It should go without saying, but after several recent conversations with clients, I’ll say it again — it doesn’t matter how well you’ve followed your “best practice” processes, gathered your competitive data, and made your executive compensation decisions correctly, if you haven’t documented them.
There are three elements to establishing the “rebuttable presumption of reasonableness” that is part of any best practice CEO compensation approach, and provides support in justifying compensation decisions: 1) decisions are made by disinterested directors without a conflict of interest 2) the consideration of appropriate competitive data and 3) contemporaneous documentation. Today I’ll focus on the third element, which should be the easiest, but, based on reviews of a lot of Form 990s and Board meeting minutes, seems to be the least effectively done. Another post will look at Form 990 disclosure — this will focus on Board meetings and deliberations.
Good contemporaneous documentation means this — within a reasonable time after the discussions (play it safe and make it within 30 days), write up the minutes of your Compensation Committee and/or Board Meeting(s), and then make sure they are read and approved, and entered into the record. Make sure you have done the following:
1) List who was in the meeting. Make sure you state clearly that the question was asked as to whether any of the Directors present had any business or personal relationships with the executive under discussion that could rise to the level of a conflict of interest. The conflict of interest could seem very innocuous, but there’s no harm in playing it safe. For example, an attorney who is a member of a client’s committee recused himself from voting (although he participated in the discussions), because several years previously he had represented the CEO in a personal matter that was totally unrelated to the CEO’s employment. If any have anything that could even remotely be considered a conflict of interest, make sure it is at least disclosed, and if appropriate that they recuse themselves from voting, and note that in the minutes.
2) Make sure to reference your compensation philosophy in every meeting. Every Director should understand the philosophy and what it means. Your minutes should contain language like the following: “The Chairman reminded the Directors of the Compensation Philosophy, established in 2009, which states that the organization intends to provide competitive compensation, which means at the median for comparable health centers in our region. This means that we will establish our compensation targets at a point where roughly half of the market will pay more and half less. Of course, within our ranges, individuals with higher or lower performance will be paid more or less, as appropriate.”
3) Document each element of compensation separately, including the subject matter, the competitive data considered and the eventual decision. While conversation will obviously drift from topic to topic, make sure each one is recorded separately. You want to make sure that every decision is reasonable and that its clear it was dicusssed. Example: “The Directors considered a suggestion that the CEO be provided with a supplemental retirement plan. The Board asked for the input of its Independent Compensation Consultant (ICC) who reported that among FQHCs in general, supplemental retirement plans were not that common (15%), but appeared more frequently in larger health centers such as ours (40%). Further, because our FQHC is in an urban area, and competes with a number of other health care organizations (as noted in the compensation philosophy), we also look at a broader market. In hospitals, for example, most CEOs have some sort of supplemental retirement plan. The Board reviewed several sources of data (see attached report) which indicated that supplemental retirement contribution of $10,000/year would meet the organization’s objectives, and was well within competitive practice, and voted to establish a supplemental retirement program.”
4) Make sure that the total compensation package is reasonable, and that it is clear you discussed it. While each individual element may be reasonable on its own, when added together they may become harder to justify. Have a discussion, and make sure the discussion is recorded. For example: “After considering all of the compensation elements separately, the Board added up the total that was likely to be reported in the Form 990. Concern was raised that because of the need to contribute to the supplemental retirement plan, which hadn’t been funded in several years, there was going to be a relatively large cost reported, causing the sum total compensation on the Schedule J to appear to be well above the competitive data typically used. The Board recognized that this wasn’t necessarily going to look good, but that it was otherwise reasonable and could be explained in a footnote, and that the years prior to and after this would not have this issue. Therefor, the Board decided to go ahead with the funding, and directed the CFO to ensure that there was a clear explanation in the Form 990 concerning the funding.”
Contemporaneous documentation will become more and more important as the investigation and enforcement of “reasonable compensation” regulations increase, and the processes used are clarified. Expect increased scrutiny on compensation from the Administration following the 2012 election. Even without a concern about what the IRS, HRSA or your donors will think, properly documenting your deliberations and decisions provides for much better governance and understanding among the Board.
For more information on Board responsibilities and best practice CEO compensation, contact the author at email@example.com or by phone at 248-507-4670.
[The contents of this blog and this post specifically are not intended to provide legal advice, and should not under any circumstances be taken as such. They provide suggestions and advice concerning best practices, but do not guarantee that an organization will be insulated from legal or regulatory liability by following them. Consult appropriate counsel in your state for legal advice and guidance.]