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Consternation Over Congress' Elimination Of Outside Directors

The "Tax Cuts and Jobs Act" is giving compensation committees and their advisors much to consider.  Readers may recall that the limitation on a public company's ability to deduct compensation of specified officers did not apply to certain qualified performance-based compensation.  One of the many conditions to this exception was that the performance goals be determined by a compensation committee of the board of directors that is comprised solely of 2 or more outside directors.  26 U.S.C. § 162(m)(4)(C)(i).  Consequently, many issuers duly included an "outside director" requirement in their compensation committee charters and performance-based compensation plans.  For example, a compensation committee charter might provide:

The Committee must be comprised of at least three independent directors, each of whom must be an "outside director" as defined by Section 162(m) of the Internal Revenue Code of 1986, as amended, and a "non-employee director" as defined in Rule 16b-3 of the Securities Exchange Act of 1934, as amended.

The TCJA has now eliminated the exception for qualified performance-based compensation and with it the reference to "outside directors".  Soon, references to "outside directors" in charters and plans will not make sense to anyone who is not familiar with the history of Section 162(m) because the TCJA eliminated former subparagraph C and re-designated the remaining subparagraphs. 

Some may feel squeamish about eliminating a qualification for committee membership.  On the other hand, references to bygone statutory provisions will likely prove to be confusing.  The reference to "non-employee director" will continue to be relevant for purposes of Rule 16b-3.

Striking the requirement in a compensation committee charter that directors be "outside directors as defined by Section 162(m)" may cause additional complications because shareholder approved performance-based plans often include a requirement that they be administered by a committee comprised of, among others, "outside directors within the meaning of Section 162(m)".  (Section 162(m) never actually defined "outside director"; the term was defined in the IRS's regulations (26 C.F.R.  26 CFR 1.162-27(e)(3)). 

So how should this type of plan requirement be interpreted now?  Some might plausibly conclude that it has no meaning because "outside directors" no longer exist within the meaning of Section 162(m).  Others might conclude that the members of the compensation committee must meet the definition of "outside director" in effect when the plan was adopted.  However, the latter interpretation is a rule without a reason for it ignores the fact that the purpose of the requirement has been eliminated.

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30172DBAB0084D3A8F39D7AF0A8E79BC.ashx Keith Paul Bishop
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