– Gross-ups: “Senior executives should not receive gross-ups beyond those provided to all the company’s employees.”
– Severance Pay: “Executives should not be entitled to severance payments in the event of termination for poor performance, resignation under pressure, or failure to renew an employment contract. Company payments awarded upon death or disability should be limited to compensation already earned or vested.”
Recently, I blogged about our implementation guidance in the latest issue of The Corporate Executive. It was heartening to see that Warren Buffett agrees with this concept – forcing senior Goldman Sachs executives to agree to such provisions before he invested $10 billion in the beleaguered bank. Below I repeat a WSJ article from Wednesday:
Buffett Insists Goldman Executives Are Also Owners (by Yogita Patel)
In exchange for his $5 billion investment in Wall Street firm Goldman Sachs Group Inc., Warren Buffett is due a hefty dividend and an equity kicker, but he also got something else: a commitment from top company insiders that they will continue to hold a substantial stake in the firm. Chief Executive Lloyd C. Blankfein and three other top executives agreed that they won’t part with more than 10% of their common-stock holdings until October 2011, unless the company first redeems Mr. Buffett’s perpetual preferred shares.
In a tumultuous period in which executive pay at financial companies is under close scrutiny, the four executives’ commitment sends a strong signal to Mr. Buffett and to the market in general, said Reena Aggarwal, a professor of finance at Georgetown University. “There is so much anger at Wall Street executives right now that they end up making their money and everybody else is left out there with empty pockets,” Ms. Aggarwal said. “By doing this, [the Goldman Sachs executives] are kind of sending a signal to the market that they are not just going to run out and cash their stock holdings.”
On Sept. 23, Goldman Sachs announced that Mr. Buffett had agreed to buy $5 billion of perpetual preferred stock with a 10% coupon. Goldman Sachs has the right to redeem the preferred shares at any time, but the firm must pay a 10% premium to do so. Mr. Buffett’s investment vehicle, Berkshire Hathaway Inc., also got the right to buy $5 billion in Goldman Sachs shares at $115 a share, the price they were trading at in 4 p.m. composite trading on the New York Stock Exchange Tuesday after falling $9.00, or 7.3%.
Thursday, Goldman Sachs disclosed that Mr. Blankfein, Chief Financial Officer David A. Viniar and Chief Operating Officers Gary D. Cohn and John Winkelried had agreed to hang onto at least 90% of their current stock holdings for the term of the agreement. Their spouses and estate-planning vehicles are similarly restricted under the deal. Representatives of Goldman Sachs and Berkshire Hathaway declined to discuss the agreement.
Ben Silverman, research director at InsiderScore.com, said the agreement was necessary to show that the executives are committed and will work to create value at the company, which recently converted to a commercial bank. “The purpose of the agreement is simply to ensure that top management continues to have their interests aligned with that of shareholders, including Berkshire Hathaway,” said Mr. Silverman, whose firm tracks and rates insider stock transactions. According to Goldman’s most recent proxy, as of Feb. 11 Mr. Blankfein had beneficial ownership of 3.4 million shares, Mr. Cohn of about two million shares, Mr. Winkelried of 2.8 million shares and Mr. Viniar of 1.9 million shares.
Mr. Silverman said it is important for this type of agreement to leave executives with some wiggle room for estate planning and personal liquidity — hence the permission for the insiders to sell up to 10% of their current holdings. Ms. Aggarwal said the Goldman Sachs executives made a bold move by agreeing to the limits. “Any time you put a restriction, you’re taking away an option,” Ms. Aggarwal said. “If they didn’t want to sell, they didn’t have to, but now they definitely can’t sell.”
During our upcoming Conferences, some of the most respected compensation consultants will describe how companies can implement internal pay equity as an alternative to peer group benchmarking (see the Conferences’ agendas). With so much attention right now on excessive executive compensation, we predict that this methodology will really take off over the next year given how existing peer group surveys are comprised of inflated data.
