Navigating murky executive compensation rules.

• Author: Moorhouse, Richard L.
• Position: ETHICSCORNER

* President Obama appointed Kenneth Feinberg as the administration's so-called "compensation czar" in June and gave him the authority to set pay for high-level corporate executives of federal bailout funding recipients under the Troubled Asset Relief Program. In October, Feinberg announced executive compensation cuts averaging 50 percent for firms that still owe on their federal debts.

In addition, the American Recovery and Reinvestment Act requires certain government contractor stimulus funding recipients to report names and total compensation of their top five highest paid officers.

While the administration's focus on executive compensation has been center stage, it's worth remembering that defense contractors have long been subject to compensation review by the Defense Department's own "czar," the Defense Contract Audit Agency. Indeed, some commentators say that DCAA has stepped up its compensation scrutiny in the last several years.

Department policy as enforced by DCAA requires a contractor's calculated year-end compensation costs to be allowable, reasonable and within the office of federal procurement policy's statutorily set executive compensation ceilings. Otherwise, contractors may face DCAA disallowances of executive compensation costs and sizable repayments. Thus, allowable and reasonable compensation should be set in advance by management to allow adjustments at the beginning of the year, or alternatively, informed decisions to accept some part of compensation as unallowable.

DCAA auditors conducting compensation audits must first verify that the executive pay at issue includes only allowable elements, compensates only allowable activities and is reasonable. Generally, pay must be for current year work, and certain costs are unallowable even when the company includes them as part of an executive's compensation. For example, executive pay for lobbying, advertising, or organization/reorganization activities is unallowable.

Also, certain compensation elements are unallowable, including stock options, phantom stock, and stock appreciation rights based on corporate security price changes. Nor are profit distributions allowable costs if made to an executive who is contractually obligated to buy a substantial interest in the company.

After determining the allowable compensation elements and activities, DCAA auditors then determine total compensation reasonableness. FAR 31.205-6(b)(2) deems compensation reasonable "if the aggregate of...