I think it’s safe to generalize that in many companies, the level of compensation decision making made by the rank and file is limited, if they are involved at all. Those of us in stock compensation are used to grant approval processes involving managers, executives and board committees, and this has been a long-standing practice. A handful of companies, however, are taking a different approach to granting stock options, one that allocates decision making to the core of the organization.
Peer to Peer Grants
A recent article in the Wall Street Journal profiled companies who are taking new approaches to making determinations in employee compensation. These companies are creating internal programs that allow a broad base of employees to allocate stock options and/or cash to their peers who they feel deserve to be rewarded. The idea behind this concept is that the rank and file often have the most insight into how their peers perform. There are various shapes and flavors to how companies have approached this type of program. One company allocated 1,200 stock options to each of its employees with the idea that each employee would distribute their options to colleagues. Employees had control over who received the stock options – it could be a single allocation to one colleague, or divided among multiple targeted colleagues. There were a few ground rules, including that workers couldn’t reward themselves or company founders (who already presumably have significant grants or shares). It seems the companies are also keeping the details of these decisions confidential, releasing only general statistics and end results to participants. Employees will know they were rewarded, by not by whom.
Other varieties to these programs include internal virtual markets comprised of cash or stock options, where workers can allocate or transfer funds. Some companies have allocated imaginary dollars or shares that employees can use to recognize their colleagues. These programs may not be exchanging actual shares or cash, but management is able to see results, which may reveal some interesting perceptions coming out of the main street of the organization.
Pros and Cons
Supporters of these programs suggest that peer influence over compensation will inspire more accountability and ensure everyone contributes. Management may also gain better visibility into which employees seem to be the best performers, casting a spotlight on stars that may have otherwise flown under the radar. Skeptics warn that too much peer say in pay decisions may create resentment and fuel hard feelings for those who receive little or no rewards. Could it become a popularity contest? Those who have implemented these programs appear to remain firmly in support of them, but caution that this may not be the right approach for every company. As one business professor put it: “You need management that is comfortable giving up some say, and let’s face it, human nature isn’t all programmed that way.”
What do you think? I’d love to capture your reaction in the poll below.
The SEC plans to address the clawbacks in Section 954 of the Dodd-Frank Act between August and December of this year. Many companies appear to be waiting to make final decisions on how to apply the clawback requirements until the SEC completes the proposed rules. (There is more information on creating a clawback policy in the NASPP blog entry, Clawbacks and Executive Compensation.)
Under the Dodd-Frank Act, companies risk delisting if they do not adopt a clawback policy that complies with Section 954 (which is now Section 10D of the Exchange Act). Some of the more difficult aspects of compliance may be in the clawback period (there is a three-year look-back), the potential for little or no company discretion in enforcing the policy, the fact that the executive does not need to be at fault or have contributed to a financial restatement and the actual calculation of compensation that must be recouped.
SEC Enforcement
In 2009, the SEC brought the first enforcement action based solely on SOX clawback provisions. There has been an increase since that case of suits involving clawbacks initiated by the SEC. Last month Beazer CEO, Ian McCarthy, agreed to pay back $6.5 million in compensation under the SEC action against him. (It may not be a coincidence, then, that Beazer’s shareholders voted against pay packages for company executives this year).
Enforcement Snags
The legal aspect of actually recouping compensation under a clawback provision or policy is complex. In the Unites States, enforcement is subject to state wage laws and may or may not be feasible. Presumably, the federal regulations from Dodd-Frank will trump state law, but that is yet another detail to be worked out. Another difficulty for companies to overcome is with respect to di minimis recoupment amounts or clawbacks that would require unreasonable efforts, such as situations where the individual does not have the finances available to repay the compensation.
International Considerations
International considerations for clawbacks are covered in this great matrix from Baker & McKenzie, which differentiates between Dodd-Frank, noncompete, and nonsolicitation clawback practices. In some countries like Canada, Germany, and Mexico, the provisions of Dodd-Frank are likely to be enforceable. However, in many countries like Australia, Japan, Spain, such policies most likely would not be enforceable, particularly if there isn’t an issue of misconduct or individual culpability. There are even situations like in Ireland or the UK where the provisions are likely to be enforceable as long as they were included in the original agreement, which could be a problem for existing equity compensation.
One of the fundamental principles behind deferring payout on awards is the desire to lessen the potential time gap between the point at which an executive is rewarded for his or her policies and the point at which the company realizes the consequences or benefits of those same decisions. The deferral is one way to help keep executives focused on the long-term impact of business strategy.
Advantages
As Barbara pointed out in her August 17th blog entry, deferring the payout of shares can be particularly useful when used in conjunction with a clawback provision or to supplement the company’s ownership guidelines. A deferral may also be valuable for performance awards if there is the possibility of a future negative adjustment exists.
With clawbacks and potential negative adjustments on performance award payouts, it can be very difficult to recover shares or income after the fact, even with carefully constructed provisions. If the company must take back vested shares, it is obviously easier to do if the shares have not been disposed of, yet.
Depending on the parameters of a company’s holding requirements or ownership guidelines, it may be advantageous to an executive subject to these policies to also be subject to deferral on certain grants. The deferral may effectively delay the income event out to a point that either coincides with or is closer to the point at which the executive can dispose of the shares.
Considerations
Of course, any deferral program should be compliant with 409A. However, because there is no deferral election, designing within the parameters of 409A is easier. Another consideration is whether or not the deferral would require, or even be best suited for, a non-qualified deferred compensation program into which the vested shares may be deposited. Visit our Section 409A portal or Bruce Brumerg’s new site, www.myNQDC.com, for more on this issue.
In conjunction with 409A compliance, the general timing of the deferral is a key issue. On one hand, the deferral should be far enough into the future to align the executive’s risk on that potential income with the company’s risk. However, executives are making policy that could impact the company far into the future; there is little incentive for income that is delayed indefinitely. A compromise must be reached to find an appropriate period of time that is effective as a risk-mitigation technique that does not negate the incentivizing power of the reward.
Taxation
Some RSU programs permit participants to elect to defer the payout of shares to a future date, presumably a time when the participant’s tax bracket is lower than in the year of the original vest. 409A has made elective deferral programs more cumbersome, but they do still exist. A non-elective deferral does not give the participant control over whether or not receipt of the vested shares is deferred. As our panelists in the Conference session “Risk Mitigation for Stock Compensation” pointed out, we are at a point when income tax rates are likely to increase in the near future, which makes deferring income less appealing right now. A company implementing a required deferral of RSU or performance shares should carefully consider how to communicate the program’s goals and application to executives or other employees who will be subject to the deferral.
On a more practical administrative level, deferral of the share payout only defers the income tax withholding requirement. FICA withholding, along with the associated FUTA contribution, are due at the vest date.
Quick Survey on 6039 Returns and Information Statements
Take our quick survey on filing Forms 3921 and 3922 to report ISO and ESPP transactions to the IRS and on distributing the associated information statements to plan participants. Find out how other companies are planning to comply with these new requirements.