Executive Compensation: Making Sense of Fair and Reasonable

Written by Liz Santos, ‎Senior Vice President of Marketing and Business Development
Originally Published on CUInsight.com

BFB WebinarMy little brother recently celebrated his 40th birthday. We marked the occasion by thumbing through old pictures and making fun of each other’s unfortunate haircuts. That’s Herbie on the left, in one of our rare moments of peace, prompted only by the promise of a sugary reward.

Growing up, Herbie and I had the usual love-hate relationship, although probably more hate than love. The hate part was invariably fueled by the perception of fairness. “That’s not fair!” was a regular retort in our household, as if there was ever any room for our parents’ reconsideration. When you’re a kid, fairness is meted out by your parents, often based on gender, birth order, age, or by the almighty “Because I said so.”

For credit unions, however, it’s a different story. Fairness, especially in relation to credit union executive benefits, is more predictable and consistent than my parents’ household rules. Executive benefit plans are a critical tool in recruiting, rewarding, and retaining your leadership team. A key concept in designing these plans is “fair and reasonable.” As expected, the NCUA has rules regarding fair and reasonable compensation.

Why do credit unions need guidelines for executive compensation?

When it comes to executive compensation for credit unions, the concept of fair and reasonable serves an important purpose. Paying executives fair and reasonable compensation requires balancing the needs of the credit union (and its members and examiners) and the executives. Paying too much wastes vital resources, while paying too little risks depriving the credit union of key managerial talent. Careful attention to the process will assist the credit union in arriving at an executive compensation that is fair and reasonable and that attracts, retains, and rewards executive talent.

Do banks have the same guidelines for executive pay?

Executive compensation planning at credit unions is comparable to that at banks in terms of balancing organizational and individual needs. However, some key differences are:

  • Banks can offer stock and other equity compensation not available in credit unions, making it more difficult for credit unions to compete for the executive talent.
  • Banks are subject to different regulations that address issues such as clawbacks (e.g., repaying bonuses for restated financials), the employer’s ability to deduct the compensation for tax purposes, and golden parachute penalties.

Unless your leadership team thinks sugary birthday cake is an adequate performance incentive, I recommend viewing a recent BFB webinar, “Attracting and Retaining Executive Talent with Fair and Reasonable Compensation.” The presentation delves into what is fair and reasonable, and how to apply that concept to your executive compensation philosophy.

Burns-Fazzi, Brock (BFB) LogoBurns-Fazzi, Brock (BFB) is the NAFCU Services Preferred Partner for Executive Compensation and Benefit Consulting. Burns-Fazzi, Brock engages the law firm of Sherman & Patterson to advise on regulatory and tax compliance matters. Sherman & Patterson, located in Minneapolis, MN, has consulted with and represented tax-exempt organizations with their executive compensation needs for the past 30 years. They work closely with NCUA and state credit union regulators, and frequently write and present on these topics.

For more information and educational resources, visit http://www.nafcu.org/BFB.

Compensation and Severance Plan Rule Changes May Impact Your Credit Union

By Kirk D. Sherman and James S. Patterson, Sherman & Patterson, Ltd.

457(f) Compensation RegulationsAfter almost eight years and several false alarms, the IRS may finally issue the new Section 457(f) regulations addressing nonqualified deferred compensation plans and severance plans. Two IRS attorneys speaking at separate events have expressed hope that the regulations will be released by this summer.

Credit unions at greatest risk of having to modify their plans are those that sponsor:

  • Nonqualified deferral plans (other than 457(b) eligible plans) that allow elective deferrals,
  • Nonqualified deferral plans that use noncompete restrictions as substantial risks of forfeiture, and
  • Severance plans providing severance benefits greater than two times compensation.

For other credit unions, the new regulations may be a non-event.

What Should Your Credit Union Do Now?

  • While awaiting the new 457(f) regulations, credit union boards and management can determine whether the credit union sponsors 457(f) plans that use noncompetes or elective deferrals, and whether it has promised severance greater than the two-times limit.
  • Having identified such plans, the credit union (and its advisers) will quickly be able to determine if and how the new rules impact the credit union’s arrangements and what, if any, changes are required.

Understanding the Tax Implications of 457(f) Rule Changes

In 2007, the IRS first announced its intent to change the 457(f) rules.  If the rules are issued as the IRS anticipated, elective deferrals and deferrals subject to noncompete restrictions would no longer defer taxes.  Instead, taxes would be deferred only if the deferrals were non-elective and subject to cliff vesting (i.e., the benefit is forfeited if the executive quits before the specified vesting date).

  • Most credit union 457(f) plans already use cliff vesting, and elective 457(f) deferrals are rare.  Therefore, we expect few credit unions to have to modify their 457(f) plans.
  • The guidance is also expected to address what qualifies as a bona fide severance benefit for purposes of 457(f). Compensation paid under a bona fide severance plan would be taxed as received. Compensation in excess of the bona fide severance limits would be taxed in a lump sum at termination.
  • We expect the bona fide plan limit to be the lesser of two times the executive’s annual total compensation or two times the qualified plan compensation limit (two times $265,000 in 2015).  Credit unions can still pay severance in excess of the two times limit, if fair and reasonable, but the taxation may be different.
  • As with 457(f) plans, we expect that few changes to severance plans will be required to comply with the new rules.
  • For noncompliant 457(f) or severance plans, we expect the new rules to provide a process for transitioning to compliant designs.  Grandfathering of noncompliant arrangements seems unlikely.

