– (to get a bit more exotic) reverse back-to-back payment triggers for compensation to employees of hedge fund managers (i.e., where the hedge fund manager, as service provider to the hedge fund, gets paid upon termination of the hedge fund and uses that event as a trigger to make payments of deferred compensation to the employees of the hedge fund manager). This is the inverse of the “back-to-back arrangements” that are explicitly permitted (if drafted correctly) under Treas. Reg. §1.409A-3(i)(6).
The best time to start the 409A documentation process is several months ago. The second best time is TODAY. Remember that even after you identify the documentary “fixes” needed to comply with or be exempt from 409A, you must leave time to:
– organize the whole story for presentation to the Board or Compensation Committee for consideration and approval where required
– explain the ramifications of 409A to employees who have contractual arrangements that are implicated and outline any choices such person may have (such as whether or not to agree to a change in the “good reason” definition in order to avoid a six-month delay in payment)
– allow service providers to consult their own counsel for advice, where they are being asked to consent to changes to an agreement.
The one-year reprieve we got last October doesn’t seem as long as it once did.
In recent days, we have been inundated with sensational coverage of lucrative benefit packages to be paid to the estates of senior executives upon their death. These so-called “golden coffins” are generally contractually stipulated arrangements that range from salary continuation and life insurance payments to accelerated vesting of equity, often a big-ticket item for long-tenured executives, and (believe it or not) even post-mortem car allowance payments.
The discovery of these spectacular death benefits may be front page news, but their existence dates back to prehistoric corporate times. The recent changes in SEC disclosure rules on executive pay have forced companies to very publicly reveal the outsized deathbed gifts being lavished on top of the giant salaries, as well as panoply of expensive and often embarrassing perks.
These egregious types of executive pay arrangements are yet another example of how times are changing in the world of corporate governance. It also seems that some of the most striking examples in recent media coverage are the result of legacy deals cut many years ago, during the days when smoke-filled rooms may have obscured the objectivity of executive compensation decision making that may very well have been based on well intentioned business or estate planning goals which shaped senior executive employment contracts.
It should be noted that Compensation Design Group, Inc. (CDG) doesn’t often see these types of benefits, nor would we expect to see them in today’s senior executive contracts. In fact, we find ourselves in the midst of an inevitable slow-moving, high inertia trend towards overall belt-tightening of executive contracts. Severance multiples are declining, restrictive covenants are far more common, and compensation arrangements are written to be clearly defined and easily understood. Most importantly, the provisions in fairly designed executive contracts are able to withstand the test of reasonableness necessitated by proxy disclosure, as well as the public outcry of myriad interested parties.
Increasing regulatory oversight, congressional hearings, SEC disclosure, media attention, and rapid changes in corporate governance guidelines, are shining a white-hot spotlight on these types of executive compensation, and, on a go forward basis, directors will need to justify any benefits and perquisites given exclusively to senior management.
Consider Brian L. Roberts, the CEO of Comcast. Should Mr. Roberts be so unfortunate as to die while in office, his life would end, but his salary would continue. In fact, it would continue for five full years after his death, and yes, during that period, he would also collect his annual bonuses.
James M. Bernhard Jr., CEO of the Shaw Group has similar arrangements in his contract. He gets an extra $17 million dollars in exchange for a promise not to compete with the company for a period of two years following termination of employment. The payment is due even if Mr. Bernhard dies while on the job. No one quite knows how he is going to compete from the grave, but if he can do it, he’ll be forever known as “Lucky Jim”.
When XTO Energy CEO, Robert R. Simpson, kicks the bucket he’ll find that his pail is filled with the proceeds from a $3 million dollar insurance policy. It’s a skimpy reward – even for a dead man – but don’t worry about Bob. Had he died on December 31 of last year, he could have also taken a $111 million “bonus” with him to the grave, plus $20.5 million in instantly vested shares, plus – let’s be fair here – $4.4 million in salary. And, if you think you can’t take it with you, Simpson’s death triggers an additional $158,400 payment listed as a “car allowance.”
