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Deadline Looms for Deferred Comp Changes
11/01/05
By: Amanda Gerut, Board IQ
Legislation that tightens the rules governing deferred compensation plans has prompted boards to review their policies to ensure they’re in line with federal requirements.
Deferred compensation refers to fees directors earn that typically are invested in the funds and collected at a later date.
The American Jobs Creation Act of 2004 includes a section that impacts deferred compensation plans. One of the most notable changes is that independent directors must make their decisions regarding deferred compensation a year before that compensation is earned.
And secondly, if a director selects a date to collect the fees in the future, then decides to delay that date, they must delay at least a year in advance of collection. Along with that, directors can only delay collection in five year increments after the original date, compensation experts say.
Say, for example, a director selects the date of 2008 to collect his deferred compensation, and then decides that date is too soon and wishes to hold off collection. Under the new law, the earliest the money can be collected again is in 2013, and then every five years after.
The five-year portion is still something of a “gray area,” says John Schembari, a partner and chair of the employee benefits practice at law firm Kutak Rock. Accordingly, more guidance from the federal government is forthcoming, he says.
Compensation deferred in 2005 or later is subject to the new rules, and failure to comply will result in stiff tax penalties or possible violations of the law, experts say. Because of these changes, many boards will likely begin to review their plans to make sure they still make sense under the new regulation, and to determine whether any changes need to be made to comply with the law, says Schembari.
In a recent SEC filing, Pacific Funds disclosed that the board adopted a new deferred compensation agreement and froze their old deferred compensation agreement to comply with the new rules. In effect, says Alan Richards, the board’s lead independent director, the two deferred compensation plans were split. One reflected the plan before 2005, and the new plan reflects amounts deferred in 2005, in accordance with the new rules. The rules require that documentation regarding changes must be in order by the end of 2006, experts say. Pacific seems to be well ahead of the deadline.
Richards, who has deferred portions of his compensation to be invested in the funds, says that other than the new complexity of the rules and the additional work and expense to administer the plans, the impact to fund directors is nominal. He notes that if directors decide to defer their fees until a certain date, as a drawback, they can’t collect their fees earlier if they need the money, although the board’s plan does allow for directors to receive the money in the event of an emergency or disability.
“I don’t think we’re particularly disturbed,” says Richards. “It does reduce the flexibility to a moderate degree, but it didn’t really impact us seriously.”
Paul Dorf, managing director of Compensation Resources Inc., says the new rules will put deferred compensation plans at more of an arms length, and will disallow companies from taking liberties with the way the programs are run.
“They’ve tightened up the rules specifically so that an individual really can’t make changes to their benefit any time they want,” says Dorf.
Dorf says that in the past, concern among regulators was that executives were getting “too close” to decisions affecting deferred compensation plans. By tightening the rules and lengthening the time requirements, the money is less accessible to executives and directors that defer compensation. Dorf says that while the new rules are an attempt to close loopholes, they make the plans less attractive. He notes that every company with a deferred compensation program should review their plans in light of the rules and the possible penalties – stiff tax penalties and possible violations of the new law.
“It behooves any org, whether it’s public company or privately-owned or a not-for-profit to go back and review their deferred compensation programs to ensure that they meet all the requirements,” says Dorf. “Otherwise, there’s going to be hell to pay.”
Most large and medium-sized fund firms implemented deferred compensation plans years ago as a tax benefit for directors, compensation experts say. More fund firms have offered the plans to directors because traditional retirement benefits such as pensions have fallen out of favor. Most directors don’t need their compensation from the funds to survive, so many defer all or a certain percentage of their annual compensation to be invested in the funds and collected at a later date that may correspond with a major expense, such as a child or grandchild’s education. Usually, directors are in a lower tax bracket when they collect the funds.
Compensation experts agree that the new rules will likely not carry any special impact to mutual fund directors, and so far, directors haven’t decided not to defer fees, says David Gordon, a managing director with Pearl Meyer & Partners, an executive compensation consulting firm. Depending on the type of compensation plan offered by a fund firm, the new requirements will likely cause some additional administrative pileup, he says. So as long as fund firms have the proper software and technology to keep track of accrued deferred fees, problems will be mitigated, says Gordon.
“The complexity is kind of exponential,” says Gordon. “You’re not going to be doing this on graph paper.”
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