ISS has released 104 additional FAQs on their corporate governance policy. That’s 44 pages of FAQs but they still haven’t answered the question we all want to know, which is how many points each of the tests in the Equity plan Scorecard are worth. In fact, a lot of the FAQs provide information that I thought was already general knowledge or is so a granular as to be applicable to only a small number of companies (I think ISS must be using the term “frequently” very loosely).
For what it’s worth, here are a few highlights from the FAQs on equity plans.
Excluding Certain Grants from Burn Calculations
ISS will exclude assumed or substitute grants issued as a result of an acquisition as well as grants issued pursuant to a shareholder-approved repricing from the burn rate calculation if these grants are disclosed separately in the plan activity table in the company’s Form 10-K. This explains why I see companies do this.
Disclosing Performance Based Awards
ISS generally counts performance based awards in the burn rate calculation in the year they are earned, provided that the company has included disclosures sufficient for this purpose. Separately report the number of performance awards granted and the number of performance awards earned when disclosing plan activity. Be careful about this: if ISS can’t figure out your disclosures, they could end up counting performance awards twice.
Updating Disclosures After Year-End
If circumstances for your company have changed so significantly since the end of the year that you want ISS to base the SVT and (presumably) other tests on new numbers, ISS will do this if you update “ALL” of the disclosures required for their analysis in your proxy statement (or in another public filing that the proxy statement references). See the FAQs for list of disclosures that must be updated; it sounds like ISS is going to be a stickler about this (the use of all caps for the word “ALL” was their idea).
Fungible Share Reserves and SVT
ISS calculates the cost of plans with fungible share reserves by running the SVT test twice; once assuming all shares are issued as stock options/SARS and a second time assuming all shares are issued as full value awards. The plan has to pass both tests. It isn’t clear from the FAQ what happens if the plan passes both tests but scores better on one than the other (the SVT score is scaled; plans can earn partial credit for scores within a certain range). Maybe the plan is assigned the lowest score.
Fungible Share Reserves and Plan Duration
The plan duration is calculated by adding the shares requested to the share available in the plan and dividing by the company’s burn rate multiplied by the company’s weighted shares outstanding. For purposes of calculating the burn rate in this formula, for plans with a fungible share reserve, the FAQs state that ISS will apply the share multiplier in the plan to full value awards. Normally, ISS has its own multiplier that it uses for burn rate calculations that is based on the volatility of the company’s stock, so this is a little surprising to me. I can only assume that it hurts companies in some way (not that I’m cynical); perhaps plan multipliers are typically lower than ISS’s multiplier, resulting in a lower burn rate, which would result in a longer plan duration.
Burn Rate Commitments
If you have made a burn rate commitment in the past three years, you aren’t off the hook. Even though these commitments are defunct under the scorecard, ISS expects companies to adhere to any commitments they’ve already made. If you don’t, they may take it out on your compensation committee members.
Fixing a Liberal Change-in-Control Definition
A liberal change-in-control definition is a deal-breaker; ISS will recommend against the plan regardless of how perfect the plan’s scorecard is. A liberal change-in-control definition is one that provides for single-trigger acceleration of vesting upon a trigger that could occur even if the deal doesn’t close (e.g., shareholder approval of the deal) or other triggers that are suspect (e.g., acquisition of a low percentage of the company’s common stock).
But there’s good news—this is fixable. You can modify the CIC provision in your plan (the FAQs provide suggested language). ISS is good with this, even if the modification only applies to new awards.
Other Matters
Most of the FAQs (75 of the 104 questions) relate to Say-on-Pay votes and other corporate governance considerations, rather than directly addressing equity plan matters. These are beyond the scope of things I care about, so I didn’t read them. It’s possible they are more scintillating than the FAQs on equity plan matters.
Today I’m going to dissect a concept that’s existed in equity compensation for a long time. In fact, it’s nothing “new” per se. Yet, some recent trends, governance practices and changes in other industry areas have brought about new life to the idea. So much that I’m officially calling it the “buzz word” (okay, words) of the month. What is it? Post-vest holding periods. In this week’s blog I’ll explore why the renewed attention to this previously under-used practice. In a later installment we’ll get down to the more detailed mechanics.
What is a Post-Vest Holding Period?
