February 8, 2008

Surprise! IRS’ New Private Letter Ruling Causes Termination Provision Shockwaves

Last week, the IRS made a private letter ruling publicly available that is causing many to rethink the termination provisions in their plans and agreements. This PLR – dated September 21st! – relates to Section 162(m) and the deductability of pay arrangements for executives who are involuntarily terminated or quit with good reason. Many of the commentators so far observe that this is a reversal for the IRS.

We held off blogging on this huge development as we have read the wave of firm memos that have rolled in during the past week, many of them grappling with how to interpret this PLR and some disagreeing with each other. We have posted just over a dozen of these memos in the “Section 162(m) Compliance” Practice Area on

Next Week’s Webcast: The New IRS Letter Ruling: How It Impacts Your Employment Arrangements, Accounting, Proxy Disclosures, Etc.

Sine the IRS’ new private letter ruling may have implications for your upcoming financial reporting and proxy disclosures (not to mention compensation design), we have put together a quickie webcast for – “The New IRS Letter Ruling: How It Impacts Your Employment Arrangements, Accounting, Proxy Disclosures, Etc.” – for next Thursday. Join me, along with:

Elizabeth Drigotas, Principal, Washington National Tax, Deloitte Tax LLP
Mike Kesner, Head of Deloitte Consulting’s Executive Compensation Practice
Mike Melbinger, Partner, Winston & Strawn LLP
Paula Todd, Managing Principal, Towers Perrin
Jeremy Goldstein, Partner, Wachtell Lipton Rosen & Katz

Options Backdating Update

While the tide of new options backdating cases seems to have crested, developments continue with the outstanding SEC/DOJ cases, as well as on the private litigation front.

Last month, Gregory Reyes, the former CEO of Brocade Communications, became the first CEO to be sentenced to jail time for backdating. Reyes now faces 21 months in prison and a $15 million fine. The former CFO of SafeNet, Carole Argo, also received a prison sentence – she will serve a six month sentence and pay a $1 million fine. While no time in prison is a good time, these certainly aren’t the kind long sentences faced by financial fraud kingpins like Dennis Kozlowski and Jeffrey Skilling. I doubt, however, that four or five years ago many would have predicted any sort of prison time from cases that some continue to argue only involve benign paperwork errors and a “technical” accounting issue.

The SEC also recently announced the settlement of civil charges against Andrew McKelvey, the former CEO of Monster Worldwide, for his involvement in a long-running backdating scheme at Monster. While the terms of the settlement provide for an injunction, disgorgement and an officer and director bar, the settlement didn’t include a civil penalty “due to the overriding personal circumstances related to McKelvey.”

On the private litigation front, the derivative lawsuit involving allegations of “spingloaded” options against Tyson foods and some of its current and former directors settled last month. Under the settlement, former Tyson CEO Don Tyson, as well as the company’s largest shareholder, agreed to pay $4.5 million to the company. As Broc noted in the blog last summer, Delaware Chancellor Chandler twice refused to dismiss the lawsuit, citing the inherent unfairness of springloaded options and the board of directors’ concealment of the unlawful scheme. Chancellor Chandler’s opinions in this case are posted in our “Backdated Options” Practice Area on, and I suppose will continue to serve as the main authority out there on the state law implications of spingloading.

The San Francisco Regional Office Enforcement Staff was interviewed for this recent MarketWatch article concerning the backdating cases. Members of the Enforcement team expressed how shocked they were to first realize that such high level of people had been involved in creating bogus minutes – in particular respected, top-ranking lawyers. According to the article, the Staff used so-called “V-Charts” as a way of identifying suspicious option grants made at the bottom of the “V.” Marc Fagel, Acting Regional Director of the SEC’s San Francisco Regional Office, indicated that their focus in these cases was on management and not lower level employees. He also noted that the first line of defense for many executives – “I am not an accountant and I don’t know anything about this” – typically failed because it turned out that those executives were aware of the issues.

– Dave Lynn