Failure to disclose perks seems to be a fairly attractive target for SEC Enforcement these days. In another fiscal year-end action, Enforcement has charged Hilton Worldwide Holdings Inc. with failure to disclose in its proxy statements various perks and personal benefits provided to its executive officers. This action has the distinction of being the result of the staff's use of risk-based data analytics to uncover potential violations related to corporate perks. The case serves as a reminder that the analysis of whether a benefit is a disclosable perk can be complicated and is not the same as the "business purpose" test used for tax purposes.
Under Item 402 of Reg S-K, companies are required to disclose the total value (based on aggregate incremental cost to the company) of all perks and other personal benefits provided to each NEO, so long as he or she received perks worth at least $10,000 during the year. Perks must be identified by type and, if the perk exceeds the greater of $25,000 or 10% of total perquisites for that NEO, must be quantified and described. However, as you probably know, the analysis for determining whether an item is a disclosable "perk" can be very tricky to apply, especially when it involves the use of corporate jets by executives. The order, quoting from the 2006 Executive Comp Rules Adopting Release, lays it out well:
"'an item is not a perquisite or personal benefit,' and does not need to be reported, 'if it is integrally and directly related to the performance of the executive's duties. Otherwise, an item is a perquisite or personal benefit if it confers a direct or indirect benefit that has a personal aspect, without regard to whether it may be provided for some business reason or for the convenience of the company, unless it is generally available on a non-discriminatory basis to all employees.' The Adopting Release also states that 'the concept of a benefit that is "integrally and directly related" to job performance is a narrow one,' which 'draws a critical distinction between an item that a company provides because the executive needs it to do the job, making it integrally and directly related to the performance of duties, and an item provided for some other reason, even where that other reason can involve both company benefit and personal benefit.'"
Notably, the SEC's perks test is not to be confused with a typical "business purpose" test used for tax purposes:
"even where the company 'has determined that an expense is an "ordinary" or "necessary" business expense for tax or other purposes or that an expense is for the benefit or convenience of the company,' that determination 'is not responsive to the inquiry as to whether the expense provides a perquisite or other personal benefit for disclosure purposes.' Indeed, 'business purpose or convenience does not affect the characterization of an item as a perquisite or personal benefit where it is not integrally and directly related to the performance by the executive of his or her job.'"
However, Hilton did just that, applying a "business purpose" standard under which Hilton did not consider a benefit to be a perk if it had a business purpose that was related to the executive's job. According to the order, "Hilton's system for identifying, tracking and calculating perquisites incorrectly applied a standard whereby a business purpose would be sufficient to determine that certain items were not perquisites or personal benefits that required disclosure."
SideBar
Questions of whether items are perks—that is, whether they are "integrally and directly related to the performance of the executive's duties" or confer "a direct or indirect benefit that has a personal aspect"—can be often be thorny. Examples identified by the SEC in Release 33-8732a include
"club memberships not used exclusively for business entertainment purposes, personal financial or tax advice, personal travel using vehicles owned or leased by the company, personal travel otherwise financed by the company, personal use of other property owned or leased by the company, housing and other living expenses (including but not limited to relocation assistance and payments for the executive or director to stay at his or her personal residence), security provided at a personal residence or during personal travel, commuting expenses (whether or not for the company's convenience or benefit), and discounts on the company's products or services not generally available to employees on a non-discriminatory basis....For example, a company's provision of helicopter service for an executive to commute to work from home is not integrally and directly related to job performance (although it would benefit the company by getting the executive to work faster), clearly bestows a benefit that has a personal aspect, and is not generally available to all employees on a non-discriminatory basis. As we have noted, business purpose or convenience does not affect the characterization of an item as a perquisite or personal benefit where it is not integrally and directly related to the performance by the executive of his or her job."
According to the order, in definitive proxy statements that disclosed executive comp paid for 2015 through 2018, Hilton failed to disclose approximately $1.7 million worth of travel-related perquisites and personal benefits provided to its NEOs. As a result, Hilton understated the compensation disclosed under the caption "All Other Compensation" by an annual average of approximately $425,000. In particular, the order charges that Hilton incorrectly characterized as business expenses and not as perks the expenses of its CEO associated with personal use of corporate aircraft and the expenses of its NEOs associated with hotel stays, as well as taxes related to these items, all paid by Hilton. Hilton's proxy statements were incorporated by reference into its Forms 10-K.
After being alerted to the issue by the SEC staff, Hilton conducted an internal review and subsequently filed a definitive proxy statement providing revised disclosures regarding these omitted perquisites and personal benefits.
The SEC determined that, as a result of these disclosure failures, Hilton had violated Sections 13(a) and 14(a) of the Exchange Act and related rules and ordered the company to pay a civil penalty of $600,000.
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