Some companies have already taken the leap. In its 2008 proxy statement for Cerner Corporation, the company discloses that it uses internal pay equity guidelines that provide that its “CEO’s total cash compensation shall not be more than three times that of the next highest total cash compensation (the company’s board must approve any exception to these guidelines).” The flaw in Cerner’s internal equity methodology is that the company fails to include all compensation – including equity awards, which is where the real disparities in pay reside. Companies must be mindful to avoid giving the appearance of good governance when the realities are quite different (eg. clawbacks without teeth).
My Ten Cents: Overcoming Objections to Internal Pay Equity
To the extent there is pushback from compensation consultants about clients using internal pay equity as an alternative benchmark to peer groups, I can understand it – because internal pay likely will reduce the level of the consultant’s role in the pay-setting process. With internal pay, consultants can advise clients about how to implement internal pay equity methodologies, but they wouldn’t make money for the use of their peer group database. This is because internal pay equity is an “internal look” at the company’s own pay scale.
But for the life of me, I can’t understand why lawyers would advise their clients not to consider internal pay equity. Over the past few years, peer group benchmarking has been criticized by many quarters. It’s not that peer group analysis is not useful per se, it’s just that the current batch of CEO pay data is tainted because most boards sought to pay their CEOs in the top quartile for 15 years – thus driving CEO pay inflation through the roof.
Given that most boards rely on peer group benchmarks as the paper trail to show that they were informed when exercising their fiduciary duties – and given that peer group benchmarking is now widely discredited – shouldn’t lawyers be advising boards to find another source of documentation for their files? Or urging them to obtain at least an additional layer of protection by balancing peer group benchmarking with internal pay equity?
The old adage that “everyone else is doing it” simply doesn’t work anymore with regulators and courts. Imagine a courtroom where several experts are brought in to show how peer group data is tainted and that everyone “should have known” it. It’s easy if you try…
For those watching by video webcast, to ensure you don’t have any technical snafus for the conferences, please test your access today.
– How to Test: Use this link to test for access (this test is only available this week) by using your ID and password that you received for the Conferences (which may not be your normal ID/password for TheCorporateCounsel.net or CompensationStandards.com). If you are experiencing problems, follow these webcast troubleshooting tips.
– How to Earn CLE Online: Please read these FAQs about Earning CLE carefully to see if that is possible for you to earn CLE for watching online – and if so, how to accomplish that. Both Conferences will be available for CLE credit in all states except Pennsylvania (but hours for each state vary; see the list for each Conference in the FAQs).
When you test your access, you can test our CLE Tracker as well as input your bar numbers, etc. You also will be able to input your bar numbers anytime during the days of the Conferences too (remember that you will need to click on the periodic “prompts” all throughout each Conference to earn credit).
– How Directors Can Earn ISS Credit: For those directors attending by video webcast, you should sign-up for ISS director education credit using this form.
– How to Attend by Video Webcast: If you are registered to attend online, just log in to TheCorporateCounsel.net or CompensationStandards.com on the days of the Conference to watch it live or by archive (it will take about a day to post the video archives after it’s shown live). A prominent link called “Enter the Conference” on the home pages of those sites will take you directly to the Conference.
A number of members emailed me some of their reactions to Peter Hursh’s recent blog about restricted stock. Below I repeat Peter’s four thoughts (which I have italicized) followed by reactions sent to me – and then that is followed by further thoughts from Peter:
1. Restricted stock gets capital gains treatment, either from the date of the 83(b) election, however infrequent, or from the date of vesting. RSUs never get capital gains treatment; they are always subject to ordinary income tax. For most executives, the federal capital gains tax is 15% through 2010, and then 20%. The highest marginal federal income tax rate is 35%.
Reactions from members:
– This is true from the executive’s viewpoint but neglects to point out that the employer correspondingly gets a lower deduction to the extent the executive realizes capital gain and while this may or may not affect the size of the award it should clearly be known and considered by the committee.
– Both restricted stock and RSUs are taxed as ordinary income, restricted stock when the vesting restrictions lapse and RSUs when paid, which of course can be structured to be when the restrictions lapse. If RSUs are paid in stock, which is typical, they will also be subject to capital gains treatment.
Peter’s further thoughts:
The point is that the executive gets capital gains treatment while holding the stock, on all gains that occur after the restrictions lapse- – hence the words in my point 4: “locking in capital gains treatment from the date of grant.” The executive can never get capital gains treatment while holding the RSU’s. And, since RSU’s are typically held until termination of employment, ordinary income tax applies the entire time the RSU’s are in effect.
