Trump Deregulation and Executive Compensation: Pearl Meyer’s Outlook on Staying the Course

Last week’s press release concerning the “unwinding” of Dodd-Frank and this week's announcement from acting SEC Chairman Michael Piwowar are yet more stones in the avalanche of proposed deregulation heralded in the mere two weeks the Trump administration has been in office. Much of what has been announced would actually take quite some time to implement (and for the most part cannot be effected without Congressional action). However, it’s important to understand if and how the proposed announcements could impact the landscape on the executive compensation front as we know it, and what we should be prepared for in 2017 and beyond.

What are specific recent activities that could impact executive compensation?

Executive Order on Dodd-Frank Review: This Executive Order is written in very broad terms, but has directed the Treasury secretary to meet with other top financial regulators and deliver a report in four months (bringing us into June at the earliest) detailing what they believe is working, and not working, for Dodd-Frank. The executive order does not call for any specific changes to Dodd-Frank (or in particular on executive compensation), but rather says that the nation’s financial regulations should be based on several key principles, including prevention of taxpayer-funded bailouts, fostering economic growth, enabling American companies to be competitive with foreign firms, and advancing U.S. interests in international regulatory matters. It directs that regulations should be efficient, effective, and appropriately tailored.

SEC Public Statement on CEO Pay Ratio: Within days of the order on Dodd-Frank review, Chairman Piwowar issued a public statement seeking input on the “unanticipated compliance difficulties that may hinder them in the [CEO pay ratio] reporting deadline”. In that vein, he has requested additional commentary on the hardships of this rule by the third week of March. He notes that he has directed his staff to reconsider the implementation of the CEO pay ratio rule based on comments submitted and to determine whether additional guidance or relief may be appropriate. At this point, it’s important to note that only two of the five commissioner positions are occupied on the SEC—one by Piwowar (a Republican) and one by Kara Stein (a Democrat), so even after comments are received, the sitting commission is not necessarily going to agree on rollback of the rule.

Proposed SEC Regulatory Accountability Act (“RAA”): The House of Representatives voted in favor of the SEC RAA—a bill that would require the SEC to perform a more rigorous cost-benefit analysis on existing and new rules which could bring promulgation of regulation to a halt. It would require the SEC to review all of its existing regulations within one year to determine if they are still efficient, with a higher level of scrutiny placed on rules that cost the public more than $250 million (note that the SEC’s estimated cost of compliance with the CEO pay ratio in the first year is $1.3 billion). If the rules are not efficient, they must be modified, streamlined, and/or rescinded. This process must be repeated every five years.

New Version of Financial Choice Act ("FCA"): Later this month, we understand that Republicans will introduce a new version of the FCA which will likely include provisions to repeal the CEO pay ratio as well as require proxy advisory firms to register with the SEC and disclose potential conflicts of interest.

The Priebus Memo: The current White House Chief of Staff, Reince Priebus, issued a memo instructing the heads of federal executive departments and agencies to freeze certain regulatory activity. The memo prohibits sending regulations for publication in the Federal Register until they are reviewed by a Trump designee, requires that pending regulations be withdrawn for review and delays publication of regulations that have not yet gone into effect. Importantly, however, independent regulatory agencies, including the SEC, were excluded from coverage under this memo.

Executive Order on Reducing Regulation and Controlling Regulatory Costs: We also have President Trump’s Executive Order issued almost as soon as he took office, which provides that for every one new regulation issued, at least two prior regulations be identified for elimination and that the cost of planned regulations be prudently managed and controlled through a budgeting process. It directs the heads of all agencies to ensure that the total incremental cost of new regulations to be finalized in 2017, including repealed regulations, to be no greater than zero.

What do we think all of this means for executive compensation?

While anything could happen at this point, here are our thoughts:

Dodd-Frank Act

Although the President and current Congress have expressed desire to repeal the Act in full, it is unlikely that unwinding all of the provisions and accompanying regulations of the Act would happen immediately.

Finalized and Implemented Rules: The executive compensation provisions that are currently effective and well-embedded in proxy reporting (including say-on-pay (SOP), say-on-frequency (SOF), say-on-golden-parachutes (SOGP), committee independence, and Chairman/CEO structure proxy disclosure rules) are unlikely to change anytime soon. Even if the regulations were rolled back significantly, we doubt that it would have a significant impact on reporting, as investors and proxy advisory groups are now focused on these items and the enhanced disclosure brought about by SOP, SOF, and SOGP requirements.

Proposed Rules: Reporting requirements that may be at risk could be those that are still in the proposed stage, including pay-for-performance (Section 953(a) of the Act), regulation of financial institution incentive compensation (Section 956 of the Act), and incentive compensation clawbacks (Section 954 of the Act). However, as the concepts behind these rules are now so entrenched in corporate governance practices and such a focus of proxy advisors, we do not think that rollback of the regulations would undermine the intent of the rules as far as proxy reporting goes. Even without the regulations, shareholder and proxy advisors will remain focused on how pay relates to performance, as well as a company’s ability to clawback incentive compensation (particularly in light of the recent Wells Fargo case).