Just to make sure we’re all on the same page, the post-vest holding period that I’m talking about is an additional holding requirement imposed on vested shares. Once vested, you must hold them for a period of time (1 year? 2 years?). This is different from holding the shares until they vest (aka the service or vesting period). Typically a company would include this type of holding period in the governing plan and agreement language, in addition to vesting details.
Participants Are Already Subject to Vesting – Why an Additional Holding Period?
This is where the old concept turned hot topic comes into play. While the idea of holding shares has been around for a long time, we are seeing recent and renewed interest in implementing post vesting holding requirements. There are a number of reasons why this may be attractive to a company, including:
Clawbacks: Having a holding period after vesting maintains a “reserve” of retrievable stock in the event the company needs to clawback income from an executive. After all, once an executive liquidates stock and spends the money, it’s next to impossible to recoup those shares or proceeds in their original form. Does the company really want to try and repossess the executive’s vacation home or new yacht?
ISS Scorecard: When ISS released their new Equity Plan Scorecard (see previous blog on this topic), it became clear that the existence of post-vest holding periods count for something. This is one of the items eligible for points on the scorecard.
Prevalence of Stock Ownership Guidelines: We’ve seen the steady rise of stock ownership guidelines over the past several years, with recent data showing more than 90% of public companies having some form of stock ownership guidelines. Post-vest holding periods can help an executive achieve their ownership targets.
In addition to the reasons outlined above, there are other interesting considerations emerging. In talking with Terry Adamson of Aon Hewitt, he pointed out that in addition to the above, companies may be able to reduce their ASC 718 accounting expense on awards with post vest holding periods. Why? Because the “lack of marketability” of the award deserves a discount.
The above only touches upon the surface. Questions I haven’t explored today include the types of equity that make the most sense to cover with a post-vest holding period and whether this makes sense to implement on a broad basis.
We’ve got some great resources in the works to provide you with those additional details. With Dodd-Frank requirements for clawbacks on the horizon, the new ISS Equity Plan Scorecard coming into play this proxy season, ongoing corporate governance changes and continued interest in minimizing accounting expense, we think the concept of post-vest holding periods may be more than just a passing trend.
For additional information now, check out our latest podcast episode “Hold After Vest” (featuring Terry Adamson of Aon Hewitt). For even deeper details, we’ve got a great team of presenters assembled to address all of the points raised in this blog (including the possibility of reducing accounting expense) in our next webcast: Post-Vest Holding Periods on March 11th.
In the coming weeks I’ll touch on more of the nuances that make this topic so interesting.
In somewhat of a surprise announcement, last week the SEC proposed rules to implement the requirement under the Dodd-Frank Act that companies disclose their policies with respect to hedging by employees and directors.
This Has Nothing to Do With Yard Work
Hedging is a means by which investors protect themselves against downside risk—think “hedging your bets.” This is all well and good for the average investor, but when the investor in question is an officer or director of the company who has received compensatory awards of stock and/or options, hedging can be problematic. Companies grant equity awards to align their officers and directors with shareholders and to motivate them to increase the value of the company’s stock. If the officers and directors can use hedging instruments to protect themselves from downside risk, they might be less motivated by their equity awards.
Likewise, where a company has implemented ownership guidelines, if officers and directors can hedge against the stock they own to comply with the guidelines, then the guidelines aren’t terribly effective because officers and directors haven’t really assumed the risk of ownership.
More Controversial Than You Might Think
The proposal was issued via written consents of the Commissioners, rather than an open meeting, which is why it caught many of us by surprise. An open meeting would have been announced in advance and people that follow the SEC’s meeting schedule would have known it was happening.
I thought that this ought to be relatively simple—essentially, “disclose your hedging policy”—especially since companies are already doing this for their NEOs in the CD&A. But I guess nothing that the SEC does is very simple; the proposing release is 103 pages long. That is, however, shorter than the CEO pay ratio disclosure proposal, which clocked in at 162 pages.
Part of the complexity is that there are virtually an infinite number of possible types of arrangements and instruments that can be used to hedge a financial position. Complicated strategies like equity swaps, variable prepaid forward contracts, and collars (in case you are wondering, I have no idea what any of these things are, except that I do know that an equity swap is not the same thing as a swap exercise) and more straightforward transactions such as a short sale (I know what that is: a short sale is selling stock you don’t own yet—you are hoping the stock price will decline before you have to buy the stock to close out your position).
