What Do Executive Compensation Lawyers Do?
The primary responsibility of an executive compensation law firm is to ensure that companies’ compensation and related benefit programs comply with federal and state regulations. A company’s compensation programs must comply with the Internal Revenue Code, employment and tax laws, securities laws, stock exchange rules, other state and federal regulations, and best practices. Some laws relevant to executive compensation programs include the Internal Revenue Code, Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"), Sarbanes-Oxley Act, Securities and Exchange Commission regulations ("SEC regulations"), and the Employee Retirement Income Security Act ("ERISA"). Besides general federal and state regulatory compliance, executive compensation law firms must also oversee tax compliance and governance issues for private and public companies. Regulatory compliance regarding the Internal Revenue Code and applicable tax regulations pursuant to ERISA may vary from state to state, which is why it is important for companies to work with an executive compensation law firm that can give practical guidance which is state specific .
In addition to advising clients on regulatory compliance, executive compensation law firms also help companies design compensation packages and contracts for their executives. They assist companies by helping them determine which pay practices are suited to their business needs, employee demographics, cash management, and industry trends. After an executive compensation law firm has developed a compensation program for a client, they will most likely negotiate the contours of that compensation with the executives in question. The firm will look over the employee’s current compensation package and employee demographics to make recommendations for the new or restructured contractual agreement. Finally, if the company becomes public, the executive compensation law firm will help the company write their public proxy statements, Section 401(k) plans, incentive plans, stock option plans, and benefits packages.
Why Businesses Require Specific Legal Expertise
Businesses require the services of an executive compensation law firm primarily because administering executive compensation would inevitably run into a plethora of related, overlapping legal issues. However, most employers don’t have the in-house legal competencies, skills, and experience, to deal with these complexities.
The vast and varying laws governing executive compensation can get tremendously simple functions of executive compensation wrong, or not at all. For example, a seemingly benign issue like a payment date for an equity grant or bonus can have unforeseen tax implications.
Likewise, failing to take the proper steps to ensure that compensation arrangements don’t violate the Internal Revenue Service 409A, can mean upfront and ongoing tax liabilities the employer or employee will have to pay. Inadvertent mistakes in the drafting can also fail to constitute a legally binding contract under applicable state contract law principles, meaning the arrangements are not enforceable even when an employer intends them to be.
Specialised law firms not only have an in-depth understanding of how state and federal regulations interrelate, but also have the ability to stay on top of the many changes in employment law affecting executive compensation. This grants such law firms an edge over regular legal representation, facilitating the proper administration of executive compensation.
Elements of Executive Compensation Packages
As part of "executive compensation law" with respect to private companies, like all law firms that provide executive compensation advice, we get a number of questions on the standard elements of executive compensation packages. While no two packages are identical, certain elements are found in the majority of packages.
In most cases, the "foundational" components of an executive compensation package will include salary, cash incentives (such as bonuses and commissions), equity participation (such as stock options and stock grants), health benefits (such as healthcare and insurance), retirement (such as pensions and deferred compensation), perquisities (such as company cars and country club memberships), and severance (such as separation pay). Although the precise details of these elements of compensation will vary from contract to contract, law firms such as McCarthy Tétrault ultimately ensure that "market" rates are paid to prevent executives from being "over-compensated" (which can have negative tax implications), or worse under-compensated causing existing executives to leave the company seeking better pay.
Further, contracted "incentives", or bonuses, the right to share in the profits of the company, and entitlement elements such as healthcare, a pension, and other employee benefits provided by the company, all fall under the purview of executive compensation law. Due to the complex nature of benefit, retirement, and incentive plans, the plethora of possible plans and their corollary tax implications, the experience and expertise of executive compensation lawyers is instrumental to putting together incentive and executive compensation packages that can be tailored to each individual executive’s needs and aspirations while helping the company maximize its tax treatment and minimize its overall tax burden.
