With No 402 Guidance, Marriott Drops CEO’s Insurance

Last month, Marriott International told the Securities and Exchange Commission that it is permanently suspending the payment of premiums on the life insurance policies of its CEO for fear that such payments might violate Section 402 of the Sarbanes-Oxley Act.

In making the announcement in a Form 8-K filing, Marriott took a swipe at the SEC for failing to provide guidance as to whether split-value life insurance arrangements—ones in which two parties agree to share obligations and benefits under a permanent whole life insurance policy—constitute prohibited loans under Section 402. The company had temporarily suspended paying premiums on the life insurance policies in July 2002 in anticipation of clarification from the Commission, which has never been issued.

Section 402 of SOX was enacted to prohibit companies from providing personal loans to directors and executive officers. Specifically, the provision states that an issuer shall not “directly or indirectly … extend or maintain credit, [or] arrange for the extension of credit … in the form of a personal loan.”

Marriott did not respond to Compliance Week’s request for clarification as to whether the company had specifically asked for guidance on this issue from the SEC or was referring in its 8-K filing to a lack of general guidance from the Commission. A spokesman for the Commission said he had “no way of knowing” if Marriott had asked the SEC for advice on the matter, but confirmed that the Commission had not issued any guidance on Section 402, and that none is planned.

Andrew Liazos, a partner with McDermott, Will & Emory in Boston, told Compliance Week that in the absence of SEC guidance about whether Section 402 prohibits split-value life insurance policies—and whether pre-SOX policies are permissible under a grandfather provision—many companies have discontinued split-value life insurance policies altogether.

The Split-Dollar Demise

Shnider

When SOX was adopted in 2002, three industry groups—the American Council of Life Insurers, the Association for Advanced Underwriting, and the National Association of Insurance and Financial Advisors—urged the SEC to clarify that split-dollar life insurance is an element of executive compensation and not a “loan.” While the Commission never issued such a clarification, the generally accepted legal view is that split-dollar life insurance is covered by Section 402, according to Bruce Shnider, a partner with Dorsey & Whitney in Minneapolis.

James Barnes, a partner with Reed Smith in Pittsburgh, acknowledges that the split-dollar life insurance issue “does cry out for clarity.” But Barnes notes that, in the absence of clarity, lawyers must advise clients in a way that they believe is consistent with the intent of the Act. “It is certainly difficult to advise a company that payment of premiums in a split-dollar life insurance [context] is not prohibited.”

Barnes

Barnes, who adds there’s very little legislative history surrounding SOX because it was adopted so quickly, says that when the statute was first enacted, “there was a belief or at least hope that the insurance lobby was going to be able to go back [to Congress] and get an amendment to clarify that [SOX 402] does not address split-dollar life insurance.” That did not happen, which—as noted by Barnes—has caused most companies to avoid such payments.

But Liazos at McDermott, Will & Emory does say that certain non-equity split-dollar policies—where the officer or director has no beneficial rights at any time to permanent benefits under the policy—may still be permissible under Section 402. However, he adds that equity split-dollar policies have gone out of favor because of the uncertainty over whether they are covered by Section 402 and because of recent changes in tax rules.

Shnider agrees. “The Internal Revenue Service changed about 40 years of tax treatment of split-dollar life insurance programs [at] more or less the same time as Sarbanes-Oxley came along—that alone was going to lead to the demise of split-dollar life insurance programs,” he said.

Broker-Assisted Cashless Stock Options

SOX 402

The following excerpt is from Section 402 of The Sarbanes-Oxley Act of 2002, "Enhanced Conflict Of Interest Disclosures."

Prohibition On Personal Loans To Executives

IN GENERAL—It shall be unlawful for any issuer ... directly or indirectly, including through any subsidiary, to extend or maintain credit, to arrange for the extension of credit, or to renew an extension of credit, in the form of a personal loan to or for any director or executive officer (or equivalent thereof) of that issuer. An extension of credit maintained by the issuer on the date of enactment of this subsection shall not be subject to the provisions of this subsection, provided that there is no material modification to any term of any such extension of credit or any renewal of any such extension of credit on or after that date of enactment.

Another major area that has caused confusion involves broker-assisted cashless stock-option programs, which are meant to help officers and directors exercise their stock options without having to use other funds to pay the exercise price. Typically, the company arranges with a broker to allow employees to deliver an irrevocable notice of exercise. The broker sells enough shares to cover the exercise price and any tax withholding, the proceeds are delivered to the company, and the net shares are delivered to the employee.

Barnes at Reed Smith says the general consensus is that broker-assisted cashless exercises do not implicate Section 402 of Sarbanes-Oxley. “We were one of the first firms to issue an interpretive position that it is not prohibited,” he says. “Many firms have [subsequently] taken that same position. Most would argue that a normal broker-assisted cashless stock-option program does not involve the arrangement of an extension of credit.”

Issues arise, says Barnes, when there is a “captive broker scenario”—a broker who is dedicated to providing services for a company’s executives. “Some have argued that if you have a captive broker scenario, it’s more susceptible to being deemed an arrangement of credit,” he says. However, he adds that a solution to that can be quite simple, so long as executives aren’t required to use that broker. “Many have avoided this [issue] by making clear to executives that, although there’s a preferred broker, they’re not required to use them,” says Barnes. “As long executives have a choice, that’s sufficient.”

Shnider of Dorsey & Whitney takes a similar view, noting that members of the bar have decided that the situation is lawful “if the executive on his or her own goes and finds his or her own broker,” and it’s not arranged by the company. “If you can demonstrate that it’s purely an arms-length transaction,” adds Shnider, “there’s no indirect or direct compensation changing hands for the use of the dedicated broker, then people are pretty comfortable that’s not a prohibited loan.”

Liazos

Liazos at McDermott, Will & Emory, agrees that the “safest compliance approach at this time is for the issuer to have executive officers and directors arrange for loans with their own brokers.” Another attractive—and more popular—option, says Liazos, is a “simultaneous settlement,” where the broker does not pay the issuer the exercise price until the settlement date and no interest to the broker is due on a loan. “Using a simultaneous settlement to accomplish a cashless exercise does not pose any significant credit risk to the issuer and no sound policy suggests that this type of transaction should be prohibited.”

But in the absence of related guidance from the SEC, most of the legal experts that spoke to Compliance Week note that companies should remain cautious in their policies. According to Shnider at Dorsey & Whitney, companies are naturally “concerned about making a mistake and being caught after the fact … so people have been especially cautious.” And while most hope the Commission will provide guidance soon, they aren’t holding their breath. “There is just this recognition that the Commission has got lots to do,” says Shnider, “and this isn’t very high on their priority list.”