Hey, fashionable as it may be, you don’t expect the CEO of XTO Energy to drive through the Pearly Gates in a Toyota Prius, do you?
Eugene M. Isenberg, CEO of Nabors Industries, has himself lined up for over $275 million dollars as his last day payday in this world – an amount that is actually more than the entire 2008 first quarter income for Nabors. That pot of gold at the end of the rainbow must be looking pretty good to Isenberg who is 78 years old. The concept of making more than a quarter of a billion dollars simply for giving up breathing must be very attractive. Fortunately, Isenberg received over $500 million in compensation from 1992 to 2007. That probably took the edge off all that heavy breathing he had to do.
Even for an executive pay consultant, there’s a lot not to like about golden coffin deals. Are we outraged by these “bad example” CEOs running amuck while the American economy is running aground, making our jobs as professionals terribly difficult, putting all of the incredibly hard working CEOs and their boards of directors in a bad light, or are we just angry and upset because they make more dead than we ever will when we’re alive?
Defending significant payments to the dead has not been easy for corporate compensation committees – or the boards that they sit on. Most companies defended their golden coffin practices as “an appropriate way to take care of an executive’s family after an unexpected death” however; they also noted that those benefits were “negotiated as part of an executive pay package that has many components”.
Note to our readers: If you earn less than $50 million a year, alive or dead, don’t even try to understand these “executive pay package components.” They’re way beyond you. You probably don’t even understand why it’s necessary to shovel on the six and seven figure golden coffin perks to retain a top executive who is six feet underground. As in “I don’t care if Jim is dead. I don’t want him working for the competition!”
By now, I’m sure you’ll agree – it’s definitely time to start holistically reviewing your company’s executive contracts for such provisions.
We could rant and rave over these terrible executive pay provisions, but I have a better idea. The next time you get your annual review, and your supervisor dangles a 4% raise before your red, swollen eyes, ask if you’re worth more to the company dead or alive. Considering the cost of all your shortcomings, company management will probably be glad to double or triple your salary if you add “a quick painless death” to your goals and objectives.
Maybe you really can’t take it with you, but with the pittance they’re paying you to stay, you might as well try.
Allow me to introduce myself – Michael J. Album – a partner at Proskauer Rose practicing executive compensation law in the firm’s Employee Benefits and Executive Compensation Group. This is my first posting on this blog.
Following a tough week on 409A issues, I was having lunch in NYC with Arnold Ross and Norman Ross, principals at The Ross Companies, an exemplary benefits and executive compensation consulting firm. Arnold (father) and Norman (son) have about 65 years of compensation experience between them, and are quite knowledgeable in their chosen field.
During our conversation on compensation injustices, Arnold asked me why vested options generally expire within one year of the death and/or disability of the grantee, or in some cases within 180 days of the event. Norman politely pointed out that there should be no early expiration under such circumstances and the option should continue through to the end of the term. Anything short of a full term would simply be “punitive.”
How Do Companies Handle Death/Disability?
As we know, many companies either allow for a 180-day extension/exercise period or one-year extension/exercise period following the death or disability of the grantee. Some companies do provide for longer exercise periods. Some examples: at Chevron, the effect of death/disability on the expiration date of a stock option depends upon the age and length of service of the employee. Long term Chevron employee (i.e. one whose combined age and service total at least 90 or who is over 65 with at least one year of service) get accelerated vesting and retain the full term to exercise vested options.
Shorter term employees (i.e. those whose combined age and service total at least 75 or who are over 60 with at least one year of service) get pro rata vesting over a three year service period from date of grant and have five years to exercise their vested options or the remainder of the original term, whichever is shorter. All other employees forfeit unvested options at the time of death/disability and have only 180 days or the remainder of the original term (whichever is shorter) to exercise their vested options.
As stated in their 2008 Proxy Statement, Chevron’s policy of full/partial vesting (absent misconduct) is a “reflection of our belief that our equity and benefit programs should be based upon a career employment model ….” (See page 46 of Chevron’s proxy statement.)
