Executive Compensation and Stock Options Presented by Candace L. Quinn. 37 Offices in 18 Countries

Transcription

1 Presented by Candace L. Quinn 37 Offices in 18 Countries 10/18/2012

2 2 Executive Compensation and Stock Options Overview of Presentation I.What is Executive Compensation and What are the Components? II.Developments in 2012 Changes Ø IRC Section 409A Release of Claims Ø IRC Section 162(m) and Dividend Terms Ø Dodd Frank Act Update Ø SEC Pronouncements Ø NASDAQ/NYSE Proposed Rules Ø Institutional Shareholder Services III.What s Looming for 2013 Changes Ø SEC Rules to be Issued Ø ISS Updates Expected Ø Taxes Potential changes in Rates IV.Tax Efficiency and Mitigating Compliance Risk Ø Action Steps to Consider for Tax Efficiency Ø Compliance Considerations for Compensation Committees Ø Conduct Due Diligence Review V.Conclusion VI.Questions

3 I. What is Executive Compensation and What are the Components? Ø Salary Compensation paid during the year. Salary reflected on Form W-2. Ø Annual Incentive Bonus and any non-equity incentive award earned. Ø Equity Based Compensation Typically, subject to vesting or performance criteria. Generally, there are two types: Stock Options Grant date value of all grants during the year (Institutional Shareholder Services (ISS) uses Equilar Black-Scholes value which is 1.4x 1.6x greater than company reports).» Non-Qualified Stock Options (NQSO) Usually, a specified number of shares available at a set price Price purchased is the Exercise Price. Fair Market Value (FMV). Spread is difference between FMV and Exercise Price of each share Upon Exercise, spread is subject to Federal income tax and employment tax withholding. Upon sale of stock, capital gain/loss. 3

4 Ø Ø Ø» Incentive Stock Options (ISO) Upon exercise, spread not included in income. Requirements of ISO: must hold stock for one year and two years from date ISO was granted. Upon sale, spread not subject to income tax but treated as capital gain/loss. If holding period is not satisfied, spread will be taxed as ordinary income. Restricted Stock and Restricted Stock Units Grant date value (Number of shares times stock purchase at grant). Pension Qualified Defined Benefit or Defined Contribution Plans (change in Pension Value). Non-Qualified Deferred Compensation and Earnings Other Compensation/Prerequisites 4

5 II. Developments in 2012 Changes Ø Ø IRC Section 409A Release of Claims What is IRC Section 409A? Transitional relief by the IRS expires for deferred compensation arrangements that make payment conditional on the employee s execution of a release of claims (a release-based payment ). Deferred compensation plans, including employment agreements, need to be reviewed and revised by the end of the year. IRC Section 162(m) and Dividend Terms What is IRC Section 162(m)?» IRC Section 162(m) limits a public company deduction for executive compensation to one million dollars unless exempt qualified performance based compensation. How Do You Qualify for the Exemption?» Qualified Performance Based Compensation 5

6 » Requirements: Compensation must be paid solely on account of preestablished objective performance goals (although payments due to death, disability or change in ownership or control will not disqualify) Compensation Committee must have two or more outside directors Goals for executives must be established within 90 days after performance period begins (by March 31 for 2013 calendar year plans) or if sooner before 25% of performance period has elapsed Committee cannot have discretion to increase compensation after goal has been attained. However, negative discretion (to reduce or eliminate award) allowed Material Terms of executives performance agreement must be disclosed to shareholders to obtain shareholder approval before compensation paid Even if material terms do not change, company must still obtain shareholder approval every five years if committee has the power to adjust specific performance targets.» Compensation Committee must certify, in writing, goals have been met before compensation is paid 6

7 Stock options and SARs deemed qualified performance based and do not have to meet all other requirements if granted under a plan:» Contains maximum number of shares for which options or SARs may be granted, and» Exercise price or base value at or above the stock s grant date fair market value. Other Equity Awards, including discounted stock options, RS and RSU must meet all requirements to be considered qualified performance based compensation. New Development: Revenue Ruling Clarifies that, even if restricted stock or RSUs are qualified performance-based compensation, any related dividends or dividend equivalents must separately satisfy the requirements under Section 162(m). Action Steps: Restricted stock and RSU agreements need to be reviewed and may need revisions for compliance. 7

