PLC Global Finance update for November 2009: United States

Practical Law UK Articles 9-501-0377 (Approx. 3 pages)

PLC Global Finance update for November 2009: United States

by Shearman & Sterling LLP

Executive compensation and employee benefits

Emerging trends in executive compensation

Doreen E. Lilienfeld, Amy B. Gitlitz and Veronica M. Wissel

On 22 October 2009, the Special Master for TARP Executive Compensation released seven Determination Memoranda (Special Master Rulings) addressing the limits on compensation payable to top executives at TARP entities that received "exceptional assistance". On the same day, the Federal Reserve Board (Fed) released proposed guidance (Fed Guidance) on incentive pay at the financial organisations that it regulates (Bank Organisations). Both the Special Master Rulings and the Fed Guidance build upon several trends related to executive pay that have come more sharply into focus as a result of the financial crisis. If, as suspected, the Special Master Rulings and Fed Guidance are indicative of the shape of the future compensation landscape, then it can be anticipated that:

Efforts to place a hard cap on pay will be abandoned in favour of a reallocation among types of compensation. While the Special Master Rulings generally decrease overall compensation for top executives, they do not cap potential incentive compensation. Instead, they reinforce the idea that total compensation should be reasonably benchmarked to the market. In addition, the rulings reallocate compensation among cash, restricted stock and long-term equity awards by reducing cash compensation and subjecting more compensation to vesting and transferability restrictions.
Performance-based compensation will be subject to longer vesting and transferability restrictions and will be based on measurable and objective long-term performance goals. The Special Master Rulings represent a notable move toward paying a larger portion of compensation in the form of unleveraged company stock.
The relationship between pay and risk will be an increasingly important consideration in the compensation setting process and in compensation disclosure. The focus on risk management will likely lead to longer term performance periods, year-over-year netting and reductions in the use of cash and leveraged equity bonus awards. Both the Special Master Rulings and the Fed Guidance focus on the need for transferability restrictions on incentive pay and systematic and enforced deferrals of incentive payments.
There will be continued pressure on directors to justify new or renewed severance arrangements and to reduce or eliminate existing severance and change in control packages. Both the Fed Guidance and the Special Master Rulings are highly critical of severance payments (including golden parachutes). Any acceleration of performance periods or deferral, vesting or transferability schedules will mitigate their effectiveness as a risk management tool. The Special Master Rulings and Fed Guidance continue to place limitations on severance payments to certain senior executives and suggest that boards of directors and compensation committees be prepared to justify any new or renewed golden parachutes.
There will be continued scrutiny of and skepticism over SERPs, perks, and tax gross-ups. The Special Master Rulings take a hard line on SERPs and note that senior executives should fund their retirements using wealth accumulated during their employment. Similarly, senior executives should be responsible for paying personal expenses during and following employment. In response to public criticism, many US public companies have already limited their use of SERPs and reduced perquisites.
Prescriptive pay regulations may not extend beyond TARP regulated companies and Bank Organisations, but say-on-pay advisory votes will become more prevalent. The authority conferred upon the Special Master appears to be based on the notions that:
- certain pay arrangements are inherently objectionable;
- shareholder oversight is not sufficient; and
- prescriptive regulations are necessary.
However, it is unlikely that broad restrictions on compensation will extend beyond the covered financial organisations. Nonetheless, as there has been enough interest in say-on-pay from shareholders, Congress, and regulators, nonbinding advisory votes are likely to become common practice, if not mandatory, in the near future. In addition, the SEC and proxy advisory firms will likely demand that companies demonstrate through their annual disclosures that their compensation-setting practices and policies adhere to the emerging "best practice" principles.

While the Special Master Rulings and the Fed Guidance are specific to the financial services industry, both capture themes that are emerging in the broader compensation landscape. What, of course, is less easy to predict is whether the realignment of executive pay practices described above will actually result in a greater convergence of executive and investor interests. That will be measured, if at all, only with the passage of time.

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PLC Global Finance update for November 2009: United States | Practical Law