Compensating Executives Under the New 162(m)

Except for those who are either executives or people involved in determining the ways that executives are compensated, one of the changes to the Internal Revenue Code last fall seemed like a little throw-in designed to appease a small constituency, but that few would really care about. That small group that does understand the change, however, knows it is a pretty big deal.

Let's recap so that we can all be on the same page. Prior to the Tax Cut and Jobs Act (TCJA), and oversimplifying somewhat, public companies were entitled to deductions for executive compensation so long as such compensation did not exceed $1 million per year for a covered employee. Performance-based compensation was not to be counted against that limit and covered employees were the CEO plus the four other highest compensated employees.

Since the passage of the TCJA, there have been several key changes to Section 162(m):

• Once you become a covered employee of a company (beginning in 2017), you remain a covered employee of that company, essentially forever;
• The CEO plus four other highest paid has been changed to CEO plus CFO plus three other highest paid;
• Companies no longer get an exemption for performance-based compensation; and
• Some grandfathering exists for certain agreements that existed in writing.

That does not leave a whole lot of wiggle room for companies. And, for companies that have provided large amounts of performance-based compensation to their executive group, meaningful deductions may be gone.

I'm not about to suggest that I can fix this new problem. But, you should note that amounts that have been deductible under Section 404 are unaffected by these changes. Section 404 of the Internal Revenue Code relates to qualified pension plans. What this means is that to the extent that parts of an executive's compensation which would be subject to Section 162(m) are somehow moved into a qualified pension plan, the funding of that plan will, subject to the rules of Section 404, generally qualify for a corporate tax deduction.

Of course, there are a myriad of rules around what it takes to keep such a pension qualified including the nondiscrimination rules of Section 401(a)(4). But, for most companies that still maintain ongoing pensions, the ability to transfer some otherwise nondeductible compensation to such a pension plan may still exist. It's one of the tools in the tool box that companies should look into.

Proposed Tax Bill Would Change the Face of Executive Compensation

Yesterday, Representative Kevin Brady (R-TX), Chair of the powerful House Ways and Means Committee, rolled out the Republican tax reform proposal. And, while no tax bill in my lifetime or likely anyone else's lifetime has made it through the legislative process unscathed, the draft bill fashioned as HR 1 certainly provides an indicator of where we may be headed.

Much seems completely as expected. We knew about the slimming to four tax brackets. We knew about the narrowing of deductions. We knew that some of the more heavily-taxed states would feel the pain of restructuring. What we didn't know and what frankly came as a surprise to me and to others that I know would completely change the face of executive compensation in the US. Honestly, on its surface, these proposed changes look to me as if they they had been constructed by Democrats. It wouldn't surprise me if these changes had been pre-negotiated, but that's entirely speculation on my part.

So, what's the big deal?

There are two extremely significant proposed changes according to my initial reading.

1. The draft would amend Code Section 162(m) (the $1 million pay cap) to eliminate the exemption for performance-based compensation. In addition, that section would be amended to cover the Chief Financial Officer in addition to the Chief Executive Officer. 
2. Code Section 409A would be repealed (you thought that was good news, didn't you?) and replaced with a new Code Section 409B. Essentially, 409B as drafted would apply the much more stringent taxation upon vesting rules that have previously applied generally only to 457(f) plans. 

162(m) Changes

Section 162(m) was added to the Internal Revenue Code by the 1993 tax bill. Widely praised at the time as a way to limit executive compensation, the exemption for performance-based compensation turned out to be a far bigger loophole than had been imagined. Many companies saw this as a license to offer base pay of $1 million to their CEO while offering incentive pay (some only very loosely incentive based) without limits while taking current deductions.

That would change. 

My suspicion is that companies would return to paying their top executives as they and their Boards see fit, but with the knowledge that particularly high compensation whether performance based or not would not be deductible. Additionally, so called mega-grants and mega-awards would likely become much rarer as the cost of providing them would no longer be offset by tax savings.

409B

The ability to defer compensation has long been a favorite of high earners. The requirement to defer compensation has also been considered a good governance technique by many large employers (for example, a number of large financial services institutions require that percentages of incentive compensation be paid in company stock and that receipt must be deferred),

Much of this would go away as very few people have the ability or desire to pay taxes on large sums of money before they actually receive that money.

What Might Happen If the Bill Passes

Nobody really knows what might happen. But since this is my blog, I get to guess. Here, readers need to understand that there is no hard evidence that what I say in this section will happen, but it seems as if it could.

The draft of HR 1 appears to keep tax-favored status for qualified retirement plans. That's important because qualified retirement plans are a form of deferred compensation with some special rules and requirements attached. What this means is that to the extent that an individual would like to defer compensation on a tax-favored basis, he would need to do it through a qualified plan.

However, qualified plans need to be nondiscriminatory; that is, they must (not an exhaustive list):

• Provide benefits that are nondiscriminatory (in favor of highly compensated employees)
• Provide other plan elements sometimes known as benefits, rights, and features that are nondiscriminatory
• Cover a group of employees that is nondiscriminatory

There are techniques by which this can be accomplished in a currently legal manner, but they are not simple. It would not surprise me to see more interest in these techniques.

As I said at the beginning, I don't expect this bill to pass as is. But, these particular provisions written by Republicans should not draw ire from Democrats. We'll see where it goes.

