Executive Compensation: From Stock Options to Severance -Key Issues and Potential Pitfalls-

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1 Executive Compensation: From Stock Options to Severance -Key Issues and Potential Pitfalls- February 19, 2015 Chuck Campbell Jackson Walker L.L.P. 100 Congress Avenue, Suite 1100 Austin, Texas

2 Chuck Campbell Represents public and private sector clients in all areas of employee benefits and executive compensation, including plan administration, tax-qualified plan compliance, fiduciary responsibility, and plan investments. Participates in design, drafting, and compliance aspects of retirement plans (including 401(k), 403(b), and traditional pension plans), health and disability plans, deferred compensation plans (including handling aspects of 409A and 457 compliance), stock option and other equity compensation plans, severance arrangements, and executive employment agreements. Addresses employee benefit issues involved in mergers, acquisitions, and other transactions, including drafting and negotiation of relevant provisions in transaction documents and handling of the various transition issues that arise in such transactions. 2

3 I. Overview of Types of Executive Compensation II. Overview of Applicable Law III. Trends, Key Issues and Pitfalls Equity Compensation Bonuses and Incentive Plans Severance 3

4 I. Overview of Types of Executive Compensation 4

5 I. Overview of Types of Executive Compensation Equity Compensation Stock Options Stock Appreciation Rights Restricted Stock Restricted Stock Units Why? Align interests; no cash outlay; tax treatment Why Not? Administrative headaches; additional ownership 5

6 I. Overview of Types of Executive Compensation Bonuses and Incentive Plans Annual Bonus Plan Long-term Incentive Plans (LTIPs) Change-in-Control Plans Why? Pay for performance; retention tool Why not? Cash required; no ownership; no cap gains 6

7 I. Overview of Types of Executive Compensation Severance Cash and continued benefits Involuntary termination not for Cause Good Reason termination by executive Why? Protection for executive; enforcement of restrictive covenants Why not? Cash outlay; sour grapes 7

8 I. Overview of Types of Executive Compensation Benefits and Perquisites Retirement benefits 401(k), pension Excess benefit plans Supplemental executive retirement plans Nonqualified Deferred Compensation Welfare benefits (medical, life, disability) Moving and car allowance, memberships, etc. 8

9 II. Overview of Applicable Law 9

10 II. Overview of Applicable Law Internal Revenue Code 409A Deferred Compensation 280G Parachute Payments Contingent Upon Change in Control 422 Incentive Stock Options 423 Employee Stock Purchase Plans 162(m) - $1 Million Deduction limit Withholding obligations 10

11 II. Overview of Applicable Law ERISA Is the arrangement subject to it? ADEA Severance and release Securities Laws Reporting and proxy disclosure Corporate Governance Authority; Compensation Committee; Fiduciary concerns 11

12 III. Trends, Key Issues and Pitfalls 12

13 Trends in Equity Compensation More rigorous analysis as to its value as a compensation tool More variety (not just stock options) Favorable tax treatment??? Less use of Incentive Stock Options and more use of Non-Qualified Stock Options More performance-based vesting Double trigger vesting on a change-in-control 13

14 Key Issues with Equity Compensation Satisfaction of IRC 409A Equity compensation grants would be deferred compensation under IRC 409A and could not comply as traditionally structured without statutory exceptions Available exceptions are the stock right exception and short term deferral exception Restricted stock is exempt from 409A 14

15 Key Issues with Equity Compensation Stock right exception available for stock options and stock appreciation rights Requirements for exception: Exercise price must equal fair market value on date of grant Safe-harbor valuation methods Stock subject to option or SAR must be the stock of the service recipient No additional deferred compensation attached to option 15

16 Key Issues with Equity Compensation Short term deferral exception available for all equity compensation Payment (delivery of shares or cash) must be made within 2 ½ months after the year in which the award is no longer subject to substantial risk of forfeiture Pay as you vest Restricted Stock Units (or phantom stock) typically satisfy this requirement, as stock right exception is not available 16

17 Pitfalls with Equity Compensation Failure to complete formal grant of award that was promised to executive Promise of specific exercise price that does not equal fair market value on date of grant of award Suspect valuation method for establishing exercise price of private company Modification of equity compensation that is treated as new grant under IRC 17

18 Pitfalls with Equity Compensation Failure to satisfy Incentive Stock option requirements Failure to consider 280G impact of accelerated vesting upon change-in-control Failure to obtain shareholder approval when increasing number of shares available under the stock plan Failure to file 83(b) election on grant of restricted stock 18

19 Trends in Bonuses and Incentive Pay Emphasis on pay for performance More exotic performance provisions Increase in long-term incentive plans Change-in-control bonuses are more likely to have double trigger and gross-ups for 280G are less likely 19

20 Key Issues with Bonuses and Incentive Pay Ensure compliance with IRC 409A Satisfy short term deferral exception Compliance with a permissible payment event Separation from service, change in control, specified time IRC 280G concerns with Change-in-Control Arrangements If payments contingent upon change in control and exceed 3x the executive s base amount, executive subject to 20% excise tax and no deduction for company 20

21 Pitfalls with Bonuses and Incentive Pay Failure to document terms of bonus arrangement Annual Bonus vests on December 31 st, but not paid until after March 15 th of following year Disputes over satisfaction of performance goals If short term deferral exception not satisfied: LTIP has impermissible payment event as to 409A Definition of change in control does not comply with 409A 21

22 Trends in Severance Emphasis on Pay for Performance increases scrutiny on generous severance Shorter payment installments Good Reason termination trigger more common or standardized Cause definition not as heavily negotiated 22

23 Key Issues with Severance Satisfaction of IRC 409A through exception or compliance with permissible payment event (separation from service) Available exceptions are the short term deferral exception and the separation pay exception 23

24 Key Issues with Severance Separation pay exception requirements: Must be an involuntary termination of employment Severance amount cannot exceed 2 times the executive s annual compensation or, if less, 2 times the IRC 401(a)(17) limit ($265,000 in 2015) Involuntary termination includes a good reason termination, provided the good reason definition satisfies regulatory requirements Regulations provide a safe-harbor good reason definition 24

25 Pitfalls with Severance Failure to clearly state payment terms Payment terms do not comply with 409A Paid in installments but exceed annual compensation limit for short term deferral exception Good reason definition is insufficient due to no notice and right to cure provisions or too generous terms No separation from service due to on-going service relationship after termination of employment 25

26 Pitfalls with Severance Promised continuation of benefits following termination that does not comply with terms of benefit plan, COBRA or 409A Release provision does not satisfy ADEA requirements or fails to prevent executive from using return of release to impact year of payment in violation of 409A 26

27 Chuck Campbell Jackson Walker L.L.P. 100 Congress Avenue, Suite 1100 Austin, Texas TEL (512) FAX (512)

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