Executive Compensation:
From Stock Options to Severance
-Key Issues and Potential PitfallsFebruary 19, 2015
Chuck Campbell
Jackson Walker L.L.P.
100 Congress Avenue, Suite 1100
Austin, Texas 78701
[email protected]
512.236.2263
Chuck Campbell
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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.
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I.
II.
III.
Overview of Types of Executive Compensation
Overview of Applicable Law
Trends, Key Issues and Pitfalls
•
Equity Compensation
•
Bonuses and Incentive Plans
•
Severance
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I. Overview of Types
of Executive
Compensation
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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
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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
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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
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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.
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II. Overview of
Applicable Law
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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
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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
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III. Trends, Key Issues
and Pitfalls
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III. Trends, Key Issues and Pitfalls
• 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
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III. Trends, Key Issues and Pitfalls
• 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
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III. Trends, Key Issues and Pitfalls
• 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
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III. Trends, Key Issues and Pitfalls
• 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
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III. Trends, Key Issues and Pitfalls
• 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
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III. Trends, Key Issues and Pitfalls
• 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
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III. Trends, Key Issues and Pitfalls
• 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
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III. Trends, Key Issues and Pitfalls
• 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
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III. Trends, Key Issues and Pitfalls
• Pitfalls with Bonuses and Incentive Pay
– Failure to document terms of bonus arrangement
– Annual Bonus “vests” on December 31st, but not
paid until after March 15th 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
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III. Trends, Key Issues and Pitfalls
• 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
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III. Trends, Key Issues and Pitfalls
• 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
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III. Trends, Key Issues and Pitfalls
• 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
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III. Trends, Key Issues and Pitfalls
• 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
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III. Trends, Key Issues and Pitfalls
• 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
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Chuck Campbell
Jackson Walker L.L.P.
100 Congress Avenue, Suite 1100
Austin, Texas 78701
TEL
(512) 236-2263
[email protected]
FAX
(512) 391-2190