The SEC requests comments on a number of matters related to the rules, including:
Should the disclosure apply to all employees (the language included in Dodd-Frank) or just officers and directors (the individuals investors are probably most concerned about when it comes to hedging)?
Should the rules be part of corp governance disclosures under Reg S-K Item 407 or part of the Say-on-Pay disclosures under Item 402? The proposal includes them under Item 407, which means that shareholders technically aren’t voting on them as part of Say-on-Pay.
Types of equity securities that should be subject to the disclosure.
Should companies be required to disclose hedging activities that employees, officers, and directors have engaged in?
Should smaller reporting companies or emerging growth companies be exempted from making the disclosure or subject to a delayed implementation schedule?
Comments should be submitted to the SEC by April 20, 2015.
Cooley’s blog has a nice summary of the proposal, if you don’t want to read all 103 pages.
Most of us who work in and around stock compensation have figured out by now that it takes a village to pull this off. By “this”, I mean successful administration of an equity plan – including compliance with tax, securities and other regulatory reporting/disclosures/requirements, interacting with and educating participants, recordkeeping, policy adherence and at least a dozen other things that I didn’t list. While we may have figured out that we can’t shoulder the responsibility alone, there are varied amounts of leverage available to help get the job done. Add in a global element – meaning issuing equity to participants outside of the U.S., and the complexity magnifies. In today’s blog, I explore the village needed to really stay on top of your global stock plan.
Data Doesn’t Lie
In the 2012 Global Equity Incentives Survey, co-sponsored by the NASPP and PwC, 78% of survey participants said that compliance is the most challenging issue in administering a global equity plan.
In the NASPP’s 2014 Domestic Stock Plan Administration Survey, co-sponsored by Deloitte, 74% of participants have either zero (0) or one (1) full time person dedicated to administering the company’s stock plans. Also surveyed were the quantity of part time personnel who performed stock plan duties part time, with those numbers spread across the board. There did appear to be a correlation between number of personnel and the size of the participant population with outstanding equity awards. The more participants, the more in-house personnel. That makes sense.
71% of respondents working for a public issuer reported outsourcing all or part of their equity plan administration, with 40% reporting they outsource 75% or more of their plan duties.
While the staffing and outsourcing data doesn’t dissect global versus domestic participants (though the survey is titled “domestic”), it can be largely assumed that many companies have at least some global participants (not all, but many).
The Village
We’ve figured out by now that administering a global equity plan is not a one-person job. Even if one person is tasked primarily with responsibility for the plan’s administration (such as the stock plan administrator or stock plan manager), that person likely oversees a number of other in-house and external resources that touch the company’s stock plans.
Given that the biggest issue in administering a global stock plan is compliance (no surprise there), the question then turns to how to use the “village” to succeed in compliance. When I think of a global stock plan village, I think of the following key components:
In house person overseeing equity programs
In house interested parties (like finance, accounting, treasury, payroll, human resources)
External legal and tax advisers who have specialized knowledge about tax, legal and securities regulations in places where the company has participants
First line resources (not necessarily advisers, but sources of information about new or emerging issues in the jurisdictions where the company has stock plan participants). These include things like the NASPP’s Global Stock Plan Portal.
Local contacts in foreign jurisdictions (e.g. local human resources personnel)
Service providers who offer recordkeeping, mobility, education, plan design or other services
Compensation consultants
I am sure there are others that you will write me about if I’ve missed them; the point is that it takes a lot of moving parts
Even with the village in place, the person tasked with oversight of the equity plans needs a constant and fresh supply of information on global practices and changes relevant to them. This is not in lieu of the village, this is part of the village. Some companies rely solely on local jurisdictions to let them know about regulatory changes. While local contacts are a helpful resource, they should not be the only resource. It’s important that the person tasked with oversight of the equity plans maintains just that – oversight. And that includes proactive awareness of jurisdictional changes.
Expanding the Village
I want to highlight a few resources to add to your village that are already available to you as part of your NASPP membership. Again, these are no replacement for the necessary parties to your own global village. However, they are front line sources designed to help you achieve what the majority describes as the most challenging issue – compliance.
Before I list the resources, it’s quiz time! Pop Quiz: Which 3 countries have the MOST subscribers to NASPP Alerts (updates on country specific developments)?