Finalized but not Implemented Rule: As for the newest finalized but not yet implemented regulation—the CEO pay ratio—this may be the hardest one to call. It was scheduled to be effective for 2018 proxy filings and involves an incredible amount of information gathering and thought. While we had been encouraging clients to stay the course until very recently, Chairman Piwowar’s immediate reaction to the order on Dodd-Frank rollback and the wording of his cautionary statement has made the plot thicken. At this juncture, companies that have dug into the process may want to step back and focus their energy on submitting comment letters to the SEC. The letters should be very specific in addressing the time, energy, and resources that have been devoted to the process so far, in specific time and dollar expenditures. They should also point out specific difficulties or ambiguities involved with compliance. Pearl Meyer will be doing the same and is happy to reiterate your thoughts. It is impossible to tell how long it will take the SEC and Treasury to react (or for Congress to gain traction with repeal under the FCA) so we will not know the outcome of the scenario until at the earliest April.  We believe the most probable outcome of this analysis is delayed effectiveness of the rule.

Taxation

With an administration set on an overhaul of the tax code, the impact on executive compensation could be far-reaching:

Tax Rates: Proposed reform under Trump would bring the maximum individual income rates down to 33% from 39.6%, and maximum corporate income tax rate down from 35% to 15%. In addition, repeal of the alternative minimum tax rate (AMT) is also a priority.

Carried Interest: Under current law, the income of private equity and hedge fund partners are generally taxed at a rate of 20% under the carried interest rules. Over the past few years, both parties have promised to do away with current carried interest tax treatment, with such payments being either subject to individual or corporate income tax rates. If subject to individual rates, we should expect to see a shift away from profits interests to more typical forms of equity compensation for these partners.

Section 162(m): Prior to the Trump campaign, there were various proposals to eliminate or reform the performance-based compensation exception to the $1 million limit on deductions for executive compensation. Even without reform in this area, if the corporate tax rate were reduced to 15% we query if companies would continue to jump through hoops to meet this exception, as the value of the deduction would similarly be reduced. There may also be a shift away from non-qualified stock options and performance-based stock (which are currently not subject to the $1 million limit) to time-based stock or other guaranteed fixed forms of payment.   

Incentive Stock Options (“ISOs”): We’ve seen a decline over the years in ISOs as a result of the AMT which limits the tax advantages to the employee, but still denies a deduction to the employer. If the current administration succeeds in repealing the AMT, we could see an uptick in the popularity of this vehicle.  

Deferred Compensation/Section 409A: While the Trump administration has not yet specifically targeted one of the most confusing pieces of tax legislation passed in many decades, there have been various recent bills aimed at repealing the ability of individuals to defer taxation of compensation. One of these would replace 409A in its entirety with 409B, which would require taxation of all forms of compensation when it is no longer subject to a substantial risk of forfeiture (i.e., when it vests). If the law is changed in this regard, companies may spend as much time undoing their outstanding deferred compensation arrangements as they spent in all the years since 2007 trying to comply with 409A. 

Employment

New overtime laws put into place by the Obama administration were scheduled to go into effect on December 1, 2016. Those included raising the annual income threshold to qualify for exempt status (i.e., not being subject to overtime rules) from $23,660 to $47,476. Shortly prior to implementation, the U.S. District Court for the Eastern District of Texas, after hearing arguments from the DOL, as well as the 21 states and more than 50 business groups challenging the DOL’s changes to the overtime exemption salary threshold, issued a preliminary injunction against the changes. The injunction halts the original compliance deadline. Whether or not the rule changes take effect, and when, will be determined at a later date in court. Timing on when the court will hear the merits of the case is unclear, but if the judge determines that the DOL had the authority to raise the salary thresholds, the rule changes could take effect quickly after his ruling. There’s a good chance that the Trump administration, which is eager to roll back regulation, will decide not to provide federal resources for defending the DOL’s position, thereby killing the new rule. While employers should stand ready to comply and understand the implications of the new rule, early compliance is discouraged as it would be very difficult to reverse new classifications if the current FLSA rules are ultimately left intact.   

Affordable Care Act

While the intricacies of the ACA are largely beyond the purview of an executive compensation discussion, it is worth noting here that it is probably well ahead of the aforementioned topics in terms of regulatory priorities for the Trump administration. It is impossible to tell where this legislation will go, but we believe that with the immediate focus on health care reform, we will not see imminent changes to executive compensation related provisions of the Dodd-Frank Act or tax laws specifically targeted at executive compensation arrangements.

Conclusions

Because there are so many balls in the air at this point, we recommend that for at least this compensation planning cycle and proxy season, stay the course in practicing good governance and providing thoughtful disclosures. In addition to business as usual in the compensation planning and reporting phases, we recommend that clients quickly gather their thoughts and experiences on the CEO pay ratio process and draft a meaningful letter to the SEC describing the problems and ambiguities they have encountered. Remember that no matter how the year unfolds, shareholders will still want to see compensation disclosure and practices that exemplify good governance and that make sense in light of corporate strategy, regardless of the regulatory noise.