Pension and Executive Compensation Reform in the Wake of Enron Corporation

This article focuses on those aspects of the Sarbanes-Oxley Act that directly affect retirement plans and executive compensation

Background - Many publicly held companies allow employees to invest their retirement plan assets in company stock. With the collapse of Enron Corporation and with other publicly held companies admitting to accounting irregularities, employees investing in company stock have seen their retirement savings cut substantially.

To make matters worse at Enron, at the time the accounting irregularities became publicly known, Enron’s retirement plan was in a "blackout period." A "blackout period" is a period of time in which retirement plan participants cannot make financial transactions, such as transfers among funds, withdrawals, loans or distributions. Blackout periods occur when retirement plans change recordkeepers or may be regularly scheduled periods.

During the blackout period, Enron employees watched as the value of Enron stock, and their retirement savings, plummeted. Meanwhile, Enron executives sold their Enron stock before and during the retirement plan’s blackout period.

The demise of Enron sparked federal legislators to introduce numerous corporate governance bills, most of which address blackout periods and executive compensation. On July 30, 2002, President Bush signed the first of the corporate governance acts, the Sarbanes-Oxley Act of 2002 (the "Act").

The purpose of this Client Memorandum is to focus on those aspects of the Act that directly affect retirement plans and executive compensation. You should refer to our web site for other Client Memoranda that address other aspects of the Act.

Section 306(b) of the Act requires plan administrators of defined contribution plans with more than one participant to give 30 days’ advance written or electronic 1 notice of blackout periods. This requirement applies to both publicly and privately held companies and is effective January 26, 2003.

Although the Department of Labor has been instructed to issue guidance and a model notice, the Act provides the basic requirements. A notice must be sent to all participants and beneficiaries affected by a blackout period and must contain:

• The reasons for the blackout
• An identification of the investments and other rights affected by the blackout period
• The expected beginning date and length of the blackout period
• A statement that investors should evaluate the appropriateness of their current investment decisions in light of the inability to direct or diversify assets during the blackout period, and
• Any other matter as determined by the Department of Labor

Additionally, if the expected length of the blackout period changes, the plan administrator must notify affected participants and beneficiaries of the change.

The Department of Labor may assess penalties of up to $100 per day for failure to provide timely notice. Additionally, the civil remedies under the Employee Retirement Income Security Act of 1974, as amended, apply.

The Act provides three exceptions to the 30-days’ advance notice requirement. If an exception applies, the plan administrator must provide notice of the blackout period containing the above information to all affected participants and beneficiaries as soon as reasonably possible, unless advance notice is impracticable.

The first of the exceptions is when a fiduciary, acting with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use, determines, in writing, that deferral of a blackout period would undermine the plan’s exclusive purpose of providing benefits to participants and their beneficiaries and of defraying reasonable expenses of administering the plan.

The second exception to the 30 days’ advance notice requirement applies when the inability to provide the notice timely is due to unforeseeable events or events out of the control of the plan administrator. A fiduciary of the plan must document such inability in writing.

The third exception to the 30 days’ advance notice requirement applies in a merger, acquisition, divestiture or similar transaction involving the plan where individuals either become or cease to be plan participants.

For purposes of the Act’s notice requirements, a blackout period is the suspension, limitation or restriction on the ability of participants or beneficiaries to direct or diversify assets credited to their plan accounts or to obtain loans or distributions from the plan for more than three consecutive business days.

According to the Act, blackout periods do not include suspensions, limitations or restrictions that (i) occur by reason of the securities laws, (ii) are regularly scheduled and disclosed in the summary plan description or (iii) apply due to a qualified domestic relations order.

Section 306(a) of the Act bans certain equity securities transfers by directors of and executive officers employed by the issuer during any blackout period of the issuer’s defined contribution plan. During a retirement plan blackout period, these executives may not purchase, sell or otherwise acquire or transfer any nonexempt employer equity securities received in connection with their service as executive officers or directors.

This ban applies only to blackout periods, as defined above, where at least 50 percent of participants and beneficiaries under all defined contribution plans of the issuer are affected by the blackout.

Any profit realized by the director or executive officer from the prohibited transfer of an equity security during a blackout period must be remitted to the issuer. The Securities and Exchange Commission enforces this section of the Act, which is effective January 26, 2003.

Effective immediately, Section 402 of the Act significantly curtails personal loans from publicly held companies to their executives. According to the Act, employers cannot extend, maintain or renew credit to any director or executive officer.

The Act exempts the following loans:

• Any personal loans existing on July 30, 2002 are exempt; however, they may not be renewed or materially modified
• Loans by issuers regularly engaged in the consumer credit business that are made on terms no more favorable than those offered by the issuer to the general public
• Loans made by FDIC-insured banks and thrifts

Whether this ban on loans applies only to loans under state law, as opposed to amounts considered loans under only federal law, is unclear. If the Act applies to amounts deemed to be loans by federal law, many split-dollar life insurance arrangements could be adversely affected because the Internal Revenue Service has released proposed regulations requiring that some split-dollar arrangements be treated, for federal income tax purposes, as loans. We are waiting for additional guidance on this issue.

The Securities and Exchange Commission enforces this section of the Act.

Under Section 304 of the Act, a restatement of financial statements by an issuer of securities may require certain executives to reimburse the issuer for certain bonuses. Generally, this reimbursement requirement applies if misconduct caused material noncompliance with the financial reporting requirements under securities law that led to the restatement of financial statements. The issuer’s chief executive officer and chief financial officer must reimburse the employer for any bonus or equity-based compensation received from the issuer within twelve months after the issuance of the financial statements that need to be restated. Additionally, these executives must disgorge any profits they received from the transfer of employer securities during that twelve-month period. The Securities and Exchange Commission has discretion to exempt any person from this law as it deems appropriate. This provision is effective immediately.