Sharing actual experiences arising in our compensation consulting work provides some of the most valuable information for our readers. The questions we are asked and the types of work being requested by clients generally serve as a good source for timely topics. Without divulging any confidential information, I believe some of our recent experiences in the past few months offer a topic that warrants a closer look by many organizations.
We have encountered a number of instances this year where we have been asked to review several years of documentation supporting an organization’s governance of executive compensation. In some cases, our work involved a search for confirmation of detail to support a past pay action. In others there were specific requests to examine the quality of existing documents supporting the pay program. Both approaches allowed us a firsthand opportunity to see what clients had in their possession, or thought they had, regardless of the fact that the applicable questions on the Form 990 were checked with a “Yes.”
It is worth mentioning that the criteria we use to evaluate the materials follow the Internal Revenue Service (IRS) Intermediate Sanctions’ guidance for the Presumption of Reasonableness. We generally focus on determining:
- The participants/role of independent directors in compensation decision making
- The quality of competitive compensation data from “comparable” sources used in decision making
- The quality of contemporaneous documentation (i.e., minutes) kept to record the discussions and decisions related to executive pay
These criteria can be met by satisfying some rather broad requirements outlined in the provisions of the Intermediate Sanctions. The precise manner of doing so is generally left up to the organization in question. Our reviews express our opinion as to how well organizations could substantiate their satisfaction of the requirements for the Presumption of Reasonableness.
In our reviews, we examined: board and compensation committee members; the schedule of their meetings; staff positions for which the board has direct compensation decision making authority; records of board meetings and resources used by board members engaged in compensation decision making. Additional materials such a formal compensation strategy/ policy statements, and board/compensation committee charters, for example, were also reviewed in those instances where organizations were using them.
In many cases, we discovered that despite the fact that the boxes were checked affirmatively on the Form 990s and the certainty of compliance expressed by individuals directly involved in the compensation process, there were opportunities to strengthen or initiate critical practices needed to secure the Presumption of Reasonableness. The balance of this article will highlight the types of issues we have encountered and provide steps that should be taken to avoid problems.
OVERSIGHT BY INDEPENDENT BOARD MEMBERS/COMMITTEE
This requirement was the one most generally satisfied by the organizations reviewed. All independent members of the organization’s board or a committee of independent board members were usually involved in oversight of executive compensation matter. To the degree that opportunities for improvement were noted, they included:
- Expanding the scope of board authority over staff pay to include all “Disqualified Individuals,” not just the Executive Director/CEO. In most cases, the organization’s CFO/principal financial officer should also be included in the scope of board- level authority. In fact, it might be highly desirable to have final authority for compensation of all positions reporting directly to the Executive Director/CEO rest with the board.
- Board members should be especially cognizant of any role that the Executive Director/CEO might play in the determination of his/her own pay. While it may be perfectly appropriate for the executive to present a “self-appraisal” of performance or make recommendations for direct subordinates, the Executive Director/CEO should not solely be relied upon to provide competitive compensation information or a recommendation for his/ her own compensation. Furthermore, the CEO/Executive Director should be formally excused from the meeting as board members discuss and decide his/her compensation actions.
- Formalize board/compensation responsibilities for compensation with a formal charter or statement of responsibilities and authority. All parties involved in the administration of the compensation must be fully aware of their respective roles.
COMPETITIVE COMPENSATION DATA FOR COMPARABLE ORGANIZATIONS/POSITIONS
Our reviews indicate that many organizations need to do a significantly better job to satisfy this requirement. In several instances, competitive data could not be produced despite earlier reports it was used nor could the actual data sources or specific Form 990s that were used be recalled. More often, we observed the following:
- It was difficult or impossible to demonstrate that data from comparable organizations were being presented for board consideration.
– In some cases, pay data was reported from similar types of organizations, but no information about the size / scope of the organizations included in the pay data sample was available. Accordingly, it was not possible to determine if pay levels represented much larger/ more complex organizations and / or locations with markedly different employment cost
– Form 990s were collected from organizations totally unrelated to the organization in question (different type(s) of entities and/or radically different size/scope of operation) with no rationale for their inclusion in the information shared with the board.
- In some cases, even if organizations were generally comparable, it was not apparent that positions cited in the competitive analysis were comparable to the client organization.
