Executive Compensation Update

1
Executive Compensation Update

• Bill Sweetnam
• John McGuiness
• Eric Cotts
• October 19, 2006

2
Overview

• 409A
• SEC Exec Comp Disclosure Rules
• Backdated Options
• Congressional Hearings

3
409A

• New Notice 2006-79 extends until end of 2007
• Good faith compliance period
• Deadline for documentary compliance
• Transition relief for distribution elections
• Final regs still anticipated later this fall

4
409A

• Reporting and Withholding
• Not addressed in Notice 2006-79
• Guidance should be issued shortly
• Guidance should require reporting and withholding
  on 409A violations in 2006
• Anticipated extension of time for reporting of
  annual deferred compensation amounts

5
409A
Problem Areas Retirement Plans

• Determining key employees
• Avoiding material modifications
• changes made to related qualified plan
• 30-day rule for new participants
• no prior participation in any similar plan
• 401(k) mirror plans
• contingent benefit rule under 401(k)

6
409A
Problem Areas Equity Plans

• Definition of service recipient stock
• options to buy subsidiary stock
• FMV of private company stock
• Stock option exercise extensions
• RSUs with retirement feature
• Deferrals of RSUs

7
409A
Problem Areas Executive Severance

• Fitting arrangements into 409A exemptions
• bifurcation
• good reason payment triggers
• Treatment of medical and other post-employment
  fringes

8
409A
PPA amends 409A to provide adverse treatment for
funding (including rabbi trusts) of NQ plan
benefits for public company officers where

• Qualified DB plan in controlled group is at
  risk
• Plan sponsor in bankruptcy
• Underfunded qualified DB plan termination occurs

9
SEC Exec Comp Disclosure

• New rules apply to 2007 proxy statements
• issued in August 2006
• Significant changes to the January 2006 proposed
  rules on option grants and pension plan
  disclosures

10
SEC Exec Comp Disclosure
Requirement of a single total compensation figure
provided for each covered executive, including

• Value of option and other equity grants
• Annual change in actuarial value of DB plans
  (qualified and nonqualified) and above-market
  earnings on NQDC
• use FAS 87 assumptions
• Perks 10,000 exemption

11
SEC Exec Comp Disclosure
Significantly expanded retirement and severance
benefits disclosures

• Pension benefits table lump sum values
• FAS 87 assumptions used
• NQDC table
• Potential severance/change of control benefits
  payments estimated
• assuming 12/31/06 termination

12
SEC Exec Comp Disclosure
Stock option grant disclosures

• Rules do not use the term backdating or
  prohibit the practice
• Increased disclosure of (1) timing of grant, and
  (2) determination of exercise price
• Additional disclosure required if exercise price
  not based on closing price on grant date

13
SEC Exec Comp Disclosure
New Compensation, Discussion and Analysis
section discussing policies and decisions,
including

• Option and equity grant practices
• Decisions to waive or modify performance goals
• Impact of accounting and tax treatment, including
  Section 162(m)
• 2007 proxy will address 2006 decisions

14
Backdated Options
SEC and others investigating whether companies
engaged in backdating stock option grants

• SEC investigating over 100 companies
• Issuance of option with exercise price below
  value on date of grant (discounted option) may
  result in securities law disclosure issues,
  accounting charges, tax issues and shareholder
  suits

15
Backdated Options

• Potentially significant tax issues for companies
  and executives with discounted options
• 162(m) FMV and shareholder approval
  requirements
• 409A Generally subject to and will violate
  409A rules (unless vested before 2005)
• Disqualification of ISOs nonqualified option
  treatment

16
Backdated Options

• IRS requesting information about options as part
  of audit
• Copies of SEC reports or filings or internal
  investigation reports regarding the company's
  practice with grants and exercise of stock
  options
• Details regarding any options referenced in the
  filings or reports exercised during the years
  under examination
• Date all corporate action completed for option
  grant
• Effective date of option grant
• Fair market value of underlying stock at these
  two dates

17
Congressional Hearings

• Driven by backdating stories
• Senate Finance hearing focuses on governments
  response to backdating
• Are current tax laws, regulations adequate to
  rein in and prosecute backdating?
• Senate Banking hearing at which SEC Chairman Cox
  testified

18
Congressional Hearings

• Big focus of the Senate Finance hearing on
  Section 162(m)
• Complaints it has skewed compensation away from
  cash comp to options and other performance-based
  compensation
• Chairman Grassley and Baucus both indicated may
  need to revisit 162(m)

19
Congressional Hearings
Senate Finance Committee may look at taxation of
certain fringe benefits

• Particular focus on executive health benefits
• noted lavish benefits despite nondiscrimination
  rules
• Much discussion of income tax treatment of
  executives personal use of corporate aircraft
• Appropriateness of tax gross-ups

20
Congressional Hearings

• What will happen under new Congress
• Continued emphasis on executive compensation, no
  matter what party is in control
• If change in control, expect more restrictions on
  deferred compensation
• Source of revenue
• Sense of fairness
• Interaction with qualified retirement plans