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Employee Compensation and Benefits Changes Under the Tax Cuts and Jobs Act

The following post is a general summary of the changes to the Internal Revenue Code made by the recently enacted Tax Cuts and Jobs Act (the “Act”) that affect employee compensation and benefits: Executive Compensation Updates Loss of Deduction for Compensation in Excess of $1 Million Currently, Section 162(m) of the Internal Revenue Code limits the ability of publicly held corporations to deduct annual compensation paid to a “covered employee” in excess of $1 million, with an exception to this limit for certain performance-based compensation. Beginning on and after January 1, 2018, the Act amends Code Section 162(m) to eliminate the exception for “qualified performance-based compensation” (which includes stock options, stock appreciation rights, and compensation paid upon the attainment of pre-established performance goals) and commissions. There is limited grandfathering relief available under the Act that preserves the deductibility of existing arrangements that pay out after 2017, provided the “written binding… Continue Reading

Delaware Supreme Court Adopts Fairness Standard of Review for Discretionary Equity Compensation for Directors

On December 13, 2017, the Delaware Supreme Court held that discretionary equity compensation grants to directors are subject to an “entire fairness” standard of review, rather than the more deferential “business judgment” rule, even if the equity incentive plan has been adopted and approved by the company’s stockholders. Specifically, the Delaware Supreme Court held that when stockholders have approved an equity incentive plan that gives the company’s directors discretion to grant themselves awards within general parameters, the directors will be required to prove the fairness of their awards to the corporation and will not be able to rely on the business judgment rule unless (i) the directors submit specific compensation decisions related to equity grants to themselves for approval by fully informed, un-coerced, and disinterested stockholders, or (ii) the plan is self-executing (i.e., the plan grants awards to directors over time based on fixed criteria, with the specific amounts and… Continue Reading

Application of Code Section 409A to Back-to-Back Arrangement

On June 23, 2017, the IRS Office of Chief Counsel issued Chief Counsel Memorandum Number 201725027 (the “Memorandum”) addressing the application of Section 409A of the Internal Revenue Code (“Section 409A”) to certain back-to-back arrangements. The taxpayer in the Memorandum managed investment funds, including the funds of a foreign corporation, with whom the taxpayer had entered into an arrangement to defer some of its management and/or performance fees from the foreign corporation (referred to as an “ultimate service recipient plan” or “USR plan”). The taxpayer also sponsored a deferred compensation arrangement for its investment professional employees (referred to as an “immediate service recipient plan” or “ISR Plan”). While the deferral elections and payment triggers of the USR Plan and ISR Plan were coordinated, the USR Plan provided that payment would be made to the taxpayer under the USR Plan even when amounts were forfeited by a participant under the ISR… Continue Reading

SEC Charges CEO for Failing to Properly Disclose Executive Perks to Shareholders

A former CEO of a marketing company has agreed to settle charges by the U.S. Securities and Exchange Commission (the “SEC”) that his executive perks were not properly disclosed to the company’s shareholders. According to the SEC’s order, annual filings disclosed that the company’s CEO and chairman received an annual perquisite allowance of $500,000 in addition to other benefits. However, the SEC’s investigation discovered that the company paid for the CEO’s personal use of private airplanes as well as charitable donations in his name, yacht and sports car expenses, cosmetic surgery, jewelry, medical expenses for family members, pet care, and a wide range of other perks that the company failed to properly disclose. The SEC alleged the CEO improperly obtained an additional $11.285 million in perks beyond his disclosed benefits and the $500,000 annual allowance. The CEO has since resigned and returned $11.285 million to the company. The CEO consented… Continue Reading

Limits Set in Equity Plans Yield Less Stringent Standard of Review

In a recent Delaware Court of Chancery case, stockholders brought suit against a company’s directors alleging breach of fiduciary duty for awarding themselves “grossly excessive compensation.” The excessive compensation in question included equity grants issued pursuant to the company’s equity incentive plan. The terms of the stockholder-approved plan provided limits on the number of shares that the company could issue as stock options, restricted stock, and restricted stock units and on the number of shares the company could award to employees and directors. The court held that the specific equity awards could be reviewed pursuant to the business judgment rule, which is the standard used to review executive compensation approved by a disinterested committee rather than a more stringent standard required for “self-dealing.” In applying the business judgment rule, the court found that it was critical that the director-specific limits set forth in the plan differed from the limits that… Continue Reading

