On July 21, 2016, the Department of Labor (“DOL”), Internal Revenue Service (“IRS”), and Pension Benefit Guaranty Corporation (“PBGC”) (collectively the “Agencies”) proposed major revisions to Form 5500. The stated goals of the proposed revisions are to improve annual financial reporting requirements, enhance the ability of the Agencies to data mine reported information, increase transparency of service provider fee information, and increase compliance with the Internal Revenue Code (“Code”) and the Employee Retirement Income Security Act of 1974 (“ERISA”).

Although most of the changes, whatever they ultimately may be, will not become effective for a couple of years, there are some changes that are currently applicable because they affect the 2016 Form 5500.  These changes include the following:

• IRS-Only Questions: Although the IRS has added certain compliance questions to the 2016 Form 5500 and to Schedules H, I, and R, the IRS has instructed filers to not complete Lines 4o and 6a through 6d of Schedules H and I, “Part VII – IRS Compliance Questions” of the Schedule R, and the “Preparer’s Information” at the bottom of the first page of Form 5500.
• Administrative Penalties: In accordance with ERISA Section 502(c)(2), as amended by the Federal Civil Penalties Inflation Adjustment Act Improvements Act of 2015 (the “2015 Inflation Adjustment Act”), the new maximum civil penalty for a plan administrator who fails or refuses to file a complete or accurate Form 5500 is $2,063 per day (up from $1,100 per day). The DOL expects to adjust these penalty amounts annually for inflation no later than January 15th, as required by the 2015 Inflation Adjustment Act.
• Schedules H and I (for defined benefit plans only): Line 5c adds a second part to the question that asks whether a defined benefit plan is covered by the PBGC insurance program.  Under the updated instructions, filers who check “yes” will also have to enter the applicable confirmation number from the PBGC’s ‘My Plan Administration Account’.

Though the more in-depth proposed revisions will not become effective for at least a few years, we are seeing a trend in Form 5500 changes where the IRS, DOL and PBGC want to see more information and data included.  Based on the growing complexity, now is a good time to start preparing for increased reporting requirements and data collection.

A Mid-Season Look-in on 2017 Proxy Say on Pay Results

According to the Semler Brossy 2017 Say on Pay Results of Russell 3000 companies (as of April 26, 2017), average support for 2017 Say on Pay resolutions was 92.6% of votes cast, with just 1.3% of companies failing say-on-pay (the lowest fail rate in the Say on Pay era).  Further, 80% of companies received shareholder support in excess of 90%, higher than any previous year.  Finally, 15% of companies received approval ratings between 70% and 90% (two percent lower than 2016) and 4% of companies received approval ratings between 50% and 70% (down from 6% in 2016).

As in prior years, an ‘against’ recommendation from ISS heavily correlates with a poor say-on-pay result.  In 2017 ISS issued ‘against’ recommendations approximately 10% of the time, and the average shareholder support was 70% in those cases, approximately 25% less than the average shareholder support when the ISS issued a ‘for’ recommendation.  With results similar to prior years, this continues to show that ISS is a clear and important influencer on shareholder voting behavior. 

Therefore, it is critical for companies to have a strong idea of where the ISS recommendation is going to fall, because it will have an effect on Say on Pay approval.  That being said, ISS does reevaluate companies each year and does change its recommendations year over year when companies take action (or fail to take action when appropriate).  Although data for 2017 is still insufficient for comment at this time, 6% of companies that received an ‘against’ recommendation from ISS in 2015 received a ‘for’ recommendation in 2016.  Conversely, 7% of companies that received a ‘for’ recommendation from ISS in 2015 received an ‘against’ recommendation in 2016.

Companies and management can prepare for the Say on Pay voting by eliminating problematic compensation practices.  The top two reasons companies failed Say on Pay in 2016 were due to pay and performance disconnects and/or problematic pay practices (preliminary data for 2017 shows that  this trend continues).  Out of the companies that failed Say on Pay in 2016, 81% attributed the failure to one of those two causes.  While this represented a reduction over prior years, both factors remained the primary cause of Say on Pay failure by a wide margin. 