Compensating Executives in a "Challenging" World

The rationale has always gone something like this: if you don't compensate your executives at least equal to their peers and if you don't reward their performance, you will never have a top tier executive group and your company will not succeed.

Is that statement true? Is part of it true?

We're getting much closer to finding out. The big news this proxy season is from shareholder proposals on executive compensation. That's right -- since Say-on-Pay votes are non-binding, shareholder groups are looking to force companies to put components of executive compensation to a binding shareholder vote.

Before getting into a few details, let's understand how most companies are reacting. It's not surprising, but as a group, large corporations do not think their shareholders understand executive compensation. They are seeking to keep these votes off of their proxies. As a precursor to doing so, they request what is known as a "no-action letter" from the Securities and Exchange Commission (SEC). In brief, when a government agency issues a no-action letter, it assures the requestor that it will not take action on a given issue. So, when a company seeks such a letter from the SEC, the company is asking the SEC to confirm that it will not take action, for example, for a failure to place a particular item in its definitive proxy.

One of the most ardent submitters of executive compensation proposals is the largest American labor union, the AFL-CIO. In a statement, the AFL-CIO said, "We opposed compensation plans that provide windfalls to executives that are unrelated to their performance."

On its surface, that seems very prudent. But, it may be a bit trickier in practice.

What makes compensation related to performance? How does one define performance? Is compensation as expressed in the Summary Compensation Table? Is it cash only? Does it include equity? Does it include the (proxy-includable) value of deferred compensation?

Here is how it would strike me.

• Base pay is not related to performance. But, generally, to the extent that such pay is deductible to the employer under Section 162(m) ($1 million pay cap), some observers will not consider it to be egregious. On the other hand, in today's world of pay ratios and calls for increases in rank and file wages, other observers will ask that it be capped at some multiple of either the median pay for the entire company or even that of the lowest-paid employees of the company.
• Bonuses are theoretically related to performance. To the extent that the criteria used to evaluate executive performance and by extension, executive bonuses, are appropriate, so should those bonuses be. To play devil's advocate, however, if an executive knows how her bonus will be calculated, she may take inappropriate risks (for the company) in order to maximize the expected value of her bonus. Similarly, she may find ways to accelerate certain items into the fiscal year in question while deferring others until the next year. 
• Long-term incentives are [nearly] always performance based. In today's world, it is expected that those incentive payouts will be based on the achievement of a set of goals related to metrics deemed appropriate for that executive. Often, there are circuit breakers (elements that if the executive fails to meet a pre-established minimum level of performance, he will not receive a payout or that part of a payout at all). But, long-term incentives are often paid in company equity. This means that compensation will, to a large extent, be tied to share price. As we know, however, share price is not always tied to corporate performance. On any given day, share price may be influenced by such as the state of peace or war in the Middle East, a speech given by the President of the United States, or the rise or fall of housing starts during the last month. 
• What about deferred compensation (here I am referring to traditional deferred compensation plans, either defined benefit or defined contribution)? It's rarely performance based. Theoretically, the company is paying an executive less today for a promise to give them some of that pay in the future. What sorts of plans should be challenged? If an executive voluntarily defers some of their compensation and it grows at a rate tied to some broadly investable index, is that okay? Suppose she has a DB SERP that looks just like the broad-based plan (qualified plan), but without limitations applicable to qualified plans. Institutional Shareholder Services (ISS) is generally fine with this, but major labor unions may not be. And, if that SERP looks very different from qualified plans, even if there is a good reason for it, this may be a situation where no institutional shareholders are satisfied.

What should Boards of Directors and their Compensation Committees do about all of this? ConocoPhillips shareholders are asking that the Compensation Committee develop a program to determine which portions of a bonus should be paid immediately, which portions should be deferred, and what adjustments should be made to those deferrals based on performance.

Perhaps this has some merit. If it does, however, it's a bit of a nightmare for people who need to figure out how to make such a plan 409A-compliant and for those who need to administer FICA tax payments.

On the other hand, if adjustments are to be made based on performance, can't the same executive who is able to manipulate performance metrics in the LTI scenario described above also find a way to manipulate them here? Where there are objective formulas, there are smart people who can figure out how to game the system. Where there are subjective evaluations, Boards will be accused of pandering to the executives of the companies.

More than ever, the Compensation Discussion and Analysis (CD&A) will be very key. Explaining why the mix of objective and subjective factors was chosen can go a long way to appeasing large shareholders. Explaining how levels of compensation were chosen is a must. And, for the first time, we may see companies rationalizing their levels of executive pay as compared to rank and file pay.

With all of these challenges to executive compensation, these are challenging times for Compensation Committees.

Benefits and Compensation After the Elections

Suppose there was a presidential election this year. Just suppose. And, further, suppose that election had a winner. Just suppose.

It is extremely likely that the winner will be someone nominated by either the Democratic Party or by the Republican Party. And, it is not at all unlikely that the party of the winner will keep or gain control of both houses of Congress.

From the standpoint of tax policy, and by extension, benefits and compensation policy, what will this mean for you, the employer or employee? Should you care?

I don't think we're far enough along to do a candidate-by-candidate analysis, but I do think that we are aided by the fact (at least I think it's a fact) that the remaining viable candidates fall generally into a few small buckets from these standpoints (yes, Carly Fiorina will give us a 3-page tax code (no idea what it might say) and Gary Johnson who has declared for the nomination of the Libertarian Party is a Fair Tax proponent). In fact, I think there are at most four such buckets remaining.