A. United Kingdom, Canada, Germany
B. China, United Kingdom, France
C. China, France, Japan
D. United Kingdom, France, Bermuda
The answer is at the bottom.
I threw that question in to introduce the first resource: NASPP Alerts. If you’re missing out on NASPP Alerts, you’re – well, missing out. Did you know your NASPP membership includes the ability to select which countries you’d like to receive updates about? It’s a simple as a check box. When something new is posted for a country that you’ve subscribed to, you will get an email. Right now you can get alerts for up to 69 countries. I’ll make it even simpler – to set your alerts, go here.
The second resource is the NASPP’s Country Guides, also available in the Global Stock Plans portal. If you look on the left side of the page, there are country-specific guides for 34 different countries. These are authored by local practitioners (the Canada Guide is authored by a law firm in Canada, the Japan Guide was prepared by lawyers in Japan, and so on). Several of these guides have been updated within the last 12 months. The Guides are not designed to replace your advisers, but rather to complement that relationship. They are perfect for the moment when you are sitting in a meeting and someone says “we are acquiring stock plan participants in Argentina next week” and you suddenly need to know the stock plan lay of the land in Argentina before you can have a full discussion with your advisers. Each Guide covers the basic tax, regulatory and securities considerations in the jurisdiction.
Finally, if you have a global related question, post it to our Global Stock Plans Discussion Forum (different from the general Q&A forum). The questions in the Global forum are answered by our Global Task Force members, who specialize in various aspects of global equity plans.
Some of you are already plugged into these resources, but for the rest that may not have discovered them yet – take a moment to check them out. After all, adding more to your village may help ease the compliance challenges.
-Jenn
Answer to pop quix: A – United Kingdom, Canada, Germany (in that order)
It’s been a while since I posted a stock compensation grab bag. Here are a few recent developments that don’t warrant their own entry but are still worth knowing about.
HSR Filing Thresholds
Good news: now executives can acquire even more stock! Under the Hart-Scott-Rodino Act, executives that acquire company stock in excess of specified thresholds are required to file reports with the Federal Trade Commission and the Department of Justice. The thresholds at which these reports are required have increased for 2015. See the memo we posted from Morrison & Foerster for the new thresholds, which are effective as of February 20, 2015.
If you have no idea what I’m talking about, check out our handy HSR Act Portal.
Final FATCA Regs
The Foreign Account Tax Compliance Act (FATCA) requires employees to report any overseas accounts that hold specified foreign financial assets, which could be interpreted to include stock awards issued by non-US corporations. The assets (stock awards, for our purposes) are reported on IRS Form 8938 (“Statement of Specified Foreign Financial Assets”), which is filed with the annual tax return. Final FATCA regulations, released in December 2014, clarify that unvested awards, do not need to be reported on Form 8938 until they have “substantially vested” (except in the case of a Section 83(b) election).
Dodd-Frank Rulemaking Update
The SEC has pushed back its agenda of rulemaking projects under the Dodd-Frank Act. The proposed rules for clawback requirements, disclosure of hedging policies, and pay-for-performance disclosures and the final rules for the CEO pay ratio disclosure have been pushed back to October 2015 (just in the time for the 23rd Annual NASPP Conference). This is despite comments from SEC Chair Mary Joe White last fall that the SEC was pushing to issue the final CEO pay ratio rules by the end of year. That’s a big delay—from the end of 2014 to October 2015—especially given the pressure on the SEC to issue these rules.
Section 83(b) Election Update
When making a Section 83(b) election, employees are required to include a copy of the election with their tax return for the year in which the election is made. In PLR 201438006, the IRS ruled that a Section 83(b) election was valid even though the taxpayer failed to attach a copy of the election to his Form 1040. If the failure had invalidated the election, employees could effectively revoke the election by “forgetting” to include it with their tax return—and, as we all know, Section 83(b) elections are irrevocable once the deadline to file them has elapsed.
If you’ve read any of my prior blogs, it’s no secret that I’m a fan of employee education. Good employee education. Comprehensive employee education. Normally I don’t rant in the forum of the NASPP Blog, and today I will do my very best to avoid doing so, but I’m on the verge of it so be warned.
