Editor: Please tell our readers about your background and professional experience.
Scerbak: After graduation from law school and a one-year clerkship, I began practicing in 1994. Since I began practicing in the area, I have had the opportunity to experience first hand all the changes in the compensation and benefits area that have occurred since the mid-90s. One of the reasons I enjoy the practice is that it is a fast moving and interesting area of law.
Editor: Would you tell our readers how Goodwin Procter's Business Law practice and ERISA/Employee Benefits practice work together in helping clients manage executive-compensation programs amid the myriad of regulatory requirements?
Scerbak: The ERISA/employee benefits practice is a specialty. We work with the business law attorneys very closely since almost every area of corporate law has some aspect of employee compensation that needs addressing. For example, this includes drafting executive compensation agreements, equity compensation or long-term incentive plans, providing public companies proxy disclosure advice, and negotiating the benefits and compensation aspects of mergers and acquisitions. We also keep our business law colleagues apprised of important developments in the area that will affect clients.
Editor: At what point in a transaction do you get involved in counseling a client that is making an offer to buy a company?
Scerbak: We normally get involved relatively early in the process. As a general rule, our benefits group will review the plans of the target, negotiate benefits provisions of a purchase agreement, provide guidance on how to handle outstanding equity awards and on what liabilities the target will bring with it. Of course, all of this varies depending on the kind of transaction. If the company will be putting into place new equity or incentive plans or negotiating new agreements with the executives, we will be involved in that as well. And, of course, when we represent the target or seller, we work on the same issues but from the other side. We also counsel clients on disclosure for those public clients whose compensation plans may require shareholder approval prior to the time a transaction is consummated.
Editor: In looking at a proxy statement, I was just astonished at the newly added required level of disclosure regarding executive compensation. Doesn't this wealth of information confuse rather than help the reader?
Scerbak: It seems, and is, a lot of information. However, it is important to realize that the largest investors are institutional investors such as pension funds. They have very sophisticated investment managers who understand this level of detail. The institutional investors have been largely in favor of increased disclosure. And the SEC has responded with the new rules. An individual investor may not have the time or interest in reading through such lengthy disclosure information; however, even if the individual investor does not read through all the tables and footnotes, he or she will still get a lot of information from just reading the new Compensation Discussion and Analysis section, sometimes called the CD&A.
Editor: The information in the disclosure focuses on five "named executive officers." I understand that in the past year the SEC changed the way in which the named executive officers are determined. Could you explain who they are?
Scerbak: Basically, the SEC now defines the "named executive officers" as the company's principal executive officer or PEO, the company's principal financial officer or PFO and the company's three most highly compensated executive officers other than the PEO and PFO. Prior to 2007, the named executive officers were defined as the chief executive officer of the company and the company's four most highly compensated executive officers. In other words, prior to this year, the named executive officers included one officer by virtue of title and four by virtue of compensation level. As of this year, the named executive officers include two by virtue of title and three by virtue of compensation level.
Editor: You mentioned the new narrative section, the CD&A. Please give our readers some sense of the reach of the CD&A statement which appeared in the 2007 proxy statements.
Scerbak: The SEC introduced the CD&A this year. It is meant to address, in a narrative form, the objectives of a company's compensation program, what the compensation program is designed to reward, every element of compensation and why the company chose to pay it, how the company determines the amount of compensation, and how decisions on the various elements of compensation fit into an overall compensation objective. In other words, the CD&A is designed to give the investor a very thorough understanding of what is being paid to whom and why it is being paid.
Editor: I understand that there have been some changes in the Summary Compensation Table, and that, in particular there is greater disclosure of perquisites. Are there any grey areas for determining what items should be disclosed?
Scerbak: The Summary Compensation Table is the main tabular summary of all elements of compensation. The table's columns call for disclosure of salary, bonus, stock and option awards, cash incentive plan compensation and pension benefits. There is an additional column in the Summary Compensation Table called "All Other Compensation." Basically, any element of compensation that is not disclosed in the other columns is disclosed in this column. This will include any amounts that have been paid or have come due. Some elements of compensation included are change in control payments and tax gross-ups. Perquisites and other personal benefits must be reported in this column as well unless the total value of the perquisites and personal benefits in the aggregate is less than $10,000. If the total value is at least $10,000, then each item must be identified by type. Further, if the value of any particular perquisite exceeds the greater of $25,000 or 10% of the total value of all perquisites, it must be disclosed in a footnote.
In terms of identifying perquisites, the SEC states that an item is a perquisite if it confers a direct or indirect benefit that has a personal aspect to it regardless of whether it is provided for some business reason or the employer's convenience unless it is generally available on a nondiscriminatory basis for all employees. For example, a country-club membership that is not used exclusively for business-entertainment purposes, a personal financial advisory service, personal travel using a vehicle owned or leased by the company, or security provided at personal residences must be disclosed.
Editor: I understand that the new definition of "named executive officer" has had an unintended effect on a provision of the Internal Revenue Code that governs the deductibility of certain executives' compensation. Could you explain that?
Scerbak: Section 162(m) of the Code was passed in 1993. Congress was responding to concern about the rising compensation levels of executive officers and enacted a law to limit the deductibility of certain executives' compensation by public companies to $1,000,000 unless the compensation was linked to achievement of objective performance goals. Under the law, the executives who are covered by it are the chief executive officer of the company at the end of the year and the employees whose compensation had to be reported under the SEC rules due to being among the four highest paid officers of the company for the taxable year. The law does not include a provision stating that the employees covered under Section 162(m) will change if the SEC changes the determination of which executives should be included in a company's disclosure.
Editor: What does this mean for companies in practice?
Scerbak: Until recently, it was not clear what it would mean for a company's determination of which officers would be covered by Section 162(m). However, this month, the IRS issued Notice 2007-49. It states that based upon the statutory language of Section 162(m), which has not been amended, the IRS will interpret the term "covered employee" to mean the principal executive officer (rather than the chief executive officer) of a company and its three most highly compensated officers for the taxable year whose compensation is required to be included in the summary compensation table. In other words, one fewer executive will be covered by Section 162(m) absent an amendment to the law by Congress.
Editor: Was it an oversight by the SEC when it changed the definition of named executive officer?
Scerbak: I don't think it can be called an oversight. The securities and tax laws are separate statutory and regulatory regimes. The SEC determined that the purpose of the disclosure was best served by requiring the inclusion of the principal financial officer in the group of named executive officers. It chose not to add the PFO to the other five executives whose compensation was already being disclosed. Rather, it chose to add the PFO and have only three rather than four officers included due to their level of compensation. It is up to Congress to determine whether Section 162(m) should be amended so that the executives covered by Section 162(m) are identical to those who are named executive officers under the disclosure rules.
Editor: With the many complexities posed by the SEC requirements as to disclosure and the burdens placed on corporations for determining the total compensation of their executive officers, what suggestions do you have for making sure there are not missteps as to the disclosures regarding the named executive officers?
Scerbak: First and foremost, a company has to understand what is being asked of it and should consult counsel for assistance. By working with counsel, the officers and responsible employees will come up with a comprehensive list identifying all the elements of compensation and benefits that should be disclosed.
We've now gone through our first proxy season. Compiling the information and disclosing it in its new form will become easier in future years.