Dealing with Regulatory Issues
A major challenge for companies is navigating the regulatory and compliance issues that often crop up when dealing with executive compensation matters. The SEC demands a high level of accuracy and detail in the disclosure of executive compensation arrangements in a company’s 10K and other regulatory filings. The IRS and other agencies have tax rules that closely govern how companies are taxed in connection with executive compensation . There is a dizzying variety of regulatory perspectives — from the executive (who is taxed immediately) to the company (for whom accounting rules apply) to the securities regulators (who require prompt disclosure of potential compensation issues) to the IRS (which imposes significant taxes, penalties and interest on companies where compensation arrangements don’t meet requirements). A single misstep can impact both the company and affected executives in terms of taxes (and possibly penalties), management time, and reputational risks. Both companies and executives find that they need to be fully informed of the regulatory requirements that apply to the various aspects of compensation, from design to disclosure to taxation.
Selecting an Executive Compensation Law Firm
Much like a marriage it is important to put a lot of thought in the selection of the right law firm. While most businesses think of retaining legal counsel as a sign of a major problem, hiring a law firm that specializes in executive compensation means that you will have a qualified ally for unforeseen hiccups down the road.
There are several items to consider when selecting a law firm. Typically, the firm that specializes in executive compensation is a relatively full-service firm. You may have to do some research to narrow down the field of prospective law firms. Look for lawyers with experience. Most likely, there are several events throughout the year where lawyers will be speaking or giving presentations. Inquire whether any attorneys from the firm have been active in one of these forums. If you are local, check out any legal "backslapping" events held by the city bar association or local business group. Like the other attendees, many lawyers use these events as an opportunity to network with potential clients. When they are not at these functions, lawyers give speeches, make presentations, or teach classes. Consider hiring an executive compensation law firm that has lawyers with demonstrable experience on these non-billable job opportunities.
Ask around. Look for someone who should know, like your human resources department, or even a former employee or business partner you trust. They usually know of an executive compensation law firm they respect. It may be that one of their colleagues or business associates has had a good working relationship with one of the lawyers from a particular firm. Ask around.
Your selection process will involve getting the help of one or more of your advisors. Your accountant is an invaluable tool in finding the right law firm. Your accountant will know which firms others are using. Remember that finding the right law firm is not just a one-person job. You’ll need as many eyes and ears as possible. Beware of the recommendations of non-partners who may have a vested interest in being perceived as a great business finder.
Additionally, look at the firm’s track record/experience. Law firms that specialize in employee benefits and executive compensation law are very unevenly distributed across the country. Most large law firms, for example, do not even claim specialization in this area of the law. And a number of the large "national" law firms that do claim to specialize in executive compensation law do not devote significant staff time to this practice area. Do the firms you are considering represent publicly traded companies? A public company usually has a stock plan and a series of arrangements and practices for its employees that require greater attention from their counsel than those of a closely-held company.
Finally, don’t pass on hearing a third opinion. The third opinion is incredibly useful in avoiding confirmation bias, i.e., either wanting to pass on advice, but can’t after receiving two separate confirmations, or wanting something to work out to be true, and get it with two confirmations.
Executive Compensation Trends
There are some fundamental areas where executive pay is headed that have been the focus of debate and revisions by the SEC in the past few years. These include efforts to curb so-called excesses, assuring disclosure of "skin in the game" equity compensation, and clarifying what is meant by the term "compensation committee".
An area of continued focus that is also a current priority for investors is of course executive compensation and its link to company performance . Some of the trends which we continue to see include:
• Pay For Performance
• Focus on Long-Term Shareholder Value
• Pay At Risk
• Use of Equity Compensation Awards
• Longer Performance Measurement Periods
• Development of Clawback Policies and Agreements
• Use of Restricted Stock Units Linked to Performance
• Rapidity of Disclosure of CEO Pay
• Enhanced Disclosure Requirements Related to the Consideration of Risk
With concern over excessive pay and the prospect of additional rules governing pay packages, companies must continually be reinventing their packages to effectively address the issue of attracting and retaining top talent in a cost-effective manner.