Let's identify them from left to right (that is how we usually read):

• The Democratic Socialist (DS) Bucket whose main component, Senator Bernie Sanders (I-VT, but caucuses with the Democrats and running for the Democratic nomination) has recently told us, "Yes, your taxes will go up."
• The Mainstream Democratic (MD) Bucket whose main component, former Secretary of State Hillary Clinton will, according to her website today (it did say something somewhat different on this topic at the end of last year), lower taxes for the middle class (and by extension the lower class) and raise taxes on the wealthy including big business.
• The Traditional Republican (TD) Bucket that includes the likes of [alphabetically] Chris Christie, governor of New Jersey; John Kasich, governor of Ohio; Marco Rubio, junior Senator from Florida; and Donald Trump (yes he is mainstream for this purpose), businessman from New York, which generally would lower tax brackets and flatten, or make less progressive, the tax code.
• The Conservative Republican (CR) Bucket that includes Ben Carson, retired physician from Maryland, and Ted Cruz, junior Senator from Texas which would replace the current income tax structure with a flat tax.

I'm going to make things a little tougher on you here Rather than reiterating these buckets, I'll comment on how different philosophies might affect things.

We all know the health care debate. Sanders wants to move to a single-payer system. Clinton likes the status quo under the Affordable Care Act (ACA). The Republicans with the exception of Kasich want to repeal the ACA and start over again. Kasich, on the other hand, thinks that this is an impractical solution and would keep some portions of the ACA and change others.

On the pension side, Republicans as a group are in favor of self-reliance. This would tend toward a world of nothing but 401(k) (and similar) plans. Their philosophy is that prudent Americans should be able to save enough for their own retirements, especially with the benefits of an employer match. Of course, many of them will be dismayed WHEN they read my blog to know that I disagree with that.

Clinton is much tougher to figure out on this. But, we can look to her stated tax policy and work our way back. When taxes on high earners and large corporations increase, so does the value of tax deductions. So, under a Clinton presidency, we might expect to see more high earners and profitable corporations accelerate contributions to benefit plans in order to accelerate tax deductions. Could this result in somewhat of a rebirth of defined benefit (DB) plans? Theoretically, it should, but in practice, I would expect that even if that rebirth occurs, it will be very limited.

Sanders would prefer to see a single government-run retirement system for everyone; that is, we would have expanded Social Security and Medicare with smaller benefits and less availability for those who have been the highest earners. In this scenario, although I personally don't see Congress going along with it, the prevalence of employer-provided retirement plans could decline significantly. On the other hand, it would not be antithetical to his philosophy to see a DB requirement in much the same way that the ACA leaves employers with a health care requirement. Could we see pay or play here?

With regard to executive compensation (nobody is saying much about broad-based compensation other than to say that under their Presidency, there will be more and better jobs and pay will increase rapidly), we have another large rift between the candidates. Here, one of the biggest elements is the view of what has probably been President Obama's second signature bill, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank). (Why couldn't they have given the law a short name like Fred so that I don't have to test my typing skills every time I cite the law?) 

Sanders is a huge fan of Dodd-Frank. That said, he doesn't think the law has gone far enough. He has said many times that the reinstatement of Glass-Steagall should have been part of Dodd-Frank. Sanders, much like Senator Warren (D-MA) as well as former Senator Dodd (D-CT) and former Representative Frank (D-MA) believes that one of the most important parts of Dodd-Frank is Title IX, the section on executive compensation. Sanders is a huge proponent of tieing levels of executive compensation to that of the rank and file and of their companies as well as generally limiting executive compensation. Under a Sanders presidency, do not be surprised to see a presidential proposal that would limit CEO compensation for example to a pay ratio as defined in Section 953(b) of Dodd-Frank to something like 10.

Clinton is also a Dodd-Frank fan. But, there is a big difference here. Secretary Clinton has long had both ties and obligations to the large Wall Street banks. She periodically invokes Glass-Steagall, but knows that its repeal allowed Goldman Sachs, for example, to grow into the financial giant that it has. At the same time, though, Clinton, who I believe is still far more likely than not to be the Democratic nominee, knows that the Democratic platform will be influenced by the likes of Sanders and Warren. Expect that the compromise will be in the form of promises to scale back executive compensation. As broad-based plans in which executives participate tend to be exempt from similar scrutiny, those higher-paid individuals may look to solutions that have been proposed over time in this blog.

On executive compensation, Republicans are fairly united. All, that I am aware, would push for the repeal of Dodd-Frank and for no more (or fewer) restrictions on executive compensation. As free market proponents, they would tell us to let the fair markets determine how top executives should be paid. All that said, proposals like that will be anathema to most (perhaps all) Democrats and unless the GOP were to gain a filibuster-proof majority in the Senate, such proposals are not likely to become law. However, as Republicans without exception are looking to lower the top marginal tax rates as well as corporate tax rates, look for more emphasis on current compensation and perhaps less emphasis on deferral opportunities.

As the 2016 election process matures and there are fewer candidates, we'll be able to dig deeper. In the meantime, you have my opinion. What's yours?

And, if you think my opinions have any merit, let me help you address what will be coming with the 2016 elections.

Expect Reported CEO Compensation to be Down for 2015

Last year, there was an uproar. CEO compensation had gone through the roof. Or, so people thought. I predicted it would happen and I was correct. We heard the cries from all directions. Politicians including presidential hopefuls talked about the millionaires and billionaires and oftentimes, they pointed to executive compensation.

