Executive Compensation

Update

Bill SweetnamJohn McGuiness

Eric CottsOctober 19, 2006

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Overview §409A SEC Exec Comp Disclosure Rules Backdated Options Congressional Hearings

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§409A New Notice 2006-79 extends until end of

2007: Good faith compliance period Deadline for documentary compliance Transition relief for distribution elections

Final regs still anticipated later this fall

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§409A Reporting and Withholding

Not addressed in Notice 2006-79 Guidance should be issued shortly Guidance should require reporting and

withholding on §409A violations in 2006 Anticipated extension of time for reporting of

annual deferred compensation amounts

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§409A

Determining key employees Avoiding material modifications

changes made to related qualified plan 30-day rule for new participants

no prior participation in any similar plan §401(k) mirror plans

contingent benefit rule under §401(k)

Problem Areas – Retirement Plans

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§409A

Definition of service recipient stock options to buy subsidiary stock

FMV of private company stock Stock option exercise extensions RSUs with retirement feature Deferrals of RSUs

Problem Areas – Equity Plans

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§409A

Fitting arrangements into §409A exemptions bifurcation good reason payment triggers

Treatment of medical and other post-employment fringes

Problem Areas – Executive Severance

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§409A

Qualified DB plan in controlled group is “at risk”

Plan sponsor in bankruptcy Underfunded qualified DB plan termination

occurs

PPA amends §409A to provide adverse treatment for funding (including rabbi trusts) of NQ plan benefits for public company officers where:

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SEC Exec Comp Disclosure

New rules apply to 2007 proxy statements issued in August 2006

Significant changes to the January 2006 proposed rules on option grants and pension plan disclosures

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SEC Exec Comp Disclosure

Value of option and other equity grants Annual change in actuarial value of DB plans

(qualified and nonqualified) and above-market earnings on NQDC use FAS 87 assumptions

Perks – $10,000 exemption

Requirement of a single total compensation figure provided for each covered executive, including:

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SEC Exec Comp Disclosure

Pension benefits table – lump sum values FAS 87 assumptions used

NQDC table Potential severance/change of control

benefits payments estimated assuming 12/31/06 termination

Significantly expanded retirement and severance benefits disclosures

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SEC Exec Comp Disclosure

Rules do not use the term “backdating” or prohibit the practice

Increased disclosure of (1) timing of grant, and (2) determination of exercise price

Additional disclosure required if exercise price not based on closing price on grant date

Stock option grant disclosures

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SEC Exec Comp Disclosure

Option and equity grant practices Decisions to waive or modify performance

goals Impact of accounting and tax treatment,

including Section 162(m) 2007 proxy will address 2006 decisions

New “Compensation, Discussion and Analysis” section discussing policies and decisions, including:

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Backdated Options

SEC investigating over 100 companies Issuance of option with exercise price below

value on date of grant (“discounted option”) may result in securities law disclosure issues, accounting charges, tax issues and shareholder suits

SEC and others investigating whether companies engaged in backdating stock option grants

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Backdated Options Potentially significant tax issues for

companies and executives with discounted options §162(m) – FMV and shareholder approval

requirements §409A – Generally subject to – and will violate –

§409A rules (unless vested before 2005) Disqualification of ISOs – nonqualified option

treatment

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Backdated Options IRS requesting information about options

as part of audit Copies of SEC reports or filings or internal

investigation reports regarding the company's practice with grants and exercise of stock options

Details regarding any options referenced in the filings or reports exercised during the years under examination

Date all corporate action completed for option grant Effective date of option grant Fair market value of underlying stock at these two

dates

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Congressional Hearings Driven by backdating stories Senate Finance hearing focuses on

government’s response to backdating Are current tax laws, regulations adequate to

“rein in and prosecute” backdating? Senate Banking hearing at which SEC

Chairman Cox testified

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Congressional Hearings Big focus of the Senate Finance hearing on

Section 162(m) Complaints it has skewed compensation

away from cash comp to options and other “performance-based compensation”

Chairman Grassley and Baucus both indicated may need to revisit 162(m)

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Congressional Hearings

Particular focus on executive health benefits noted lavish benefits despite nondiscrimination

rules Much discussion of income tax treatment of

executives’ personal use of corporate aircraft Appropriateness of tax gross-ups

Senate Finance Committee may look at taxation of certain “fringe benefits”

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Congressional Hearings What will happen under new Congress

Continued emphasis on executive compensation, no matter what party is in control

If change in control, expect more restrictions on deferred compensation

Source of revenue Sense of fairness Interaction with qualified retirement plans