To attract and retain key executives, banks have implemented nonqualified benefit plans as part of their overall compensation strategy. One of the challenges of bank board members is to understand what is or is not included in these agreements and how the agreement terms affect other agreements such as change-in-control, employment contracts, equity plans and others.
Prevalence of Nonqualified Plans
Such plans are common in the banking industry. According to the American Bankers Association 2013 Compensation and Benefits Survey, 64 percent of banks surveyed offer some kind of nonqualified deferred compensation plan for top management (CEO, C-Level, EVP), and 45 percent of respondents offer a Supplemental Executive Retirement Plan (SERP). Types include performance-driven benefit plans, director retirement plans, death benefit or survivor income plans, and phantom stock or stock appreciation rights (SARS) plans.
To avoid violating the U.S. Department of Labor rules concerning plan eligibility, participants in nonqualified plans should be limited to a “select group of management or highly compensated employees,” which taking a conservative approach, is typically no more than 10 percent of a company’s employees. In addition, the included employees should have the ability to affect or substantially influence the design and operation of their deferred compensation plan.
It is important for the board to understand the terms of their deferred compensation plans and the potential ramifications. Common questions that arise regarding some key agreement terms are:
- What happens if the executive chooses to retire early or extend the time to retirement? Generally the benefits are payable at the time the executive separates from service. Depending on the plan design and the board’s intent, the benefit amount for delayed retirement may remain the same or may be increased.
- What happens in the case of involuntary termination or termination-for-cause? Termination-for-cause provisions often include forfeiture of some or all of the benefit.
- What happens if the executive becomes disabled? Some plans provide that payments commence upon separation from service due to disability while some commence at normal retirement age.
- What type of vesting is common in plans? Since nonqualified plans are not governed by ERISA (Employee Retirement Income Security Act), they may use a number of different vesting options including: immediate, graded, cliff, rolling, or at-retirement. Vesting will vary depending on the objectives of the plan, tenure of the executive and annual expense accruals required.
- What type of non-compete/non-solicitation terms are included? Some agreements include a definition of these terms, although many banks include them in separate agreements which should be consistent. The length of the non-compete/non-solicitation period as it relates to a nonqualified plan is typically 12 to 36 months, but may last as long as the benefit is being distributed.
- Nonqualified benefit plan agreements should be reviewed together with other compensation related agreements, such as those mentioned above. So-called “golden parachute rules” are discussed in a previous article and are a perfect example of why a thorough review of all such agreements is critical.
Agreements generally include other terms such as pre- and post-retirement death, change-in-control, and form and timing of payment.
Key items to consider/evaluate when reviewing plans and agreements include:
- Are key terms consistent with other implemented agreements such as employment agreements, change-in-control agreements, non-compete/non-solicitation, long term incentive plans and equity plans?
- Has the total cost of a change-in-control based on the agreement provisions, including the accelerated vesting of benefits, been calculated and discussed with the board?
- Are the plans properly documented in accordance with IRC Section §409A as appropriate, which governs deferred compensation plans?
- Does the plan provide a meaningful benefit to the participant? Many plans were designed at a time when the benefit was meaningful, but the participant’s role and compensation may have significantly changed.
Nonqualified benefit plans will remain an important piece of the overall compensation strategy to attract and retain key officers, but it is critical to design meaningful and effective plans and ensure the plan documentation language is clear and avoids conflicts with all employment and benefit-related agreements. For deferred compensation plans subject to IRC 409A, there is limited ability to change the form and timing of payments after implementation; therefore, it is critical to work with experienced professionals who can help make sure you get it right the first time.
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