However, ISS’s continued focus on metric setting rigor is gaining traction in the market.  In 2016, 50% of companies reported that the rigor of performance goals was a leading contributor to a Say on Pay failure, whereas only 33% reported as such in 2015 (preliminary data for 2017 indicates this will likely be higher in 2017).  To help ensure these pitfalls are avoided, Compensation & Benefit Solutions has extensive experience assisting companies with their proxy drafting to ensure shareholders understand that best practices are followed and will vote “yes” on Say on Pay.

Checking in on Non-Employee Director Pay Litigation

As you may remember, the decision from a recent case in Delaware created an avenue for shareholders to more easily sue companies over their equity compensation grants to non-employee directors (link).  Specifically, in Calma v. Templeton, the Delaware Chancery Court denied a motion to dismiss where non-employee director compensation grants were made pursuant to a shareholder approved plan.  The court’s decision was based on the fact that although the equity plan contained limits on the size of equity grants that could be made, the limits did not distinguish between executives and non-employee directors, and were set so high as to not be meaningful.  As such, the court held that the shareholder approval of the plan was not sufficient to ratify the board’s action with regard to the equity compensation granted to non-employee directors.  Therefore, rather than being subject to a “corporate waste” standard of review, the court held that the equity awards were subject to the entire fairness standard.

In early April, a new decision came from the Delaware Chancery Court in In re Investors Bancorp, Inc., applying the decision from Calma.   In Bancorp, the court upheld the board’s equity compensation grant to non-employee directors on the basis that the equity plan under which the awards were granted was approved by shareholders, and more importantly, the plan contained explicit meaningful limits on grants to non-employee directors.  Among the key distinctions from Calma was the fact that the plan in Bancorp had limits that specifically applied to directors.  However, the court did indicate that director-specific limits alone were not enough, and that the limits themselves must be meaningful.

It appears that plan drafters learned a key lesson from Calma, and the courts are receptive to more narrowly tailored approaches in plan drafting to avoid application of the entire fairness standard to non-employee director compensation cases.  However, the emphasis on meaningful limitations means companies must pay more attention to whether the limitations contained in their plans potentially amount to no limit at all.  In addition to being able to help with drafting, reviewing, and revising equity plan documents, Compensation & Benefit Solutions has extensive experience assisting companies with benchmarking equity plan limitations to ensure board members are protected.

IRS Implements New Information Document Request Management Process

Effective April 1, 2017, the Tax Exempt and Government Entities Division of the Internal Revenue Service issued a new Information Document Request (“IDR”) management process for its agents to follow.  This new process is designed to more actively involve the taxpayer in establishing timelines and discussing the issues.  Additionally, the process creates a formal timeline for examiners to follow when issuing an IDR.  This new process is different because there will be an initial contact letter and phone contact prior to the issuance of an IDR.  The previous guidance did not call for either of those; therefore, the IDR often served as the taxpayer’s notice of an examination.  In addition, the timeline associated with the new process is more formalized and rigid than the prior process.

Although the new process does have some positive aspects, the most noticeable change is the lack of flexibility afforded to the examiners.  Under the prior process, examiners were given significant latitude in setting deadlines and extending those deadlines.  That latitude has been expanded in setting the initial due dates, but was replaced with semi-rigid rules regarding extensions.  As anyone who has gone through an IRS examination knows, what appear initially to be straight-forward requests can often become much more time and labor intensive.  Given these changes,  it is still a best practice to establish a good rapport and working relationship with the examiner, and to reach out proactively if a taxpayer anticipates any challenges to complying with deadlines or specific IDRs.

The lasting effect of the guidance is still largely unknown given the recent effective date, but it appears that deadlines will be less fluid and more concrete, which can increase stress.