In this Ropes & Gray podcast, Renata Ferrari, head of the firm's executive compensation practice group, Zach Blume, a partner in the firm's strategic transactions practice group and Claire Rosa, counsel in the firm's executive compensation & employee benefits practice group, discuss legal issues and other considerations related to executive compensation actions public companies are or may be considering taking in response to the current global health emergency and related economic crisis.
Claire Rosa: Hello and welcome everyone. Thank you for listening to this Ropes & Gray podcast, which is a series of alerts, podcasts, webinars and other resources focused on COVID-19 related legal developments affecting our clients. I'm Claire Rosa, counsel in our tax & benefits department, and my practice is focused on executive compensation. Today, I'm going to be speaking with Renata Ferrari, a partner in our tax & benefits department, and the head of our executive compensation practice group, and with Zach Blume, a partner in our strategic transactions practice group who regularly advises our public company clients on securities law compliance and governance issues. On this podcast, we are going to highlight some considerations relating to compensation actions that companies have been taking, or might be considering taking, in response to the current global health emergency and related economic crisis.
Renata Ferrari: Thank you, Claire. We hope everyone that is listening right now is doing well and staying safe. Because of everything else that's going on, executive compensation may or may not be an area of immediate concern for every company right now, but we know that many companies are facing challenges around executive compensation now, or will be in the future, as the longer-term economic repercussions of the current situation become clearer.
Claire Rosa: Yes, agreed. So, Renata, to start, many companies are responding to or are thinking about responding to cash flow issues right now with across-the-board reductions of salary and/or performance bonuses. What should those companies be thinking about from a legal perspective?
Renata Ferrari: All companies who are considering making changes to their compensation programs should be reviewing any existing plans and agreements to see if they need to obtain consent to make the changes that they want to make. For certain executives with employment contracts, a salary reduction or reduction of a bonus opportunity might require consent or even a waiver of "good reason." There might be other legal issues to review with counsel, including how any changes that are being contemplated might affect the enforceability of any restrictive covenant agreements. For executives who don't have any contractual entitlements to salary or bonus, consent shouldn't be required, but most companies will want to make sure that their executive team is on board before any changes are made to their current compensation. Public companies will also need to evaluate whether the actions they are taking trigger any disclosure obligations and make sure they're ready to make any required disclosures within a pretty short period of time after making those determinations. Zach, can you speak to that?
Zach Blume: Sure. So, if a public company materially changes the compensation of its CEO, CFO or any other named executive officer, that will trigger an 8-K disclosure obligation under Item 5.02(e). The decision of whether an 8-K is required will be a matter of judgment regarding the level of reduction and materiality. Some pay cuts or pay freezes might not be at a level that strictly requires an 8-K filing, but we are seeing a lot companies filing an 8-K regarding executive pay cuts or pay freezes that may not be material because they think it's important for investors to be aware that those actions are being taken, in particular if they are happening at the same time as other belt-tightening actions affecting the company or employees more broadly. We're also seeing companies disclose on an 8-K reductions to board compensation even though board compensation changes are not required to be disclosed in a current report. For companies, the 8-K ends up being part of their overall communications strategy about how they are responding to the COVID-19 crisis.
Claire Rosa: If a company is required to file an 8-K, when does it have to be filed?
Zach Blume: If an 8-K is required, it would need to be filed within four business days of the effective date of the relevant action – whether that's a compensation committee or board action, or the entry into an agreement or an amendment to an agreement. Because of the relatively short time period, especially at a time when most people are dispersed and a lot is going on with these companies, companies may decide that it is impractical to ask executives for written waivers when they are not strictly required.
Claire Rosa: Got it. For public companies who haven't yet filed their 2019 proxy statement, do they have to include COVID-19 related compensation actions that are being taken in 2020 in their proxy disclosure?
Zach Blume: Companies are generally only required to disclose compensation decisions about the company's named executive officers for the prior year (so, 2019 in this example), but many companies will include a discussion of changes for the current year's compensation program if they're material or deviate from prior practice (such as the adoption of a new equity program). If a company is doing a prospective salary cut or freeze in 2020, for example, it's probably not required to be included, although companies may elect to disclose anyway. But if a company is not paying bonuses to its NEOs that were earned in 2019, that would definitely need to be disclosed in the proxy. We're also seeing some companies include disclosure that they expect that their compensation decisions or results for 2020 will be impacted by COVID-19, although, again, that's not technically required. There will certainly be questions, when it comes time to disclose 2020 compensation decisions next year, about how to report waivers or deferrals of compensation. The SEC's current guidance on waived compensation would suggest that it would still need to be reported (and won't affect your NEO determinations), but we'll see if additional guidance comes out later this year.
Claire Rosa: What about the impact of the current crisis on the performance metrics applicable to 2020 bonuses or performance-based equity awards with outstanding performance periods?