At General Motors, vested options remain exercisable for the full remaining term under applicable retirement provisions; outstanding options vest immediately upon death and remain exercisable for three years from the date of death or for the remainder of the original term, whichever is shorter. (See page 48 of GM’s proxy statement).
Why Not Take a More Generous Approach?
The point of the approach taken by Messrs. Ross was this – the executive had assumed the risk of devoting his/her service to the issuer, and the issuer had an option on the executive’s work life – if the executive resigned prior to vesting, he/she suffered the economic risk through forfeiture of unvested options and a limited 90-day exercise period. Death/disability were involuntary events – why deprive the executive’s estate of the upside on the remaining option term?
I responded that the issuer was not an insurer, that it was “unfair” for the disengaged executive (or his/her estate) to benefit from the efforts of the new executives who stepped into handle matters and that the aggregate effect of “dead man”/“dead person” options could eat into available “head room,” making it more difficult to grant new equity to active employees. Companies would also be concerned about the administrative issue of dealing with widows and orphans holding options for the remaining term. Besides, this is the way it has been done for years.
Messrs. Ross shook their heads. Think out of the box. Sure the WSJ had just run an article highlighting criticism of huge cash “severance” payments to dead executives. But this wasn’t cash, this was equity. The number of dying/disabled executives was a limited universe – not likely to really affect available equity. The FAS 123R option expense changes were not going to be increased in any practical sense, since the traditional Black-Scholes “fair market value” pricing model uses company wide historical exercise data – which is not likely to be impacted by a few estates holding options to term.
– Michael Album, Partner, Proskauer Rose; Ishai Mooreville, a summer associate from the University of Michigan Law School assisted on this blog posting.
David Swinford wrote a recent note relating to consultant availability—suggesting that committees need to ensure that their lead consultant will be available when needed. I completely agree with this, but would offer one simple thing that companies can do to aid this process: Make sure the consultant is available when scheduling a meeting!
I know this sounds absurdly simple, but I can’t tell you how often that I have had clients reach out to all of the board members to determine their availability, schedule the meeting, and then call me with the meeting date and time on the assumption that I will be available. When dealing with the inevitable conflicts that would result, I applied a simple rule—I went to the meeting of the client that asked first, irrespective of size of company or existing relationship. In my view, it was the only fair thing to do.
So, as you are planning a special meeting or creating the Board calendar for 2010, think of your consultant as if he or she is another Board member. Check their availability, and get dates on their calendar as soon as possible. For busy people, it is always easier to take dates off the calendar than it is to put them on.
We have posted this quick survey to learn more about how research & development costs play a role when it comes time to set bonus levels for senior managers.
This survey was suggested by a doctoral student who is conducting research to gain additional insight into some of the practical issues and challenges faced by those in charge of setting and disclosing executive pay. If you ever have survey ideas, please drop me a line.
As of the market close on June 23rd, 40.3% of the Fortune 500 companies’ executive and employee stock options were out of the money by an average – 34.5%. It also appears that many of their incentive plans – especially long term – are also underwater.
Looking ahead into my murky crystal ball, I am increasingly concerned that our current system of executive compensation is designed for an expanding economy, increasing profits and a climbing stock market, rather than businesses in difficult competitive shape relative to global competitors, a floundering market and a profit squeeze.
Absent the rosy world to which we have grown accustomed, can we continue to pay the same level of “target compensation” tied to modestly rising base salaries for lower levels of expected/target performance?
On the other hand, can we force feed performance targets that may be unrealistic in view of current business conditions and thereby bring pay (and morale/motivation) down relative to results produced? Clearly, substantive consideration of the issues involved is needed.
In my experience, relative financial comparisons become very complicated and lose credibility with the compensation committee and senior management team when the results are skewed by unusual items. For example, if a peer company had an asset impairment last year, this year’s ROIC may be at the top of the peer group. Why? Not because of improved financial performance, but because its capital has been largely written-off. Thus, even a modest profit makes the company look like it is batting .400.
