Executive Compensation Enters Uncertain Territory with Tax Overhaul and Other Changes Pending


 

As the first year of the Trump administration nears an end, legislative and regulatory changes affecting executive compensation remain in flux. 

One of the biggest unknowns at the moment is the extent to which a GOP tax overhaul plan would alter existing provisions governing executive compensation. In addition, various elements of the Dodd-Frank Wall Street Reform and Consumer Protection Act face possible elimination if the White House and congressional Republicans are able to advance their deregulatory agenda. 

Rewrite of Tax Code

A draft tax reform plan released Nov. 2 by the House Republican leadership, dubbed the Tax Cuts and Jobs Act (H.R. 1), included language that could dramatically affect executive compensation plans and practitioners.

For example, the plan proposed a change to Internal Revenue Code Section 162(m) which sets a $1 million deduction limitation for compensation of certain top executives. While Section 162(m) currently allows companies to exclude performance-based compensation from the $1 million limit, the House tax plan would get rid of that exception.

Other executive compensation changes that appeared in the House leadership’s draft—including a proposal to treat stock options as deferred pay and rewrite Code Section 409A, which governs nonqualified deferred compensation plans—got axed before the measure was approved by the House Ways and Means Committee and sent to the House floor.

Of course, Republicans in the Senate have their own ideas on how to rewrite the tax code, and President Trump has changes he wants to see reflected in a final package. The full extent of the impact on executive compensation will only become clear if and when tax reform legislation receives final approval on Capitol Hill and at the White House.

Revamp of Dodd-Frank

In addition to pending tax changes that could reshape the executive comp landscape, the GOP’s deregulatory agenda has placed various Dodd-Frank Act requirements on the chopping block.

One of the most sweeping efforts to overhaul Dodd-Frank is the Financial Choice Act of 2017 (H.R. 10). Even though the House approved this legislation on June 8, it has languished in the Senate and faces slim prospects of passage given opposition among Democrats.

Legislation isn’t the only avenue available for taking down unwanted Dodd-Frank requirements, however, as evidenced by recent regulatory shifts coming out of the Securities and Exchange Commission.

Here’s a quick rundown on the status of some of the main Dodd-Frank provisions affecting executive compensation:

CEO pay ratio disclosures—Publicly traded companies subject to this requirement under Section 953(b) of the Dodd-Frank Act must report to the SEC the ratio of the median employee’s compensation to the annual total compensation of the CEO starting with the 2018 proxy season. This is one of the provisions targeted for elimination by the Financial Choice Act, and the pay ratio rule also received fresh scrutiny at the SEC in the wake of President Trump’s election. Nevertheless, the SEC released interpretive guidance in September indicating that the reporting requirement will go into effect as scheduled (to the displeasure of many). Keep an eye out for further developments, though, as the Department of Treasury has also called for repeal of the pay ratio rule. 

Say-on-pay votes—This requirement under Section 951 of the Dodd-Frank Act gives shareholders the opportunity to weigh in on executive compensation plans and “golden parachute” arrangements in nonbinding votes at least every three years. The SEC’s final rule implementing the say-on-pay provisions came out in 2011, but the Financial Choice Act would scale back the requirement. Investors have already grown accustomed to flexing their say-on-pay muscles, so if the current requirements were scrapped, it’s likely that large institutional investors would seek other ways to exert influence over executive pay.

Clawbacks—Under proposed regulations implementing Section 954 of the Dodd-Frank Act, national stock exchanges would no longer be able to list the securities of companies that haven’t developed, implemented, and disclosed clawback policies for incentive-based compensation. The Financial Choice Act would limit the requirement to current or former executive officers who had control or authority for company financial reporting, but the rule won’t apply to anyone until it has been issued in final form.  The SEC has pulled the proposed rule on clawbacks off of its immediate rulemaking agenda, instead classifying it as a long-term action, which means nothing will happen anytime soon.   

The SEC, under new commissioner Jay Clayton, has also moved several other rulemaking endeavors to its long-term action list. Among them are rules under Section 953(a) of the Dodd-Frank Act, which calls for “pay versus performance” disclosures of the relationship between executive compensation and company financial performance, and Section 955 of the Dodd-Frank Act, which calls for disclosures of whether employees or board members are permitted to hedge any decrease in the market value of equity securities they’re granted as part of their compensation.

Even without the Dodd-Frank overhaul envisioned under the Financial Choice Act, regulatory action has at least slowed down in the wake of President Trump’s election. And the administration and congressional Republicans clearly have further plans in mind that will affect executive compensation.  

If those plans don’t come to fruition by the end of this year, you can be sure they will remain on the agenda in 2018.

 

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