As the 2016 proxy season evolves, perhaps some will tell you that their cries were heard. But, were they?

I predict that reported (in proxies) CEO compensation for 2015 generally will be down from 2014. There are several reasons that you don't hear in the campaign ads, notably:

• Pension discount rates have risen
• Equity markets generally did not perform well

What does all that have to do with CEO compensation?

People who recall my tirade last year know that many CEOs, especially those who run large companies and do have very high compensation have a defined benefit (DB) SERP as part of their compensation package. And, when discount rates fall as they did during 2014, SERP liability generally increases and that increase is considered by the SEC to be part of executive compensation. Similarly, when discount rates rise, SERP liability generally decreases meaning that the contribution of many SERPs to reported DB compensation for 2015 will be 0 (you're not permitted to report a negative number). When pay ratio reporting finally kicks in, this may be a really big deal.

What does the performance of equity markets have to do with CEO compensation? Again, most large public company CEOs receive sizable chunks of their compensation in stock whether that be in options, restricted stock, or some other form of stock compensation. When the value of that stock decreases, so does the value of that piece of their compensation.

This leads to an interesting question with an obvious answer. Did the economic conditions in 2014 that resulted in extremely large reported CEO compensation meant that CEOs were overpaid in 2014 compared to other years. And, similarly, were those same CEOs underpaid in 2015 compared to 2014? 

The answer to both questions is of course not. For most of these people, their pay packages were extremely similar in 2015 to what they were in 2014 and similarly in 2013. It's not that often that we see radical changes in the way that a particular CEO is paid. 

But, these external factors drive the numbers and those numbers often drive the conversation.

The final pay ratio rules won't be effective for about 2 years. Of course, companies are being encouraged to disclose earlier and some will. Perhaps this is the proxy season to start. Perhaps this is just the proxy season to understand how volatile it will be.

I can explain it. I can help.

SEC Finalizes Pay Ratio Rule -- Read the Plain English Description Here

Wednesday, after much controversy over the last five years, the Securities and Exchange Commission (SEC) released its final rule under Dodd-Frank Section 953(b) sometimes known as the Pay Ratio Rule. I have friends who are executive compensation attorneys and if you need legal advice on this rule, I can recommend any number of them to you, but I am going to write about it from a practical standpoint in plain English. What happened?

First, I'd like to commend the SEC. The statute on this rule has been very controversial. The SEC, in my opinion, has taken an approach that remains largely faithful to the exact wording of the statute and fully faithful to the intent of the statute (I'm not here to argue if the statute is worthwhile) while at the same time being sensitive to the concerns of employers with regard to the potential cost of compliance. It's rare that a government agency handles such a quandary this well.

Back in 2013, the SEC released a proposed rule on this topic. Since that time, the SEC received 287,400 comments on the proposed rule. More than 285,000 of them were form letters, but that still means that roughly 2,000 people took the time to write customized comments. To the credit of the Commissioners, they appear to have considered every last one of them. What they have crafted is practical, assuming that you find the result of the work practical.

What does the rule say? Here we go.

In its definitive proxy, each registrant shall disclose three items (at least since the rule says that the disclosure may be augmented):

• The pay (as defined for proxy purposes) of the PEO (generally known as the CEO or Chief Executive Officer),
• The pay (same definition) of the median-compensated employee of the employer, and
• The ratio of the first item to the second expressed as some number (integer will work) to 1.

Identifying the median compensated employee can be a very costly process. Consider a company with 1001 employees. The median compensated will be the one whose compensation is more than that of 500 others and less than that of 500 others. In order to determine this (by the letter of the law), one would need to determine the annual total compensation (that's the proxy compensation) or ATC for each of the 1001. They would need to be ranked and then we would find the 501st person. That is a lot of work.

The final rule allows for two significant simplifications for purposes of determining the median employee:

• Companies may choose to use sampling techniques in order to reasonably determine who the median paid employee is, and
• Companies may use and consistently applied measure of compensation from payroll or tax records.

While the first of those may be more trouble than it is worth, the second should be a big help to lots of companies.

Further, once a company establishes a median employee, it may use that same employee for three years provided that there have not been significant changes (undefined term) in the compensation practices or the makeup of employees. If that employee terminates, then the company may reasonably select a similarly situated employee as a replacement.

Many commenters were concerned about the disclosures for multi-national companies especially those with significant numbers of employees in lower cost-of-living countries. Certainly, for example, $50,000 per year goes further in Kyrgyzstan than it does in the US. The final rule allows companies to adjust (on a nation-by-nation basis) compensation for cost-of-living differences.

Calculating proxy compensation can be cumbersome. It includes other than just cash compensation. So, for companies with defined benefit plans and broad-based equity compensation arrangements, it is entirely possible that multiple outside experts would need to be engaged. While that remains the case, the final rule allows companies to make reasonable estimates of components of compensation.

