The Election Happened, Now What?

As the politicians like to say, the people have spoken. Now what?

There are lots of things I could say here about the policies of either side and what I think is right, wrong, or beyond comprehension, but that would be as worthless as much of the blather that occurs inside the Beltway.

What we have now is the same President that we have had for the past four years, roughly the same makeup of the Senate, albeit very slightly more left-leaning it appears and the same House of Representatives although perhaps slightly more right-leaning in its ideology. What we also have is an Administration which no longer needs to be in campaign mode. This means that policies and regulatory agendas which perhaps were on hold for political or non-political reasons may move forward.

Before moving forward, I caution you that what I am about to write is nobody's opinion but my own and that it is only my opinion on the morning of November 7, 2012. It may be different this afternoon, tomorrow, or some other day, but I hope that it doesn't change too much.

PPACA (health care reform or ObamaCare if you prefer) remains the law and it will remain. Whether they like the law or not, companies must prepare for 2014 when many of the key provisions of the law will take full effect. As an American, I hope that most employers do not make the decision to convert many employees from full-time to less than 30 hours for the sole purpose of excluding those employees from semi-mandatory coverage, but that is a decision that some will make.

The President is a strong believer in nationalized benefits programs (see, for example, ObamaCare). Look for his Administration to put forth a proposal for mandatory employer-provided retirement coverage with the option being contributing to a national retirement exchange. Retirement plans will look much more portable in this proposal. And, more coverage means more tax expenditures which must be paid for. Look for them to be paid for with tax savings generated from reductions in 415 limits and 402(g) limits. In other words, the highest earners will not be able to save as large a percentage of their incomes for retirement.

Historically, the Democrat Party has favored defined benefit (DB) plans more than the Republican Party. Republicans as a group have viewed that such plans are not representative of individuals taking responsibility for themselves. However, unless Congress really seeks the assistance of outside experts, do not look for any sort of resurgence in the DB world. Every effort from Washington to promote DB plans has been fraught with agency intrusion that moves employers away from DB.

At the same time, look for the President to leave Ben Bernanke in charge of the Federal Reserve and Tim Geithner in charge of Treasury. This will likely mean continuing low interest rates in an effort to spur the economy. The pension funding stabilization provisions of MAP-21 have, in the short run, allowed companies to not have exorbitant expenditures to fund their DB liabilities, but accounting disclosure often attached to loan covenants and credit-worthiness of companies that sponsor the plans will be unaffected by funding rules. In fact, companies that choose to make the MAP-21 minimum required contributions will have their accounting disclosures look worse.

President Obama has made it clear that he plans to raise taxes on high earners. We've previously written here about the FICA tax increases under ObamaCare as well as the 2013 combination of tax increases sometimes referred to as Taxmageddon. When marginal tax rates increase, deferred compensation becomes more valuable. Look for more companies to focus on nonqualified deferred compensation plans for their executives.

Similarly, the estate tax, or death tax, if you prefer, is due to return with a 55% top rate. Individuals who have accumulated significant wealth will be looking for ways to transfer that wealth to their heirs. Privately-owned companies will frequently look to ESOPs perhaps through so-called 1042 exchanges to plan for wealth succession.

Executive compensation is going to be a huge issue. As tax rates increase and the limitations in qualified plans likely decrease, deferred compensation will be become a bigger issue. With increases in deferred compensation come larger risks both for the executive and the employer. Funding such plans has become increasingly difficult while failure to fund them leaves unmitigated risk for both parties.

Dodd-Frank was one of the hallmark laws of the first Obama Administration. Seven key executive compensation provisions remain unregulated, but look for all of them to be regulated soon. Particularly critical among them are:

• Policy on erroneously awarded compensation
• Disclosure of pay versus performance
• Pay ratio disclosure

Look for the Administration to consider policies that would cut the million dollar pay limit under Code Section 162(m). While the original 162(m) codification probably backfired, most Americans would not consider it particularly controversial to limit the amount of compensation that is not performance-based that top executives receive.

Finally, in all areas, look for increases in required disclosures. Thus far, regulatory guidance in this arena has gone to levels under the Obama Administration not seen before. For employers, this means additional administrative burden. For employees, unless disclosures can be more useful, this will mean more stacks of paper for the trash bin.

And, look for gridlock once again as each side blames the other. Who will blink first? I'll report on the first blinkage here.

Suppose You Couldn't Have Your Annual Shareholder's Meeting

In 2010, Congress passed and President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) into law. Billed as a reaction to the financial crisis and abuse by the financial services industry of the public trust, Dodd-Frank has been more ... much more. Whether that more and much more has been good for the public or for anyone else is a matter of opinion. My opinion, as it is with most laws is that there were good parts, and there were less good parts. But, as is often their wont, Congress attacked a problem with far too broad-reaching a weapon.

Many of the more controversial provisions of the nearly 3000 page law lie in Title IX dealing with executive compensation and paramount among those may be the Shareholder Say on Pay (SSOP). Under these provisions, shareholders have the opportunity to weigh in, albeit in a non-binding fashion, on executive compensation proposals.

