“Every day,” says attorney Lisa Van Fleet, “we get asked things like, ‘How can we eliminate our match? What if we change our benefits program midyear? How do we manage a reduction in force? How do we put together severance pay packages?'”
Times have changed for every company. Since the economic downturn, not surprisingly, most of Van Fleet’s calls concern cutting costs associated with compensation and benefits. Van Fleet is a partner with the St. Louis office of the law firm Bryan Cave LLP.
“Those things have been the daily meat of our work for the last 9 months.” she adds. “The funny thing is, up until midnight on December 31, 2008, we were working with people to bring their deferred compensation plans into compliance with IRC Section 409A, the new executive compensation rules.”
Then, “almost at the stroke of midnight,” she says, it switched, and people wanted help to take compensation away from those same executives, or at least restructure the compensation. “Ironically, 409A, which was designed to prevent executive abuses, actually impedes your ability to take compensation back,” she notes.
Cutting Executive Compensation
In the companies she consults with, Van Fleet sees two broad areas of concern over executive compensation: One is midyear program changes, and the other is design changes.
For example, for midyear changes companies might want to eliminate bonuses or equity compensation arrangements. Or they might want to convert cash payments to equity payments, because they simply don’t have the cash. On the other hand, they may not be trying to reduce costs, but want to change from guaranteed bonuses to bonuses tied to the performance of the company.
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If your company wants to make mid-year changes, Van Fleet says, you need to measure those changes against the requirements of 409A.
“For example, say you have executives who are making $500,000 a year in cash, plus they have some deferred compensation arrangements. Let’s say they made an election to defer some portion of the cash compensation, and now you decide to convert $300,000 of their cash compensation to equity compensation. What has that done to the deferral election? Is that a permissible change?”
Whenever you contemplate such changes, you need to evaluate existing deferral arrangements against 409A to see if you’re creating any problems, Van Fleet says.
The second area of concern in executive compensation is design changes. “We’re seeing employers want to scale back on their compensation packages” but 409A brings something new to consider, says Van Fleet.
In addition, she notes, your payouts may be constrained because the company is in financial distress. If you want to make a payment under the deferred compensation plan, but making the payment would cause the company to be in jeopardy as an ongoing concern, Section 409A says you can’t make the payment.
No Clear Definitions
“Unfortunately, the IRS has never defined what it means by some of the terminology in 409A. It says, for instance, that if a company is experiencing a ‘downturn in financial health,’ then there are restrictions on the company’s ability to pay out deferred compensation.
“But it doesn’t define what ‘a downturn in financial health’ means.” Let’s face it, she says, nearly every company out there is experiencing a downturn in financial health right now.
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“Without a litmus test, without a definition,” she asks, “how can we know which companies are allowed to pay out deferred compensation?”
Overall, she says, “While we are seeing a lot of changes in the executive compensation area as a result of the current economic environment, the legal issues that are being raised are largely because of 409A.”
In tomorrow’s Advisor, we’ll get Van Fleet’s tips on proceeding with changes, and we’ll take a look at a unique one-stop resource for compensation data and guidance.
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