What Should Your Credit Union Do When the IRS Issues the Guidance?

After the IRS issues the new 457(f) guidance, and especially if it expands the guidance beyond what is expected, your credit union should check with its advisors to make sure you address any modifications to your nonqualified deferral or severance plans that may be required at that time.

Watch the recent webinar, “Attracting and Retaining Executive Talent with Fair and Reasonable Compensation,” presented by Kirk Sherman, Dr. Loretta Dodgen of Human Capital Solutions Group, and Chris Burns-Fazzi of Burns-Fazzi, Brock to learn more about executive compensation trends and challenges.

Burns-Fazzi, Brock (BFB) LogoBurns-Fazzi, Brock (BFB) is the NAFCU Services Preferred Partner for Executive Compensation and Benefit Consulting. Burns-Fazzi, Brock engages the law firm of Sherman & Patterson to advise on regulatory and tax compliance matters. Sherman & Patterson, located in Minneapolis, MN, has consulted with and represented tax-exempt organizations with their executive compensation needs for the past 30 years. They work closely with NCUA and state credit union regulators, and frequently write and present on these topics.

For more information and educational resources, visit http://www.nafcu.org/BFB.

Credit Unions Get Competitive Compensation Insights from Survey

For the 9th consecutive year, NAFCU and Burns-Fazzi,Woman holding "Pay" sign Brock (BFB) will conduct a comprehensive survey of credit union executive compensation and benefits. The NAFCU-BFB Survey of Executive Compensation and Benefits is the industry’s most comprehensive study of executive compensation.

How can your credit union participate?

  • NAFCU members have been sent an email invitation to complete the online survey.
  • Nonmember credit unions can register to receive the survey by signing up at http://www.nafcu.org/execsurvey.

 Here are the top things you should know about this study:

  • All credit unions are invited to participate.
  • Any participating credit union’s individual responses are completely anonymous.
  • Participating credit unions will receive a complimentary copy of the detailed report about the survey.
  • The deadline for credit unions to complete the survey has been extended to Friday, April 10, 2015. (If you are a NAFCU member and have not received your invitation, please contact Clark Research Associates by email at nafcusurvey@clarkra.com).

Credit union decision-makers use the findings from this annual survey to get a better view into competitive salaries, bonus plan factors, deferred compensation, and health and welfare benefits; all specific and relevant to our industry.

A study like this empowers credit unions to participate and then benefit from the findings.  By using the survey insights, credit unions can more effectively evaluate how their executive compensation program compares with peer institutions,” said NAFCU Services President Randy Salser.”

A credit union’s ability to recruit, reward, and retain leaders depends upon access to trustworthy and relevant data,” said David Frankil, president at Burns-Fazzi, Brock. “This survey helps credit union boards and executives understand current trends in the marketplace and develop a custom compensation philosophy, and we’re thrilled to once again have the opportunity to support it.”

The results of the study will be presented by Burns-Fazzi, Brock at NAFCU’s Annual Conference and Solutions Expo in Montreal, Canada from June 23 – June 26, 2015.

Tailoring Executive Benefits to the Executive and the Credit Union

By David Frankil, President, Burns-Fazzi, Brock and Associates

Some people are lucky enough to be able to walk into a store, pick a nice suit off the rack, maybe have the sleeves adjusted and the cuffs hemmed, and walk out with something that fits them perfectly.

My experience is more like major surgery, but when done right the suit looks great.

The same is true for executive benefits – some rare executives and their credit unions are fortunate enough to have a set of circumstances and needs that allow them to take something basic and off-the-shelf.  But more often they end up with their proverbial arms sticking out and socks visible with cuffs four inches off the floor.  What they really need is a more complex mix of solutions that are tailor-made for them.

Where we see credit union executives considering (or stuck in) ‘one-size-fits-all’ solutions, it is usually because there is a misperception that credit union executives can only have one type of executive benefit.  In other words, they think they have to pick just one from a long list that includes 457(b), 457(f), Split-Dollar Plans, Invested Retirement Plans, and others.

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Aligning CU Executive Incentives With CU Goals and Member Needs

By David Frankil, President, Burns-Fazzi, Brock and Associates

Dr. Jack Clark from Clark Research Associates presented the results of the 2014 NAFCU-BFB Executive Compensation and Benefits Survey at this summer’s NAFCU Annual Conference.  There were many tidbits in the presentation, but one topic caught my eye – the wide variety of incentives that Boards have used to create bonus plans for top executives.

The topic of how incentives affect behavior is far from new – go back to freshman-year economics and Adam Smith –

“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.”

Adam Smith, An Inquiry into the Nature & Causes of the Wealth of Nations, Vol 1, March 9, 1776

Just as water finds its own level, economic activity naturally seeks its highest and most efficient use.  That’s not to say that the greater good is subverted to individual self-interest, rather that well-designed compensation models effectively align individual incentives with desired outcomes that benefit the credit union, its members and top executives.

On that we can probably all agree – but what are the metrics and desired outcomes that will create optimal goal alignment?  To use a baseball analogy, home runs are great – but rewarding players just based on home runs would result in tons of shortstops and second basemen batting .075 as they swung from the heels every time up at the plate.  You’d have a hard time finding anyone who wanted to pitch too.

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