The statute makes clear that an employee is every employee worldwide, whether full-time, part-time, temporary, or seasonal of the controlled group. The final rule allows for all of these simplifications or adjustments:

• A determination date applied consistently within 3 months of the end of the fiscal year
• Only subsidiaries included in the consolidated financial statements need be considered
• Employees where data may be unattainable due to national (or EU) privacy rules may be excluded
• De minimis numbers of employees (up to 5% in total) may be excluded on a country by country basis

Let's look in more detail at those last two. Suppose the number of employees excluded under the privacy rule exception exceeds 5%. Then you are done with your exclusions. On the other hand, if your privacy exclusions are exactly 2% of your total population, then you may exclude other countries whose total employee population is less than an additional 3% of your total population. If, for example, you can't find another country with fewer than 3% of your total employees, then you are done with your exclusions.

In preparing these disclosures, companies will make lots of assumptions, simplifications, and estimates. All must be disclosed.

In somewhat of a gift to employers, additional disclosures and ratios are permitted, but not required so long as the additional disclosures and ratios are no more prominent than the required ones. I think this could be useful.

Consider a company with its management team and sales force in the US, but the bulk of its production facilities in third world countries (I'm not weighing in on whether this is a good or responsible practice or not). Because manual labor is particularly inexpensive in Burkina Faso, for example, Everybody's Favorite Company (EFC) has an extremely high pay ratio, say 10000 to 1. Its CEO had total compensation of $10 million and most employees in Burkina Faso earned only $1000. And further, EFC can't find cost-of-living data for Burkina Faso, so it is not able to do that adjustment. EFC is perhaps rightfully concerned about its pay ratio disclosure, so it elects to do a second pay ratio disclosure limited specifically to US employees. In this case, the ratio declines to 100 to 1.

A second company with a December 31 fiscal year end, everest.com, does a massive holiday business. As a result, Everest has a high pay ratio reflective of its hiring each year of seasonal employees. In fact, in a typical year, Everest has more than twice as many employees from September 1 through December 31 than it does the rest of the year. As a result, Everest reports a pay ratio of 750 to 1. Everest doesn't like this, so it chooses to determine an additional ratio of all but seasonal employees. The company is much more pleased to find that this ratio is only 175 to 1.

Generally, companies are required to report the pay ratio for any fiscal year beginning on or after January 1, 2017 (there are exceptions for certain new filers and emerging companies). This means that the first required disclosures (companies are encouraged to disclose before then) will generally be in the early months of 2018.

The final rule is long and complex. There are many legal issues around it and for those you should contact an attorney. 

There are also issues that are far more consultative in nature. They will generally require quantitative acumen, actuarial knowledge, and comfort with executive compensation, as well as a focus on business issues. For those, you should just click here.

Bloomberg Article on CEO Compensation

Proxy Hysteria Arrives -- I Was Right

I told you it would happen, didn't I? I said that companies whose executives participate in defined benefit (DB) pension plans, especially nonqualified plans were going to report massive increases in CEO compensation. I said that there would be a big name company for which the increase in CEO compensation due in large part to the amount from pensions would create hysteria.

It has happened. Bloomberg reported in a video and an article that GE CEO Jeffrey Immelt was rewarded with an 88% increase in compensation despite sluggish performance. The company attributed the compensation increase to his reshaping of the company and to an increase in the value of his pension.

In my opinion, this could have been handled better. They could have focused on the message from my January 7 post. It said right there what was going to happen. I wouldn't lie to you and I wouldn't lie to GE.

Let's digress for a moment and think about how executive compensation is disclosed for the named executive officers (NEOs), including the CEO, at a public company. The company discloses compensation generally in the Summary Compensation Table (SCT) of the proxy. In the Compensation Discussion and Analysis section (CD&A), the company is afforded the opportunity to discuss its compensation practices, procedures, and policies. As the CD&A is a narrative, the company is required to discuss its rationale for its policies, but it is certainly not precluded from explaining changes. In fact, this is a great place for the company to explain what happened.

According to the Bloomberg article, Immelt's total compensation was approximately $37.3 million. I am neither condoning nor condemning that level of compensation here; that's not my point. Bloomberg says that that amount represents an 88% increase in compensation. Using that figure suggests that Immelt's compensation in the previous year was approximately $19.8 million. Further, Bloomberg says that GE noted that without the pension increase, Immelt's 2014 compensation would have been $18.9 million.

Opportunity knocked, but nobody opened the door. Apparently, GE did give Immelt a roughly 6% increase in base pay apparently from $3.2 million to $3.4 million. There appear to have been no other changes in compensation structure or policy with regard to the CEO.

Suppose GE took the step of explaining the pension increase. The pension plans in which Immelt participates did not change. He wasn't granted a massive benefit increase resulting in his total compensation doubling. What happened was that his 2014 compensation replaced his 2009 compensation (remember 2009 was a horrible year for the US and global economies) in a 5-year average, pension discount rates dropped (this increases the present value of pension benefits), and the Society of Actuaries released a new mortality table (I suspect GE adopted it) reflecting longer life expectancies in general.

What could GE have controlled in an effort to keep Immelt's disclosed compensation relatively steady? They could not have controlled discount rates as they are based largely on the high-quality corporate bond market. They could have chosen, subject to the approval of their external auditors, to not update the mortality table to use for the calculations, but that would only have been obfuscating the issue and frankly, the updated table is likely more appropriate for them. Finally, 2009 happened in 2009. It can't be undone. Incentives paid out more in 2014 than they did in 2009. That's true for almost all companies. What it is reflective of, that corporate performance has improved, is true for many companies and it's a good thing.

So, GE and Immelt didn't do anything evil. Their crime, so to speak, was not an error of commission, so much as it appears to have been one of omission.

