Compensation Committee Corner : Executive Compensation Lawyer & Attorney : Winstead Law Firm : Director Liability, Employee Benefit Arrangements

Moving into the 2010 proxy season, companies may want to consider 2010 Policy Updates recently issued by RiskMetrics Group (PDF) and their related Frequently Asked Questions (PDF) (collectively, the "Policy Updates").  Consideration of the Policy Updates may be particularly warranted for NYSE companies because RiskMetrics and/or institutional shareholders may have increased influence this proxy season due to changes under NYSE Rule 452 (PDF) (i.e., the elimination of discretionary voting by brokers in uncontested director elections).

Under the Policy Updates there is a continued emphasis on pay for performance.  For example, a company should consider whether a negative correlation exists between CEO pay and company performance.  According to the Policy Updates, such a negative correlation may exist if:

• the company's one- and three year total shareholder returns ("TSR") are in the bottom half of the company's Global Industry Classification Group, and
• the CEO's total compensation has increased in the last year-over-year.

If a negative correlation exists, then RiskMetrics will assess (over a time horizon of five years) the CEO's total compensation relative to the company's TSR, with the most recent year being a key consideration.

The Policy Updates also provide that a company should ensure its compensation arrangements do not constitute "poor pay practices," which according to RiskMetrics include: 

• pay that encourages excessive risk taking,
• multi-year employment contracts,
• excessive bonus payouts,
• excessive perquisites,
• excessive severance provisions, and 
• gross-ups.

There are other changes to the Policy Updates that make it a worthwhile read for any compensation committee member, especially since RiskMetrics may recommend a negative vote on the re-election of compensation committee members if pay for performance is not correctly aligned or poor pay practices exist.

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Compensation committee members (and the officers of the companies to which they serve) generally put forth a lot of effort to ensure compensation paid to their covered employees are deductible under Section 162(m) of the Internal Revenue Code of 1986, as amended.  The purpose of this blog entry is to highlight that certain compensation arrangements may need to be amended prior to January 1, 2010 to comply with Revenue Ruling 2008-13 (PDF).

As background, Section 162(m) generally provides that compensation paid by a public company to a covered employee is not deductible to the extent it exceeds $1,000,000 ("$1mm"); however, an exemption to the $1mm limit applies for performance-based compensation that satisfies certain conditions (the "Exemption").

To highlight the application of the Exemption, consider a simple example: In a given year assume a public company pays one of its covered employees $1.7mm in cash to which $300,000 is covered by the Exemption. Under this example, the public company would be able to deduct $1.3mm (representing the $1mm limit plus $300,000 covered by the Exemption) and the remaining $400,000 would not be deductible. 

In 2008 the IRS released Rev. Rul. 2008-13, which provides that the Exemption is not applicable for compensation tied to performance conditions that are wholly or partially waived when a covered employee terminates employment without cause, resigns for good reason or retires.  This caught many in the tax community off guard because Rev. Rul. 2008-13 appeared to represent a fundamental shift in IRS policy (prior to Rev. Rul. 2008-13 the tax community generally believed that such waivers were appropriate due to previous IRS private letter rulings addressing the subject). 

Therefore, to ensure the deductibility of compensation paid to covered employees under the Exemption, the following arrangements (and possibly more) should be reviewed to determine whether they should be amended to comply with Rev. Rul. 2008-13: employment agreements, performance-based bonus arrangements, and restricted stock and restricted stock unit award agreements.  With some exceptions, compliance is required prior to January 1, 2010.

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On December 16, 2009, the SEC adopted final rules (PDF) that broaden executive compensation disclosures within proxy statements and annual reports. The new rules are effective on February 28, 2010, just in time for the 2010 proxy season.

As a summary, the final rules generally:

• expand director qualification disclosures,
• require a description of the board's role in risk oversight and an explanation of its leadership structure (e.g., whether it combines the CEO and Chairman positions),
• require disclosure of certain fees paid to compensation consultants,
• require a discussion of compensation risk management policies that are "reasonably likely to have a material adverse effect on the company", and 
• change the valuation of equity awards reported in the Summary Compensation Table and Director Compensation Table (from the accounting expense recognized during the year to the grant date fair value).

Though the final rules are straight forward and for the most part consistent with the proposed rules, companies should review these rules to determine whether immediate action is required. For example, director and officer questionnaires will likely need to be revised, the company may need to gather information on engagements with its compensation consultants, and it is possible that using the grant date fair value of equity awards may change the identity of a company's named executive officers for 2009.

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