8 Ø Dodd Frank Act Update Non-binding say on pay» SAY on PAY (SOP) 2013 will be the third year of SOP for most public companies Goal: Affirmation of Company s current executive pay programs and alert board when programs are overly generous or insufficiently aligned with company s performance Reality: SOP has far-reaching implications for corporate governance, transparency, and compensation committee management Recent related SEC Guidance on SOP New Institutional Shareholder Services (ISS) supermajority approval standard ISS CEO pay-for-performance test SOP derivative litigation and settlements Compensation Committee Independence» Dodd-Frank Independence requirements for Compensation Committees and Compensation Advisors. 8

9 Ø 2012 SEC Changes June 2012, SEC issued final rule on Listing Standards for Compensation Committee (Past SEC Rules addressed Say on Pay and approval of Golden Parachutes) According to SEC Rule, National Exchanges must issue proposed rules prohibiting the listing of stock of any company not complying with Independence rules; and Requires all National Exchanges to establish listing standards for compensation committees to be independent. Independence means:» Identify the source of compensation of each director; and» Whether the director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary Ø NASDAQ/NYSE Proposed Rules NASDAQ now requires compensation committee to have a written charter. Committees must be able to obtain the advice of an independent compensation consultant, legal counsel and other advisor. 9

10 Are you Ready for 2013? Action Steps» Review committee charter and proxy disclosures. Ø Institutional Shareholder Services What is ISS? Section 162(m) voting» ISS new policy is to conduct a full equity plan analysis in determining whether or not to vote in the affirmative for equity plans.» Burn rate policy.» Compensation committee structure concerns. 10

11 Are you Ready for 2013? III. What s Looming for 2013 Changes Ø SEC Rules to be Issued Dodd-Frank s clawback policy and CEO pay ratio disclosure requirements. Dodd-Frank s clawback policy mandates recoupment of incentive compensation paid to executive officers in the three years preceding any accounting restatement of the company s financial statements that exceeds the amount of incentive compensation that would have been paid had the restated financial statements applied. No requirement that an executive engage in misconduct. Clawback policy has a no fault approach to the recoupment of incentive compensation. Dodd-Frank s CEO pay ratio disclosure mandates the disclosure of the ratio of CEO pay to the median pay of all other employees. 11

12 Are you Ready for 2013? SEC Commissioner Troy A. Paredes discusses: pay for performance, hedging policy, clawback and internal pay ratio Addressing SEC Rule on Dodd Frank s clawback policy and CEO pay ratio disclosure requirements (July 13, 2012), Commissioner notes:» Difficulty with Workability in Practice» Concern compensation arrangements would be restructured executives would receive less incentive pay which could be clawed back, larger discretionary bonuses, higher base, less incentive, pay and executive performance issues. Concern with CEO pay rate too low.» Disconnect between Business Strategy and Company s Culture. Ø ISS Updates Expected ISS updates its proxy voting guidelines annually, typically in January. Likely ISS will maintain focus on CEO compensation and/or total shareholder return ( TSR ) in determining whether to recommend an approval, withhold or no vote on such compensation. Prior year s update focused on the methodology to determine the alignment between CEO compensation and TSR. 12

13 Are you Ready for 2013? Ø Taxes No matter who is President, taxes will likely be changed. Increase in ordinary income tax rates. Rates are as follows: 2012 Ordinary Income Tax Rates 2013 Ordinary Income Tax Rates 35% 39.6% 33% 36% 28% 31% 25% 28% Increase in capital gain tax rates. Rates are as follows: 2012 Dividend and Capital Gain Tax Rates 2013 Capital Gain Tax Rates 15% 20% 13