Renata Ferrari: Well, companies will have more flexibility this year than they may have had in the past, at least from a tax perspective. The good thing is that since 2017 tax reform eliminated the performance-based exception to 162(m), the loss of deductibility under Section 162(m) should not be a factor for committees to have to consider when deciding whether to exercise discretion in relation to performance metrics. So, depending on where things end up and what they ultimately decide is appropriate, compensation committees should be able to respond to the current economic situation and make any necessary adjustments to existing programs. Right now, because the crisis is relatively new and the timing of its duration is uncertain, many companies are taking a wait-and-see approach with respect to outstanding short-and long-term performance awards. Some companies have already started tracking elements of performance related to existing criteria and impact so that they can keep the board informed and ultimately this might be helpful to explain any later discretionary adjustments that are made to the goals. Before making any adjustments to performance metrics under equity awards, companies should check with their accountants to determine whether the adjustments will constitute modifications to the awards for which there'll be an accounting charge. Any charge associated with the adjustments will also have to be disclosed in the summary compensation table and in the grants of plan-based awards table with respect to awards granted to named executive officers. As a general matter, shareholders tend to dislike the exercise of significant discretion and also discretionary adjustments to performance metrics, so companies that do adjust should consider how to best frame their disclosure for why they made the adjustments and how their compensation committees determined the appropriate adjustments.
Zach Blume: We've also been receiving questions from companies that have not yet granted equity awards on whether and how to take into account a company's depressed stock price when making these grants. Companies should be looking at their plans' individual limits because they could actually come into play with the lower stock prices. We've also seen some companies consider using an average stock price instead of a spot price when determining the number of full value shares to be granted (for companies that aim to provide a certain grant date value to executives and other employees) to both limit the dilution as well as to counter any perception that executives are benefiting from a lower stock price by being granted a greater number of stock-based awards.
Claire Rosa: Something we haven't heard much about in the last few years is option repricing – has anyone started to raise this?
Renata Ferrari: We have heard some discussion about repricings or at least raising the question about what a repricing would entail. Many companies use stock options less, or as a smaller percentage of their overall equity award programs, than they did in 2008 and 2009. As a result, underwater options may not be as big of a concern for some companies as they had been during the financial crisis. Most plans prohibit repricings without shareholder approval, and ISS does not like them. During the financial crisis, it seemed as if there was a little more flexibility on the part of the then-ISS to support repricing when they were value for value exchanges in which executive officers and directors did not participate. So far, we have not seen any updates from ISS on their policies in light of the crisis.
Zach Blume: One other thing to note on the repricings is that they can be relatively tricky to implement and if they involve optionholder consent, a company has to consider whether the repricings constitute a tender offer, which will lead to disclosure and a requirement to hold the offer open for at least 20 business days, so it's good to think about that in advance of taking any actions.
Claire Rosa: Thanks, Zach. Renata, you mentioned the last financial crisis – is there anything that we can learn from that as it relates to executive compensation?
Renata Ferrari: I think one thing that we can learn is that most decisions will be judged in hindsight and even if they were the right decisions to be made at the right time, in the light of a healthier economy they may be viewed as benefiting executives at the expense of shareholders.
Zach Blume: Completely agree about that. It'll be important to have a thoughtful and not a reactive process where the interests of all constituents—the executives, employees and stockholders—are considered. Also, we live in a world now where the executive compensation disclosure is just so much more in depth than it was 10 years ago. Before making any significant changes to programs, you should review prior disclosure to make sure that you're not going to be seen as breaking commitments you had made to shareholders in better times.
Claire Rosa: Are there any other types of questions that are coming up for companies right now related to executive compensation?
Renata Ferrari: There have been a lot of questions recently that relate to the applicability of the Section 409A rules, both with respect to nonqualified deferred compensation plans specifically, but also the potential applicability of those rules to other changes to existing compensation arrangements. One specific question that has come up a lot in the context of nonqualified deferred compensation plans is whether employees are able to suspend their 2020 deferral elections on the basis of the "unforeseeable emergency" exception to the deferral rules. Although the current global health emergency and economic situation seem like they might be an "unforeseeable emergency" generally, the crisis by itself won't actually be sufficient to constitute an unforeseeable emergency for Section 409A purposes. We've also received questions on waivers of salary with a promise to pay something in the future when the crisis is over. The bottom line on Section 409A is that it's a very strict set of rules that may limit in a way that is not intuitive what might otherwise seem like it should work from a practical perspective. Before making any explicit or implicit promises of make whole payments, Section 409A should be considered.
Another thing we are keeping an eye on, of course, is the executive compensation limitations that were included in the CARES Act, which were summarized in our previously published alerts related to the Act. There were a few provisions limiting compensation and severance payments to officers and employees by reference to the "total compensation" they received in 2019, which will be relevant, not just to companies in the airline industry, but to any eligible businesses seeking to benefit from any direct lending under the emergency relief fund provisions. The way the current legislation is drafted creates a lot of questions about how "total compensation" will be calculated and how those provisions will be applied, and hopefully the Treasury will issue some guidance soon that will answer some of those questions.
Claire Rosa: Well, we'll certainly be paying attention to all of this and keeping folks updated. Renata and Zach, thank you both so much for your time today, and many thanks to our listeners. If you are listening, be sure to check out the Coronavirus Resource Center on our website, www.ropesgray.com, where you can see all of our latest alerts, access other resources and subscribe for immediate notifications as we continue to add updates to that site. Of course, you can also subscribe to our series of podcasts wherever you regularly listen to podcasts, including on Apple, Google and Spotify. As always, please do reach out to any of us if we can be helpful in thinking through any executive compensation or disclosure-related issues you might be facing. Thanks again for listening and take good care, everyone.
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