Ordinary Equity Issuances to Company Insiders Can Result in HSR Act Violations and Penalties

Directors, officers, and other persons who directly or indirectly hold common stock worth close to or more than $80.8 million (the threshold amount for 2017) should consult legal counsel before acquiring any more shares to determine if compliance with the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act“), is required prior to completing any additional acquisitions. In recent years, the Federal Trade Commission and the U.S. Department of Justice have more aggressively enforced the HSR Act, including inadvertent failures to file that occur when an insider of a company with significant equity value acquires a small number of shares-whether through a restricted stock grant, shares issued as director compensation, the exercise of a stock option, open market purchases, or otherwise. For example, in January 2017, the agencies imposed a fine of $780,000 on an individual who was a founder, officer, and director of a company for his… Continue Reading

SEC Releases Additional Guidance on CEO Pay Ratio Disclosure

The SEC recently published Compliance and Disclosure Interpretations (“C&DIs“) relating to the CEO pay ratio disclosure rule. This disclosure rule under Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires a public company to disclose the ratio between its CEO’s annual compensation and the median annual compensation of all other employees. The new C&DIs include guidance on the selection of an appropriate alternative compensation measure and clarify that if an alternative compensation measure is utilized to determine the median employee, the time period utilized does not have to be a full annual period. Moreover, the time period utilized does not have to include the date on which the employee population was determined. View our prior post on the SEC’s adoption of the CEO pay ratio disclosure rule here. View the full text of the C&DIs here.

ISS 2017 Global Voting Policy Survey Results

Institutional Shareholder Services Inc. (“ISS”) recently released the results of its annual global voting policy survey. Respondents include institutional investors, corporate issuers, as well as consultants and advisors to public companies. Survey responses provide helpful insight into the current views of influential institutional investors in addition to signaling changes to ISS voting policies. This year’s survey was light on executive compensation related questions but did provide helpful feedback on two topics. (1) Frequency of Say-on-Pay: 66 percent of institutional investors favor annual say on pay votes, consistent with current ISS policy. (2) Pay for Performance Metrics: 79 percent of institutional investors support the incorporation of financial metrics, in addition to total shareholder returns, into the ISS pay-for-performance models that identify potential misalignments between CEO pay and company performance. The three most popular alternatives were return on investment metrics (e.g., return on invested capital), return metrics (e.g., return on assets or… Continue Reading

Ninth Circuit Holds Disgorgement Remedy Applies Regardless of Personal Misconduct of Issuer’s CEO or CFO

The U.S. Court of Appeals for the Ninth Circuit reversed a district court’s ruling interpreting Section 304 of the Sarbanes-Oxley Act (“SOX”) in an enforcement action filed by the SEC alleging that defendants participated in a scheme to defraud investors by overstating revenue by millions of dollars. SOX 304 requires reimbursement of certain types of compensation, such as bonuses or equity-based compensation received by CEOs and CFOs, within 12 months of the public issuance or filing of financial statements that are required to be restated due to a reporting error that is a result of “misconduct.” Previously, the SEC had sought to apply SOX 304 against CEOs and CFOs who were alleged to be personally involved in the wrongdoing leading to the restatement. However, in this case, “it is the [misconduct of the issuer of the financial statements] that matters and not the personal misconduct of the CEO or CFO.”… Continue Reading

IRS Issues Proposed Section 409A Regulations

The IRS recently issued proposed regulations that would amend the final regulations issued under Section 409A of the Internal Revenue Code. These regulations provide a number of clarifications and changes in response to practitioner comments. For instance, the regulations clarify that the separation pay plan exception may apply to a service provider who had no compensation in the year preceding the year of the separation from service. In such situations, annualized compensation from the year of separation is used. In addition, the term “eligible issuer of service recipient stock” now includes an entity for which a person is reasonably expected to begin, and actually begins, providing services within 12 months after the grant date of a stock right (i.e., an inducement option). The regulations also clarify that (i) a service provider’s right to reimbursement of reasonable attorneys’ fees and other expenses incurred to pursue a bona fide legal claim against… Continue Reading

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