Executive Compensation Update
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Executive Compensation
Update
Bill SweetnamJohn McGuiness
Eric CottsOctober 19, 2006
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Overview §409A SEC Exec Comp Disclosure Rules Backdated Options Congressional Hearings
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§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
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§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
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§409A
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)
Problem Areas – Retirement Plans
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§409A
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
Problem Areas – Equity Plans
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§409A
Fitting arrangements into §409A exemptions bifurcation good reason payment triggers
Treatment of medical and other post-employment fringes
Problem Areas – Executive Severance
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§409A
Qualified DB plan in controlled group is “at risk”
Plan sponsor in bankruptcy Underfunded qualified DB plan termination
occurs
PPA amends §409A to provide adverse treatment for funding (including rabbi trusts) of NQ plan benefits for public company officers where:
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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
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SEC Exec Comp Disclosure
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
Requirement of a single total compensation figure provided for each covered executive, including:
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SEC Exec Comp Disclosure
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
Significantly expanded retirement and severance benefits disclosures
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SEC Exec Comp Disclosure
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
Stock option grant disclosures
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SEC Exec Comp Disclosure
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
New “Compensation, Discussion and Analysis” section discussing policies and decisions, including:
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Backdated Options
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
SEC and others investigating whether companies engaged in backdating stock option grants
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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
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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
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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
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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)
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Congressional Hearings
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
Senate Finance Committee may look at taxation of certain “fringe benefits”
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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
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