executive compensation checklist for new and experienced board members (credit union conference...

The Compensation Checklist

Learn the pitfalls to avoid as you craft your

CEO’s compensation package

Presented By:

James S. Patterson, Attorney

Sherman & Patterson, Ltd.

Tom Telford, Executive Vice President

Burns-Fazzi, Brock & Associates

Overview

• New Part 750 – Golden Parachute /

Indemnification Payments

• Proposed Rule on Executive Compensation

• New Rule 701.4

• Cash Compensation Philosophy

• Example of WesCorp Litigation

• 10 Best Practices of Compensation Oversight

• 5 Step Safety & Soundness Road Map for

Executive Benefit Plans

Part 750

• Part 750 – New rules relating to

– “Golden Parachute” payments

– Indemnification payments

Golden Parachutes

• Distinguish “legitimate severance payments”

• Two part test

–Payments “contingent on termination of

employment”

–Received when credit union is “troubled”

Golden Parachutes

• “Troubled”

– Insolvent

–Under Conservatorship

–Deemed by a regulator to be troubled, or

–Assigned a 4 or 5 CAMEL or CRIS rating

Golden Parachutes

• Exceptions

– Pre-existing arrangements, death benefits, properly designed collateral assignment split dollar plans

– Bona fide deferred compensation

‒Nondiscriminatory severance

• Up to 12 months of salary

• Different levels (with a permitted 10% variance) must cover at least 33% of employees

Indemnifications

• Whether or not “troubled”

• Payments disallowed if

–Assessed civil penalty

– Removed from office

– Subject to cease and desist order

• Exception “to the extent” findings are in the

individual’s favor

• Interim payments allowed subject to limitations

• Applies to credit unions with assets in excess

of $1billion

–Excessive compensation

–Excessive risk taking

–Or both

Proposed Rule on Executive Compensation

Proposed Rule on Executive Compensation

• Disclosure Requirement (persons covered,

succinct description, material changes, specific

reasons why incentive compensation does not

encourage inappropriate risks)

• Submit annual report to the appropriate

federal regulator, in the format specified

Proposed Rule on Executive Compensation

• Additional requirements for larger credit

unions

–More than $10 billion in assets

–Three year deferral required (or annual

pro-rata distributions)

Proposed Rule on Executive Compensation

• Six factors for determining whether an arrangement provides

excessive compensation

– Amount of compensation

– Prior compensation paid to the individual and to others

with comparable expertise

– Credit Union’s financial condition

– Compensation paid by comparable “institutions”

– Projected total cost and benefit

– Connection between the individual and any breach of duty

Rule 701.4

• Describes duties of FCU Board of Directors

• Effective January 27, 2011

• Financial skills requirements – 6 months

• NCUA letter of clarification (11-FCU-02)

Rule 701.4

• Five director duties*

– General direction and control

– Good faith (ordinarily prudent person standard)

– Fair and impartial

– Working familiarity with finance and accounting

practices

– Direct FCU operations according to federal laws

* Can rely on information from employees or consultants – must “merit” confidence

Rule 701.4

• Financial Statements

–What does this line mean?

–Why is this important?

• Is the item’s value changing over time?

Why?

• Is the change important?

Line Item Dec 09 Mar 10 %

Chg

Jun 10 %

Chg

Sep 10 %

Chg

Dec 10 %

Chg

Assets

Real Estate

Loans 225,604,566 222,728,670 -1.3 222,155,136 -0.3 221,618,831 -0.2 203,188,690 -8.3

Unsecured

Loans 88,600,852 87,209,049 -1.6 88,437,591 1.4 88,776,772 0.4 89,709,394 1.1

Liabilities &

Capital

Dividends

Payable 969 930 -4 489 -47.4 797 63 740

-7.2

Accounts

Payable & Other

Liabilities

8,608,737 9,169,506 6.8 10,160,759 10.5 12,103,137 19.1 10,198,461 -15.7

Income &

Expenses

Loan Income 31,472,513 8,216,680 4.4 16,525,981 0.6 24,816,678 0.1 33,259,417 0.5

Investment

Income 15,442,991 3,121,244 -19.2 5,424,092 -13.1 8,253,164 1.4 10,757,912 -2.2

Rule 701.4

• How to acquire financial skills

– FCUs need training policy providing:

• Internal/external training, self, on-the-job

• Education: college courses, OSCUI,

NCUA E & I internet-based training

Rule 701.4

• Management oversight

–Board, among other things, must directly set

compensation

–Establish policies

–No “screening” or “filtering” from CEO

Compensation Philosophy

• Guiding principles and objectives

– Purposes (e.g., degree of leverage?)

