Section 162(m) Compliance Alert - Do You Need to Seek Shareholder Approval of Your Incentive Plan in 2014?

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By John McGrady, III, Esq.  

Buchanan Ingersoll & Rooney PC, Pittsburgh, PA

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 §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 §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), §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 §162(m).

Review Proxy Disclosures: Plaintiffs'
attorneys continue to bring derivative suits against corporations
and their boards challenging the corporation's compliance with
§162(m). The lawsuits allege, among other claims, that (i) the
corporation failed to comply with the procedural requirements of
§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 §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
§162(m).

Update/Establish Grant Procedures: Several
recent targets of derivative suits contain §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
§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
§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.

For more information, in the Tax Management Portfolios, see
Maldonado and Daley, 362 T.M.
, Securities Law Aspects of
Employee Benefit Plans, Brisendine, Drigotas and Pevarnik, 385
T.M.
, Deferred Compensation Arrangements, Moran, 390
T.M.
, Reasonable Compensation,  and in Tax Practice
Series, see ¶5420, Reasonable Compensation, ¶5715, Taxation of
Nonqualified Deferred Compensation Plans - Sections 409A and
457A.