Regarding the last thought of this comment – “If RSUs are paid in stock, which is typical, they will also be subject to capital gains treatment” – my reply is: “Yes, but only the stock gains that occur after the individual receives the stock are subject to capital gains tax. Although RSU’s can be designed to pay out before termination of employment, they seldom are.”
2. Restricted shares are protected from creditors in bankruptcy. RSUs, which are nothing more than deferred compensation that tracks the performance of the company’s stock, are not protected from creditors in bankruptcy.
Reactions from members:
– This a particularly confusing comment since while it is true that the settlement obligation reflected by RSUs are not protected from the claims of creditors in the event of the employer’s bankruptcy, the creditor status claim of the RSU holder will come ahead of the equity status claim of the restricted stockholder.
– If a company goes bankrupt, I agree that the restricted stock is not subject to the claims of creditors, but the stock is worthless anyway.
Peter’s further thoughts:
On the last point, I agree but that’s assuming the executive still owns the stock. The executive could have sold the stock while still employed, while he or she probably has the RSU’s until termination of employment. That is, long before any signs of bankruptcy, the executive could have sold the stock sometime after the restrictions lapsed and the stock went up in price, so that he or she cashed in at the more favorable capital gains tax rate.
3. The recipient of restricted stock has the flexibility to sell his or her shares, once vested, even while he or she continues to be employed by the company or serve as a director. RSUs are often not available to cash-in until the individual terminates employment with the company.
Reactions from members:
– In many, many cases pre-409A and I suspect in even more cases post-409A RSUs will settle upon vesting thereby permitting the shares to be sold so the difference this comment is based on will not be as prevalent as the comment would lead the reader to believe.
– RSUs can be designed to work exactly like restricted stock–he is criticizing the vehicle assuming a certain design.
Peter’s further thoughts:
Most RSU’s are designed to be held until termination of employment, especially under the new and complex rules on deferred compensation.
4. The section 83(b) election should not be dismissed out of hand. The executive who truly believes in his or her company will make the election, locking in capital gains treatment from the date of grant. If the executive thinks that the stock price will go through the roof, then he or she can be a big winner. Moreover, the election sends a very strong message to shareholders abut the alignment of the executive’s interests with theirs.
Reactions from members:
– Section 83(b) elections are very rare. If an executive leaves the company during the restriction period, the stock is forfeited even though taxes have been paid. There aren’t a lot of executives who want to take on that risk.
– By the way, the dividends and voting rights on restricted stock do not have to commence on the date of grant. The dividends can be held until vesting occurs, and the voting rights can be barred until vesting.
Peter’s further thoughts:
The person responding is “criticizing the vehicle assuming a certain set of facts,” to borrow the words above. Yes, there is that risk of forfeiture – but only if the executive leaves voluntarily without “good reason” or is fired for “cause,” neither of which happens very often at all, and both of which are minimal risks from the executive’s standpoint.
– Ed Hauder, Senior Attorney and Consultant, Exequity, LLP
I had a conversation with a client recently about retention issues. The company’s past several performance and bonus cycles had not paid out and are unlikely to do so and most stock options that remained outstanding after the company switched to performance shares were granted at prices far in excess of the current stock price. A top executive recently left as well as one of the executive’s direct reports. The client was concerned about the potential loss of employees across his organization. We talked more and it turned out that he believed while his Board of Directors would be concerned about the loss of key talent, they would first want to see evidence that employees were leaving before addressing the issue.
There is definitely a concern that you don’t want to address an issue that doesn’t exist, i.e., grant retention incentives where none were needed. This is especially true given the general take of the media and reaction of certain shareholders when retention efforts are disclosed. But companies also need to consider what would happen if they did lose employees. An ounce of prevention is worth a pound of cure (and is generally cheaper).
So what should a company in this type of situation do? I discussed analyzing the compensation packages (i.e., equity holdings and bonus potential) of key employees – those employees whose loss would cause alarm or the loss of key institutional memory or impact the company’s ability to achieve its strategic objectives or shareholders’ view of the company (“high potentials”). If these employees didn’t have a sufficient “at risk” stake that they’d have to turn their backs on to leave, then it might be appropriate to ensure that they were granted such a stake.