14 Starting in 2013, dividend income would be subject to ordinary income tax rates. Payroll tax holiday set to expire. This means employees social security tax rate will return to 6.2% from the temporarily reduced rate of 4.2%. 0.9% hospital insurance (HI) tax applies under Code Section 3101(b) (2) to wages received with respect to employment in excess of: $250,000 for joint returns; $125,000 for married filing separately; and $200,000 for single. 3.8% Medicare tax for high-income individuals under Code Section In general, the tax is imposed on the lesser of: (i) net investment income for the year or (ii) the excess of modified adjusted gross income for the year over the following income levels: $250,000 for joint returns; $125,000 for married filing separately; and $200,000 for single. Net investment income is generally interest, dividends, annuities, royalties, rents, most capital gains, and income from passive activities minus allowable deductions for such items. 14

15 Are you Ready for 2013? Currently, standard supplemental wage withholding rates are 35% for supplemental wages over $1 million and 25% for below $1 million. Supplemental wages are all wages paid by an employer that are not regular wages. Examples include: income recognized on the exercise of a nonstatutory stock options, bonuses, back pay, commissions, wages paid under reimbursement or other expense allowance arrangements, nonqualified deferred compensation includible in wages, wages paid as noncash fringe benefits, and wage income recognized on the lapse of a restriction on restricted property transferred from an employer to an employee. If tax rates go up, supplemental withholding rates will rise to 39.6% for over $1 million and 28% for below $1 million. Also, some employees will ask employers to pay 2013 bonuses in 2012 be wary of IRC 409A. 15

16 Are you Ready for 2013? IV. Tax Efficiency and Mitigating Compliance Risk Ø Action Steps to Consider for Tax Efficiency Engage an Independent Compensation Consultant To advise the Compensation Committee as to the proper mix of cash-settled and equity-settled equity compensation awards Grant Incentive Stock Options (ISOs) ISOs are not subject to Medicare (or Social Security) taxes Settle Executive Equity Awards The same level of share ownership may not make sense in the context of greater tax equalization between equity-settled awards (e.g., shares of restricted stock) and cash-settled awards (e.g., restricted stock units); and Implement Share Repurchase Program (Cash Flow Permitting) Because executives and directors could be insiders under the Securities Exchange Act of 1934, as amended (the Exchange Act ), the company should consider integrating any such share repurchase program with its insider trading policy and the requirements of Exchange Act Rule 10b-18 (which could provide the company with a non-exclusive safe harbor from certain market manipulation rules). 16

17 Are you Ready for 2013? Ø Compliance Considerations for Compensation Committees Addressing IRC 162(m)» Consider an Umbrella Arrangement Committee establishes an objective formula that sets a ceiling on incentive compensation while retaining discretion to reduce or eliminate compensation.» Pre-IPO Plans 162(m) doesn t apply to compensation paid during reliance period before going public. Evaluate Committee Independence Monitor Consultants Arrangements» Views and recommendations of any compensation consultant retained by the compensation committee can significantly affect the types and amounts of executive compensation.» Verify Independence and Representations in Retainer Letter Should be no business or personal relationships with members of the compensation committee; and» Require Conflict of Interest Policies and Procedures from Consultants Watch out for Consultant s Agreements requiring members of the committee to indemnify and hold harmless the compensation consultant for losses. 17

18 » Seek Independent Legal Review of Compensation Consultants arrangement» Do not retain Compensation Advisor that owns stock of Company Identify any red flag practices of Compensation Committee» Approving or Permitting Additional Fees for Committee Member Raised if Company paying a member of the committee a consulting, advisory or other compensatory fee, in addition to committee or board retainer fees» Permitting Affiliation of Committee Member with Management Raised independence concerns if a member of the committee affiliates with the company or any subsidiary in addition to role as a committee member» Retaining Compensation Advisor that has business or personal relationships with committee member Ø Conduct Due Diligence Review Conduct independent Due Diligence Compliance Review to ensure best practices governance standards implemented, transparency provided and verify absence of conflict of interest. 18

19 V. Conclusion Ø Ø 2012 Regulatory Requirements and 2013 Expected Developments require focus on: Best Practice Corporate Governance; Compliance with Regulatory Requirements and Securities Law; and Developing Effective Policies and Procedures Governing Executive Compensation Process is Prudence 19

20 VI. Questions 20

21 Contact Information Squire Sanders (US) LLP Candace L. Quinn 30 Rockefeller Plaza, 23rd Floor New York, New York Phone: (office) 21

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