As is often the case with such provisions, plaintiff's bar views provisions such as these as an opportunity to litigate the matters. In one case, in California, in order to get a temporary injunction lifted, a company was forced to delay the implementation of their executive compensation proposal, file a revised and more detailed definitive proxy (Form 14A) and pay plaintiff's attorneys more than half a million dollars.

Suppose they hadn't done this. Then a state judge in California was precluding the company from conducting its annual meeting.

And, this was not because the executive compensation package was viewed as being outlandish, but simply over a few provisions that MAY not have been worded perfectly.

On ISS and SERPs

We're getting close to proxy season for issuers of proxies under the purview of the Securities and Exchange Commission (SEC). And, especially since the passage of Dodd-Frank which gave us the new concept of the  (non-binding, but very important) Shareholder Say-On-Pay (SSOP), one of the most important names that we see is Institutional Shareholder Services (ISS).

In a nutshell, ISS provides a service to institutional shareholders of issuers. By performing their analysis of SSOP proposals, ISS gives its subscribers guidance related to how they should cast their SSOP votes. While I may not sound entirely favorable toward ISS and their opinions in this post, I do think this is a valuable service.

For those people who would like to understand ISS's standards and protocols, they have a fairly detailed website with new practices for 2013 as well as their comprehensive 2012 policies.

Now I quote directly from their comprehensive 2012 policies:

 Egregious pension/SERP (supplemental executive retirement plan) payouts:

§  Inclusion of additional years of service not worked that result in significant benefits provided in new arrangements

§  Inclusion of performance-based equity or other long-term awards in the pension calculation

I could be particularly troubled by what I see there, but it's not what gives me pause. Generally, granting of additional years of service for top executives is not a best practice. Similarly, inclusion of long-term awards in compensation for SERP purposes is not a best practice.

However, ISS appears (emphasis here on appears as compared to has) to have taken the position that having a SERP with a more generous formula than in a qualified plan also constitutes an egregious SERP. Often, they are correct. But, not always.

There is a reason, or at least there ought to be, that SERPs are designed as they are. Some companies, for example, tend to promote from within and their executives will likely be long-service employees who are motivated by retention devices rather than attraction devices. SERPs perform this function well. Freezing a SERP when the qualified defined benefit (DB) plan is frozen may be detrimental to shareholders as executives will no longer be bound by the retention device.

What should ISS do? While I have often said negative things about the Summary Compensation Table (SCT) in the proxy, perhaps the SEC had it somewhat correct when they designed it. While technical pension issues may make the pension data in the proxy less valuable than it otherwise might be, the pension accrual is part of annual compensation.

Now, suppose an executive receives lower direct cash compensation than his peer group (other companies), but receives more in deferred compensation through a SERP. Should this be problematic to shareholders? In my opinion, it should not be. In fact, since direct cash compensation is the proverbial bird in the hand while deferred compensation may not be paid if the company suffers particularly adverse business circumstances such as bankruptcy, the generous SERP in lieu of generous current cash may actually be more desirable. But, it's not viewed that way.

New methodologies allow reviewers of proxies to better make this analysis. I'm working on a paper that will explain this in more detail. Regular readers will see it here.

MAP-21 and SERP Funding, Now May be the Time

If you work with US defined benefit (DB) pensions and you haven't been living under a rock, then you are probably familiar with MAP-21, the law passed this summer whose more formal name is Moving Ahead for Progress in the 21st Century. It was positioned as a highway bill, but you are too smart for all that and know all about positioning. Where building highways costs money, lowering corporate deductions for pension plans raises money (or gets scored that way by the Congressional Budget Office). So, MAP-21 included pension funding relief.

In a nutshell, MAP-21 allows plan sponsors to use significantly above-market discount rates in the determination of funding requirements for their qualified pension plans. The trade-off comes in increases in PBGC premiums. But, while the first of these items is optional, the second is required.

So, where am I going with this? If you read the title of this post, you may be wondering.

Flashback to late 2004. Congress passed and a different president signed into law another act supposedly designed to create jobs. This one had a much more in-your-face title, the American Jobs Creation Act of 2004. With that innocuous name, however, came a new section of the Internal Revenue Code, Section 409A that among other things removed distribution and funding flexibility for DB SERPs. Since that time, many executives have wondered how to get their benefits, or at least portions of them, out from under the dark veil of 409A.

For some companies, MAP-21 may have provided an answer.

WARNING: before considering an option such as what I am about to describe, plan sponsors should very carefully consider the underlying risks.

The time may be right to consider a QSERP. Briefly, a QSERP is a means to transfer certain nonqualified benefits to a qualified plan. You can read about them in more detail here.

So, why might now be the right time. MAP-21 has given companies the ability to use higher discount rates in funding their pension plans. This means that any restrictions that might have arisen due to low funded statuses have likely disappeared. So, companies have the opportunity to fund this obligation in a qualified plan without having to fund it all at once.

Risk managers might tell you not to do this and there are good reasons. Paramount among them is that temporary use of above-market discount rates does not change the "true" funded status of a plan.