Of course, you could look at the situation from the point of view that the economy is bad in general. Therefore, employees are less likely to change jobs and put themselves at risk for down-sizing, etc. at a new employer. You might then think you should just wait and see whether there is a significant jump in turnover of employees before acting. While this approach has a certain appeal, the problem with it is that if high potentials leave, it will be too late to address the situation. In good and bad economic times, it is often a company’s high potentials who will be most able to secure new positions outside the company.
During troubling economic times, every company wants to hire high potentials to help weather the storm and improve their businesses. Thus, even if the employee turnover rate itself remains constant, if the make-up of the employees who leaves is largely high potential employees, then a company that relies on the talents of its employees will be left a hollow shell of what it once was.
So, I asked my client if they had looked at their high potentials and I heard a fairly familiar refrain, “We haven’t seen any list of high potentials, and if such a list exists, it may only be in the head of our CEO.” Well, at least the CEO knows, right? While true, it makes it difficult to monitor the turnover of high potentials and to manage them like the valuable assets they are. What would happen if others had a chance to see and react to such a list or even assist in its creation? What if a high potential employee was told that he or she was on the list? Might not that recognition alone coupled with the challenge of seeing the company through these difficult economic times be enough to reenergize and recommit the employee to staying the course with the company? It might.
As well as being able to look at the group of key employees whose loss could hurt the company, knowing who is a high potential can enable a company to make rational decisions regarding which employees it should encourage to stay through recognition, greater assignments, compensation and other opportunities and, if needed, retention grants. That strikes me as a prudent way for a business to make decisions regarding the potential loss of a valuable asset. And make no mistake about it, high potential employees are a valuable asset who can help make a good company great or whose disappearance can condemn an “ok” company to remain mired in mediocrity and not develop into what it might otherwise have become.
In my experience, employees generally are not solely driven by compensation (heresy, I know, with me being a compensation consultant). Instead, after some base amount of compensation, high potentials look for career challenges – opportunities to learn, develop and grow – and recognition that their contributions are seen and appreciated by higher ups (which could be accomplished through something as simple as a personal note from the CEO – the type of low cost, high impact action that can help motivate your high potentials and keep them engaged and focused on your business). Another thing I’ve noticed is that most high potentials make their decision to stay at a company based on the people they work with and the challenges and opportunities they perceive they have.
Businesses usually make decisions regarding threats to other business assets without waiting to see a loss. Sure, some companies need to experience a huge data theft before IT security becomes a hot-button issue, but normally companies take prudent steps to protect their valuable business assets – they hire security services to protect their offices, plants and equipment or they file patents and trademarks to protect their intellectual property from others. So why can’t companies look at high potentials in the same way from a business perspective? If companies looked at high potentials the same way as any other valuable business asset, many would find that discussions and decisions concerning compensation, while likely initially more difficult, could in fact do a better job of helping the company achieve its strategic objectives.
However, let’s recognize that this is not an easy thing to do. Not everyone can be above average (or a high potential). Not all companies are headquartered in Lake Woebegone. That isn’t to suggest that all employees don’t contribute to the company’s success. Most of them do in some form or fashion. Instead, it simply recognizes the truth that some employees have a bigger impact on a company and should be treated as the valuable asset they are. Companies should at least be in a position to decide what to do with such valuable assets and be able to protect their investment of time, effort and resources in such individuals rather than allow them to slip away due to lack of knowledge or neglect. So why not identify your high potentials so you know who is critical to your organization, and then work out how to keep these folks engaged and committed to the long-term efforts of your company?
In the furious activity of the past few days, it’s easy to understand why many in Congress have demanded salary caps on Wall Street executives as a condition of approving the Bush administration’s bailout of the financial system. After all, in the eyes of the American public, many of the same people who will be leading the effort to get the the diversified financial industry sector back on its feet were the very same “masters of the universe” whose greed and myopia brought the sector, and, subsequently our country, to its knees in the first place.