– Peer group compensation standards

– In writing and signed by Board Chair

• Administrative Responsibility

– Monitor compensation regularly to ensure

consistency

– Delegate day-to-day responsibilities to CEO or

other executive(s)

WesCorp

• One side of the story

• Seeking damages from key executives for SERP

payments

• Illustrates importance of process (e.g., active

board involvement, third party review,

documentation of intent, executive session)

10 Best Practices of Compensation Oversight

• Develop compensation philosophy

• Specify covered positions

• Seek comparability data

• Annually review compensation

• Consider multiplier effect

10 Best Practices of Compensation Oversight

• Engage periodic consultant review

• Consultants report to Board

• Inspect plan modifications

• Ensure plan document is compliant

• Associate with professionals to monitor legal

developments

5 Step Safety and Soundness

Road Map for Executive Benefit Plans

1. Develop a written compensation philosophy (NCUA 701.4)

2. Executive Benefit Plan Vendor Due-diligence (NCUA

701.4)

3. Gain knowledge and understanding of the executive benefit

plan

options that exist

4. Determine the right balance of fair and reasonable for your

credit union in rewarding an executive benefit plan (NCUA 701.4)

5. Seek to understand and mitigate the risks that impact

executive benefit plans (NCUA

701.19)

1- Develop A Written Compensation Philosophy

NCUA

701.4, the NCUA Letter No. 11-FCU-02

• Develop a written compensation philosophy

• Specify covered positions

• Seek comparability data

• Annually review compensation

• Consider multiplier effect (e.g., salary increases

may increase Defined Benefit SERP benefits)

1- Develop A Written Compensation Philosophy

NCUA

701.4, the NCUA Letter No. 11-FCU-02

• Engage periodic consultant review

• Consultants report to the board (NCUA is

concerned about CEO’s “screening” or “filtering”

info)

• Inspect plan modifications

• Ensure plan documentation is compliant

• Associate with professionals to monitor legal

developments (e.g., expected regulations under

IRC

457(f))

2- Executive Benefit Plan Vendor Due-diligence

Three Key Elements to Vendor Consideration

• Evaluate the vendor’s experience and expertise

• History

• Endorsements

• Business Model

• Weigh the vendor’s reputation in the industry

• Clients

• Financial Health

• Examine key operational issues

• Online Administration

• Compliance Reporting

• SAS70

• Field Personnel

Checklist for Board Due Diligence & Compliance

Reasonable Compensation Package

The Board should review the benefits provided to key employees at the various payment scenarios:

– Retirement / Payment date

– Death

– Disability

– Involuntary Termination

– Termination following Change of Control

– Termination for “Good Reason”

– Voluntary Termination

Checklist for Board Due Diligence & Compliance

Informal Funding Review

The Board should review the informal funding investment purchased to offset the cost of the benefit plan. This includes:

–Review of the type of investment

–Current values

–Year to date performance

–Concentration based on percentage of total equity

Checklist for Board Due Diligence & Compliance

Overall Annual Plan Performance

The Board should review the overall performance of the plan. By comparing the annual expense of the plan to the earnings of the investment, the Board will be able to determine if the plan is performing as projected or if they need to make any adjustments.

• Total expenses, including annual benefit expenses, informal funding fees, premium expenses and administration fees

• Current income from the informal funding investment

• Impact to the bottom line of the Credit Union

Types of Plans & Uses: Tax Deferral (Deferred Compensation – Retention)

1. 457(b)

2. 457(f)

3. 451

Taxed Immediately (Section 162 – Vesting)

1. Restricted Bonus

2. Secular Trust

Tax Avoidance (Welfare Benefit Plans – Tax Arbitrage)

1. Post Retirement Medical

2. Split Dollar

3- Gain Knowledge and Understanding of the

Executive Benefit Plan Options

4- Determine the Right Balance of Fair and

Reasonable For Your Credit Union in

Rewarding a Benefit Plan

• Employees will need about 70-80 percent of

pre-retirement income

• Retirement income sources include

– Social Security

–Qualified retirement plans

• High income earners will have a gap due to IRS

limitations on qualified plans and annual exempt

amounts with Social Security.

