Last week I blogged about the SEC’s agenda for this year, which includes a heavy focus on continued enforcement actions. While this is certainly one area on our radars, I’m reminded that there are other areas of “action” that could cast scrutiny on our practices. One such area is litigation. A few months ago, I blogged about one type of litigation that had taken hold – the shareholder driven lawsuits that challenged proxy disclosures. What I didn’t explore was all of the other areas where we’ve seen “action” in the form of enforcement or litigation. In today’s blog I’ll explore other areas (including some you may not have thought about) that have been the subject of a lawsuit.
I had a great aid in preparing this blog. Thanks to Executive Pay and Loyalty, I was able to access a “cheat sheet” that literally organizes stock award litigation by topic, complete with corresponding court cases. The full document is available on our web site.
Litigation Lessons Learned
What lessons have been learned from litigation in recent years? Here are a few of them:
Termination of Employment: This is a sensitive area, one that I’m betting is ripe for litigation. Not so much because an employee is terminated (that’s more of an HR concern), but if the employee misses the opportunity to exercise vested in-the-money stock options, they may come forward wanting restitution or compensation. The filing of a lawsuit doesn’t automatically make it a valid claim, or mean that the company will lose. We are reminded that sometimes there are “nuisance” cases – particularly if an employee simply “missed” the key pieces of information that would explain post termination provisions. Whether or not the claim is a solid one, any litigation takes time, money and focus away from more constructive activities. I see a couple of ways to minimize litigation opportunities in this situation – one is an “auto-exercise” of the vested stock option (See my recent blog on “The Case for Auto-Exercise”, January 16, 2014); another is to proactively send terminated employees the key documents that remind them of post employment provisions.
Defining Plan Terms: The more defined your plan terms are, the better. According to Executive Pay and Loyalty, it is better to have a longer plan document with explicit definitions than not. Litigation involving ambiguities is likely to be resolved against the employer. If you’re seeing a plan provision that is repeatedly the subject of questions or challenge from employees, this may be something to raise to your legal counsel to see if further clarification is needed.
Option Expiration During Blackout Period: The cheat sheet I mentioned suggests that employers be wary of stock options that expire during a blackout period. It is a best practice for plans to expressly address this in order to avoid angering employees and former employees who lose value due to a black-out period that interferes with their final time to exercise a stock option. I have actually seen several plan documents that are silent on this issue, so if your plan is up for amendment or overhaul, this may be a good area to document a defined practice. If it’s not in the plan document, at minimum identify a consistent approach or procedure for options expiring during a blackout and communicate it to employees in writing.
The Bottom Line
All of the issues described above have been the subject of court cases, and the suggestions I outlined are based on the result of those lawsuits. For more information on specific cases and a list of the other areas affected by litigation (including 162(m), and director compensation), check out the full Stock Plan and Award Litigation: Risk Management Checklist I mentioned as the basis for this blog.
We know we’re entrenched in a world that is highly regulated, scrutinized, audited and evaluated. The more we evolve our practices to be preventative, the better equipped we’ll be to stand up to investigations, enforcement actions, lawsuits and other nuisances.
Tip #4 for Submitting a Winning Speaking Proposal Don’t underestimate your competition. We get around 150 proposals for about 40 sessions–the odds are against you. They are especially against you if you leave it to the last minute and submit some half-completed idea of a speaking topic. The submitters of winning proposals have already started thinking about speaking topics, are asking their colleagues to help refine their ideas and join their panel, and are looking for clients to serve as case studies. Make sure you submit a well thought out proposal that succinctly but clearly describes (and sells) your idea, that includes a well-rounded panel of speakers, and that stands out from the competition. Look for topics that are unique–that haven’t been presented before or that provide a new perspective.
Sign up for the NASPP’s acclaimed online Stock Plan Fundamentals course which will be offered this spring. This course is a great introduction to stock plan administration; register by February 14, 2014 for the early-bird rate.
Register for the 22nd Annual NASPP Conference. The Conference will be held from September 29-October 2, 2014 at the Mandalay Bay in Las Vegas. Don’t wait–the early-bird rate is only available until March 14.
I’m feeling old. So I thought to myself “why should I be the only one to feel old–I write a blog, why not make my readers feel old too?” With that in mind, I’ve created the How Old Are You Game.
How to Play I’ve listed a number of major events in stock compensation and how long ago they occurred. Give yourself 1 pt for every event you personally experienced during your career in stock compensation.
Event
How Long Ago
The Social Security withholding rate was 4.2% and the JOBS Act was enacted (click here if you don’t remember the significance of JOBS, it’s too complicated to explain in this table).
2 years
Cost-basis reporting went into effect.
3 years
Dodd-Frank was enacted.
4 years
The last year that Section 6039 just required a participant statement, not a filing with the IRS.
5 years
The SEC adopted a roadmap that would have had companies adopting IFRS this year.
