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Dodd-Frank: A Rundown

The Dodd-Frank Wall Street Reform and Consumer Protection Act has been in place for nearly three years. We’ve provided a quick refresher of exactly how the Act works and how it affects you, the executive. 

The most relevant part of the act for executives is the “Say on Pay” proposal. Subtitle E focuses on executives and states that, at least once every three years, a public corporation is required to submit to shareholder vote the approval of executive compensation. Shareholders may also disapprove golden parachute payments.

“Say on Pay” is a term used to describe the process where a firm’s shareholders have the right to vote on compensation afforded to executives. It is intended to limit compensation by not awarding executives too much money. The shareholders review the CEO, CFO, and the next three highest paid executives.

How does this affect me?

Executive bonuses will be subjected to periodical reviews by the shareholders. Potentially they can block executive compensation if they deem it to be excessive or if the company is underpeforming, although the shareholder vote is non-binding. However, for the most part, executive compensation has been approved by shareholders and Dodd-Frank has proved to be a fair system for rewarding the work of executives.

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Shares Explained

We are now firmly entrenched in the Say on Pay era and this means more varied forms of compensation than ever before. Companies will frequently offer their executives a variety of stock options – whether it’s a form of wages, give the executive a vested interest in the company or to reward management for meeting certain targets.

The type of shares issued becomes more varied and convoluted each year. An executive will have to not only understand the type of share or shares that they are receiving, but the conditions that come with these shares. From acceleration provisions to exercise dates and from strike prices to the benefits, there is a great deal to look out for and understand.

Here is a quick rundown of the 6 most common types of equity:

1) Incentive stock options (ISOs) can only be granted to employees and is the only equity option that offers favorable tax treatment. Usually, an employee is given the option to purchase stock at a predetermined price. This is the most common form of equity offered to employees.

2) Non-qualified stock options (NQSOs) are similar to ISOs but without favorable tax deductions. This means the employee is taxed on any profit made when purchasing the stock at its cheaper, predetermined price.

3) Stock Settled Appreciation Rights (SSARs) grants an employee payment in stock. The payment is equal to the amount which the value of stock has increased since the employer-employee agreement was made.

4) Phantom Stock is similar to SSARs, but the employee is paid in cash instead of stock. The payment is still equal to the amount which the value of the stock has increased, but the employee receives no actual stock.

5) Restricted Stock Grants are a fixed amount of shares that are given to the employee that are subject to a right of forfeiture or repurchase by the company.

6) Restricted Stock Units (RSUs) is when an employee is granted stock to be paid at a specified date in the future. These are also subject to forfeiture or repurchase by the company. RSUs are usually used by newer companies that are looking to grow.

Once again, it is necessary to stress the importance of understanding different types of stock. Too often, when an executive leaves a company for whatever reason, there is a messy and complicated severance package that is usually complicated by the shares owned by the executive. Clearly, it is beneficial to avoid a messy process!

If you have any questions about equity compensation, feel free to contact us today. Also, check out our FAQs by clicking on the link at the top of the page or at Gordon Law Group.

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Top 5 Ways to Improve Executive Compensation

  • Know your value — Start by gathering data.  What are other executives paid, in your own industry and your own company?  How has your company performed, compared to your industry peers as well as you own benchmarks?  How have you performed?  Are their particular compensation trends impacting your position?  If your company has been performing particularly well or if you are headhunted for a new executive position, you may be worth more than you think.

 

  • Don’t be afraid to negotiate, but align your interests  While base executive pay has been falling in recent years, more and more companies now offer “pay-for-performance,” and if you understand your value then you have room.  The key is aligning your interests with the company’s.  Ask yourself a simple question:  does your compensation package give you the incentive to achieve the company’s goals?  For example, a bonus plan targeted to increasing revenue may only encourage low-profit, high-revenue sales.  Is that your company goal?  Lofty goals prove similarly ineffective.  Better to work through your company’s strategic plan and approach your Board of Directors with an incentive package that has everyone facing the same direction.

 

 

  • Understand the terms — Frequently, even experienced executives fail to fully understand the terms of their own deal.  Between all the clauses and different types of stock, it can be a bit confusing.  But, small tweaks can yield significant results.  Look a bit more closely at your employment documents, and review our executive compensation FAQs here.

 

  • Take the long-term view — This applies to two separate areas of executive compensation.  First, when you negotiate the deal, try to see through the smaller, short-term stumbling blocks.  Are they important to your goals?  For example, if multi-year stock vesting troubles you, add accelerators.  If your starting salary is too low, add incremental pay raises tied to performance metrics or time.  Second, take note of the company’s realistic plans.  Are the stock grants truly valuable?  Are they buried under preferred stock, convertible debt or other senior obligations?

 

  • Get good advice — Your company’s lawyers and accountants look out for your company, much like you do, taking advantage of every chance to benefit the organization.  But who’s watching out for you?

 

If you would like to speak with one of our attorneys about any questions or concerns you may have, please contact us today.

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Carried Interest: A Breakdown

Carried Interest or the “carry” refers to the percentage of the profit received by fund managers. Commonly, a manager who oversees a fund on behalf of limited partners receives a share of the profit from any investment gains. By way of example, a hedge fund manager usually receives 20% of the profits. Essentially, the carry rewards managers for enhancing fund performance, and serves as a useful incentive-based income.  While “profits” can be manipulated, good definitions, as well as clawbacks and collars serve to protect both managers and their funds from compensation swings.

If you have any questions about your carry, tax or any other executive compensation questions, contact us today.

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Executive Trends – 2011

As the first year of Dodd-Frank comes to a close, we recap the major trends in executive compensation from the previous year:

  • Focus on structure, design and stability of executive contracts as economy begins to pick up
  • Closer communication with shareholders
  • Significant concern with external governance and pay for performance
  • Emphasis on accurate goal-setting and formula to measure performance

Predictions for 2012 and beyond:

  • Pay for performance will continue to be the flavor of the day, taking up a higher percentage of overall compensation
  • Continuing efforts to streamline and improve formulas and metrics to measure performance
  • Deeper reliance on peer groups and focus on long-term incentives
  • Further attempts to eliminate inefficient pay practices
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