4- Determine the Right Balance of Fair and

Reasonable For Your Credit Union in

Rewarding a Benefit Plan

55.3%

69.5%

0.0%

34.2%

67.6%

0.0%

17.3%

51.5%

31.3%

12.4%

41.2%

46.5%

6.1%

27.1%

66.7%

3.0%

20.1%

76.8%

0%

25%

50%

75%

100%

125%

$50,000 $100,000 $175,000 $250,000 $500,000 $1,000,000

Pre-Retirement Compensation Levels

Soc. Sec. 401k Gap

4- Determine the Right Balance of Fair and

Reasonable For Your Credit Union in

Rewarding a Benefit Plan

Example of GAP

PARTICIPANT DATA PROJECTED ANNUAL DISTRIBUTIONS

Age Years Salary ($) Proposed Projected

FROM EXISTING BENEFIT PLANS

Proposed as of of as of Retirement Final Retirement Social Current Participant 4/1/2012 Service 4/1/2012 Age Salary ($) Length (Yrs) Security ($) Plans ($) Amount ($) %

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)

PRESIDENT/CEO 44 21 275,000 62 661,820 20 19,584 112,213 131,797 19.91%

TELLER 25 40 29,544

62 171,113

23 19,266 79,662 98,928 57.81%

BRANCH MANAGER 57 37 74,066

62 90,028

23 10,548 28,094 38,642 42.92%

Notes/Assumptions:

Total Existing

- The report indicates the participant's projected final average compensation rate, growing from the current compensation rate at a 5.00

percent annual increase (inflating on January 1 of each year).

4- Determine the Right Balance of Fair and

Reasonable For Your Credit Union in

Rewarding a Benefit Plan

How Many Have Nonqualified Benefit Plans?

Credit Union Executive Compensation/Benefits Survey -

CUES (2011)

Percent Offering SERP

Asset Size

<$20M

-

$69.9

M

$70

M-

$99.

9M

$100

M-

$199.

9M $200M-$399.9M

$400

M-

$599

.9M

$600

M-

$999.

9M $1B or more

457(b) 13% 19% 37% 44% 51% 65% 76%

457(f) 14% 15% 33% 34% 51% 49% 44%

Split Dollar 7% 13% 16% 14% 14% 32% 22%

Credit Union SERPs Offered for CEO Position 457(b), 457(f) and Split-Dollar Plans by Asset Size

Credit Union National Association - CUNA (2010-2011)

Percent Offering SERP

Asset Size

$100M

-

$150M

$150

M-

$200

M

$200

M-

$300

M $300M-$400M

$400

M-

$600

M

$600

M-

$1B $1B or more

457(b) 33% 39% 40% 39% 57% 70% 56%

457(f) 23% 15% 28% 39% 49% 39% 36%

Split Dollar 9% 12% 12% 15% 19% 16% 9%

Credit Union SERPs Offered for CEO Position 457(b), 457(f) and Split-Dollar Plans by Asset Size

National Association of Federal Credit Unions-Burns-Fazzi,

Brock - NAFCU/BFB Survey (2011)

Percent Offering SERP

Asset Size

$40M-

<$75M

$75M-

<$150M $150M-<$335M

$335M-

<$750M $750M +

457(b) 12% 14% 38% 44% 75%

457(f) 15% 16% 15% 41% 40%

Split Dollar 2% 15% 10% 6% 5%

Credit Union SERPs Offered for CEO Position 457(b), 457(f) and Split-Dollar Plans by Asset Size

5- Seek to Understand and Mitigate the Risks

That Impact Executive Benefit Plans

Board Due Diligence

Issues of Safety and Soundness

Roadmap to Construct a Plan, Identifying and Avoiding Risks

Legal and

Product

Risk

Analysis

Ongoing

Board Due

Diligence &

Administratio

n

Third Party

Relationship

Vendor

Selection

Questions? James S. Patterson, Attorney

Sherman & Patterson, Ltd.

jpatterson@splawfirm.net

Tel: (763)479-2699

Tom Telford, Executive Vice President

Burns-Fazzi, Brock & Associates

ttelford@bfbbenefit.com

Tel: (888) 494-8911

http://www.nafcu.org/BFB/