EXECUTIVE COMPENSATION IS AN ISSUE THAT MOVES IN and out of the headlines. And, from time to time, it surfaces in the courtroom. Shareholder activists, as well as major institutional investors including pension funds, have begun to express concerns about large payments to executives. Increasingly, major shareholders have also sought to hold corporate boards of directors accountable for pay packages that are viewed as overly generous because they are excessive compared to the market or are unrelated to performance. In the public company context, securities regulations in both the United States and Canada require disclosure of the compensation paid to the five most highly remunerated executives in the prior year. If those individuals have been overly compensated at a time when a pension fund is underfunded, tough questions could be asked. FIDUCIARY OBLIGATIONS A corporate board acts in a fiduciary capacity when it sets the compensation of senior executives. In justifying these decisions, a board will generally state that it is acting in the best long-term interests of the corporation and presumably shareholders, when it sets compensation levels. In so doing, it will rely on expert reports that demonstrate that pay and compensation are at market levels and are required in order to retain the services of the executives. In determining the contributions that are made to pension plans, the board of directors stands in a fiduciary position, not only to the corporation, but as well to the beneficiaries of the pension plan. In addition, the board must also act in a manner that conforms with pension legislation. It is also arguable that certain forms of executive compensation (i.e. option plans)and pension plans are similar because both represent payment at a later date for services rendered and are, therefore, deferred wages. A failure to adequately fund the pension plan could result in the board breaching its fiduciary duties to plan members. In determining whether or not there has been such a breach, a court will consider all relevant evidence. This could include the payment of excessive compensation at the same time that decisions were made to not properly fund the pension plan. While it could be argued that simply meeting the obligations imposed by pension legislation will constitute a complete defence, this may not always be the case. An actuarial valuation is only required to be filed once every three years if the plan is fully funded or in surplus at the time the actuarial report is filed. The recent spate of corporate insolvencies has demonstrated that actuarial reports can grow obsolete and become irrelevant if there is a sharp decline in both equity markets and long-term interest rates. Prudent boards are often provided with updates prior to the date of a formal valuation. If such a valuation disclosed a shortfall and executives were receiving pay increases or were receiving overly generous compensation, then a subsequent insolvency that resulted in a shortfall in the pension plan could mean a board will be found to have breached its fiduciary duties to plan members. In addition, plan members might be able to argue the board was in breach of its duties under corporate statutes that govern corporations, which allow creditors and others to argue that a board’s behaviour has been unfair. If a claim were successful, then the board could be subject to civil liability under the business law statutes. At first glance, there may not seem to be much of a connection between executive corporation and an underfunded pension plan. However, in making its decisions, a board must be mindful of all of its obligations. If it fails to do so, then it could face liability under both the law of fiduciaries, as well as corporate statutes. Hugh O’Reilly is a partner with Cavalluzzo, Hayes, Shilton, McIntyre and Cornish in Toronto. horeilly@cavalluzzo.com For a PDF version of this article, click here. |