A Service to Go with a Sad Story

I am going to pitch a service here that all employers should consider. If you are spending money to provide additional benefits for your executives, that money should go to them and not to the government.

Sometimes a good idea comes out of a sad story. And, I'm happy to report that in this case, it's sad because a company wasted money providing a generous benefit for its executives and then didn't tell the executives the pitfalls, but it's not sad in the context of someone going bankrupt or suffering a tragedy.

I got a call yesterday afternoon from someone who found me on the internet, probably through this blog. His wife is a participant in a SERP. Her employment with the company ended in July (I don't know how or why, I just know that it ended).

In early 2007, the wife received a communication from her employer. It told her that her SERP was being split into two pieces -- a 409A-grandfathered piece and a non-grandfathered piece. This was a not uncommon strategy. In addition, the non-grandfathered piece had a default payment of a lump sum of the present value of the accrued benefit payable six months after termination. A participant could elect a different form and or timing of payment (within limits defined in the plan). All of this is very normal in the world of SERPs post-409A.

Apparently, that is all the communication told her. It didn't explain the complexities of 409A. From what I could gather, her employer didn't want to give too much information because they were worried about potential litigation. So, they probably figured that giving no guidance at all meant that they gave no incorrect guidance.

When I answered the phone, the unhappy husband told me that he and his wife assumed that she could change her option when she terminated. So, she accepted the default and went on her merry way. Now, she will be receiving a lump sum that they don't really need right now and paying about half of it to various governments in the form of taxes.

Here's the idea. An employer could choose to go all the way or just do part of this.

Get an outsider like me who understands executive rewards and the 409A and other tax implications to help communicate to your executive group. In what I would term a perfect world (assuming that the employer chooses to not do the communication themselves), here is what would be entailed:

• Provide the outside consultant with the plan provisions and data for all the parts of the rewards package that you would like covered (SERP, deferred compensation plan, equity compensation, cash compensation, severance, change in control, etc.)
• Invite your executive group to a meeting. In that meeting, the outside consultant presents to the group generically on those elements of the rewards package. In that meeting, each executive, will get a summary/informal statement of their rewards package showing values and costs. The executives will place greater value on their rewards packages when they know how much they are worth and how much you are spending on them.
• With signed waivers (consulting, not legal, tax or accounting advice), allow executives to have individual meetings with the outside consultant after the group meeting. Let them ask questions about what they can change and when, what are their options, and what are their restrictions?
• These meetings can cover as much or as little of the executive rewards package as you would like, but the idea is to use the money that you are spending on executives for executives, not for the government.

Consider it. Let me help.

Pay Ratio Rule Explained ... In Plain Pithy English

Yesterday, the Securities and Exchange Commission (SEC) approved by a 3-2 vote along party lines a proposed rule implementing the pay ratio rule of Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Only here are you likely to see an explanation of the rule in words that you can understand and use. And, be forewarned, there is nothing in the rule that either serves to reform Wall Street or to protect consumers. In case you missed that, let me repeat in different words: the rule serves no useful purpose.

That said, I commend the commissioners and their staff for their efforts in crafting a rule that seems to well follow the statute while removing significant burden on companies in complying. I do not believe that the two dissenting votes object so much to the way the rule was crafted as they do that the rule was crafted at all.

Some of you will need some background on the rule. For those who don't, to refresh, 953(b) requires an issuer [of proxies] to disclose the ratio of the compensation as defined in Item 402(c)(2)(x) of Regulation S-K for the median-compensated employee in the company to that same definition of compensation for the CEO.

So, what does the proposal say? And, why, John, do you of all people, since you have clearly been anti-953(b) commend the commissioners and their staff?

The rule allows for significant simplification in the process. That said, multinational companies with decentralized payrolls may still spend millions of dollars complying with 953(b), but that still pales when compared with what they might have spent.

