New Laws Affecting Executive Compensation and Corporate Governance

002 has been a busy year for new and proposed rules governing executivecompensation. Below are just a few key developments.

THE SARBANES-OXLEY ACT OF 2002
    This law affects a number of executive officer and director compensationpractices at public companies:

• Most company loans to executive officers and directors are now prohibited,but the scope of the ban is not clear. As a result, certain split-dollar lifeinsurance arrangements (i.e., whole life insurance policies under which thecompany typically pays all or part of the premium and is repaid at maturity outof the cash value or proceeds), option exercises via broker loans and othercompensation practices that might be interpreted as extensions of credit need tobe reviewed.

  
  

• Officers and directors must report changes in their beneficial ownership ofcompany stock before the end of the second business day following the day thetransaction is executed. (Previously, transactions were reported monthly within10 days after close of each month.) Option grants as well as exercises aresubject to this accelerated reporting.

  
  

• CEOs and CFOs must pay back bonuses and profits from stock sales if a companyis required to restate its financial statements and the restatement is due tomaterial noncompliance as result of misconduct.

  
  

• Executive officers and directors may not buy or sell company stock during ablackout period when employees cannot change their investments in company stockheld in their Section 401(k) accounts.

  
  

GOVERNANCE PROPOSALS
    Separate sets of new rules proposed by the New York Stock Exchange and NASDAQwould require shareholder approval of all compensatory stock plans and materialamendments to such plans, except tax-qualified, non-discriminatory employeebenefit plans—(and any “parallel” nonqualified plans); inducement grantsto new employees; the conversion, replacement or adjustment of outstandingawards to reflect a merger or acquisition; and pre-existing shareholder approvedplans acquired in a merger or acquisition.

SPLIT-DOLLAR LIFE INSURANCE
    Split-dollar life insurance has been a useful tool for providing and securingexecutive benefits. Proposed Internal Revenue Service (IRS) regulations wouldprovide comprehensive guidance regarding the taxation of split-dollar lifeinsurance arrangements and would have design implications, particularly wherebenefit security is a major issue.

    Two mutually exclusive methods have been proposed:

• If the employer is the owner of the policy, the economic benefits of asplit-dollar life insurance arrangement will be treated and taxed as currenttransfers to the employee.

  
  

• If the employee is the owner of the policy, payments by the employer will betreated as a series of loans to the employee, taxable under the rules forbelow-market compensatory loans.

  
  

    The proposed regulations will be effective for arrangements entered intoafter the date of publication of final regulations. The IRS has also issued anumber of transition and grandfather rules covering arrangements entered intobefore the effective date of those rules.

GOLDEN PARACHUTES
    The accelerated vesting of a stock option is treated as a payment forpurposes of the golden parachute rules. In conjunction with the issuance of newproposed regulations, the IRS has indicated that the parachute value of anoption should be determined based on a modified Black-Scholes model rather thanon the option’s intrinsic value or spread. Use of this methodology will resultin larger parachute payments (and increased costs for companies that gross-upexcise tax liabilities).

DISCLOSURE OF EQUITY COMPENSATION PLANS
    The Securities and Exchange Commission (SEC) has adopted new rules designedto enhance disclosures regarding equity compensation plans, including plans thathave not been approved by shareholders. Companies must now disclose, in tabularformat, the number of securities to be issued upon the exercise of alloutstanding options, the weighted-average exercise price, and the number ofsecurities remaining available for future issuance. This information must beprovided separately for shareholder approved and non-shareholder approved plans.

    No disclosure is required with respect to tax-qualified employee benefitplans, such as §401 (k) plans and employee stock ownership plans (ESOPs). Onthe other hand, employee stock purchase plans, whether or not qualified, must bedisclosed.

    Excerpted from “Reconsidering Compensation and Other Needs in an Era ofHeightened Corporate Scrutiny,” written by Mark Meltzer of Sibson’s NewYork office.