Deferred Comp Rule May Catch Some Boards Napping

Companies are scrambling to tweak — and, in some cases, overhaul — their deferred comp plans to meet the December 31 date for compliance with Section 409A of the Internal Revenue Code.
The final version of the rule, which was adopted in early April, broadened the scope of benefits that fall under 409A, introducing a new level of complexity that has forced companies to reassess their deferred compensation programs. Boards are waiting to review and approve the revised plans. The problem is, many directors don’t understand the final rules and what needs to be done to comply with them, say experts.
Compensation consultants and benefits lawyers have been struggling to get their clients in compliance, and many say they have a long way to go. To that end, a consortium of 92 law firms sent the IRS a letter late last month seeking a one-year extension on the regulation’s compliance date.
The deadline is not realistic given “the corporate governance processes many of our clients have adopted with respect to decision making related to executive compensation matters,” the letter states.
The rule, which was adopted in late 2004 as part of the American Jobs Creation Act, lays out very specific guidelines and requirements for deferred compensation plans.
The changes included in the final version of the rule by the IRS were not a huge surprise, but they require further review and, in most cases, revisions, says Neil Leff, a lawyer with Skadden, Arps, Slate, Meagher & Flom who worked on the letter. Many companies’ benefits are interrelated, so a change to a specific benefit has a domino effect on the rest of the plan, he says.
There are “a lot of traps to run between HR and accounting... [and] proxy implications and a lot of ramifications, and ultimately management will make a recommendation to the board and the board will get a presentation,” Leff adds.
Boards, unlikely to rubber-stamp the changes, will need time for review. “They’ll want to relook at [the plan] and look at it in the totality of overall compensation,” says Bill Sweetnam, a lawyer with the Groom Law Group who also worked on the letter.
What directors do not know definitely could hurt them when it comes to 409A, says Paul Dorf, a compensation consultant with Compensation Resources. Among the changes included in the final rule is an all-or-nothing provision that could render the company’s entire plan non-compliant. That’s a huge change from earlier versions of the rule, which included a severability provision stipulating that any portion of a plan document deemed to be in non-compliance with the code was viewed on its own and did not result in the entire document being deemed non-compliant, Dorf explains.
But even those companies are likely still puzzling over 409A. The final regulations raised a host of issues and questions that are still subject to much debate, according to the law firms’ letter. “As a result, even expert practitioners differ or are uncertain of how to apply the rules to many common business practices,” it states.

The change affects virtually every company, Leff says. “It’s not too much of an oversimplification to say that virtually every employment agreement will require amendment,” he says.