Fmr XOM CEO already under water,...

and it's not because he fell off a drilling platform, according to a recent lengthy article in Politico Magazine.  And not long before that, Bloomberg reported that Rex Tillerson had checked into a sanitarium in Germany on his first trip abroad as U.S. Secretary of State.  All in all, it has not been smooth sailing for Mr. Tillerson since being sworn in as the nation's chief diplomat on February 1st.

Tillerson nominated for Secretary of State, retires as XOM CEO

After he was nominated in December by President-elect Trump, XOM CEO Mr. Tillerson announced his retirement from the company effective at yearend.  Having joined the company as a production engineer in 1975, Mr. Tillerson had been scheduled to retire when he reached the age of 65 in March of this year.  Prompted by this unexpected turn of events, there was the matter of what to do about unvested restricted stock units (RSUs), amounting to approximately two million underlying XOM shares then worth about $184 million.  Simply retaining them in their existing form was not an option, so to speak, because doing so most certainly would run afoul of federal conflict of interest standards and/or could give the appearance of conflicts hindering his ability to serve effectively as the 69th U.S. Secretary of State.

Agreement to mitigate potential conflicts

Consequently, on January 3rd, ExxonMobil filed an 8-K with the Securities and Exchange Commission disclosing that the company had entered into a Cancellation and Exchange Agreement (the "Agreement") with Mr. Tillerson subject to his being confirmed by the U.S. Senate and taking office as U.S. Secretary of State.  The Agreement outlines how the compensation and benefits Mr. Tillerson has earned over his 40+ year career would be handled.

The Agreement provides that Mr. Tillerson will surrender all unpaid XOM restricted stock and restricted stock units he holds in exchange for a cash payment to an irrevocable Ethics-Compliance Trust established with an independent third-party trustee (the "Trust") equal to the value of underlying XOM common stock determined under a market-based formula.  The payment will be discounted by approximately $3 million (at current market values) consistent with guidance from federal ethics authorities.

Under the Agreement, Mr. Tillerson will surrender all unpaid deferred cash bonus units (referred to as Earnings Bonus Units"), having total settlement value of approximately $3.9 million.  The surrendered Earnings Bonus Units will be cancelled without any compensating payments in exchange.

According to the filing, the net effect of the foregoing is a reduction of approximately $7 million compared to compensation and benefits Mr. Tillerson otherwise would have received.

Although unmentioned in the 8-K, Mr. Tillerson apparently would also surrender entitlement to other benefits such as retiree medical and dental benefits, and administrative, financial and tax support.

The Agreement also states that Mr. Tillerson's vested benefits under XOM's defined contribution and defined benefit plans will be paid or distributed to him in the normal course as provided under the terms of those plans, consistent with federal conflict of interest guidelines.  Mr. Tillerson's death benefit coverage under XOM's group life insurance plan for certain executives - which provides a benefit to Mr. Tillerson's survivors of approximately $13 million - will be cancelled.  The company commits to use its best efforts to obtain and, if so, pre-pay a life insurance policy from an independent third party supplying substitute coverage as comparable as possible to the terminated coverage.

Dueling tax provisions

Relying on §409A of the Internal Revenue Code, a number of tax attorneys and pay experts contend that the trust set up with the proceeds from Tillerson's RSUs creates a taxable event, to the tune of about $70 million in income plus another roughly $8 million in Medicare tax - and if Tillerson does not pay what he owes this year, he will be violating the law.  Columbia Law professor and executive compensation expert Robert J. Jackson Jr., a former Obama administration Treasury Department official, told the New York Times, “Everything in the trust is his property today, which means he must pay tax on it.”

Tax expert Robert Willens demurs, noting that §409A was never meant to apply to restricted stock units, or stock options, where the final payout is at risk.  A precipitous drop in the stock price could result in the the RSUs being worth a lot less, or nothing at all.  Under such circumstances, §83 of the tax code is implicated, stipulating that in deferred compensation arrangements, if there is a substantial risk of non-payment, then no taxes are owed until the taxpayer actually gets the money.  And RSUs are deemed to have a substantial risk of non-payment.

But in order to divest himself of his interest in XOM stock, the company is converting his RSUs and turning them into cash, and depositing the proceeds into the trust.  Because the trust preserves the same vesting schedule as the RSUs, the company and Tillerson maintain that §83 tax treatment should apply.  But with cash not RSUs in the trust, §409A could kick in, requiring Tillerson to pay upfront.

Willens, the tax expert, points out that the trust agreement, which is in place for 10 years, has a clause that requires Tillerson to forfeit whatever remains in the trust in the event that Tillerson returns to the oil and gas industry, in any capacity, even as a  consultant or lobbyist for any entity.  Since Tillerson's main expertise is in the oil and gas business, Willens argues, there is a real possibility that he will return to the industry in some capacity, which would mean that, because of the risk of non-payment, the trust still qualifies for treatment under §83.

No easy answers for company but others should take notice

Charles Elson, director of a corporate governance center at the University of Delaware, said the board of Exxon Mobil was "between a rock and a hard place.  There were no easy answers. I’m not saying they did the right thing or the wrong thing. I think they came up with what they thought was a measured answer.’’  While Elson noted the board eliminated the downside risk of continuing to hold XOM shares, the value of the stock could go up or down in the future, so Tillerson could have fared better or worse depending on when he took possession of the shares.

With more CEOs and other top corporate executives likely to be nominated for senior government positions and more CEOs considering their own suitability for the role of the nation's Commander-in-chief, this could be an issue more frequently confronting companies in coming years.

Robert Stead