– Jobs were “matched” strictly on the basis of generic office titles (e.g., Executive Vice President, Associate Director, etc.)
– No information was presented that ensured unique or unusual characteristics in the client’s position (or an external benchmark position) had been identified and addressed in the competitive analysis.
- Competitive data of questionable quality was used in the compensation analyses.
– Surveys published or pay analyses performed three or more years ago were used as the basis for current decision making- Consultant reports failed to provide sufficient documentation to establish comparability in competitive analyses and/or relied upon poor quality data
– Consultant reports failed to provide sufficient documentation to establish comparability in competitive analyses and / or relied upon poor quality data.
– Only direct pay/cash compensation data was included in the competitive analysis without any consideration of benefits, perquisites and deferral/retirement income arrangements to assess total remuneration.
DOCUMENTATION (i.e., MINUTES)
In most cases, we find this the area to be the one in need of the most improvement. Many organizations could not produce minutes of meetings that specifically address details of decisions surrounding compensation. Perhaps; out of concerns about confidentiality or confusion about the responsibility for taking the minutes, the minutes simply were never taker. other common areas we cited for improvement included:
- Provide more detail in the meeting minutes to ensure that an accurate record of information, discussions and decisions about compensation were recorded.
– Noting members in attendance or participating by phone and mentioning staff or outside professionals participating in the discussion.
– Carefully noting that staff members or any conflicted parties were excused from meetings when compensation is being discussed or decided.
– Noting and including copies of any reports, surveys or other information used in the meeting.
– Recording the actual vote/affirmation made by the board or committee for the pay action in question.
- Ensure that meeting minutes are drafted reviewed with participants and approved by the earlier of the next meeting or within 60 days. Initial drafts of meeting minutes can be circulated to meeting participants electronically with a request for comments, changes and / or approval. It is then quite easy to produce and circulate the final in order to obtain approval. It is important to verify and date the approval of the minutes by participants as part of the final document.
- Organize and retain all documentation concerning the compensation program in a central location. Ensure it is a resource available for reference to board members in the future or outside authorities that may request to review it.
- Finally, organizations might find it helpful to prepare a formal document which describes the overall compensation program as well as the general principles which guide it. This type of document is helpful for a number of reasons.
It provides a means for discussing, arriving at a consensus and finally documenting the principles, policies and practices that will govern the organization’s approach to all forms of compensation by:
– Providing identification of pertinent “competitor” – similar service offering, employing/ competing for similar executive resources, etc., used to establish a marketplace for determination of competitive pay practices
– Defining the desired position of overall compensation in relation to the competitive marketplace (i.e, at, above, below the market) as well as the rationale for support of this desired position
– Identifying the components that will be used in the compensation program (i.e., salary, bonuses, retirement plan, benefits, perquisites) and the role that each will play to achieve he desired position described above
- Encourages stability / consistency in pay policy and practices. Rotation of board member assignments, turnover in board members and / or the executive team sometimes produce changes in pay practices. Without a formal position on pay policy, pay practices can change based on personal points of view.
- Finally, this document, along with the other forms of documentation discussed above, becomes an impressive component of an overall description of the compensation program that can be sued for new board member orientation / education or to explain it to any outside official that might have a need to review it.
Our experience suggests that many organizations have some, but not all, of the information needed to be reasonably certain of their entitlement to the Intermediate Sanction’ Presumption of Reasonableness. Incorrect, incomplete or non-existent records in any of the broad areas discussed here will seriously erode the likelihood of success. In all probability, the discovery of a few issues generally leads to additional requests for more information and more extensive examination.
No matter how carefully and well-intentioned the administration of the compensation program has been, the absence of appropriate documentation to support past practices and decisions will raise questions.
Outside board members and senior staff members would be well-advised to critically examine or arrange for an outside examination of the current state of their compensation program’s recordkeeping and documentation. Organizations should ask themselves the following question:
“Would an outsider reviewing these documents understand and accept this as evidence of good management of our pay?”
Waiting to discover problems until the organization is embroiled in a pay-related controversy or under review by government official invites needless worry and embarrassment.
This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Summer 2014). Copyright © 2014 BDO USA, LLP. All rights reserved. www.bdo.com