Nonetheless the decision of Congress to impose some form of still unspecified executive pay limits, a demand reluctantly accepted by Hank Paulson and the Bush administration last week, is a mistake. At this very moment, it’s a valiant struggle to keep a straight face when you read the words “talent” and “Wall Street” in the same sentence. And yet, precisely because Wall Street is currently a trainwreck, the financial system will desperately need scores of simply brilliant and hard working executives and key employees, if it is to return to a state of financial health that benefits the rest of the economy.
The sort of sums that would satisfy Congress as a cap may be far above the income levels of average Americans, but if artificial caps are put into place, there will be no surer way of driving the financial services industry sector offshore, or into private equity or hedge funds where it will be beyond the gaze of regulators. Besides, if ever there was a time when executive pay in financial services, investment banking, and in general industry overall is likely to be depressed by the market, it is now. The financial bubble didn’t only inflate asset and stock prices, but, as a result of executive pay plan design that was largely equity-based, it also inflated pay. Now the bubble has burst in an ugly way, and hundreds of thousands want work.
U.S. politicians have a lamentable record of intervening in setting executive pay. In the early years of the Clinton administration, Congress imposed IRS 162(m), a salary cap of $1 million, beyond which companies faced a tax penalty for any pay above the cap that wasn’t “performance-based”
Executive pay rose as CEOs beneath the cap, realized that they might be “underpaid”, and another set of executives gained from an outpouring of creativity, as companies, with a great deal of help from (mea culpa) executive pay consultants invented myriad types of short- and long-term incentive plans get around the limit. This not only complicated an already confusing situation, it also made it harder for shareholders to know who was getting what, when, and most importantly, why.
If the “deja vu all over again” foolishness of Congress trying to set and regulate executive pay levels is an old lesson, the financial crisis is teaching some new lessons to shareholders. Forget the conventional wisdom that paying executives in large grants of stock options or restricted stock their own companies ensures “skin in the game”, thus driving sensible risk-taking and maximum shareholder value decision-making.
In recent collapses of Lehman Brothers and Bear Stearns, senior management did not just take reckless gambles with other people’s money. Dick Fuld and Jimmy Cayne took reckless gambles with their own, still failed to do the right things, consequently ended up losing everyones money, as well as most of their own fortunes. Public company shareholders and institutional investors, and watchdogs should remember that loading up top executives with shares can certainly be an aid to corporate governance, but not a substitute for it.
For executives and employees alike, the tales of Lehman Brothers, Washinton Mutual, Countrywide, and other catastrophic corporate failures, especially after meltdowns like Enron, Tyco, Global Crossing, the whole “.com bust”, is a reminder of the danger of having too much capital tied up in the company where you work.
Additionally, it clearly magnifies the need for a “balanced portfolio” of executive pay vehicles that are both operationally and market driven. Many more truly talented executives and key employees will now demand their short- and long-term incentives in cash, and perhaps ask for even more shares. That surely will have an effect on the way that companies recruit key employees and on equity-based executive pay in general. And, hopefully, the concept that forcing significant equity-based stakes on executives in their own companies as a means to stop bad decision making has finally been put to rest.
A strong message to Congress – the design and payout structure of executive pay programs is far more important than the amount – especially in the financial services industry sector. For Wall Street executives, foolish short-term risk-taking could be discouraged by matching the timing and payout of executive compensation to the achievement of performance metrics for the companies and portfolios they are responsible for. And, if we’re going to collect capital from the taxpayers, we ought to insure that there is adequate return on invested capital to them, as well as any of our stakeholders, and link those successes directly to executive pay – without guarantees of wealth in spite of failure at the detriment of employees and shareholders.
Congress can certainly ask that financial institutions put up more capital if their executive pay structures appear to be dangerously risky. That makes far more sense than capping executive pay. In the end companies, their Boards of Directors and their shareholders are far better at setting executive pay than government bureaucrats will ever be.
Lastly, there will never be adequate fixes to executive pay in any industry sector – public or private – as long as there are guaranteed “Golden Parachutes” that allow executives to bail out of a crashing company while both employees and shareholders go down with the ship. Candidly, what has created the highest degree of recent outrage in executive pay has been the captains of those sinking ships paddling away in their own comfortable lifeboats, while women, children, and all remaing souls went under.