GE had to know that this "increase in compensation" would set off alarms. Bloomberg appears to have received or at least heard statements from GE. Why did GE not prepare its spokesperson to address this? The fault was not in changes to their compensation program; the fault was in their lack having a prepared message.

I don't expect that they will be the only company to face this issue. I can help you craft the message. Get out ahead of this problem.

You'll thank me later.

Proxy Hysteria Coming For Companies With DB Plans

You read it here first. During the upcoming proxy season, there is going to be hysteria over the executive compensation disclosures in proxies for companies with defined benefit (DB) plans, especially those with nonqualified plans for their named executive officers (NEOs).

What's going on? As part of an NEO's compensation, filers are required to include the increase in the actuarial present value of DB plans. The actuarial present value is a discounted value of the anticipated payment stream just as it was a year earlier. While there are many assumptions that actuaries select in determining an actuarial liability, two, in particular, have changed for many companies from 12/31/2013 to 12/31/2014. One is the discount rate which will have decreased by somewhere in the neighborhood of 100 basis points and the other is the mortality assumption. Late last year, the Society of Actuaries (SOA) released its newest mortality study and many companies elected to adopt the new tables.

The effect of the change in discount rate will vary, largely on the age of the NEO in question, but it's not unreasonable to think that for most NEOs that just that discount rate change will have increased the actuarial liability attributed to them by 8%-12%. Yes, Americans are living longer. Mortality assumptions should be updated from time to time. But, for proxy purposes, the year of the update causes an additional spike in the liability attributed to the individual NEO, perhaps an additional 5% depending upon age and gender.

So consider an NEO whose 2013 compensation included $1,000,000 due to the increase in the actuarial present value of accrued pension benefits. If that person is still an NEO at the end of 2014, he or she will have had an increase in liability due to surviving one more year (interest and mortality totaling perhaps 6%), an increase due to increases in included compensation (a large bonus could have increased even 3-to-5 year average compensation by 25% (recall that in the case of a 5-year average that 2014 which was a good year for many businesses replaces 2009 which was a dismal year for many businesses)), and increases due to changes in discount rates and mortality assumptions.

So, with no changes in compensation practices, our NEO who had $1,000,000 of compensation attributable to him or her in 2013 might see that turned into an increase of $1,500,000 in 2014.

There will be outrage. Proponents of the pay ratio rule of Dodd-Frank Section 953(b) will point to these increases and say that the rank-and-file got 2%-4% increases. The media will not understand what happened. Congress, and this might be the year that it matters as the new Republican control has suggested that it will try to repeal some parts of Dodd-Frank, will not understand.

But those people who chose to read my ramblings will get it. Companies that foresee the issue can address it. It can't be solved in its entirety, but it can be managed.

I know how.

Do you?

PCAOB Expands Purview of Accounting Profession to Review Compensation Arrangements

Unless you are in a field related to accounting or review of public companies, you may never have heard of the PCAOB, or more formally, the Public Company Accounting Oversight Board. It is actually a private-sector, non-profit company that was created by the Sarbanes-Oxley Act (SarbOx or SOx) in 2002. According to SOx, the PCAOB is to, among other things, oversee the audits of public companies. In part, to do so, the PCAOB creates a set of auditing standards that must be approved by the Securities and Exchange Commission (SEC).

Got that?

So, why am I writing about this? Earlier this year, the PCAOB issued Auditing Standard 18. In late October, the SEC approved it. And, so it is.

Auditing Standard 18 (AS18) is a lovely document. It's 223 pages of, and I can't think of a better word for it, stuff carrying the clearly far too brief title, "Related Parties and Amendments on Significant Unusual Transactions and a Company's Financial Relationships and Transactions with its Executive Officers."

Got that as well?

Among other things, AS18 asks that auditors, among other things:

1. Read the employment and compensation contracts between the company and its executive officers
2. Read the proxy statements and other relevant company filings with the SEC and other relevant regulatory agencies that relate to the company's financial relationships and transactions with its executive officers
3. Obtain an understanding of compensation arrangements with senior management other than executive officers including incentive compensation arrangements, changes or adjustments to those arrangements, and special bonuses
4. Inquire of the Chair of the Compensation Committee as well as outside compensation consultants
5. Obtain an understanding of expense reimbursement policies with respect to executive officers

All of this is to be done to identify risks of material misstatement.

I understand why all of this is being done. Early in this century, there were a number of corporate scandals resulting from apparently fraudulent misstatement of financials. Many of you remember Enron, WorldCom, and Tyco. This is intended to be one more step to lessen the likelihood of such abuses and to restore faith that corporate America, as a whole, are being good citizens.

We place lots of faith in auditors in this regard. Now, I have friends and acquaintances who are auditors. Some of them are very good and knowledgable. And, this is not intended to say that the rest (the complement of some of them) are not good, but in any profession, some practitioners will always be better than others.

Here, however, the PCAOB and the SEC are either assuming that auditors have sufficient expertise in compensation arrangements to handle this undertaking or that the firms of which they are a part have this expertise internally to which the auditors may refer. At the Big 4, this is probably the case. They have massive staffs and are able to engage specialists to handle such complex questions. How about the next tier of auditing firms? Do they have this expertise? I don't know, but I suspect the answer is sometimes. Let's take it down one more tier. Do those firms have that expertise? Again, I'm guessing, but I suspect that the answer is not very often. And, if we move to the smallest of the auditing firms, I would be inclined to move the needle to rarely, if at all.

