Fessing up to jet perquisites

Understating the value of personal usage of the company aircraft can lead to significant penalties.

The disclosure rules of the Securities and Exchange Commission are designed to protect investors by providing material information about public companies. This includes information that reasonable investors would likely want to know when they’re deciding whether to buy or sell securities and voting on corporate matters, such as the election of directors.

Investors have certainly demonstrated an interest in disclosures regarding business jet usage. In 2012, for example, a shareholder of Chesapeake Energy Corporation brought a derivative suit alleging that its executive officers and board of directors wasted millions of dollars by making personal flights on its jets. The plaintiff argued that public filings understated the cost of such flights by as much as $10 million.

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The past couple of years have been tough for business jet manufacturers.

But understating the cost of business jet usage does more than raise the hackles of shareholders; it can lead to significant financial penalties from the SEC. In a 2005 settlement, that commission imposed a $1.5 million penalty against Tyson Foods and a $700,000 penalty against its former chairman and CEO, Donald Tyson, for failing to disclose $3 million of perquisites received by him and his friends and family, including “personal use of company-owned aircraft.” Last July, following a whistleblower lawsuit by a Dow Chemical employee who claimed she was fired for questioning perks received by Dow CEO Andrew Liveris, the SEC agreed to a $1.75 million settlement with that company stemming from repeated failures to disclose perquisites (including jet travel) in its proxy statements and annual reports.

SEC regulations require disclosure of compensation paid to the principal executive and principal financial officers, the three most highly compensated executives other than the foregoing, and a couple of other individuals. These disclosures appear in the so-called “Comp Table” of the annual proxy statement. A similar table discloses compensation paid to directors. Both tables have a column for “other compensation,” which includes perquisites like travel on the company’s jet. Disclosure of perquisites for a given executive is not required until their value exceeds $10,000, and once their value exceeds the greater of $25,000 or 10 percent of total perquisites, they have to be footnoted or identified in an accompanying narrative. Creative drafting of these identifications and disclosures consumes a good deal of legal time and talent.

The first thing to notice is that the SEC is interested only in the company’s top dogs. If a lowly senior vice president pays a modest charge to fly on the corporate jet, the SEC doesn’t care, though the IRS will have its hand out for the ticket tax and the FAA may be on the ramp to shut down the flight as illegal compensation for air transportation.

Second, the SEC has its own standards for deciding whether perquisites need to be disclosed. Dow Chemical got into trouble with the commission because it failed to disclose perquisites on the theory that there was a business purpose behind them. That’s a nice theory, but the SEC wants them disclosed unless they are “integrally and directly related to the performance of the executive’s duties.”

So how should compensation consisting of flights on a company jet be calculated? As was once argued in Corporate Counsel magazine, one might expect the SEC to look at the value to the executive on the flights. A logical way to calculate that value is to consider what the executive would have paid to charter a comparable aircraft for the trip. Compensation, though, is a two-edged sword; one party receives it, but one party also pays it. The SEC focuses on the latter. Instead of tracking the benefit to the executive, it wants the company to disclose to the public what it calls the “aggregate incremental cost” of the flight.

For example, a company operates a business aircraft, and the CEO uses it to fly to Aspen for a vacation. The fixed costs—such as those for pilots, insurance, and hangar—will be borne by the company whether the CEO makes that trip or not. Therefore, they do not figure in the company’s incremental cost for the trip. On the other hand, fuel, landing fees, and other direct operating costs (DOCs) would not have been incurred if the CEO hadn’t flown to Aspen, and that’s what the SEC wants to see disclosed as “other compensation.” In a letter to the SEC, the National Business Aviation Association supported this view, saying “the current standard of reporting, aggregate incremental cost, is the proper valuation methodology for valuing perquisites and other personal benefits.”

Still, issues remain. The SEC’s method of calculating the costs of perquisites reflects the idea that a company uses its jets primarily in its business, so the personal use is merely an “incremental cost.” But suppose that’s not the case? The plaintiff in the Chesapeake lawsuit argued that the company should have been disclosing the fixed costs of using its fractional shares because a high proportion of the executives’ use was personal. If the principal purpose of the aircraft is the personal use by the company’s top dogs, it’s the corporate use—not the personal—that is “incremental.”

But personal use raises another issue. A complete picture of the incremental cost to the company should arguably include the loss of tax benefits for perquisite flights. If a company buys a jet and puts it in service this year and all the flights satisfy IRS standards as business flights, the company can deduct 100 percent of the purchase price against taxable income in 2018. On the other hand, if some of the flights were wholly or partly for the “entertainment, recreation, or amusement” of company employees, the IRS will disallow a portion of the deduction. And, unlike the SEC, the IRS looks at the total cost of owning and operating the aircraft, not just the incremental cost (the DOCs) related to perquisites for key executives. This can result in significantly higher taxes for the company.

I am not aware that the SEC has ever asked companies to disclose disallowed tax deductions resulting from personal use of their aircraft, but some do it anyway. Coca-Cola’s 2018 proxy statement, for example, says that among the items included in calculating the aggregate incremental cost of personal use is “the amount, if any, of disallowed tax deductions associated with such use.” This is a conservative (and laudable) approach to the issue. Meanwhile, part of the SEC’s settlement with Dow was an agreement that the company would retain an independent consultant to help it implement processes and internal controls “to reasonably ensure payments and other expenses are properly evaluated for perquisite disclosure under the securities laws.”