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Executive Compensation Update. Bill Sweetnam John McGuiness Eric Cotts October 19, 2006. Overview. § 409A SEC Exec Comp Disclosure Rules Backdated Options Congressional Hearings. § 409A. New Notice 2006-79 extends until end of 2007: Good faith compliance period
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Executive Compensation Update Bill Sweetnam John McGuiness Eric Cotts October 19, 2006
Overview • §409A • SEC Exec Comp Disclosure Rules • Backdated Options • Congressional Hearings
§409A • New Notice 2006-79 extends until end of 2007: • Good faith compliance period • Deadline for documentary compliance • Transition relief for distribution elections • Final regs still anticipated later this fall
§409A • Reporting and Withholding • Not addressed in Notice 2006-79 • Guidance should be issued shortly • Guidance should require reporting and withholding on §409A violations in 2006 • Anticipated extension of time for reporting of annual deferred compensation amounts
§409A Problem Areas – Retirement Plans • Determining key employees • Avoiding material modifications • changes made to related qualified plan • 30-day rule for new participants • no prior participation in any similar plan • §401(k) mirror plans • contingent benefit rule under §401(k)
§409A Problem Areas – Equity Plans • Definition of service recipient stock • options to buy subsidiary stock • FMV of private company stock • Stock option exercise extensions • RSUs with retirement feature • Deferrals of RSUs
§409A Problem Areas – Executive Severance • Fitting arrangements into §409A exemptions • bifurcation • good reason payment triggers • Treatment of medical and other post-employment fringes
§409A PPA amends §409A to provide adverse treatment for funding (including rabbi trusts) of NQ plan benefits for public company officers where: • Qualified DB plan in controlled group is “at risk” • Plan sponsor in bankruptcy • Underfunded qualified DB plan termination occurs
SEC Exec Comp Disclosure • New rules apply to 2007 proxy statements • issued in August 2006 • Significant changes to the January 2006 proposed rules on option grants and pension plan disclosures
SEC Exec Comp Disclosure Requirement of a single total compensation figure provided for each covered executive, including: • Value of option and other equity grants • Annual change in actuarial value of DB plans (qualified and nonqualified) and above-market earnings on NQDC • use FAS 87 assumptions • Perks – $10,000 exemption
SEC Exec Comp Disclosure Significantly expanded retirement and severance benefits disclosures • Pension benefits table – lump sum values • FAS 87 assumptions used • NQDC table • Potential severance/change of control benefits payments estimated • assuming 12/31/06 termination
SEC Exec Comp Disclosure Stock option grant disclosures • Rules do not use the term “backdating” or prohibit the practice • Increased disclosure of (1) timing of grant, and (2) determination of exercise price • Additional disclosure required if exercise price not based on closing price on grant date
SEC Exec Comp Disclosure New “Compensation, Discussion and Analysis” section discussing policies and decisions, including: • Option and equity grant practices • Decisions to waive or modify performance goals • Impact of accounting and tax treatment, including Section 162(m) • 2007 proxy will address 2006 decisions
Backdated Options SEC and others investigating whether companies engaged in backdating stock option grants • SEC investigating over 100 companies • Issuance of option with exercise price below value on date of grant (“discounted option”) may result in securities law disclosure issues, accounting charges, tax issues and shareholder suits
Backdated Options • Potentially significant tax issues for companies and executives with discounted options • §162(m) – FMV and shareholder approval requirements • §409A – Generally subject to – and will violate – §409A rules (unless vested before 2005) • Disqualification of ISOs – nonqualified option treatment
Backdated Options • IRS requesting information about options as part of audit • Copies of SEC reports or filings or internal investigation reports regarding the company's practice with grants and exercise of stock options • Details regarding any options referenced in the filings or reports exercised during the years under examination • Date all corporate action completed for option grant • Effective date of option grant • Fair market value of underlying stock at these two dates
Congressional Hearings • Driven by backdating stories • Senate Finance hearing focuses on government’s response to backdating • Are current tax laws, regulations adequate to “rein in and prosecute” backdating? • Senate Banking hearing at which SEC Chairman Cox testified
Congressional Hearings • Big focus of the Senate Finance hearing on Section 162(m) • Complaints it has skewed compensation away from cash comp to options and other “performance-based compensation” • Chairman Grassley and Baucus both indicated may need to revisit 162(m)
Congressional Hearings Senate Finance Committee may look at taxation of certain “fringe benefits” • Particular focus on executive health benefits • noted lavish benefits despite nondiscrimination rules • Much discussion of income tax treatment of executives’ personal use of corporate aircraft • Appropriateness of tax gross-ups
Congressional Hearings • What will happen under new Congress • Continued emphasis on executive compensation, no matter what party is in control • If change in control, expect more restrictions on deferred compensation • Source of revenue • Sense of fairness • Interaction with qualified retirement plans