Other risk managers might tell you that you should do this and you should do it now. Why? Let's consider a simple example. Suppose you have agreed to pay your CEO an additional $100,000 per year (for life starting at age 65) from the SERP. This is over and above what he will get from the qualified DB plan. The present value of that obligation is the same whether that benefit is in the qualified plan or in the SERP. But, in the qualified plan, you get these advantages and many others:

• The benefit will not be subject to 409A
• You could efficiently fund the benefit immediately and generally get an immediate tax deduction for that funding
• That tax deduction may be taken at a higher corporate tax rate than it will be in the future
• When the CEO retires, his benefit can be paid out of a large pool of assets rather than creating a cash flow crunch

This is a complex process and there is much to consider. But, for the right company, now is the time. You'll only know if you are the right company after careful analysis. Ask an expert.

Inflation Finally Adjusts Pension Limits Again

I'll start out by apologizing for not posting for a while. I've been on the road in multiple time zones and sometimes (well, actually always), blogging isn't priority #1. But, it's time to get back to it.

As most readers will know many of the limitations that affect qualified retirement plans are subject to indexation and the timing of the announcements is mid-October. So, without further ado, here you go with the 2013 limits:

• The limit for deferrals to 401(k), 403(b), most 457 plans and (believe it or not), the Government Thrift Plan increases from $17,000 to $17,500
• The limit on catch-up contributions for people who turn age 50 (or older during the year) stays at $5,500
• The defined benefit 415 limit has increased from $200,000 (annual benefit as a single life annuity at age 65) to $205,000
• The 415 limit for defined contribution plans will be $51,000 up from $50,000
• The limit on compensation that may be considered under the plan increases from $250,000 to $255,000
• The threshold for determining Highly Compensated employees remains at $115,000
• The pay cap for governmental plans rises from $375,000 to $380,000

I'll be back to posting more regularly again. Thanks for being patient.

Compliance or Policy?

This is going to be a fairly short post, I think. I want to talk a bit about what should be the greater influence on benefit program design -- compliance or policy?

Right now, and especially as PPACA (health care reform or ObamaCare, if you prefer) is starting to exert its influence, it seems that most benefit program design is structured to facilitate compliance with the myriad of laws that Congress has passed since ERISA was signed 38 years ago. Just think, you provide a big health care benefit, you pay a Cadillac Tax. Your NHCEs can't afford to defer to your 401(k), your HCEs don't get to benefit. You would like to provide your employees with retirement income, but you cannot stand the volatility in corporate cash flow and P&L of a defined benefit plan.

Seems wrong, doesn't it?

So, even to the extent that you have a policy that is governed by things like true long-term cost and what is right for your employees and your business, you are unable to implement that policy while being in compliance.

Seems wrong, doesn't it?

Of course, it's wrong, but the people who make the laws don't seem to get it. They don't believe in benefits policy. They don't believe in retirement policy. They believe in tax policy and gerrymandering the tax code to make it work, often at the expense of corporations (large and small) and their employees.

Seems wrong, doesn't it?

Connecting Executive Rewards

After all these years, I find it amazing. Consideration of executive rewards is still split up into pieces. And, those pieces are handled by different internal functions and by different consulting constituencies.

In a fairly typical case, cash, long-term incentives and equity are handled by the executive compensation function and by the executive compensation consultants. Executive retirement programs are typically handled by the retirement function and by the retirement consultants (frequently actuaries).

This is not a problem. The problem lies in the fact that the left hand and the right hand don't communicate with each other. And, they don't have compatible methodologies.

Let's look at retirement first. Traditionally, executive retirement packages have been designed to replace some targeted percentage of the executive's base plus bonus in their last few years before retirement. That methodology is not wrong. In the typical executive retirement study, consultants are asked to benchmark the plan design. Does it align with current trends and practices?

Consider executive compensation. Here, consultants look at such this as total cash compensation and total direct compensation. They benchmark this against the organization's peer group regressing (adjusting) for differences in size (and sometimes complexity). They develop medians and percentiles. That methodology is not wrong.

Suppose a Board chooses to pay its CEO at the 60th percentile. Perhaps they feel that their is complexity to their organization that belies its size. Suppose they also have an executive retirement program that their consultants say is pretty mainstream. I am going to tell you that almost to a degree of certainty, the retirement consultants have not considered the level of the CEO's pay in determining that the retirement program is mainstream. Isn't deferred compensation a part of compensation?

What would happen if we used the same approach for retirement benefits as we do for other forms of executive compensation? Suppose we calculate an annual value for such benefits and add it to other forms of compensation before doing that regression. Something tells me that the results might be surprising. In some cases, it might justify that rich SERP for which the proxy analysts have such disdain. In other cases, we might find that the company is perhaps inappropriately inflating TOTAL compensation -- the sum of the value of the entire rewards package.

In order to make this work, the executive compensation people need to talk to the retirement people and conversely. They need to speak each other's languages. Today, there are many gaps. There just aren't enough of us who are bilingual in this regard.

Perhaps we need to be.