Hundreds of corporations may have to register their deferred compensation or non-qualified supplemental retirement plans with the Securities and Exchange Commission.
The SEC appears to be changing its position on registration because corporations have established, or expanded, their plans in response to the 1993 tax law changes that raised individual tax rates and reduced the amount of retirement benefits that can be funded on a tax-exempt basis. Many companies' plans now encompass middle managers, instead of just top executives.
Although the agency has not formally articulated its new position in any regulations, SEC officials have turned down several "no action letter" requests for exempting such plans from securities laws in the past year.
Consequently, companies that cannot claim other exemptions from securities laws must register their plans as securities offerings with the agency and provide prospectuses to all participating executives, or risk being sued by the SEC.
The SEC traditionally had exempted such plans from registration and required companies to register such plans only if participants received returns tied to the employer's stock. The commission changed its position, however, because of the large number of people now participating in the plans, once reserved for corporate top brass.
So long as companies limited such plans to a few highly paid, sophisticated, top executives, SEC officials reasoned, the supplemental plans could claim the same sort of exemption companies claim when they offer securities to institutional investors. Recently, however, SEC officials expressed concerns that companies might have expanded these plans to include middle-management executives.
"In the 1980s, companies set up these plans for very highly paid people" who would classify as sophisticated investors, said an SEC official who declined to be identified. "Now with changes in the tax law and many more people participating, it's less clear if a private placement exemption is available," the official said.
Companies can still claim the private placement exemption, but in order to do so they would have to restrict their plans to a small group of top executives.
The SEC's change of mind could affect large companies with huge numbers of highly paid executives participating in such "top hat" plans, but would probably not affect small plans. The SEC's new policy also might apply to companies that have expanded existing plans as a result of the 1993 changes in tax law.
The new position probably would apply to most plain-vanilla deferred compensation plans, which let executives forgo part of their current salary or bonus and instead take the money several years later. The new policy probably also would apply to the scores of SERPs, or supplemental executive retirement plans, that companies have established in recent years.
SEC officials declined to discuss whether such a policy might apply to all SERPs, or only those where employees may opt to participate, and may contribute. Benefits lawyers, however, suggest the SEC's new position may not apply to SERPs that mirror traditional pension plans and do not include employee contributions.
A number of companies have set up traditional deferred compensation plans for highly paid executives following President Clinton's 1993 tax law, which bumped up the highest individual income tax rate to 39.6%. Executives who choose to participate in such plans do not pay current income taxes on the deferred portion of their paycheck. Instead, they pay taxes when they later receive distributions from the plans, tied to returns on a variety of investment options offered by their employer.
Hundreds of companies also have set up SERPs because of the 1993 law. The law lowered to $150,000 the amount of salary on which companies can base retirement benefits, resulting not only in pension cutbacks for highly paid executives, but also limiting how much they - and their employers - can contribute to 401(k)s and qualified profit-sharing plans.
Even though SERPs are not tax-advantaged like traditional deferred compensation plans, companies have rushed to establish them to make up benefits higher paid executives otherwise would have lost. As with ordinary deferred compensation plans, participants in such plans typically receive returns tied to a stock or bond index, some other benchmark, or returns on mutual funds.
Two-thirds of 167 large U.S. companies with more than 10,000 employees surveyed recently by William M. Mercer Inc. have non-qualified defined contribution plans, up from 20% of those surveyed a year earlier.
A December 1994 survey by Towers Perrin found 86 of 203 companies have defined contribution SERPs, all intended to restore benefits lost because of recent tax law changes.
Merrill Lynch & Co. is the first known to have registered its deferred compensation plan with the SEC, after being turned down for an exemption last year.
The giant Wall Street firm, which set up its plan last year, paid $34,483 to register its 1995 plan with the SEC last August, according to its registration statement. The securities firm paid another $31,304 to register amendments to its 1994 plan with the SEC last November. The 1994 plan is valued at $90 million, and the 1995 plan is estimated to be valued at another $100 million and covers about 3,000 highly paid executives.
"An increase in tax rates always makes people consider whether to have a deferred compensation plan. Our benefits people just decided it was a good idea in light of the increased taxes," said a Merrill Lynch official who preferred to remain unidentified.
Merrill Lynch's plan allows participating employees to forgo part of their current bonuses and instead opt to later receive money linked to the performance of up to 25 different Merrill Lynch mutual funds through the deferred compensation plan.
Merrill Lynch first discussed its new plan with SEC officials last April, and sought an exemption some months later. The firm decided to withdraw its request for an exemption and register its plan after discussions with SEC officials convinced Merrill Lynch the agency was going to turn down its request.
Meanwhile, John D. Watson Jr., a partner in the Washington office of Latham & Watkins, also sought an exemption for a Fortune 500 company's deferred compensation plan last year, but similarly was denied the exemption. Mr. Watson declined to name his client, which had sought the exemption after it decided to expand its plan.
"We had heard the (SEC) staff was taking a more aggressive and inconsistent view with past interpretations about whether deferred compensation plans that paid you a return based on a market index or your own stock price were securities," he said.
After SEC officials made it clear they were not going to grant the exemption, Mr. Watson's client skirted registering its plan by claiming a private placement exemption, he said.
SEC officials declined to say if they are considering issuing any new regulations on the matter, but confirmed they are continuing to respond to queries.
The SEC's new position also raises another thorny question, suggests A. Richard Susko, partner at Cleary, Gottleib, Steen & Hamilton, New York. Companies that register might not be able to tie returns of a deferred compensation plan or SERP to a private investment pool, shadowing the investment options available under their 401(k) plan, he says.
"If the SEC continues to assert this position that these are sales of securities, then the natural consequences of this position are difficult, if not insolvable problems under the Investment Company Act," he said.