It’s Section 6039 reporting time, W-2s are on their way, cost basis reporting is on the brain (are employees going to figure this all out?) So my mind has naturally been on – education. Educating never stops, but it’s definitely at a peak this time of the year. Which then brings me to the question – did we educate enough? Did we put enough good information in our employees’ hands to help them navigate their questions without giving them the dreaded “advice” or leaving them short on facts?
Advice Gone Bad
Picture this: I’m thinking through all the questions I just posed above, when someone suggests that I check out a recent episode of a national radio broadcast. The topic of the show is financial advice. People call in, they get financial advice. Over the radio. Okay, so I’m already thinking – well, if someone calls in over a radio show to get financial advice, they probably should know that it’s really hard to know all the factors in that format, so take whatever it is with with a grain of salt, right? I listened to the show, and here’s that part that makes me want to vent. Someone calls in and asks a question about an Employee Stock Purchase Plan (ESPP). The caller wants to know if they should invest in their company’s ESPP plan. Oh yay, there’s a plug for ESPP! Except that the radio host got it all wrong. He asks if the discount is 15%, and then says something to the effect of “yeah, that’s the law – they’re all 15%.” Then he goes on to tell the person not to invest in it. He doesn’t ask about whether there is a look back, or if it’s a Section 423 plan or not, or how the company’s stock has performed. And, to those who know ESPPs, we know there is no “law” dictating a 15% discount. Then, the host went on to remind his audience about all the licenses he used to hold (I’m assuming investment licenses), which came across to this listener as an effort to boost his position on why ESPP was a no-no. I started frothing at the mouth.
I did some additional digging and found that this show has millions of listeners per week. Now, maybe not all are interested in investing in their ESPP, but I bet some have an ESPP. And then it hit me – how frustrating it would be if the caller (or listeners) were employees of my company, and my educational efforts were going up against a famous radio personality who has ESPP all wrong. And, this isn’t the first time the same show has put out incorrect information on ESPPs – I found another blog from 6 years ago highlighting the same issue from the same personality. It’s frustrating when someone in a position of influence and giving financial advice in the earshot of millions gets it wrong.
Own the Message
And then it hit me – although we can’t control what education (no matter how bad or inaccurate) comes from other sources, we can control our own messaging and we have to do a darn good job at it or someone else is going to do it for us. That’s the point of my blog today.
Let’s face it – there are great, good and bad advisers in every category. It’s safe to assume that many of our employees are going to turn outside the company (as we often encourage them to do) to seek advice. This definitely is not a knock against all the advisers out there that get it right. There are plenty of those inside this industry and outside – and they are a valuable resource to our participants. The hard part is when they get bad advice from advisers who don’t understand equity plans. My conclusion is this – we obviously can’t control if a radio host gives bad ESPP advice to millions of listeners. Or, which advisers our employees choose. What can control is what we put out there. We don’t want to leave our employees in the position of having to fill in the blanks. The advice line is a fine one, but I have to think there are ways to put out enough factual information that employees can take that and make sense (or not) of what they are being told from their advisers – even famous ones.
So where can employees go for good information? In addition to your own internal communication efforts, employees can also seek information from myStockOptions.com, your service provider web site (which may also offer them access to advisers who have equity compensation knowledge) and even sites like the IRS’s website. There are several consultants out there that would be happy to come in and educate your employees. And, don’t forget the NASPP also has an Employee Communications portal – we’re always looking for more sample communications that can be shared generically in the portal, so if you’ve got samples send them to me at jnamazi@naspp.com.
I’m hopeful that one communication effort at a time, we can equip our participants with the information needed to recognize inaccurate information and bad advice.
Our first discussion of cost-basis reporting was posted back in 2009, yet, here we are, still talking about it half a decade later.
Why Am I Still Blathering On About This?
This is still a topic for discussion because the rules have changed again this year. For any shares acquired on or after January 1, 2014, brokers are no longer allowed to voluntarily include the compensation income recognized in connection with the option or award under which the stock was acquired in the cost basis reported on the Form 1099-B issued for the sale. This means that for any shares employees acquired under their options and awards this year, the cost basis reported on Form 1099-B is likely to be too low. Employees will have to report an adjustment on Form 8949 when they file their tax return to correct their capital gain/loss for the underreported basis.
