Baker's Choice: January 2005

January 2005
Since my last e-letter, we've seen substantial changes to the tax laws, issuance of the final (!) rules on accounting for stock options, new disclosure obligations from the SEC, revised shareholder approval rules at the NYSE . . . enough to keep everyone busy for some time to come. Moreover, merger & acquisition activity is on the rise, posing complicated issues for executives facing a change in control. Today's links are intended to help you sort through your compensation alternatives in this rapidly changing environment.

Increased M&A Activity Means You Need to Review Your Agreements NOW. With pundits predicting an upsurge in m&a/IPO activity for 2005, we can expect to see continued scrutiny of "golden parachutes" and other executive compensation techniques, both in the popular press and the academic/legal literature. High profile deals like the Oracle/PeopleSoft acquisition inevitably result in company-wide job losses and reassignments, but also raise important questions about which negotiated executive benefits survive and which must be agressively asserted prior to closing. The key is to understand how you are affected by all elements of the executive package, whether contained in corporate plans and policies (such as RIF-specific severance or stock option plan acceleration) or in individual contracts. For a framework to help you get started, download my short article, Protecting Your Rights in M&A.

New Tax Rules Make Executive Compensation Planning More Challenging. As predicted, the "American Job Creations Act of 2004" was signed into law in October and became effective on January 1, with transition guidance published last week as IRS Notice 2005-1. The upshot: most forms of elective deferred compensation -- including bonuses, installment severance compensation, stock appreciation rights, discount options and the like -- will immediately be taxable to the executive unless structured to comply with strict rules regarding timing of elections and distributions. There will be very little flexibility to accelerate distributions (other than in a few narrow circumstances like a change in control). Although the rules have already kicked in, we have a year to modify existing plans to make them compliant, so now is the time to take a close look at any arrangements you rely upon for future payouts. A recent Aon Consulting Alert does a good job summarizing the new rules; you can also download my outline on Deferred Compensation Strategies.

In another tax development, the IRS has just made it nearly impossible to treat certain contract payments as non-wage compensation. Reversing close to 50 years of precedent, the IRS held in two recent rulings that future payments made as a signing bonus or to cancel an employment contract will be wages for FICA, FUTA and income tax withholding purposes. Again, a strict standard can be applied to challenge wage classification but it is unlikely to succeed so long as the contract itself is related to future or past employment.

And Now Presenting (if anyone's left in the house): The Final Stock Option Accounting Rules. The FASB issued FAS 123(R) (Share Based Payment) on December 16, 2004, requiring all companies to expense options based on fair value. As expected, most public companies must adopt FAS 123(R) by the first fiscal quarter beginning after 6/15/05; nonpublic entities have until the first fiscal year beginning after December 15, 2005. Although Congressional tech-defender Nancy Pelosi released an outraged statement chastising the board, it looks like the time has come for Silicon Valley companies to throw in the towel. At a Stanford Law conference last week, SEC Chief Accountant Don Nicolaisen said that the agency may provide implemetation guidance on the "nuts and bolts" of applying the standard, but reiterated that the SEC firmly backs the FASB's decision to require expensing. Meanwhile, when a few companies reacted by quickly accelerating unvested options, an SEC rep speaking before the AICPA in December said that the agency will expect extensive disclosure of the reasons for such acceleration. Anyone who wants to delve into the rules should rely first on their accounting firm for details; however, F.W. Cook has a good general overview online for those who'd like a fast briefing.

Some quick catching up: Google escaped with no penalties for failing to register its employee stock options, but SEC officials claim they are sending a message that violations of Rule 701 are not acceptable even if they could be "fixed" by recission offers. . . California companies with 50 or more employees must provide supervisors with sexual harrassment training under Assembly Bill 1825, effective January 1. . . Following 18 months of comment and amendment, the final 401(k) regulations were issued on December 28, 2004.

Those of you who'd like to hear more about these changes might want to attend the Beyster Institute/NCEO 2005 Annual Conference, where I will be moderating a panel on equity compensation developments. The conference ("Share Equity: Create Value") is aimed at executives/entrepeneurs and takes place April 20-22, 2005 in San Francisco. You can find more information on the conference website.

As always, I welcome your questions and comments!