TheCorporateCounsel.net

March 5, 2007

Another 409A-Related Deadline: California Developments Linked to Backdated Options and Section 409A

Tahir J. Naim of Fenwick & West provides this timely warning about a March 15 deadline from the California Franchise Tax Board: California’s Franchise Tax Board has implemented a program related to collection of its taxes for 2006 income recognized by certain taxpayers due to Section 409A that parallels the IRS program described in IRS Announcement 2007-18. The deadline for participation in this program is March 15, 2007.

It is the position of California’s Franchise Tax Board that, as of 1/1/05, California’s Revenue and Taxation Code Section 17501 automatically incorporated into California law the provisions (including the 20% tax and interest) of Section 409A of the Internal Revenue Code.

In other words, California taxpayers whose deferred compensation arrangements trigger the application of the federal 409A tax will also have a commensurate California tax liability for a total tax liability of at least 85% (federal = 35% + 20% + 1.45% + 409A interest + CA of 9.3% + 20% + CA 409A interest) on income which in at least some instances the taxpayer will not yet have received.

Executives who are “specified employees” (as defined in Section 409A) will want to pay particular attention to ensuring their severance arrangements include the 6-month delay on any payments that would trigger the tax under Section 409A (more broadly, this will also heighten the need of issuers with employees in California to have backing for the position that their stock option exercise prices are no less than fair market value of the underlying shares on the date of grant).

Although the law was effective with respect to 2005 income, it may be that California – like the IRS – will concentrate its focus on the collection of taxes arising in 2006 and thereafter. For example, it is only with California’s 2006 Form 540 that mention is made of 409A taxes (see the instructions to Line 33 of the form).

If you need more information, contact the California Franchise Tax Board at 916.845.7057. [And speaking of 409A, Corp Fin has issued its second tender offer prompt payment exemptive letter.]

Pay Bosses More! Gimme a Break…

I keep thinking we have seen the last of the WSJ opinion columns urging that CEOs be paid more. Wrong again! This recent opinion column from two senior fellows at the Cato Institute really takes the cake.

You know we are in for a laugher when the column starts off with the theme of: “Excessive executive compensation harms no one but perhaps the stockholders who put up with it.” Getting past that excessive compensation does indeed hurt employee morale (not to mention how leaders are viewed by many in this country, etc.), I don’t see how these senior fellows make their argument that “stockholders are putting up with it” with a straight face.

First, shareholders haven’t known how high levels of CEO compensation have really gotten because the SEC rules historically haven’t elicited the full compensation story from companies (these rules were changed last summer, but the new and expanded disclosures aren’t in quite yet). For that matter, most boards themselves didn’t know how much they are paying their own CEOs until tally sheets became a mainstream practice within the last year or so. As tally sheets have begun to be used for the first time, the “Holy Cow” surprise felt by the NYSE board in the Dick Grasso incident has proved not to be an isolated event.

Second, many shareholders simply aren’t putting up with it. Unfortunately, they have only limited tools at their disposal to try to effectuate change: submitting nonbinding shareholder proposals to companies to place on annual meeting ballots, and more recently, “just vote withhold” campaigns against director nominees. This soon may change as the movement to force annual shareholder advisory votes on executive compensation is gathering momentum on Capitol Hill (and with companies as Aflac just became the first US company to agree to do it in 2009).

With more disclosure in their hands and a vehicle to express dissatisfaction, I believe we will soon have pretty solid proof that shareholders don’t want to “put up with it”; they’ve just been stuck with it as boards continue to follow outdated – and ill-formed – processes that have led to mind-boggling compensation packages to CEOs. As I have long contended, I don’t believe most directors want to overpay CEOs – it’s just that the processes put in place over a decade ago led to some unintended results.

This cycle must end. It’s incumbent on boards to fix these problems and have some backbone to realize that layering on a few more million won’t really incentivize a CEO to perform just a wee bit more when the CEO is already sitting on a pay package worth tens of millions. Arguing otherwise doesn’t seem to be a logical read of human nature.

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