Most auditors that I know are nice people. Most auditors that I know are pretty smart. Most auditors that I know are pretty honest. That said, most auditors that I know are being asked here to weigh in on matters in which they have no training and are frankly not likely to have it anytime soon.

What is the answer? I'm not sure. I'm not a fan of more regulation or more government control generally, but perhaps people who engage in review of compensation arrangements of public companies need some sort of licensure. Actuaries need it for many functions that we perform and we are also, as a group, pretty nice, smart, and honest.

I think that the PCAOB and SEC have used their unencumbered power to stretch too far. Perhaps, it's time to rein them in?

Executives Need Retirement Education, Too

It's been a long time since I blogged. I needed a break. I needed some fresh ideas. I didn't feel like writing on anything technical. I didn't feel like offering my opinions. I just needed to stop writing for a little while.

This morning, however, I saw an article in the News Dash put out by Plan Sponsor. It stressed that plan sponsors feel that perhaps the biggest issue in nonqualified plans is participant education. Citing from the article, one in five said that education was a top challenge while 18% cited participation and appreciation. I think that they are essentially the same thing, so that makes 40% (rounded) and that's enough for me to conclude that this is a major issue.

Why is this? Executives generally make a lot of money (whatever a lot is). They are generally used to dealing with financial matters. They already have their qualified plans. What makes these plans so different?

There's a lot. Taxation is different. They usually don't have a real pool of assets that they can play with. They don't get the same level of disclosures. They don't understand Code Section 409A. And, they generally don't know if what they are getting is good compared to what their peers at other companies are getting or not.

What's the answer?

I suggest rewards education for executives. In my experience, it is rare that this can be done internally. Internal people are often considered to have a bias or an agenda. It comes better from the outside.

Who or what should that outsider be? It should be an independent person, one who has no horse in the race, so to speak. It should be a person who can speak to all facets of executive rewards -- cash compensation, deferred compensation, equity compensation, retirement compensation, change-in-control agreements, and the like. Unfortunately, there are not too many of them around.

Oh, wait, I can do all that!

Treasury Modifies Section 83 Regulations

The Treasury Department recently issued revised final regulations under Code Section 83. While Section 83 regulations are longer and more complex, this was a short document that focuses specifically on "substantial risk of forfeiture."

So, what do these new regulations do? They add a paragraph that explains that you cannot create substantial risk by putting something in a plan document that is not going to happen and say that it creates substantial risk. In fact, they specifically say that a forfeiture provision that is not likely to be enforced (based on all the underlying facts and circumstances) does not create substantial risk.

Generally, the litmus test that is being applied is whether receipt of the property is conditioned upon performance of future services. So, for example, if nonstatutory stock options vest only if the executive works for the company for 5 years after the grant date, then there would (my read, but not a legal opinion by any means) be substantial risk of forfeiture until the options vest.

Interestingly, this regulation has retroactive applicability relating to property transferred after January 1, 2013.

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 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.

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.

Senate Finance Committee Mulls Executive Compensation Changes

In late May, the Senate Finance Committee released its seventh paper in a series discussing ways on which it might consider reforming the existing Tax Code. Earlier this week, I discussed some of the possibilities in the retirement arena; today, I explore executive compensation.

For years, the intermingling of executive compensation and the Tax Code was a pretty simple consideration. Companies paid their executives a lot of money (but nowhere near as much as they do today). Essentially, executives paid taxes on compensation when it was constructively received and companies got deductions at the same time.

Each time that there was an abuse or perceived abuse, Congress saw fit to fix it through changes to the Internal Revenue Code. Rather than solving a problem, they often created a newer and bigger one. Congress sought to control the amounts that executives are paid by creating the $1 million pay cap under Code Section 162(m). I wrote about this problem back in 2011. Then, there were the Enron and Worldcom debacles and Congress presented us with Code Section 409A as part of a jobs bill of all things.

In any event, here are the proposals that the Finance Committee "may wish to consider" as it moves forward with all deliberate speed.

1. Revise the limits on the deductibility of executive compensation.
1. Repeal 162(m). In my opinion, repealing the limit would allow companies to pay executives more directly and would probably meaningfully decrease executive compensation.
2. Expand the 162(m) group. This, again in my opinion, would serve to increase the number of people for whom large companies would try to get overly creative and overpay their top employees, especially on the sales side.
3. Apply 162(m) to all equity compensation as well. 
4. Change the 162(m) limit to 25 times the compensation of the lowest-paid employee in the company. This would cause companies to eliminate lower-paying jobs. I see no benefit to this proposal.
2. Revise the rules related to nonqualified deferred compensation (NQDC). 
1. Modify or repeal Code Section 409A.
1. Repeal 409A and replace it with Treasury authority to promulgate rules that tax NQDC when it is constructively received. Didn't we used to have these rules?
2. Repeal 409A for private companies. 409A was put in to stop a run on the bank like the one that occurred in the Enron debacle. Private companies truly are a different situation.
3. Repeal the 20% penalty tax under 409A. Hmm! If you take the penalty out of a tax penalty, then you lose its teeth. Either repeal the section or keep it, but don't have it there with no teeth.
2. Repeal NQDC. That is, tax service providers on compensation in the year that it is earned rather than allowing deferral.
1. As an alternative, tax the employer currently on the buildup in deferred compensation.
2. Allow either the company or the executive to pay that tax in the item immediately above.
3. Revise the rules related to equity compensation.
1. Repeal incentive (at the money) stock options. Since ISOs get special tax treatment, repealing them would remove the incentive for grantees of such options to hold the shares once they exercise their options.
2. Modify deductibility of stock options.
1. Limit the deduction to the amount recorded on the company's books when the options are granted.
2. Deduct the stock option cost in the year that it is expenses.
4. Revise golden parachute rules.
1. Essentially repeal the excise taxes and the limitation on employer's deductions. This sounds like the pre-1984 rules.

