Earlier this month, in In re Investors Bancorp, Inc. Stockholders Litigation, the Delaware Court of Chancery reiterated its view that placing a meaningful limit on director equity awards to be granted under a stockholder approved equity plan allows the court to determine whether director equity awards are excessive under the more lenient business judgment rule. Continue Reading Another Reminder that Director Limits set forth in Equity Plans Allow Director Compensation to be Reviewed under the more Lenient Business Judgment Rule
On August 5, by a vote of 3-to-2 with the SEC Commissioners voting along party lines, the SEC approved the final rule to implement the requirements of Section 953(b) of the Dodd-Frank Act, which instructed the SEC to amend existing rules under Item 402 of Regulation S-K to require public companies to disclose the ratio of their CEO’s annual total compensation to that of the median annual total compensation of all company employees. All public companies will be subject to this new disclosure requirement, with the exception of emerging growth companies, smaller reporting companies and foreign private issuers.
The rule requires companies to disclose:
(a) The median of the annual total compensation of all company employees, excluding the CEO;
(b) The annual total compensation of the company’s CEO; and
(c) The ratio of (a) to (b).
Companies will be required to provide disclosure of this ratio commencing with their first fiscal year beginning on or after January 1, 2017, which information will be disclosed in the Executive Compensation section of a company’s Form 10-K (or proxy statement). Thus, disclosure will begin in the 2018 proxy season. In addition to the ratio itself, disclosure describing the methodology used to identify the median employee, determine total compensation and any material assumptions, adjustments (including allowable cost-of-living adjustments) or estimates used to identify the median employee or to determine annual total compensation will also be required. As described in the proposed rule, when identifying the median employee, the final rule requires companies to include all employees, including full-time, part-time, temporary, seasonal, and foreign employees employed by the company or any of its subsidiaries and to annualize the compensation of permanent employees who were not employed for the entire year, such as new hires. Companies may not, however, annualize the compensation of part-time, temporary, or seasonal employees. Consultants and other advisors who are not employees and individuals who are employed by unaffiliated third parties are not to be included in the calculation.
Section 162(m) of the Internal Revenue Code precludes the deduction by public companies for compensation paid to certain covered employees in excess of $1,000,000 in any taxable year. This limitation on deduction does not apply to performance-based compensation. Such performance-based compensation is deductible so long as the following requirements are met:
- the compensation is paid solely on account of the attainment of one or more pre-established, objective performance goals,
- the performance goals must be established by a compensation committee comprised solely two or more outside directors,
- the material terms of performance goals under which the compensation is to be paid must be disclosed to and approved by the shareholders, and
- prior to payment of the performance-based compensation, the compensation committee must certify in writing that the performance goals have been attained.
Under the existing regulations, compensation attributable to stock options or stock appreciation rights are deemed to satisfy the performance-goal so long as, among other requirements, the plan under which the option or right is granted states the maximum number of shares with respect to which the option or right may be granted to any employee during any specified period and that cap is preapproved by the public company shareholders.
On March 31, the IRS issued final regulations clarifying the satisfaction of the performance-goal and shareholder approval requirement with respect to stock options and stock appreciation rights. Specifically, the IRS clarified that the performance-goal requirement is satisfied if the plan states the maximum number of shares with respect to which options or rights may be granted during a specified period to any individual employee. Further, the IRS clarified that the plan will satisfy this per employee limitation even if the plan provides the aggregate maximum number of shares with respect to which any equity-based award may be granted to any individual employee, such as restricted stock units and restricted stock. The IRS noted that this is not meant to be a substantive change in the regulations but only a clarification regarding satisfaction of the per employee limitation requirement.
The final regulations clarifying the per employee limitation requirement apply to compensation attributable to stock options or stock appreciation rights granted on or after June 24, 2011.
The final regulations also clarified the applicability of the transition rules for compensation payable pursuant to a restricted stock unit by companies that become publicly held after the grant. Generally, when a company becomes publicly held, the compensation deduction limitation under Section 162(m) does not apply to any compensation paid pursuant to a plan existing during the period prior to the company becoming public, and the company may rely on this transition relief provision until the earliest of:
- the expiration of the plan,
- a material modification of the plan,
- the issuance of all employer stock that has been allocated under the plan, and
- the first meeting of the shareholders at which directors are to be elected that occurs after the close of the third calendar year following the calendar year in which the IPO occurs or, in the case of a company that did not have an IPO, the first calendar year following the calendar year in which the company becomes publicly held.
This transition relief applies to any compensation received pursuant to the exercise of a stock option or stock appreciation right, or vesting of restricted stock (even though the compensation from time based restricted stock grants would not generally be exempt as a performance-based grant after the transition period), granted under a plan that would be eligible for the transition relief so long as the grant is before any of the above events. Under the final regulations, the IRS clarified that restricted stock units are eligible for the transition relief only if the compensation attributable to the restricted stock unit is paid (i.e. the shares underlying the award are delivered) before the first to occur of the above events, not merely granted.
The final regulations regarding the transition relief provisions apply to remuneration resulting from a stock option, stock appreciation right, restricted stock or restricted stock unit that is granted on or after April 1, 2015.
While the IRS does not deem these regulations to be significant, they do provide needed clarification to compensation committees and practitioners tasked with ensuring that compensation payable under equity and bonus plans is deductible by the companies. Moreover, private companies that become public are now on notice that the transition relief is limited for restricted stock units that vest after the transition period has terminated.