Bonus! Executives Getting Rewarded For 404 Success

Some executives are getting a pat on the back—in the form of a bonus—for helping their companies successfully navigate their first year of Sarbanes-Oxley’s notorious Section 404.

A recent search of "material definitive agreements" filed on Form 8-K (available via Compliance Week’s searchable databases; see box at right), shows numerous companies awarding top executives for completing Section 404 projects, which often entail painstaking work with IT staff, finance executives, business managers and external auditors.

Golden

“It’s relatively new phenomenon,” says Howard Golden, senior executive compensation consultant at Mercer Human Resource Consulting. Golden says the practice isn’t “that widespread yet, but I think we’ll probably see it in some of the proxies being prepared now for 2005.”

Some companies, such as instrumentation manufacturer Varian and software maker Pegasystems, approved paying bonuses to certain executives for the successful completion of their 404 projects. Others, such as PPL Corp., Toll Brothers and Patriot Transportation Holding, noted in their 8-K filings that Section 404 was part of their performance-based compensation metrics (see disclosure samples in box at right).

Compensation consultants interviewed by Compliance Week said the awards seem appropriate.

Todd

“I think this is proper,” says Paula Todd, managing principal at Towers Perrin. “Most incentive arrangements have a portion of the award tied to corporate performance and a portion tied to individual performance. If you’re a financial executive, one of your most import roles in the last few years has been SOX and 404 compliance.”

“If something is an important priority for a company, there’s no reason not to list it as a metric,” Golden says. Still, he notes that 404 may be “one of many metrics used” for bonuses, and the overwhelming majority of metrics companies rely on are financial. “There’s a place for some qualitative metrics.”

Fairly Common, SOX Driven

According to its 8-K filed in December 2005, Varian’s compensation committee decided to pay a special cash bonus of $15,000 to Controller Sean Wirtjes “in recognition of his leadership and efforts in fiscal year 2005 on the corporation’s initiative to meet the requirements of Section 404 of the Sarbanes-Oxley Act.”

Pegasystems’ compensation committee authorized a $30,000 bonus to Chief Financial Officer Christopher Sullivan in recognition of his “efforts to ensure the company’s compliance with Section 404 of the Sarbanes-Oxley Act of 2002,” according to its 8-K filed last September.

Pennsylvania electric utility PPL, meanwhile, reported that it included in its operating goals “specific requirements tied to continued compliance with Section 404 of the Sarbanes-Oxley Act of 2002, including enhancing the efficiency of the compliance process.”

Farr

Paul Farr, senior vice president at the $6.2 billion PPL, explains that the company created a “corporate-wide goal for SOX compliance that affected incentive compensation for all management and supervisory personnel, in both Year One and Year Two.”

The goals for each year were tailored to the specific nature of the annual compliance efforts, Farr says, and focused mainly on developing and implementing an effective compliance process, identifying and remediating control deficiencies, and ensuring that PPL has effective controls over financial reporting.

In the first year, 2004, “there was a significant amount of work throughout the organization, domestically and internationally, to identify key transactions related to financial reporting, to identify the risks related to those transactions, to assess the internal processes to control those risks, and to enhance internal controls to ensure compliance,” Farr says, as well as considerable uncertainty about the scope of the effort required less external guidance on the specific requirements.

“In short, the entire framework for SOX 404 compliance had to be established,” Farr recalls. “Many employees were required to perform compliance activities in addition to completing their normal job responsibilities.” In contrast, much of the 2005 focus shifted to enhancing efficiency of Section 404 compliance process, implementing new systems for that purpose and instituting best practices learned from 2004, Farr says.

In its 8-K filed in December, luxury home builder Toll Brothers said performance goals for Joel Rassman, the company’s chief financial officer, included “presiding over and effectuating the timely and successful completion of the controls testing process under Section 404 of the Sarbanes-Oxley Act of 2002.” Patriot Transportation Holding, which has subsidiaries in the transportation and real estate businesses, included Section 404 as one of the performance criteria for its chief executive and chief financial officers in its December 2005 8-K filing as well.

Tower Perrin’s Todd, who called the practice of awarding bonuses for Section 404 work or using 404 as a metric “fairly common,” says “bonus year 2004 probably was the peak of this … Pay for financial executives has been going up. A lot of that is SOX-driven.”

Not Eyebrow Raisers

For that portion of a bonus that’s tied to the individual’s role, Todd says, companies must consider “what’s unusual that year or whether there were any special challenges or big projects that are out of the ordinary for their job.” During the first year of implementation, Todd says, “404 fit all of those. It’s out of the ordinary, and it’s somewhat measurable. You either did it or didn’t, and either had exceptions or not.”

A few years from now, she says, Section 404 may be considered a regular part of the job and “probably wouldn’t warrant a special bonus goal.”

“This is acknowledging that 404 was a lot of extra effort and an important task,” she continues. “Bonus plans send messages to people about what the company really wants them to do. They’re the company’s way of saying, ‘this is a high priority’.”

Todd adds that other companies may have paid such awards, but may not have noted that they specifically related to Section 404. What’s more, payments to employees below the CFO level wouldn’t appear in 8-K filings. “I’m sure there are people in the finance function who got paid extra who were doing the heavy lifting [on 404], but they may not be subject to 8-K filings,” she says.

Bill Gerek, a senior consultant at Hay Group, says he hadn’t seen companies making these types of awards, but “it’s not unusual to have bonuses for reaching milestones in project achievement.”

Gerek says the examples cited by Compliance Week shouldn’t raise any eyebrows because the amounts aren’t very big. “In the scheme of what executives get paid, these aren’t huge amounts,” Gerek said. “Compliance with 404 is a big bugaboo for a lot of companies. To incent people or to reward them after the fact if they’ve done a good job could make sense.”