In this post, we share a few thoughts about recent developments and trends regarding nonqualified deferred compensation incentives for key bank employees. Banks are seeking ways to attract and retain talent, while ensuring that compensation arrangements are aligned with newer statutory guidance, such as the Dodd-Frank Act and Section 409A of the Internal Revenue Code (the “Code”).

409A Penalties

Code Section 409A added new rules for “nonqualified deferred compensation.” Even if an executive compensation arrangement such as an employment agreement, severance agreement, change in control agreement, or equity compensation plan does not provide “nonqualified deferred compensation,” the arrangement may be required to follow strict deferral election and payment timing rules under Section 409A.

Executives are at risk of early income inclusion, a 20% penalty tax, and interest charges if their compensation arrangements violate the evolving 409A guidance. So the first question is whether the IRS is enforcing the potentially harsh penalties, even as to parties who have made a good faith compliance effort while guidance has evolved. In a word, yes. 

Consider a 2013 decision in the Court of Federal Claims, Sutardja v. United StatesStock options are generally exempted from 409A. But this case involves a stock option that was allegedly issued at a price discounted below market value, and 409A does apply to discounted options. The option was issued in December 2003, with an exercise price equal to that date’s stock price, and ratified in January 2004, on a date when the stock price was higher. Subsequently, Section 409A was enacted. In January 2006, prior to the issuance of regulations, Mr. Sutardja and his employer entered into a reformation to amend the exercise price to the higher price. Presumably they believed this was a permissible way of addressing an option that had been issued prior to the law change. Sutardja then exercised the option. Relying upon Notice 2005-1, which provided that discounted stock options were included in the definition of deferred compensation, the IRS deemed the 2006 exercise of the option to constitute a violation of Section 409A, and assessed excise tax penalties against Sutardja. (Note that regulations were not promulgated until 2007.) Sutardja appealed to the court, which rejected a number of his arguments, and announced that it would set the matter for trial on the issue of whether the stock option was discounted at the time it was granted. If the IRS is willing to pursue penalties against executives in a case like this one where there was little Section 409A guidance available and an apparent good faith attempt to correct the issue, we can only imagine how aggressive the IRS will pursue executives in other instances.

Correction of 409A Errors

Given the potential substantial costs to executives, and evolution of guidance over time, we encourage banks to review their executive arrangements on a periodic basis to determine whether their executives have exposure to any potential 409A issues. For example, if an arrangement is structured to provide for payment based on when an executive signs a release, rather than based on a fixed date, that arrangement may violate 409A. Arrangements may have been structured in that manner prior to issue of regulations. If errors are discovered, it may be possible to correct them under a correction program, or to otherwise mitigate the harsh result for the executive.

Mandatory Deferral of Annual Bonuses

Subsequent to the Trouble Assets Relief Program (“TARP”) and statutory changes including the Dodd-Frank Act, banks have begun to revise their executive compensation practices to better ensure that executive compensation is aligned with corporate goals and financial performance. One trend that is starting to develop at larger, publicly held banks (generally over $1 billion in assets) is the mandatory deferral of annual bonuses.  This is viewed as a method to discourage unnecessary and excessive risk-taking, and some believe the Dodd-Frank Act rules may be revised at some point to require this.

Discretion Built Into Deferred Incentive Arrangements

Many banks have begun to build more discretion into incentive arrangements, so that they can make adjustments to awards based on unexpected circumstances. A severe downturn in economic conditions, or the discover of problems during an audit, could lead to circumstances where payment of awards would seem inappropriate. For the purposes of bank regulators and shareholders (particularly of publicly held companies, in light of Say-on-Pay), management needs to be able to explain the reasons for the discretion and demonstrate consistency in approach. Measures may include appointing a committee that develops guidelines and scorecards. 

Claw-back and Recoupment

The Dodd-Frank Act requires publicly held companies to disclose their policies for recouping executive payments in the event of a financial restatement. As a result, claw-back and recoupment provisions are becoming increasingly common in deferred incentive plans. In essence, the provisions state that if the bank is required to restate its financial statements or discovers other wrongdoing after payment has been made, the bank has the authority to force the executive to repay certain amounts paid by the bank.


A supplemental executive retirement plan (“SERP”) is a nonqualified retirement plan that provides benefits to a select group of management or highly compensated employees. These plans allow for greater employer contributions than are permitted in the 401(k) plans and other qualified plans. While many banks traditionally offered defined benefit SERPs, these plans have been criticized by regulators and shareholders as costly and not aligned with corporate goals, particularly as banks wind down their qualified defined benefit plans, and accordingly these plans are on the decline. Some banks, such as mutual banks and privately held banks that cannot issue equity awards, might consider a defined contribution SERP with performance-based contributions. A defined contribution SERP is structured somewhat like a 401(k) plan, with employer contributions, with vesting and other provisions.


Banks have numerous tools available to them for offering nonqualified deferred compensation incentives to help recruit and retain key executives, and need to ensure that these arrangements are properly designed so as to comply with applicable law and align the executives with corporate goals. If you have not reviewed your programs recently, this might be a good time to consider whether the programs are up-to-date, and effective.