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ETHICAL ISSUES IN EXECUTIVE COMPENSATION Dallas/Fort Worth ISCEBS Felicia Finston [email protected]

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Page 1: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

ETHICAL ISSUES IN EXECUTIVE

COMPENSATION

Dallas/Fort Worth ISCEBS

Felicia Finston

[email protected]

Page 2: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 3: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 4: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 5: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 6: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 7: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 8: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 9: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 10: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 11: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 12: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 13: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 14: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 15: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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?

Page 16: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 17: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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?

Page 18: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 19: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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?

Page 20: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 21: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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?

Page 22: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 23: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 24: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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?

Page 25: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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

Page 26: ETHICAL ISSUES IN EXECUTIVE  · PDF fileETHICAL ISSUES IN EXECUTIVE COMPENSATION ... The first step to establishing ethical compensation ... corporate boards and management

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?