This is certainly an interesting combination of proposals. I feel sure that even the least observant among my readers can work out which proposal came from Democrats and which from Republicans. Note that not a single one of the proposals talks about repealing Title IX of Dodd-Frank. Alas.

Plaintiff's Bar -- The Good, The Bad, and The Ugly

Collectively, they are known as plaintiff's bar. These are the attorneys who gear their practices toward representing plaintiffs in civil litigation. As I see it, they fall into three categories:

• The group who represent plaintiffs in litigation where the plaintiffs in question have clearly been wronged. While it's not where I am going to focus here, consider, for example, the made-up case where plaintiff goes to a restaurant (think Japanese steak house) where the chefs put on a show for their diners. They toss food. They flip spatulas. I have never seen a diner get hurt in one of these situations. But, in this fictional situation, one chef decides to fling diners' food to them on razor sharp knives. One diner gets up to leave because he is frightened and just as he does, a knife flies astray and hits him blade first in the back, seriously injuring him. The restaurant's insurer says that the diner assumed a risk when he sat down at the hibachi grill. I don't have legal training, but the lay person in me thinks he needed an attorney to right this wrong.
• The group who represent plaintiffs who have probably not been wronged, but where there might be a court that will find for plaintiffs and award massive damages. As an example, consider the spate of cash balance plan lawsuits that were filed. Typically, the issue was age discrimination. Whether or not there actually was age discrimination in designs was a matter of opinion. As a group, actuaries are well-trained to opine on this issue. Being one of these actuaries and being one who knows many others, I've not personally found one yet who thinks that cash balance plans are inherently age discriminatory. But, the attorneys filing the suits know that all they need is one big win and the payoff for them will be huge. I disagree with these attorneys, but it is possible that they are right and I am wrong.
• Finally, there is the group who seek out plaintiffs to file lawsuits where there is never any thought of wrongdoing. All they are doing is hoping that defendants will think it is less expensive to settle the lawsuits than to defend them. Since the attorneys in such situations don't, in my opinion, even care if there is any wrongdoing, I view this as the worst of all situations.

Yes, I have an example for you. As regular readers of this blog know, Dodd-Frank and its older brother Sarbanes-Oxley have imposed significant requirements on issuers of proxies to disclose executive compensation. Most companies have worked hard to ensure that their disclosures are, at a minimum, adequate. A meaningful percentage of them have gone above and beyond in their disclosures providing information to shareholders beyond that which is required and providing excellent supporting rationale for their compensation decisions.

So, what's the litigation here?

A group of attorneys made the startling (well not really) discovery that if you could find a way to stop a company from holding its annual shareholder's meeting that all proverbial hell would break loose. I wrote about this here. What they claim is that disclosure of executive compensation in the proxy is inadequate for the shareholder to make an informed decision regarding say-on-pay or some other vote on which their client could weigh in.

We apologize for this brief commercial interruption before returning you to your regular program. In my profession, I work with a lot of people who do understand compensation. Many of them are also shareholders in companies so that they get to cast their votes on these matters. As part of the small group who could actually make sense of these disclosures, how many of them actually take the time to review the executive compensation disclosures in proxies? A very unscientific review of data that I did on this group (this means that I observed, asked a few people and took a guess) suggests that fewer than 10% of this group actually reviews the executive compensation disclosures carefully enough to opine on its reasonableness. Most institutional shareholders outsource the review and even the firms to whom they outsource such review are working far more from checklists than they are from hard analysis of the data.

So, there's no case, right?

That's not the point. A well-timed lawsuit can cause a company problems. Put yourself in the position of a company and decide how you would react when you learn that plaintiffs have gone to court seeking an injunction to prevent you from holding your annual shareholder's meeting (for those even less legally informed than me, this means that a court would prohibit that meeting from taking place). You are probably left with just a few options, all costly and none foolproof:

• Fight the injunction and hope you win
• Settle to make plaintiffs and their attorneys go away, so to speak
• File significantly enhanced disclosures with the SEC and provide them to shareholders on a timely enough basis

The attorneys for plaintiffs are betting that most companies will choose what's behind door number two. That is, they are betting that companies will opt to settle for an amount of money whereby those attorneys will recover their expenses plus perhaps 35%-40% of the remaining settlement. That makes it profitable litigation for those attorneys.

What should companies do?

There is no great answer, but it seems a good tact to prepare for this sort of litigation.

• Enhance your disclosures proactively. That is, make yourself a less vulnerable target. 
• Have a team internally that understands the issues and that can be mobilized to combat the opposition. This should probably be composed of internal people and have outside counsel in the loop.
• Make your disclosures convincing. Describe how you developed your practices and why they are appropriate for your company in your industry and your geography.

And, yes, there is a fourth thing that you can do that some may think is as useful as the first three: hope you don't get sued.

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.