Spring has arrived - time again for benefit plan cleaning, with the help of the Quarles & Brady Employee Benefits & Executive Compensation Law Practice Group. This alert is the third in the "Spring Cleaning" series. Over the next several weeks, we will provide you with various to-do items, reminders, and tips in the employee benefits and executive compensation areas. In this "special" edition, we will focus on two issues that impact many publicly-traded companies —deductibility of compensation under Code Section 162(m) and fiduciary responsibility for company stock in a 401(k) plan.
Code Section 162(m) Refresher
Under Section 162(m) of the Internal Revenue Code (the "Code"), a public company's income tax deduction for compensation paid to its CEO and next three named executive officers other than the chief financial officer ("Covered Individuals") is generally limited to $1,000,000 per Covered Individual, per year. However, compensation that qualifies as "performance-based", which, among other things, is compensation that is paid under a shareholder approved plan and conditioned on the attainment of predetermined, objective performance goals, is not counted toward this limit. If your goal is to ensure that your company can deduct the full amount of bonuses and equity awards paid to the Covered Individuals, here are a few steps you should take each year:
Make sure that shareholders approved your equity and incentive plans in the last five years. If you go more than five years without shareholder approval, any compensation paid under those plans will not qualify as performance-based even if it is otherwise tied to financial performance criteria.
Consider incorporating incentive (bonus) plans into your equity plan. This will avoid the need to take multiple plans to shareholders for approval and decrease the chances that you will miss a shareholder approval deadline for your incentive plans.
Confirm that your company's compensation committee is made up solely of outside directors (directors who are not employees or former employees of the company and who are not paid for services outside of normal directors fees).
Tie incentive payments and vesting of awards other than stock options and stock appreciation rights (which are automatically performance-based if other requirements are met) to performance criteria that have been approved by shareholders.
Ensure that the compensation committee approves performance criteria for bonuses and equity awards in the first quarter of your company's fiscal year (or, if sooner, in the first quarter of the performance period) and obtain compensation committee certification of satisfaction of performance goals in advance of payment. Do not modify performance goals mid-year.
Do not exercise or retain in your plan documents discretion to increase payments for reasons other than satisfaction of predetermined, objective performance goals. (Discretion to decrease payments is permissible.)
Avoid employment or severance agreement provisions that permit payment of bonuses or other compensation tied to performance upon involuntary termination, good reason termination or retirement without regarding to satisfaction of performance goals.
Ensure that your equity plan sets a limit on the number of shares that can be granted to any individual plan participant and abide by those limits. Aggregate limits (e.g., no more than 100,000 shares among all participants) will not meet this requirement.
Company Stock in a 401(k) Plan - Things to Consider
Company stock in a 401(k) or other defined contribution plan presents numerous challenges to plan fiduciaries. Prior to the U.S. Supreme Court's 2014 decision in Fifth Third Bancorp v. Dudenhoeffer, plan fiduciaries were somewhat insulated from fiduciary breach claims challenging the offering of company stock in a plan if the plan terms mandated the offering. If you have a 401(k) plan that offers company stock as an investment option and have not already done so, you should:
Review plan language and consider modifying plan language that mandates a company stock offering to clarify that the company stock fund is only "mandatory" to the extent the offering is not inconsistent with ERISA. Without this modification, you may have a plan provision that requires fiduciaries to ignore their fiduciary duties under ERISA.
Consider hiring an independent, third-party fiduciary to oversee the company stock investment and periodically analyze the prudence of the offering. While the failure to use a third party fiduciary certainly is not in itself a fiduciary breach, we do think it is at least worthwhile for plan fiduciaries to consider the best way to ensure that a company stock offering remains prudent and in the best interests of plan participants and beneficiaries. Similarly, you may want to consider whether officers and others with inside information should be involved in decisions to retain a company stock fund in your plan.
Ensure that your fiduciary committee periodically reviews company stock fund performance and that committee minutes reflect that review. It is often the case in litigation involving plan investments that the process that plan fiduciaries followed is as important as whether they made the best decision.