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Slide No. 2
The first step to establishing ethical compensation
practices is to have an ethical organization.
Absent a continual focus on ethics, it may be
easier to rationalize short-sighted or executive
focused decisions without considering the long-
term impact on the organization, its employees,
customers or shareholders
Ethical behavior should be one of the metrics for
awarding compensation
Government isn’t equipped and shouldn’t step in
to regulate ethics
Overview of Ethical Considerations
Slide No. 3
Incentive targets too easy to meet
Incentives encourage high risk strategies
Poor design rewarded executives for
riding the tide of market rallies even when
company under performed
Penalties such as clawbacks were lacking
when gains were reversed or misconduct
occurred
Disparity between executive pay and
benefits and rank and file
Historical Flaws in Executive Compensation
Slide No. 4
Responsibility must reside with
corporate boards and management –
the tone at the top must reflect a strong
ethical tone
Studies have shown that culture is the
largest influence on employee conduct
(e.g., Enron)
Ethics must apply to day-to-day conduct
and be reflected in compensation
policies
Implementing Ethical Compensation
Practices
Slide No. 5
Establish an ethics committee
Recruit knowledgeable ethical
professionals to serve on board
Call on internal ethics and compliance
personnel to develop metrics to
measure ethical culture and present
data to the Board to help tie ethical
behavior to executive pay
Establish financial incentives for ethical
leadership by the CEO
Things Corporate Boards can Do
Slide No. 6
Insist on transparency in
communicating compensation structure
and other corporate decisions
Consider whether there should be limits
on executive pay to ensure pay equity
Put systems in place to build ethical
awareness over the long term
Things Corporate Boards Can Do
Slide No. 7
Raise ethical expectations
Legitimize discussions about ethical
issues
Encourage ethical decision making
Prevent ethical misconduct and provide
basis for enforcement
Role of Ethics in Executive Pay
Slide No. 8
Compliance with the law
Description of desired employee conduct (e.g.
teamwork, respect, fairness) and values (e.g.,
organizational good versus individual good)
Methods of rewarding desired conduct and values
Incentives
Discretionary bonuses
Compensation increases
Discretionary retirement contributions
Accurate accounting
Elements of an Ethical Executive
Compensation Policy
Slide No. 9
Not required but creates accountability and
defined expectations
Detailed or Not
Address every value and conduct an
organization can think of
Just state core conduct and values
Clearly identify objectives
Written in plain every day language
User friendly
Respond to real life questions and situations
Include necessary forms or communications
Documentation
Slide No. 10
Introduction explaining the purpose of the policy and
its purpose
Statement of core values of the Company – explain
what values of the company and how those values are
to be expressed via executive conduct
Substantive provisions – how desired behavior will be
tied to executive compensation
Information and resources – where to get additional
guidance
Backed up by executive pay and benefit plans and
policies
Contents
Slide No. 11
Determine corporate values desired
Create task force
Collect data
Initial draft
Leadership input
Field test and final revisions
Have policy reviewed by legal counsel
Board approval
Communicate and educate
Review and update
Development
Slide No. 12
How many organizations incorporate
the concept of ethical behavior in their
executive compensation programs?
Is ethical behavior a condition to incentives
and other rewards?
Is plan design governed by the organizations
ethics?
What is the scope?
Limited to incentive compensation or other?
Mandatory or not?
Talking Points
Slide No. 13
Common ethical issues arising under
executive compensation plans
Legal compliance issues – form versus
operations
Potential propensity to favor top management
in design and administration
Incentive plan designs that invite questionable
behavior without considering risk/reward to the
company
Conflict of administrators in keeping
executives happy versus complying with the
plan terms or applicable law
Talking Points
Slide No. 14
You are the VP HR for Best Company
The CEO calls and wants you to take
an early distribution from the company’s
deferred compensation plan to buy a
new house
You know this would violate the terms
of the plan and 409A
Case Study One: 409A Violation
Slide No. 15
Tell him you need to look at the plan
and forget to call him back
Tell him the plan doesn’t allow it
Tell him you need to contact legal
counsel and let them be the bad guys
Allow the distribution, after all he is the
CEO and you want to keep your job
What should you do?
Slide No. 16
You are the manager of the Company’s deferred
compensation plan
The CFO calls you regarding a provision in the
plan that suggests she should have received a
distribution of $450,000 in 2012
You know if there is a problem with the language
the 409A correction program cannot be used.
You check the plan and it turns out the CFO is
right
Example Two: Potential 409A
Distribution Failure
Slide No. 17
Immediately audit all other participant accounts in
the plan?
Call counsel?
Are the CFO’s interests adverse to the
Company?
Do you have an obligation to make the
distribution and report the 409A error?
Can you/should you gross up the CFO?
Do you have an obligation to fix other
participant accounts?
What should you do?
Slide No. 18
Your company is negotiating with a
potential new CEO, who, to your
knowledge, has no legal representation
The CEO candidate asks you to explain
the pros and cons of participating in the
company’s nonqualified deferred
compensation plan
Example Three: New Boss
Slide No. 19
Meet with her to explain the pros and
cons, but tell her she should also
discuss with her own adviser?
Provide her with a written summary
prepared by outside counsel explaining
the pros and cons?
Advise her to consult with her own tax
and/or legal adviser?
What should you do?
Slide No. 20
Executive makes an election under
section 409A to defer a portion of his
compensation to the company’s
nonqualified deferred compensation plan
Company does not begin deferrals in first
pay period in 2015
Deferral form and plan do not specify
when the compensation will be withheld,
but historically company has done it
ratably throughout year
Example 4: 409A contribution issue
Slide No. 21
Begin deferrals at the next pay period
so total amount is contributed by year-
end?
Treat as a 409A violation and ask
executive to repay initial deferral
amount (or take from his pay)?
Ignore the deferral election?
What do you do?
Slide No. 22
What if executive wants to revoke his
deferral election?
Do you allow even though a 409A
violation?
Does it matter if executive doesn’t want
to report as 409A violation to IRS?
Additional Facts
Slide No. 23
The Internal Revenue Service is
conducting an audit of your deferred
compensation plan
The agent learns that you, like him, are
an avid golfer and that the company
has a membership for all employees at
Wowza country club
The agent suggest that if you take him
to the country club as your guest that
he will go easier on the plan audit
Example 5: Government Audit
Slide No. 24
Invite him to club Wowza – after all
leniency is leniency?
Report him to his supervisor?
Report the incident to your supervisor
and seek guidance?
Tell him that what he proposes is
unethical and you will not be a part of
it?
What do you do?
Slide No. 25
You are working with the CEO and a
compensation consultant to structure
the company’s new incentive plan
The CEO wants the plan to be simple,
just based on revenue or profit
You are concerned that this could lead
to questionable behavior by promoting
sales growth without considering the
overall risk/reward to the company
Example 6: Incentive plan design
Slide No. 26
Voice your concerns and encourage a
plan design that more closely aligns
with the interests of the corporation?
Say nothing and leave it to the Board of
Directors to determine if the plan is
sound?
Leave the meeting so you can report
your concerns to your boss?
What do you do?