Let’s Review
When you sell stock, your cost basis in the stock is subtracted from your net sale proceeds to determine what your capital gain or loss is. For shares acquired under stock awards, your cost basis is the amount you paid for the stock, plus any compensation income recognized in connection with the acquisition (in the case of NQSOs and restricted/units) or disposition (in the case of ISOs and ESPPs) of the stock.
Brokers have been required to report a cost basis on Form 1099-B since 2011. Previously, brokers were allowed to voluntarily include the compensation income recognized in connection with the award in the reported cost basis. This was good because it meant that sometimes the basis reported on Form 1099-B was correct, making it easy in those instances for employees to report their sales on Schedule D and calculate the correct capital gain/loss. But it was also bad because there was no way to tell, when looking at Form 1099-B, whether the reported basis included the compensation income or not. The end result was a lot of confusion and possibly a lot of over-reported capital gains.
Where Are We Now
You might think the IRS would fix this problem by making brokers indicate whether the basis reported on Form 1099-B includes the compensation income. But you would be wrong. Instead, the IRS decided that the basis reported on Form 1099-B should only be the purchase price. This way everyone knows what basis is reported on Form 1099-B. It’s the wrong basis in most cases, but at least we know what it is. That’s a step in the right direction, I guess.
To make things more confusing, for shares acquired before January 1, 2014, brokers can still voluntarily include the compensation income in the basis reported on Form 1099-B (and still can’t indicate on the form if they’ve done this). And, for option grants, brokers can treat the grant date as the acquisition date. I think that most brokers are planning to apply the new rules to everything, regardless of when the shares were acquired/option was granted, but you should check with your brokers to verify what they are doing.
What This Means for Employers
Forms 1099-B will be issued around mid-February. You should plan on distributing some educational material to employees to explain this. The NASPP webcast “The New Forms 1099-B Are Coming! Are You Ready?” will provide more information on the topic. In addition, we’ve updated all the sample forms, flow charts, and FAQs in our Cost-Basis Reporting Portal for the new rules and the 2014 forms. New this year, we’ve added Cost Basis Cheat Sheets, featuring flow charts explaining how to calculate the adjusted cost basis for most types of stock awards.
The new session of Congress comes with agendas and proposals. Notably, one of the changes proposed by House Democrats (essentially a resurrection of last year’s proposal) sought to add a new section to 162(m), in addition to expanding its reach.
I was going to try and summarize this myself, when I came across an article by Steve Seelig and Puneet Arora of Towers Watson on the topic that summarized the issue better than I could, so I am just going to quote the article. Broc Romanek quoted them, too, in his CompensationStandards.com blog, so I guess we’re all on the same page.
As part of their alternative to the Republican agenda, House Democrats have dusted off last year’s proposal to limit the deductibility of executive pay to $1 million for companies that fail to increase their rank-and-file pay to keep pace with U.S. economic growth…This bill is part of larger democratic “action plan” focusing on the middle class that also would provide tax breaks to workers earning under $100,000 per year.
The House previously voted down Van Hollen’s procedural motion to consider the bill, but he’s expected to reintroduce the bill later this year. The Democrats appear determined to keep the CEO-versus-worker-pay issue in the news pending the Securities and Exchange Commission (SEC) release of final CEO pay ratio regulations, as evidenced in the “dear colleague” letter released by House Minority Leader Nancy Pelosi (D-Calif.) on the opening day of the new session.
The Van Hollen bill would take a different approach than the California bill we blogged about last year, which would have limited state tax deductions for executive compensation on a sliding scale depending on the ratio of executive pay to rank-and-file pay. (For more on the California proposal that was defeated in the state legislature, see “California Legislation Would Limit Tax Deductions for Companies Where the CEO Pay Ratio Is Too High,” Executive Pay Matters, May 1, 2014.) Instead, it would add a new section to existing Section 162(m) of the tax code to limit to $1 million the deductibility of compensation (including performance-based compensation) paid to any current or former employee, officer or director if the average pay of all of the company’s U.S.-based non-highly-compensated employees (as defined under the qualified plan rules, i.e., those below $115,000 for 2015) does not keep pace with the growth of the U.S. economy. U.S. economic growth would be based on the average of productivity growth (based on Bureau of Labor Statistic measures) plus adjustments in the cost of living under the tax code.