– Pearl Meyer, Senior Managing Director, Steven Hall & Partners
In response to last week’s blog on mandatory stock option exercises, I would respond that the technique is useful, but for purposes other than those outlined. Requiring exercise and limiting appreciation without a clear corporate objective appears to contradict the grant’s purpose of motivating and rewarding the creation of shareholder value – and the more, the better.
I’ve used this technique, but to achieve a specific corporate purpose – such as to provide employees with the opportunity to earn the negative spread on underwaters while preventing double dipping and to limit the charge to earnings for an option grant.
In Proposed Regulations issued July 29, 2008, the IRS has made a restrictive, and, in my view, unjustified interpretation of the $25,000 limit for ESPPs set forth in Code Section 423(b)(8). This view, if sustained, will require many companies with purchase periods overlapping calendar years to revise their approach to the $25,000 limit, as reasonably interpreted under the statute and existing regulations. It will likely also require reprogramming by service providers who track the $25,000 limit.
What does Section 423(b)(8) provide? There are three concepts in the statute as follows:
1. The $25,000 limit is an annual limit that applies per calendar year (or any part of a calendar year) in which the option is outstanding (no mention of exercisability).
2. The rate (not amount) of accrual of a right to purchase shares is regulated per calendar year the option is outstanding.
3. The right to purchase stock is deemed to “accrue” when it first becomes exercisable.
The first concept is easily understood. If an ESPP “option” is granted December 1, 2008 (i.e., that is the start of an offering period) and expires 24 months later on November 30, 2010, then (leaving aside for a moment the rate and accrual concepts) it is possible for the employee to be given the right to purchase up to $75,000 in fair market value of shares (determined based on the grant date fair market value of the shares), because the option is outstanding in three different calendar years – 2008, 2009 and 2010. No problem so far.
However, Section 423(b)(8) puts a cap on the rate of accrual of the option by calendar year – namely, the rate of accrual may not exceed $25,000 per calendar year the option is outstanding. Here, it is clear that if the ESPP in question had a purchase date on May 31, 2009, it could not permit the employee to purchase $75,000 in shares, because that would reflect an accrual of $37,500 per calendar year the option was outstanding. Again, no problem so far.
Here is the problem. The IRS takes the third concept of 423(b)(8), that an option accrues when it first becomes exercisable, and then concludes that this must mean that no amount of the option can “accrue” (i.e., no purchase date can permit a purchase) in excess of $25,000 in any calendar year – regardless of how long the option has been outstanding.
Hence, in the above example, on the May 21, 2009 purchase date, only $25,000, not $50,000 of shares could be purchased, since the first “exercisability” of the 12/1/08-granted option accrued in 2009.
The IRS by its own admission – see preamble to Proposed Regulations – was trying to interpret 423(b)(8) in a manner consistent with the ISO $100,000 limit. This is, to put it bluntly, absurd, because the statutory language is entirely different. The ISO limit regulates simply the value of shares that can first become exercisable in any calendar year. The ISO language makes no reference either to the period the option was outstanding or to the rate of the option becoming exercisable.
The IRS, to reach its conclusion under 423(b)(8), had to read into the statutory language the phrase “and exercisable” after the phrase “for each calendar year in which such option is outstanding at any time” and read out of the statute the word “rate” of accrual. An option which is granted in 2008 but first becomes exercisable in 2009, and which permits $50,000 in shares to be purchased in 2009, simply does not reflect a rate of accrual in excess of $25,000 per calendar year the option is outstanding, even though there is an actual accrual of $50,000 in 2009.
This seems so obvious to me it makes me doubt my Stanford Law School and public high school English class education.
I am commenting on the Proposed Regulations to the IRS. If you share my view, please feel free to send your own comments to:
CC:PA:LPD:PR (REG-106251-08)
Room 5203
Internal Revenue Service
PO Box 7604
Ben Franklin Station
Washington DC 20044
– Mike Andresino and Tom Brennan, Posternak Blankstein & Lund LLP, Boston
Have looked at posts on numerous blogs – plus the non-stop CNBC squawk – here’s a question we are not seeing answered: We assume that some executive compensation limits and corporate governance reforms will be included as a condition of an entity participating in the bailout by selling assets to the government (or its new RTC II). The disconnect we have observed is that every commentator seems to assume that the bailout participants will be publicly traded financial institutions. But it’s clear from both the House and Senate bills that public companies will not be the only “financial institutions” to be bailed out.