Disclosure Items

The rule requires the disclosure of three specific items:

1. Compensation for the median-compensated employee in the company
2. Compensation for the CEO (or PEO if you like the SEC vernacular better)
3. The ratio of 1 to 2, expressed as 1 to some integer, e.g., 1 to 377

Where a company uses sampling techniques, simplifying processes, or other estimation techniques (to be discussed later), the company is to describe these techniques, processes, assumptions, and methods in enough detail to be understandable to an investor, but not necessarily to satisfy an economist or statistician.

The issuer, at its discretion, may include other disclosures with it to assist an investor or potential investor in understanding the ratio. Such disclosures should be provided on a reasonably consistent basis. In other words, if in year 1, the issuer uses wiggle words to explain why the pay ratio is 1 to 999, then in year 2, the issuer should use similar verbiage to explain why the pay ratio is now 1 to 17.

Calculation of Compensation

As for other purposes in the proxy such as the Summary Compensation Table, compensation is to be calculated using the methods in 402(c)(2)(x). Without confusing the reader, this includes cash as well as the value of certain equity compensation and the increase in the present value of accumulated pension benefits, among other things. While the issuer (company) will already have calculated this for the CEO, the calculation for the median employee, hereafter referred to as Jane Doe, will also use the same methodology. So, to the extent that Jane is granted stock options and participates in one or more employer-sponsored pension plans (government-mandated plans are generally excludible), that must be included as part of compensation. 

Additionally, all disclosures are to be done in US dollars. Therefore, to the extent that (and I pity the poor company) Jane is paid in foreign currency, the value of such currency must be converted to US dollars. No adjustments may be made for cost-of-living differences in foreign geographies.

Who Gets Counted and How

All employees of the employer on the last day of the fiscal year are to be counted (leased employees and temporary employees of contractors may be excluded). Permanent full-time employees who worked less than the full fiscal year may have their compensation annualized. Part-time, seasonal, and temporary employees may not have their compensation annualized. And, as should now be clear unless you have slept through my first few paragraphs, foreign employees must be counted.

Simplifying the Process

This is where the SEC made us proud (hey, I was proud of them for this, but I guess I shouldn't put words in your mouth). Frequent readers will recall that I described 953(b) as a legislated disaster. (Actually, I need to thank Mary Hughes, my editor at Bloomberg/BNA for coming up with that description.) I am going to get a bit technical for a moment as I explain why to those people who have been hiding behind the rock in my blog.

Section 953(b) requires that companies disclose compensation for their median-compensated employee. Suppose a company has 999 employees. Then, the median-compensated employee (you remember her, Jane Doe) is the 500th highest-compensated. In order to determine who that is, the company would have to determine the compensation (402(c)(2)(x)) for each employee in the company. Currently, that is a by-hand process for the five employees usually disclosed in the Summary Compensation Table of the proxy. Doing it for another 1,000 or so would not be a worthwhile operation. Remember, for many companies, many employees will have many elements of compensation that take many hours to determine and that is way to many manys to be justified in the spirit of reforming Wall Street or protecting consumers.

The proposed rule allows companies to use sampling methods and and alternative forms of compensation in determining the median employee. For example, a company with only US employees, but having 250,000 of them might sample by selecting only those employees whose Social Security Numbers end in 22, 55, or 88. This seems unbiased and would still tend to produce a group of 7,500 people or so. I could go through the math for you (but, you're very welcome, I will refrain) to show you that the compensation of the median-compensated employee of the 7,500 will not vary significantly from that of Jane Doe. Further, in then determining the median of the 7,500, the company may (if it is appropriate for that company) use a convenient measure such as W-2 compensation specifically to determine which employee is the median-compensated one. Then, the company must determine 402(c)(2)(x) compensation for the CEO and that one other person.

Effective Date

I am used to reading IRS regulations. They usually tell you when you must comply with a regulation and they tell you using words (it may the only place they use such words) that you and I can understand. The SEC has chosen to do otherwise. In fact, after reading through their description three or four times, I am still not convinced that the actual rule says what their description of their own rule says. In other words, it is really confusing.

