Executive Compensation, Loans, Bonuses and Insider Trading

Given the broad spectrum of changes in corporate governance that the Sarbanes-Oxley Act of 2002 (the "Act") mandates, few, if any, public companies can afford to ignore its provisions. Several provisions of the Act are expected to have profound implications specifically on the executive compensation arrangements of many public companies.

Immediate Prohibition on Loans to Executive Officers and Directors

Effective on the date of enactment (July 30, 2002), the Act amends the Securities Exchange Act of 1934 (the "1934 Act"), making it unlawful for any public company to extend or maintain credit for, or to arrange for the extension of credit in the form of a personal loan to, any director or executive officer of a public company. The Act also prohibits any renewal of an extension of credit. The Act does not apply to any existing loans on the date of enactment, provided there is no material modification to the terms of the loan or a renewal of the loan on or after the date of enactment of the Act. Furthermore, the Act does not prevent a public company from making personal loans to employees who are not directors or executive officers, nor from making bona fide advances of corporate or indemnification expenses to directors and executive officers.

The prohibition on personal loans will impact the following executive compensation arrangements:

Stock Option Plans - Public companies often issue loans to directors and executive officers for the purchase of stock pursuant to the exercise of stock options. Under the Act, a public company will no longer be able to provide personal loans to its directors or executive officers to exercise stock options.

Executive Stock Purchase & Loan Programs - Many public companies have arranged for their executives to purchase company stock by issuing loans or guaranteeing loans issued by banks. Under the Act, these programs will no longer be permitted with respect to directors and executive officers.

Other Personal Loans - Many public companies issue or arrange for interest-free or low-interest loans to executive officers for purposes that include moving expenses, purchasing a home, paying for college tuition, and meeting medical expenses. Under the Act, a public company would no longer be able to provide these loans to its executive officers.

Split Dollar Life Insurance - Many public companies have entered into equity split-dollar life insurance arrangements with their executive officers, under which the company pays all or a portion of the premiums for a policy insuring the life of the officer. These premium payments are later repaid to the company using the policy's death benefit or cash surrender value. The Internal Revenue Service has proposed regulations that would treat certain types of split-dollar life insurance arrangements as personal loans for federal tax purposes. The prohibition on personal loans under the Act may be broad enough to prohibit public companies from entering into these types of split-dollar arrangements; however, the impact on split dollar life insurance is unclear at this time.

Two-Day Filing Requirement for Section 16 Reports

The Act amends Section 16 of the 1934 Act to substantially reduce the time when a Form 4 must be filed showing a change in stock ownership. The disclosure statement must be filed before the end of the second business day following the day on which the stock transaction occurred. The new disclosure requirements are effective 30 days after the date of enactment of the Act.

The SEC has the authority to extend the two-day filing period if it determines that a two-day period is not feasible. As written, the Act does not seem to change the current rules that allow some transactions to be reported on a delayed basis on Form 5. Within one year of enactment, all such reports must be filed electronically with the SEC, be posted on the SEC website, and be posted on the company website.

It is possible that the SEC now will not proceed with its proposed changes to Form 8-K reporting. Those changes would include a two-day reporting period for many of the same transactions.

Prohibition on Insider Trading During Plan Blackout Periods

With limited exceptions, the Act also prohibits the directors and executive officers of a public company from buying, selling, or otherwise transferring company stock during any blackout period imposed on certain retirement plans of more than three consecutive days that affects 50 percent or more of the retirement plan participants. Similar to the short-swing profit rules, if a director or executive officer buys, sells, or otherwise acquires or transfers company stock during a blackout period, any profits gained with respect to such transaction shall inure to and are recoverable by the company, regardless of the director's or executive officer's intent to violate these rules.

If a director or executive officer violates the prohibition on insider trading during a blackout period, the company may institute a legal action against the director or executive officer to recover any gains. If the company fails or refuses to bring such action against the director or executive officer that has violated these rules, any owner of company stock may institute an action in the name and on behalf of the company 60 days after requesting that the company bring such action against the director or executive officer.

Forfeiture of Certain Bonuses and Profits

The Act requires that if a company restates its financial statements as a result of misconduct relating to any financial reporting requirement under the federal securities laws, the company's CEO and CFO will have to reimburse the company for: (1) any bonus or other incentive-based compensation received from the company, and (2) any profits realized from the sale of the company's securities, during the 12-month period following the first public issuance or filing with the SEC (whichever first occurs) of the financial document embodying the financial reporting requirement that must be restated. This provision is effective immediately; however, there are many open issues. For example, what constitutes "misconduct" is critical to the application of this provision, yet the Act does not define this term.

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