The purpose of this Post is to help issuers prepare for the upcoming 2020 proxy season by providing a non-exhaustive list of certain compensatory issues/topics to consider.  To that end (listed in no particular order):

ADOPT AN ANNUAL GRANT POLICY

• Background.  It is common for Compensation Committees to initially denominate an equity award as a dollar amount, and then convert such dollar amount into a number of shares immediately prior to the date the equity is granted (e.g., executive is to receive a number of shares equal to 20% of his/her base salary).  This approach could create unfavorable shareholder optics if, for example, a U.S.-wide economic downturn were to cause the stock price of the issuer to decline.  In such a situation, the  equity grant to a key employee would cover a larger number of shares than it would have covered had there been no economic slide.  The result is that a plaintiff-orientated shareholder could allege that the executives were timing the market by granting an equity award with an artificially high number of shares.
• Solution to Consider.  If the issuer had an annual grant policy, then such could act as an affirmative defense to any allegation that the issuer was timing the market.

CONSIDER A STOCK-PRICE FORFEITURE PROVISION TO AVOID THE DRAG OF UNDERWATER STOCK OPTIONS

• Problem with Underwater Stock Options.  The concept of an “underwater stock option” occurs when the exercise price of an option is greater than the fair market value of the underlying stock.  In such a situation, the stock option is considered outstanding for purposes of the issuer's burn rate calculation even though the stock option might not be serving its purpose from the perspective of the optionee.  And repricing the underwater stock option is not likely a viable solution because a repricing would likely trigger the SEC's tender offer rules if a value-for-value exchange were sought by the issuer (i.e., a value-for-value exchange is typically sought in order to negate incremental compensation expense for accounting purposes).
• Possible Going Forward Solution Is to Implement a Stock-Price Forfeiture within the Granting Documentation.  The foregoing issues could be avoided if the stock option had a stock-price forfeiture provision contained within the forfeiture provisions of the stock option documents (e.g., if the stock price falls to a certain price, then the stock option is automatically forfeited).  A stock-price forfeiture provision could avoid the time and expense associated with repricing underwater stock options because the issuer could simply grant new stock options in normal course following the stock-price forfeiture provision being triggered (but make sure such does not trigger the cancellation/regrant provisions of NYSE and NASDAQ listing rules because, if such is triggered, the forfeiture followed by a regrant could be deemed a repricing subject to shareholder approval).
• More Information.  For more information, please see our prior Post "Tip of the Week: Could a Stock-Price Forfeiture Provision Eliminate the Existence of Substantially Underwater Stock Options".

SEPARATE NON-EMPLOYEE DIRECTOR EQUITY PLAN – 5% MINIMUM 1 YEAR VESTING CARVE-OUT

•  Alleviate Stress on the 5% Carve-Out to the Minimum 1-Year Vesting Requirement.  For issuers trying to curry points under ISS’s Equity Plan Scorecard, the “plan features” pillar has a requirement that, in order to get full points, the equity incentive plan must have a 1-year minimum vesting schedule for all equity awards (though a 5% carve-out exists such that 5% of the equity plan's share reserve does not have to be subject to a 1-year minimum vesting schedule).
• Separate Non-Employee Director Equity Plan.  There are two data points to keep in mind: first, it is common for non-employee directors to be granted fully vested stock awards in situations where they are compensated in arrears for services previously rendered, and second, the concept of an Equity Plan Scorecard does not apply to a non-employee director equity plan (i.e., no need to satisfy a 1-year minimum vesting requirement).  Therefore, having a separate equity plan for non-employee directors could relieve the stress on the 5% carve-out, thus allowing the issuer to preserve the 5% carve-out for other purposes such as new hires.

SEPARATE NON-EMPLOYEE DIRECTOR EQUITY PLAN – STOCKHOLDER APPROVED DIRECTOR COMPENSATION

• Consideration.  Consider whether all or some of a non-employee directors’ compensation should be approved by the shareholders (e.g., annual fees, compensation caps/limits, fixed formulas, etc.) in order to help protect the decisions of the non-employee directors with respect to their own compensation.  For more information, see "Discuss Director Compensation During the Fall 2018 Board Meetings".

DIRECTOR COMPENSATION

• More Robust Narrative Disclosure Preceding the Director Compensation Table.  Consider having substantially more robust narrative disclosure proceeding the non-employee director compensation table of the proxy statement.  To that end, discussions with the Compensation Committee should include:
  • What is the philosophy associated with non-employee director compensation,
  • How is pay assessed,
  • What is the frequency of the assessment, and
  • What is the process associated with any benchmarking of non-employee director compensation.

CONSIDER INCREASING THE DEDUCTIBILITY OF COMPENSATION

• Background.  The Tax Cuts and Jobs Act of 2017 eliminated the performance-based exception to the $1mm deduction limit and expanded the definition of “who” is subject to the $1mm deduction limit.  This means that, starting January 1, 2018, all compensation paid to a “covered employee” that exceeds $1mm will not be deductible.  And too, remember that covered employee status was expanded and now includes the CEO, the CFO and the next 3 most highly compensated executive officers who are disclosed in the company’s Summary Compensation Table.  Finally, the new rules require that once an executive is a covered employee, he/she will ALWAYS remain a covered employee.
• Increase Compensatory Deductions by Limiting "Executive Officer" Status.  Only an “executive officer” is eligible to be an officer disclosed in the Summary Compensation Table.  So one way to mitigate “covered employee” status is for the Board to revisit which individuals are “executive officers” of the issuer (i.e., if the individual is not an executive officer, then he/she could never be a named executive officer on the Summary Compensation Table, and therefore, such individual could never be a covered employee that is subject to the $1mm deduction limitation).
• Other Ideas to Increase Compensatory Deductions.  Other ideas consider with respect to covered employees include:
  • Implement a deferral program with future annual payouts to be less than $1mm.
  • Replace the standard 3- and 4-year vesting schedules with a longer schedule (not likely practical).
  • Move lump-sum severance obligations to installment payouts (e.g., only $1mm of a $4mm lump sum payout would be deductible if paid to a covered employee, but if the payout was structured over three years, then $3mm of the $4mm would be deductible).

INCREASE NET WITHHOLDING

• Background.  Many equity plans have a provision that limits the net withholding rate to the minimum statutory rate (i.e., the supplemental rate of 22%).  Such was previously required in order to avoid liability classification for accounting purposes.  However, the Financial Accounting Standards Board changed the rule a few years ago and now allow net withholding to occur at the highest federal tax rate without triggering liability classification for accounting purposes.
• Consider Whether to Amend the Equity Plan.  Consider whether to amend the equity incentive plan to allow for a higher net withholding rate.  Such amendment might require shareholder approval (depending upon the design of the amendment), but the upside is that any equity plan with liberal recycling provisions should enjoy a longer life expectancy associated with the share reserve.
• More Information.  For more information, please see our prior Post “Tip of the Week: 4 Ideas to Ease Tax Obligations When Equity Awards Vest During a Blackout Period.”

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