That said, I will use the SEC's own example. If the final rule were to become effective in 2014 and the issuing company had a fiscal year ending on December 31, then such issuer would need to comply for the 2015 fiscal year meaning that the pay ratio disclosure would need to be provide by 120 days after the end of 2015.

Request for Comments

Again, I praise the SEC. They actually want to get this right. They asked 69 questions requesting comments. While I don't entirely agree with their choice of questions, their willingness to ask them and to seek good answers is laudable. 

I will be commenting. I would encourage other interested parties to comment as well.

How Should Issuers Prepare?

The good news is that issuers have lots of time to prepare. It sounds to me as if you won't have to be disclosing pay ratios for another 30 months or so. That's a lot of time. It gives you time to get your ObamaCare ducks in a row before you think about this.

But, pay ratio disclosure will come. Here is a non-exhaustive list of things I think you should do.

• Figure out all the payrolls that you have company-wide
• Determine a measure of compensation that is (or something comparable is) reasonably and readily available such as W-2 or the foreign equivalent(s)
• Understand all the places and to whom equity compensation is issued
• Understand all the defined benefit (including cash balance) plans out there as well as nonqualified deferred compensation
• Prepare your foreign payroll administrators for the eventual need
• Develop a sampling method that is appropriate for your company (need help?)

You Have Questions?

The regulation and explanation combined are 162 pages. It's not exciting reading and in fact, does not have a good plot. I tried to present a readable and understandable summary here, but there's obviously much more. 

If you do have questions, you can ask me.

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Pay Ratio Here, I Fear

The did it. By an overwhelming 3-2 vote, strictly along party lines (tsk, tsk), the Securities and Exchange Commission approved a proposed rule under Dodd-Frank Section 953(b). The two dissenters, Commissioners Gallagher and Piwowar, both issued scathing condemnations of both the statute and the proposed rule while the other commissioners praised it for the assistance that it will provide to investors and potential investors.

The rule has not been published yet, or at least, I can't find a copy, but I did take some good notes, so my readers get an early summary with surprisingly enough, some cynicism from your faithful blogger.

Issuers will need to provide three numbers:

1. Compensation (Rule 402(c)(2)(10)) for the median-paid employee
2. Compensation of the CEO
3. The ratio of 1 to 2

Despite this being what the law calls for, #3 is stupid. For those who are not sure what I just said, #3 is stupid. Suppose I told you that the ratio of compensation of the median employee to the CEO is .0073. What would that number mean to you unless you are mathematically facile? Is that a good number or a bad number? Should you be happy?

I repeat, #3 is stupid. The ratio should have CEO pay in the numerator and be an integer.

Haters of the statute did get a few breaks:

• Companies may determine the median employee via statistical sampling. After doing this, they must determine the 402(c)(2)(10) compensation of that median employee rigorously. Despite commentary from Commisioner Piwowar to the contrary, this is a huge concession to issuers.
• Compensation of permanent full-time employees may be annualized.

On the other side, there are these provision:

• Part-time, temporary, and seasonal employees pay may not be annualized.
• Compensation of global employees must be currency converted.

And, on the I'm not sure until I see the actual regulation side,

• There is no rule to say how statistical sampling must be done, but it must be reasonable and consistent.
• The dispersion of pay should be a significant contributing factor in determining the sample size for statistical sampling.

I understand that the novel which shall be heretofore known as the Dodd-Frank pay ratio rule is quite voluminous. Stay tuned here to get the most easily readable and entertaining reports on what it says.

Populating Your Web Site

So, you're in a business related to benefits and or compensation. You have this really nice website. It's pretty glossy and glitzy, but you don't have enough substance on it. You need some technical or opinion articles, but either you don't have the time or you just don't like to write.

Have you ever considered specifying what you want on there and have someone else write it for you? You're here reading my blog. You know that I write on a wide variety of topics.

So, have me do it for you.  Contact me and we'll work out the details.

Pension Miseducation

Like many benefits and compensation professionals, I receive daily my fair share of e-mail blasts from consolidators -- those services that scour the web for tidbits to provide to their readers. Because they have tens of thousands of free subscribers, they are able to sell advertising. That's their business model, as I understand it.