The bill would also expand the reach of Section 162(m) to cover certain nonlisted, publicly traded companies, make sure the CFO is re-included as a “covered employee” and make it clear that income paid to beneficiaries is included in an executive’s remuneration for 162(m) purposes.
There is a silver lining—according to Towers Watson:
Given the GOP’s wider majority in the House and control of the Senate in the new Congress, any democratic proposals are even more of a long shot than before.
If anything else surfaces on this front, we’ll be sure to keep you informed. At the present the proposed changes to 162(m) (at least stemming from this proposal) appear to be a remote possibility.
In December 2013, I blogged about a mistake that garnered public attention when daily deal website Groupon exceeded their plan’s limit for shares granted in a calendar year with an RSU award to their Chief Operating Officer (“Share Limit Lessons the Hard Way“, December 19, 2013). Just when I started to think it couldn’t happen twice, nearly a year to the day of my first blog another oops! occurred. This time it involved technology company Advanced Micro Devices (“AMD”).
In an 8-K filed with the SEC on December 29, 2014, AMD disclosed that they’d exceeded their equity plan’s limit on shares granted to an individual in a calendar year when issuing a series of awards to their new Chief Executive Officer. As a result of the technical error, the chipmaker decided to void and rescind most of the CEO’s newly issued awards. In their evaluation of the situation, AMD’s board of directors affirmed that the value of the CEO’s compensation package that included the awards was appropriate and in line with shareholder interests. Given that some of the awards were negotiated as part of an employment contract with the CEO, I wonder how the company now will deal with the fact that they can’t issue the grants that were contractually promised to the CEO. I’m no lawyer, so I’ll throw the question out there with no intention of trying to answer it myself. AMD did mention in their filing that they intend to “return Dr. Su’s equity compensation to the level it should have been prior to the action to void and rescind the equity awards described above at or near the earliest practicable opportunity available to the Company, subject to law and the terms of the 2004 Plan.”
How Does This Happen?
There’s been no information on “how” the oversight occurred, and I wouldn’t expect that we’d be privy to the specifics. The fact is that it happened. What stands out to me in this case is that, just like the Groupon case, the violation of the plan limit appeared unnoticed until AMD’s own shareholders filed a lawsuit over it. I’m thinking about all the checks and balances in a grant approval process, and wondering how it was left to shareholders in both cases to catch the mistakes.
While plan share limits seem on the surface to be a simple concept to embrace, there seems to be a trend, or at least a pattern in oversights of these limits. I’m guessing there are more situations like this that are caught before shareholder lawsuits occur. A common trigger for awards that exceed the limits outlined in the plan appears to large grants (or a series of grants) to executives or key employees.
Takeaways
We hear more and more about shareholders looking for prime litigation opportunities. As a group, they definitely have become more assertive in monitoring disclosures and finding opportunities to litigate perceived wrongs. With that in mind, I turn the focus to what we can learn from these high profile, public mistakes. I put myself in the position of asking “If I worked for this company, what would I do to avoid this in the future?” A few ideas come to mind:
Use these examples (AMD and Groupon) as the basis to have a training session or discussion with your internal Human Resources (HR) executives. Since the HR executives are typically the ones involved in discussing CEO and other executive compensation with the board, go right to those executives and educate them on any share limits (and other parameters) within the plan that may be triggers for violations of plan terms. If external compensation consultants are also in a position to have discussions with the Board on executive compensation decisions, it’s a good idea to make them aware of the plan limits as well.
Audit, audit, audit. Even if an oversight occurs at the HR/board level, the next stop should be the plan administrator. Anytime new grants come through, it’s best to have a check and balance in place that compares those grants to plan limits. Keep a running total of grants to date (whether it’s year to date or some other measurement outlined in the plan). Remember there are varied types of plan limits. Common limits include the number of shares that can be granted to an individual in a calendar year, the number of shares that can be cumulatively granted from the plan in a calendar year, and limits on the number of shares related to certain types of awards that can be made within a period of time (for example, a cap on the number of shares that can be issued as full value awards in a calendar year).
Advocate for contact with the board of directors. While it’s a good step to educate those who are in contact with the board (HR executives and compensation consultants), why not see if you can gain your own opportunity to educate the board? Whether it’s in person or via a communication that is presented to the board, this may be an opportunity to go straight to the decision makers. Even if it’s not the full board, the Compensation Committee of the board is an ideal target for these communications.