Do you adjust for this, or simply use the “as reported” figures? Same goes for companies that have unusual gains or losses, severance costs associated with a plant closing, etc. If you decide to adjust for these items, you often end up having to restate the financials for the entire 15-20 company peer group. If you decide to “play it where it lies” you may unjustly penalize or reward your executives.
My Preference: Generally, I prefer to use relative TSR based on the same peer group used for compensation purposes and three-year budgeted financial goals (like cumulative EPS or 12% ROIC). That way, management is being rewarded based on both a shareholder friendly measure (i.e., TSR) and a measure that they can more directly influence (e.g. a three-year internal goal). Although this approach has its own set of challenges and issues, it has served my clients and their shareholders pretty well over time.
When hiring – or evaluating the performance of – a compensation consultant, one area of focus should be time availability. The committee needs to know its consultant will be available to discuss issues when needed – and the consultant should expect the same of committee members. From the committee’s standpoint, the consultant should not be overloaded with other client work and be reasonably available for in-person, and not just telephonic, meetings with the committee.
A senior consultant is usually the lead person on an account, but the committee should be aware of the extent to which assignments will be undertaken by a more junior person. While the latter may be competent to respond to most factual questions, the committee needs assurance that the most experienced consultant will respond when an opinion is needed regarding a particular course of action.
In turn, the consultant should explain to committee members that doing a good job requires candor from and accessibility to the committee – not just when the compensation committee chair requests a meeting, but also when the consultant believes there is an issue that deserves further consideration.
Recently, Senator John McCain has been speaking out against excessive executive compensation and has now joined Senator Obama in calling for mandatory “say on pay.” Here is a Business Week article about this – and here is an excerpt from McCain’s June 10th speech:
“Americans are right to be offended when the extravagant salaries and severance deals of CEOs … bear no relation to the success of the company or the wishes of shareholders,” says McCain, adding that some of those chief executives helped bring on the country’s housing crisis and market troubles. “If I am elected president, I intend to see that wrongdoing of this kind is called to account by federal prosecutors. And under my reforms, all aspects of a CEO’s pay, including any severance arrangements, must be approved by shareholders.”
The proposals that both Senators Obama and McCain support not only would provide shareholders an annual non-binding vote on executive pay, they would also provide shareholders with a separate non-binding vote when a company gives a golden parachute to executives while simultaneously negotiating to buy or sell the company.
With H&R Block joining the list, there are now nine companies that have agreed to a non-binding vote on pay.
Last Days: Early Bird Discount for Our Conferences
I would like to offer a little different perspective on the blog from last week about “The Price of CEO Protection.” This analysis overlooks two important variables – the wealth and the public profile, and resulting risk to the CEO of that wealth and profile, regardless of explicit threats. Some of these individuals have been very aggressive in their business dealings. One was Time Magazine’s Man of the Year. Another introduced a revolutionary and disruptive business model. All three of these examples are multi-billionaires.
A useful approach would be to analyze security costs in a multivariate model considering personal wealth (an objective number), public profile (subjective), and the how-many-you-might-have-ticked-off-along-the-way metric (probably quantifiable but not available) and then the numbers might make more sense.
Having worked directly for six of the most famous and wealthiest CEOs in the country, I can tell you that most people cannot imagine the intensity of the security issues they face. Travel to a foreign country often involves the State Department, Secret Service, and/or CIA. Their children are assumed to be kidnapping targets. Their security staff are not rent-a-cops but former Special Forces, SEALs, and CIA operatives. Not something Joe Schmoe CEO really needs to think about or pay for.
This leads to the question of whether the company should be shouldering these costs. If you note that Steve Jobs looked so skinny during his keynote last week that rumors about his health took 6% off of Apple’s stock price in two days, we note that the markets consider the well-being of “celebrity CEOs” to be a shareholder value issue, despite tax code trivia, and a valid use of company funds.