There could be all sorts of other sellers that are not publicly traded – mutual savings banks and insurance companies, credit unions, small broker/dealers, and in the case of the Senate bill, if Treasury so determines, big pension funds and private equity partnerships. Some of these are not even corporate entities. No one is complaining about executive compensation at most of these privately-held entities, and at the ones where people are, such as hedge funds, the reforms on the table (no severance, say on pay, proxy access) make no sense. We wonder whether the bill will be qualified to the effect that the executive comp and governance provisions will only apply to the extent that a participating seller or its parent holding company or affiliate has a class of stock registered under the ’34 Act?
Oddly enough, in the discussion draft of the Senate bill, an appropriate distinction is made between public and private sellers when it comes to the equity position the government intends to take. However, the bill leads into its executive compensation limitations this way:
“The Secretary shall require that all entities seeking to sell assets through a program established under this Act meet appropriate standards for executive compensation and shareholder disclosure in order to be eligible.” (emphasis supplied).
That obviously won’t work, unless appropriate means “none”…
– Michael Segal, Jeannemarie O’Brien and Ian Levin of Wachtell Lipton Rosen & Katz
By December 31, 2008, nearly every compensation arrangement maintained for any employee subject to U.S. income tax – regardless of his or her title, compensation or position – must be amended to comply with the deferred compensation rules of Section 409A of the Internal Revenue Code. Operational compliance alone will not suffice; each arrangement subject to Section 409A (and in some cases those that are not) must contain certain technical provisions that reflect Section 409A. If the written arrangement does not comply, each affected employee may face immediate income taxes and a 20% penalty tax (even if the payment has not been received or is ever received), and the employer may have reporting and withholding obligations (the long-awaited guidance on reporting, withholding and income inclusion has not yet been issued and will present a separate compliance and administrative challenge).
Although companies have had since the issuance of the final regulations in April 2007 to amend their arrangements to comply with Section 409A, the regulations are massive in breadth and scope and even the most basic principles continue to be debated among practitioners and, we believe, within the government itself. It is apparent that most companies do not have the resources to review every compensation arrangement, identify the issues, find solutions, obtain the approval of senior management or their boards and have the changes reduced to writing and explained or consented to by the affected employees by December 31, 2008. As corporate America faces its most significant financial challenges since the 1930s, its ability to allocate financial and legal resources, and senior management and board attention, to this daunting and possibly futile effort is significantly compromised in ways not contemplated even weeks ago, and clearly must take a backseat to more pressing matters.
Section 409A has achieved one of its primary goals – a six month delay rule prevents executives of public companies from “jumping ship” to get paid their deferred compensation ahead of others (recent events show that deferred compensation’s perceived tax benefits come with a very significant and real credit risk). Whether Section 409A’s other objectives warrant the costs and resource allocation needed to satisfy the overly technical documentary requirements is questionable, since its fundamental requirements have been successfully implemented by companies in operation without regard to the written terms of the arrangement. Ironically, in the current environment, for many U.S. taxpayers, the immediate payment of deferred amounts with a 20% tax penalty may be a more rational choice than continuing the deferral and living with the risk of non-payment and incurring a future penalty tax under Section 409A.
At this point, it is clear that the government’s mandate of complete and error-free documentary compliance by year end (or ever) is unattainable and unnecessary to achieve its original goals. Treasury and the IRS must take action to delay the documentary compliance requirements of Section 409A. In the absence of a delay, the burden on companies would be significantly eased if the application of the 2008 deadline was limited to the executive officers of public companies (i.e., the Section 16 officers). Moreover, the IRS should announce that good faith efforts to comply with the final regulations, both in form and operation, will be acceptable. America’s corporate resources should be focused on business matters in this critical and uniquely difficult time, without the worry that a vast portion of its workforce will be subject to a punitive and draconian tax on New Year’s Day.