Annual Reminder - If the corporation’s equity or annual incentive plan was last approved by shareholders in 2009, the plan(s) must be submitted to shareholders for re-approval in 2014 in order to ensure that future awards qualify as performance-based compensation under Section 162(m).
Compensation paid by a publicly-traded corporation to its CEO and three other highest compensated officers (other than the Principal Financial Officer) is generally not deductible to the extent it exceeds $1,000,000 per year. This limitation, however, does not apply to qualified performance-based compensation that complies with the requirements of Section 162(m).
There are numerous conditions that must be satisfied for awards to be considered performance-based compensation. Recent IRS audit activity in this area continues to reveal a number of common failures, including: (i) making mid-year changes to performance goals; (ii) making adjustments to the performance goals that were not pre-determined (e.g., adjusting for subsequent events); (iii) failing to obtain shareholder re-approval of the plan; (iv) paying awards out upon retirement or an involuntary termination regardless of whether the performance goals were satisfied; (v) using performance measures that are not included in the shareholder approved plan; (vi) paying out the compensation before the compensation committee certifies in writing that the performance goals were obtained; and (vii) issuing stock options in excess of plan limits.
In an effort to assist employers in their compliance efforts, set forth below are a few action items that employer’s should consider in order to enhance compliance.
What Can Employers Do to Enhance Compliance With Section 162(m)?
Shareholder Re-Approval of 2009 Plans: Where a plan allows the compensation committee to establish the performance goals and targets from year to year (as many plans commonly do), Section 162(m) requires that the performance goals be disclosed and re-approved by shareholders every five years. If the corporation’s equity or annual incentive plan was last approved by shareholders in 2009, the plan(s) must be submitted to the shareholders for re-approval in 2014 in order to ensure that future awards qualify as performance-based compensation under Section 162(m).
Review Proxy Disclosures: Plaintiffs’ attorneys continue to bring derivative suits against corporations and their boards challenging the corporation’s compliance with Section 162(m). The lawsuits allege, among other claims, that (i) the corporation failed to comply with the procedural requirements of Section 162(m), and (ii) the corporation’s proxy contained false and misleading statements by failing to disclose that awards violated the terms of the plan and/or did not qualify as performance-based compensation. Corporations should carefully review their proxy disclosures to ensure that they do not suggest or imply that the corporation’s plan and awards will qualify as performance-based compensation under Section 162(m). The use of language such as “may comply” or “is intended to comply” may protect the corporation from allegations of false or misleading statements in the proxy materials. Additionally, disclosures for shareholder approval or re-approval of a plan should be rigorously reviewed to ensure that they are drafted in compliance with the requirements of Section 162(m).
Update/Establish Grant Procedures: Several recent targets of derivative suits contain Section 162(m) claims involving the issuance of equity or incentive awards in excess of the plan’s specified limits. In several cases where the plan’s limits were exceeded, the Company and the executive agreed to rescind the grants that exceeded the limit in order to avoid the costs and distraction of litigation. Therefore, corporations should establish and/or update grant procedures to ensure that awards are made in compliance with the plan’s terms and that award limits are properly monitored.
Appoint a Section 162(m) Compliance Administrator: In light of the technical nature of Section 162(m), corporations should consider designating a compliance administrator in the corporation’s tax or legal department to assume overall responsibility for monitoring compliance with Section 162(m) and the corporation’s established grant procedures. The compliance administrator should be authorized to attend compensation committee meetings, and otherwise be given access to the corporation’s compensation, tax and legal advisors as necessary to carry out his or her responsibilities.