Nobody wants their mistakes made public. And, while there may not be a sole person responsible for the oversights at Groupon and AMD, these certainly were preventable mistakes. I hope this will be my last blog on this topic and companies will take to heart the importance of monitoring any and every aspect of the terms of their equity plans. Let’s not leave it to shareholders to discover the next mistake.
As I noted on October 21 (“ISS Changes Stock Plan Methodology“), ISS is changing how they evaluate stock plan proposals. Just before Christmas, ISS released additional information about their new Equity Plan Scorecard, including an FAQ. For today’s blog entry, I take a look at how the scorecard works.
What the Heck?
Historically, ISS has used a series of tests (Shareholder Value Transfer, burn rates, various plan features) to evaluate stock plan proposals. Many of these tests were deal-breakers. For example, fail the SVT test and ISS would recommend against the plan, regardless of how low your burn rate had been in the past or that fact that all the awards granted to your CEO vest based on performance.
Under the new Equity Plan Scorecard (known as “EPSC,” because what you need in your life right now is another acronym to remember), stock plans earn points in three areas (which ISS refers to as “pillars”): plan cost, grant practices, and plan features. Each pillar is worth a different amount of points, which vary based on how ISS categorizes your company. For example, S&P 500 and Russell 3000 companies can earn 45 points for the plan cost, 35 points for grant practices and 20 points for plan features. Plans need to score 53 points to receive a favorable recommendation. [I’m not sure how ISS came up with 53. Why not 42—the answer to life, the universe, and everything?] So an S&P 500 company could completely fail in the plan cost area and still squeak by with a passing score if the plan got close to 100% in both the grant practices and plan features area.
Plan Cost
Plan cost is our old friend, the SVT analysis but with a new twist. The SVT analysis is performed once with the shares requested, shares currently available under all plans, and awards outstanding, then performed a second time excluding the awards outstanding. Previously, ISS would carve out options that had been outstanding for longer than six years in certain circumstances. With the new SVT calculation that excludes outstanding options, this carve out is no longer necessary (at least, in ISS’s opinion–you might feel differently). The points awarded for the SVT analysis are scaled based on how the company scores against ISS’s benchmarks. Points are awarded for both analyses (with and without options outstanding), but the FAQ doesn’t say how many points you can get for each.
Grant Practices
The grant practices pillar includes our old friend, the burn rate analysis. But gone are the halcyon days when burn rates didn’t really matter because companies that failed the test could just make a burn rate commitment for the future. Now if companies fail the burn rate test, they have to hope they make the points up somewhere else. Burn rate scores are scaled, so partial credit is possible depending on how companies compare to the ISS’s benchmarks. This pillar also gives points for plan duration, which is how long the new share reserve is expected to last (full points for five years or less, no points for more than six years). S&P 500 and Russell 3000 companies can earn further points in this pillar for certain practices, such as clawback provisions, requiring shares to be held after exercise/vest, and making at least one-third of grants to the CEO subject to performance-based vesting).
Plan Features
This seems like the easiest pillar to accrue points in. Either a company/plan has the features specified, in which case the plan receives the full points, or it doesn’t, in which case, no points for you. There are also only four tests:
Not having single-trigger vesting upon a CIC
Not having liberal share counting
Not granting the administrator broad discretionary authority to accelerate vesting
Specifying a minimum vesting period of at least one year
That’s pretty simple. If willing to do all four of those things, S&P 500/Russell 3000 companies have an easy 20 points, non-Russell 3000 companies have an easy 30 points (more than halfway to the requisite 53 points), and IPO/bankruptcy companies have an easy 40 points (75% of the 53 points needed).
Alas, this does mean that companies no longer get a free pass on returning shares withheld for taxes on awards back to the plan. Previously, this practice simply caused the arrangement to be treated as a full value award in the SVT analysis. Since awards were already treated as full value awards in the SVT analysis, it didn’t matter what you did with the shares withheld for taxes. Now you need to be willing to forego full points in the plan features pillar if you want to return those shares to the plan.
Dealbreakers
Lastly, there are a few practices that result in a negative recommendation regardless of how many points the plan accrues under the various pillars. These include a liberal CIC definition, allowing repricing without shareholder approval, and a couple of catch-alls that boil down to essentially anything else that ISS doesn’t like.