February 2000

John P. Beavers
Partner, Bricker & Eckler LLP
August 2000

Compensation

Nonqualified Stock Options. While stock options have been and are widely used to compensate executives of for-profit organizations, there is a common misperception that nonqualified stock options are not available to compensate executives of non-profit organizations, such as tax-exempt and other non-stock organizations. The misperception centers on the notion that nonqualified stock options may only be granted to purchase employer stock. Recently, non-profit organizations have started using nonqualified stock options in property other than employ to close the gap in executive compensation between non-profit executives and their for-profit brethren. See "Incentive Compensation Is Available Through Nonqualified Stock Options," December 1999 Acredula.

Intermediate Sanction Limitations on SERPs. Several organizations are re-examining executive compensation in light of the Intermediate Sanctions Act and §4958 of the Internal Revenue Code. One target is the supplement retirement arrangement or "SERP." Traditionally, many organizations have grossed-up the compensation of their executives with SERPs in order to cover those executives’ tax liability for having to include the SERPs in current income after they were no longer subject to substantial risk of forfeiture. As a result of §4958, many compensation consultants are reducing the SERP benefit by the annuitized value of such gross-up and, in some cases, recommending further reduction of the SERP benefit to assure meeting the comparability test required under §4958.

Change-in-Control Compensation. Non-profit organizations, especially in areas such as health care, are experiencing the same consolidation that financial services and other for-profit segments are experiencing. One of the problems facing boards of acquired non-profit entities is retaining their chief executive officers through completion of the consolidation. Most organizations will have difficulty completing a consolidation without the leadership of the chief executive officer. For this reason, boards are adding golden parachute provisions entitling the CEO to additional severance pay upon discharge without cause or quit for good reason after completion of a change in control. An interesting task is drafting a definition of change in control for a non-profit entity. See Non-profits Should Consider Incentives to Retain Executive Through a Change in Control.

Avoiding §401(k) and §457 Plans. §401(k) elective deferral plans and §457 eligible deferred compensation plans offer little advantage over §403(b) annuity plans. A disadvantage of the eligible deferred compensation plans is the inflexibility in the forms of payment that may be made available under the plan because, rather than being taxed pursuant to the annuity rules under section 72, payments are taxable when made available to the participant or other beneficiary subject only to some narrow exceptions of §457(e)(9).

Compensation and Estate Planning. Rather than provide an executive with outplacement or headhunter services at the end of employment, more nonprofits are providing executives with tax, compensation, investment and estate planning during the course of employment. The rationale is that this secures the executive to the organization and allows more time and attention to be devoted to the organization’s business.

Governance

Not Allowing Corporate Compliance to Separate the Board from Management. Reacting to the Congressional drive to criminalize certain fraudulent business conduct by organizations, many non-profit organizations have established corporate compliance programs modeled on guidelines of the United States Sentencing Commission as a precautionary measure in case an organization is found guilty of criminal felonies or certain misdemeanors under federal law. By definition, these programs are to be "designed, implemented, and enforced" to "detect" and "prevent" "criminal conduct." Many organizations are re-examining these programs because their original implementation may have been as "prosecutorial" as the sentencing guidelines themselves, driving a wedge between the governing boards and the executives of these organizations. See Advising Boards to be a "Check and Balance" of Senior Management is Going to an Extreme.

Expanding Business and Professional Representation in Place of "Community" Representation in the Composition of Non-profit Boards. One of the public relations strengths of non-profit boards is that their composition consists of "community" representatives. Yet, this is also a weakness because non-profit boards are not perceived by lenders and others as possessing the same "business" and "professional" expertise and experience as boards of for-profits organizations. As a result, non-profit organizations are expanding the business and professional representation in the composition of their boards. Accomplishing this, however, becomes complicated if compensation is necessary to attract business and professional representatives. Compensation will result in the loss of volunteer immunity under the federal and most states’ volunteer immunity statutes. To offset this loss, non-profits must re-examine the adequacy of D&O insurance as well as organization indemnity.

Focusing Attention by Downsizing Boards and Reducing Meetings. The recent trend to make boards more responsive to a fast-changing global economy in the for-profit world has spread to the non-profit world. James Kristie of Directors and Boards reports that two of the most significant trends in the for-profit world have been the downsizing of boards and the number of board meetings. Large companies like General Electric have downsized their boards to 15 members and high-tech companies like Microsoft and Yahoo have maintained smaller boards of seven and five members, respectively, in order to be responsive to a fast-changing global economy. The average number of meetings per year of for-profit boards has decreased from 12 to fewer than eight. Non-profit organizations that have traditionally had boards with 30 or more members and various meetings involving board members on a monthly basis are rethinking the size and structure of their boards as well as the frequency and timing of their meetings.

Liability

Re-Examining the Adequacy of D&O Insurance. Although non-profits have not had the same access to D&O insurance products as have their for-profit brethren, insurers are making more adequate products available. Riders for such additional coverage as employment practice liability, fiduciary (including ERISA) liability, employee dishonesty, outside directorship liability, and punitive damage protection as well as endorsements for advancing defense expenses, change-in-control protection for post-transaction acts, and extension of coverage to claims of spouses are becoming more available to non-profit organizations.

Loss Prevention Safeguards. Non-profits have not customarily practiced the same loss prevention safeguards as have their for-profit brethren. Recently, non-profits have exercised closer scrutiny over:

• Meeting notices and agenda
• Discussion in and content of minutes and other corporate records
• Practices of trustees or directors in taking notes
• Memoranda and other correspondence with members of the board and management regarding adverse claims

See "Loss Prevention in the Board Room: Keeping the Blood off the Walls," January 2000 Acredula.