This morning, I opened one of those e-mails and found this article that looked like it was worth a read. In fact, there was some interesting material in there. And then there was this:

That aphorism also suits one frustration of today's pension plan sponsors. Somehow, they have to attain lofty actuarial return goals of 7% to 8%, but the expected returns they have to draw from, for both equities and fixed income, are stuck at ground level.

Hold on a second. Lofty actuarial return goals, you say? This implies somehow that the actuaries set the target and that based on that, plan sponsors and their associated investment committees then struggle to meet that target.

This is backwards. The selection of actuarial assumptions is different for accounting and for funding. In either case, however, the actuary does not just willy-nilly pick a target return on assets assumption. For ERISA funding purposes, the law mandates the selection. For FASB (ASC) purposes, the plan sponsor selects the return on assets assumption with the advice of experts including the actuary and investment adviser for approval by auditors. To the extent that the actuary finds the assumption to fail to meet Actuarial Standards of Practice (ASOPs), the actuary is to disclose such and to provide calculations representing what the amounts would have been had the assumption met the ASOPs.

Those who do not seem to understand this take a different position. The typical process for those sponsors looks like this:

• Look at the expected return on assets assumption.
• Go to the investment adviser and tell them that they need an investment portfolio that will meet or exceed that expected return on assets assumption.

But, the sponsor owns that assumption (if it is for accounting purposes). If it's for government plan funding, usually (state and local laws differ) the sponsoring government has input into the assumption. 

If an actuary has some (or all) purview over the return on assets assumption and (s)he is doing his or her job properly, the actuary will look at the investment lineup together with a capital market model and develop a return on assets assumption commensurate with that lineup. It is not the other way around. If plan sponsors do not think that their investment lineup can return 7% to 8%, then they should lower their assumption for expected return on plan assets. Yes, this will increase their financial accounting costs (and their funding costs for governmental plans). Ultimately, the cost of a plan is what it is. The cost of paying $1 per month for the rest of an individual's life is the same, no matter the actuary.

In my personal experience, for years, many plan sponsors pressured their actuaries to use more aggressive actuarial assumptions in an effort to influence P&L and, back in the days when it mattered for funding costs, to keep required contributions down. Some actuaries agreed to do that, some did not. 

But, when a plan sponsor, including a state or local government, chooses a high expected return on assets assumption, usually to manage short-term costs, that they are unable to find a suite of investments to generate that expected return is not the actuary's fault. Place blame where it belongs.

IRS HDHP Notice that Had to Be

Yesterday, the IRS published Notice 2013-57 confirming that a High Deductible Health Plan (HDHP) can, in fact, still be an HDHP if it offers preventive health care without being subject to the deductible. The IRS got this one very right, despite Congress having missed a few technical details.

Here's the rub. The Affordable Care Act (ACA, PPACA, or ObamaCare) clearly contemplates HDHPs and health savings accounts (HSAs). The law tells us all of the following:

• For an individual to make (or for the individual's employer to make on the individual's behalf) tax-favored contributions to an HSA, the individual must participate in an HDHP.
• Further, the HDHP must not pay any benefits to the individual until the [high] deductible is satisfied.
• The ACA requires that a health plan must provide first dollar coverage for certain preventive care services.

Thankfully, the IRS made a completely reasonable decision. It determined that those benefits that must be provided should not preclude the use of an HSA. IRS went further by saying that anything that is preventive care under Notices 2004-23 or 2004-50 is preventive care for this purpose whether or not it is specified as preventive care under the ACA.

Phew! And, you were worried that this little glitch was going to blow up ObamaCare.

Federal Court On the Money in Pension Case

I am stunned. Defined benefit pension plans and their funding measures and funding rules are a very complicated topic. In fact, federal judges (for private plans, they must be federal as ERISA preempts state law) often struggle to understand the intricacies of defined benefit plans.

