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In light of a recent lawsuit, CFOs should take a fresh look at how personal use of company aircraft is identified and reported for proxy purposes.
Andrew Liazos, CFO.com | US
July 17, 2012
Determining how to report perquisites has long been a bedeviling matter for public companies. It is not uncommon that more time is spent figuring out how to report perquisites than addressing any other matter on the summary compensation table.
Even though "perks" are a relatively small portion of an executive's overall compensation, investors and the media continue to closely scrutinize these benefits. Corporate-governance experts assert that perquisite practices provide insight into the compensation committee's ability to handle conflicts of interest and function in an independent manner. And the Securities and Exchange Commission has closely monitored perquisite disclosures and brought enforcement actions against responsible officers, including CFOs.
Perhaps no perk is fraught with more difficulties and traps than an executive's personal use of corporate aircraft. SEC rules generally require public companies to report the "aggregate incremental cost" of perquisites. However, the commission has not provided any rules explaining what expenses should be included as part of the aggregate incremental cost. Public companies are left to their own judgments based on the facts and circumstances regarding how much additional cost has been incurred due to personal use of corporate aircraft. Given this regulatory framework, it is not surprising that disclosures and methods for determining cost with respect to this perk vary somewhat.
About the only thing clear from SEC rules is that aggregate incremental cost does not mean the value of a benefit. Internal Revenue Service rules permit taxpayers to use so-called Standard Industry Fare Level (SIFL) rate guidelines when reporting the taxable income attributable to the personal use of a corporate aircraft. The SIFL rates largely reflect the market cost of first-class air travel. When the SEC was revamping the proxy-disclosure rules in 2006, commentators suggested that current market values be used for reporting perks. The SEC explicitly rejected that approach. The commission has stated in connection with enforcement actions that cost disclosure with respect to perks allows investors to "evaluate whether corporate assets are being used wisely or squandered."
The direct and indirect variable costs incurred with respect to personal trips by executives on corporate aircraft have typically been disclosed as part of the reported aggregate incremental cost. Trip-related variable costs related to a specific flight include such items as fuel costs, landing and parking fees, customs and handling charges, per-hour accruals of maintenance service plans, passenger catering, ground transportation, crew travel expenses, fees for contract crew members, and the use of a fractional jet interest or charter costs.
Some companies also include a portion of regular maintenance costs, such as parts and labor and repairs, and the additional tax cost due to lost tax deductions resulting from personal travel that is for entertainment, amusement, or recreational purposes. These variable costs can be quite significant and are usually much higher than the income calculated under SIFL rates.
Public companies have generally not included fixed costs incurred to own and maintain corporate aircraft as part of the reported aggregate incremental cost. Fixed costs that do not vary based on the executive's use of corporate aircraft may include depreciation (i.e., the portion of the purchase price of a corporate aircraft allocable to a year for accounting purposes), fixed pilot salaries, hangar expenses (not related to a specific trip), and year-round insurance costs.
As you might expect, such expenses are greater than the variable costs. The rationale typically used for not including any portion of the fixed costs as a perquisite is that the corporate aircraft is used primarily for business purposes, so the company would have incurred these costs anyway.
A recent shareholder derivative action is now challenging this practice as misleading. A lawsuit filed in May alleges that Chesapeake Energy Corp. and its directors significantly underreported corporate aircraft perquisites because a "significant proportion of total aircraft use" was attributable to personal use by executives, directors, and company employees.
According to the complaint, the company held a "fractional ownership" interest in which a "bank" of hours was purchased and could be used for flights on a specific plane or a comparable larger aircraft. The plaintiff's argument is essentially that some of the upfront acquisition cost for the fractional interests should have been disclosed as perquisites (along with a portion of the other full fixed costs, including the fixed management fee) because fewer banked hours would have been purchased had there been no personal use. The plaintiffs allege that these undisclosed costs were material to shareholders ("millions of dollars each year") and that directors breached their fiduciary duties by misleading shareholders about the true extent of the cost and by committing corporate waste due to approving "extravagant personal use of the company's aircraft."
The complaint also claimed that incremental costs associated with directors using the corporate aircraft to attend board meetings was personal use and should have been disclosed as a perquisite. SEC rules provide that company-incurred expenses to subsidize commuting expenses are perquisites. To make the case that director travel to a board meeting is a commuting expense, the plaintiffs analogized it to a CEO who regularly uses a helicopter commuting service to get to work. The analogy is quite a stretch and does not take into account that directors often travel from one business location to another. What is more potentially troubling is the extent to which a court might find director independence impaired by virtue of receiving a high level of compensation that is not properly disclosed.
It would be a mistake to conclude — at least for the time being — that this complaint will turn out to be an isolated incidence. The derivative action has already drawn the attention of plaintiffs' bar.
Last week one of my colleagues shared with me a website where a plaintiff's lawyer lists different forms of "corporate jet abuse" and notes a Wall Street Journal review of Federal Aviation Administration flight records that found that "dozens of jets operated by publicly traded corporations made 30% or more of their trips to or from resort destinations, sometimes more than 50%. . . . Often, these were places where their top executives own homes."
Those who are "aware of" this activity are encouraged to come forward as there are "incentive programs" for whistle-blowers that have relevant information to recover "bounties." As close to half of the Fortune 500 provides some form of personal use of corporate aircraft, it's not hard to imagine the possibility for similar lawsuits.
It is important to ensure that there are proper disclosure controls and procedures when this type of benefit is being provided to executives and directors. Personal use of corporate aircraft will likely continue to be under a microscope, and CFOs are well served by taking a fresh look at how personal use is identified and reported for proxy purposes.
(Click here for additional background regarding use of corporate aircraft.)
Andrew Liazos heads the executive compensation practice at law firm McDermott Will & Emery. The author would like to thank his colleague Ruth Wimer for her assistance with this article.