I can't blame them. Congress has written statute that is so twisted as to make it extremely difficult for experts at the IRS to provide regulations and for trained actuaries to them implement. These are people who spend much of their working lives worrying about the rules underlying pension plans. For a judge with little or no formal pension training to see through the fog is a really nice change.

So, what's it all about, [Alfie]?

In Palmason v Weyerhauser, as I understand it, plaintiffs brought suit because Weyerhauser invested too large a portion of its qualified pension assets in risky asset classes, primarily alternatives (while the opinion doesn't specify, generally pension assets are considered invested in alternative assets when those assets are classified as none of cash, fixed income, or equity, e.g., real estate or infrastructure). At some point, the plan became underfunded.

It's time for an explanation. And, the Court got this one right. Measures of the funded status of a pension plan can be on many different bases. For accounting purposes, we have two different measures of the obligations (often referred to as plan liabilities) of a plan each based on a discount rate which is determined based on yields of fixed income instruments on the last day of the fiscal year. The Pension Benefit Guaranty Corporation (PBGC) looks at the plan's liabilities based on the rates at which PBGC thinks those obligations could be settled in the event of plan termination (this tends to produce a particularly high liability). IRS (and ERISA) funding rules are theoretically similar to accounting rules, but due to smoothing techniques and a constant stream of funding relief rules, a plan's funding liability (sometimes referred to As AFTAP) may be far less than these other liabilities.

In the Court's opinion, it points out that plaintiff must have standing to sue when the claim is filed. Attorneys could give you chapter and verse as to why this is the case and what generates standing, but I'll keep it simple. Under ERISA, generally, to sue for monetary damages, one must be able to show monetary harm.

In a US qualified defined benefit pension plan, a participant (except in the case of certain plan terminations) is entitled to a payment from a pool of assets. Those assets are used to pay the benefits of all plan participants. So, unlike a defined contribution plan, a diminution in plan assets may not affect the ability of the plan to pay benefits to a particular participant.

In any event, plaintiff's expert pointed out that the plan was funded 76% or 85.5% at the time the suit was filed. These were apparently accounting and PBGC measures, but not funding measures.

How can a participant be harmed by the funding level in a defined benefit plan if the plan is not being terminated? Essentially, there are two ways:

• If a plan's AFTAP is less than 80%, a participant's ability to receive a lump sum payment may be eliminated in part or in full.
• If a plan's AFTAP is less than 60%, a participant's future accruals will cease [perhaps temporarily].

The plan was not close to either of these conditions. Near the date that the suit was filed, the AFTAP was likely in the vicinity of 100% or more.

While I do not have access to the report or testimony of plaintiff's expert, it would appear that he focused on the measures that he did because they helped his client's case. Perhaps he did this because he realized that participant had no case otherwise. 

Would you as an expert take a case where the only testimony that you could provide would be that which only purpose would be to obfuscate the real point?

Judge Lasnik was not pleased. Rarely, if ever, have I seen a pension case where the judge calls out an expert by name and essentially criticizes his testimony for ignoring the real facts of the case. I hate to criticize my actuarial brethren as oftentimes, judges have not understood really relevant testimony from actuaries and made, shall we say, interesting rulings, but in this case, the judge saw the smoke and mirrors and appropriately, in my opinion, shot down the expert. 

The Need For Honest Debate

It's that time again, it's time for a rant. But, I hope that it will be instructional as well. I'm going to talk about our need for honest debate in our legislative process. And, because this is a blog that, at least in theory, deals with benefits and compensation, I'll use benefits and compensation issues to illustrate my point.

For those who are wondering, the antagonists here are the large part of the 535 (that's the usual number) elected officials who in combination are the voting members of Congress. The protagonists, if there are any are the other 315 million or so of us who get to live by what the 535 come up with.

Let's start with nearly everyone's favorite whipping boy, the Affordable Care Act (PPACA, ACA, or ObamaCare). We all know what happened. President Obama really wanted to reform the US health care system. At various times, he indicated that he wanted to move toward a single payer system. Many of his fellow Democrats among the 535 also wanted a single payer system, but knowing that was unlikely to get enough support to become law, they settled for a bill that eventually became PPACA. The Republicans banded together to vote against it, unanimously. My distinct impression is that most didn't care what was in it. It was to be a landmark piece of Democrat-sponsored legislation and Republicans were voting against it. My distinct impression was also that most Democrats didn't care what was in it either. It was going to be a win against Republicans, so Democrats voted for it. As Nancy Pelosi (D-CA) famously said (and I am going to include the whole quote so that it is not taken out of context):

You've heard about the controversies within the bill, the process about the bill, one or the other. But I don't know if you have heard that it is legislation for the future, not just about health care for America, but about a healthier America, where preventive care is not something you have to pay a deductible for or out of pocket. Prevention, prevention, prevention -- it's about diet, not diabetes. It's going to be very, very exciting. But we have to pass the bill so that you can find out what is in it, away from the fog of the controversy.

Did Ms. Pelosi know what was in the bill when she voted for it? She probably had a general idea, but didn't know the specifics. How about the other 534? I'd wager that most of them had neither read more than a page or two, at most, of the legislation and had not been briefed on it by anyone who had read it.

Where was the debate? Where was the opportunity for individual members of Congress to discuss the good parts and the bad? Even among the most ardent Republicans who voted against the bill, I suspect it would be difficult to find many who think that mandatory preventive coverage and coverage of kids up to age 26 are bad things. On the other hand, the medical device tax that was inserted deep in the bill's bowels as a revenue raiser would probably not get support today from more than a few Democrats who voted for the bill.

Suppose the bill had truly been debated. Suppose the good parts had been picked out as the foundation for a bill that might have gotten some bipartisan support. Suppose the parts that virtually all of us can agree don't make sense had been left out. What would debate have taught us? It would have confirmed that our health care system needed some reform. It would have confirmed that providing health care coverage to millions of uninsured costs money. It's not budget neutral. It's certainly not helpful to the budget. But, we didn't have good, honest debate and we eventually have learned what was in the bill.

Dodd-Frank was another bill that was passed without a whole lot of what I might refer to as crossover voting. That is, a few Republicans voted in favor and a few Democrats voted against. But, to call it bipartisan is a bit of a stretch. The bill was massive. Many who voted for or against had a pet little provision in there that triggered their votes.

The bill was supposed to clean up Wall Street and protect consumers. I know this to be true because of the full name: The Dodd-Frank Wall Street Reform and Consumer Protection Act. Names of laws don't lie, do they? Say it ain't so.

Somehow, it became important to get Title IX in there -- the part on executive compensation. And, Senator Robert Melendez (D-NJ) managed to sneak in what regular readers know to be my personal favorite, the pay ratio provisions in Section 953(b).

I've communicated with a few people who follow Capitol Hill closely, Congressional reporters. None of them are sure how this provision actually got into the bill. They all agree that it was not debated. What happened?

Implementation of Section 953(b) will require some simple mathematics, or arithmetic if you prefer. Senator Menendez, the purported author of the section was a political science major before attending law school He was also a member of a Latin fraternity. He first entered politics at the ripe old age of 20.

I looked hard. I cannot find any evidence of Senator Menendez' mathematical prowess or of his knowledge of executive compensation. Perhaps that is why Section 953(b) is so incredibly messed up -- bad enough that I have written about it enough times to finally learn how to type the word ratio without placing an n at the end of it even though my fingers seem to prefer to type ration.

To the credit of the 535, Dodd-Frank was debated ... as a bill. But, it's tough when you have a bill that, at least in one printing, contains about 3200 pages to debate every provision. Section 953(b) escaped debate. It became part of the law.

It is bad law. Despite what the AFL-CIO says, Section 953(b) is bad law. There, I said it. Perhaps it should have been debated. Perhaps Ms. Pelosi should have said that [we] have to debate the bill so that we can put useful provisions in it. Perhaps I am dreaming.