6 years
Congress passed the Jobs Creation Act (not to be confused with the JOBS Act) which created Section 409A but also exempted ISOs and ESPPs from FICA and FIT withholding, FAS 123(R) was adopted, and IFRS 2 was issued.
10 years
Required EDGAR filing went into effect for Section 16 forms and the NYSE and NASDAQ adopted listing standards requiring shareholder approval of virtually all employee stock plans.
11 years
Sarbanes-Oxley was enacted, the IRS issued the first Rev. Rul. on the treatment of stock options transferred pursuant to divorce, and the IRS imposed a moratorium on FICA withholding for ISOs and ESPPs.
12 years
FIN 44 and EITF 96-18 were issued.
14 years
The IRS issued an FSA requiring FICA withholding on ESPP purchases.
15 years
The IRS ruled on the tax treatment of gifted options and the NYSE adopted a rule exempting broad-based stock plans from shareholder approval.
16 years
The long-term capital gains rate was reduced from 28% to 20%, Myron Scholes was awarded the Nobel prize for the Black-Scholes model, and FASB dispensed with primary and fully diluted EPS in favor of basic and diluted EPS.
17 years
The last ISOs that had to be exercised in sequential order based on grant date expired and the SEC completed the phase-in of EDGAR for all public filings (except Section 16 reports and Form 144).
18 years
The original FAS 123 was adopted and T+3 went into effect.
19 years
Section 162(m) was enacted.
21 years
The SEC significantly expanded the required disclosures relating to executive compensation, forming the basis for the disclosure framework in place today.
22 years
The SEC introduced Form 5.
23 years
Long term capital gains were last taxed at the same rate as wages.
24 years
The SEC adopts Rule 701.
26 years
Reg T was amended to allow same-day sale exercises.
27 years
Section 280G was enacted and the FASB solicited comments for the first time on APB 25 with a view towards adopting a new accounting standard for stock options.
30 years
ISOs became subject to AMT.
31 years
Congress created ISOs.
33 years
IRS issued a ruling allowing stock-for-stock exercises to be treated as a tax-free exchange of property.
35 years
The Black-Scholes model was developed.
37 years
APB Opinion No. 25 was adopted.
38 years
The FASB was formed.
41 years
Congress created “qualified stock options,” the predecessor to ISOs and ESPPs.
50 years
The Accounting Principles Board was formed.
55 years
The SEC was created.
80 years
Score:
0 Points: You are always the youngest person in any business meeting and look forward to being old enough to drink and rent a car. I used to be your age; enjoy it while you can.
1 to 5 Points: You are old enough to know better but still young enough not to care.
6 to 20 Points: You are humming the tune to “Much to Young (to Feel This Damn Old)” by Garth Brooks and sort of regret playing this game.
27 or More Points: You are reading this from the deck of your seniors’ cruise ship or the golf course (or you are seriously wishing you’d saved a little more for retirement). It is also possible that you are dead.
The Twin Cities chapter of the NASPP hosts Shawna Anderson of Dorsey & Whitney for “Preparing for the 2014 Proxy Season (Part II).” Shawna will survey the current status of recent rule changes and disclosure initiatives, provide a preview of some still pending rulemaking efforts, and provide practical advice on how to prepare your proxy statement and annual report in 2014. (Thursday, February 6, 7:30 AM)
It’s been a while since we’ve had major regulatory updates that impact stock compensation. Knowing that, I sometimes find myself scanning the horizon, looking for the next “thing” that’s going to have us examining our practices, changing procedures or implementing something new. This week my radar went into action when I heard that SEC Chair Mary Jo White had laid out quite a list of upcoming initiatives in a recent address.
Technology on the Brain
In spite of some significant cutbacks in technology dollars available to the SEC for long term initiatives, the SEC seems to still have advancement in this area on the brain. Chair White announced that the SEC has deployed a new analytical tool called “NEAT” (National Exam Analytics Tool) to help identify possible insider trading or other misconduct. This tool can identify red flags in a fraction of the time it took to do so in the past. I’m guessing this means that the wave of insider trading investigations and scrutiny is not over.
In the spring of 2013, the SEC issued guidance permitting issuers to use social media sites to communicate company announcements (see the NASPP Blog, May 16, 2013). White has now indicated that the SEC is broadly rethinking disclosure requirements for public companies and the role of technology in sharing information with investors. Last month the SEC recommended to Congress in a report (which was mandated by the JOBS Act) that the disclosure rules undergo comprehensive reexamination and reform. White shared some insight into the SEC’s thinking: “I believe we should rethink not only the type of information we ask companies to disclose, but also how that information is presented, where and how that information is disclosed, and how we can take advantage of technology to facilitate investors’ access to information and make it more meaningful to them.” Saying it and issuing a report doesn’t mean new rules are imminent, but it is perhaps a hint of things to come. It seems within the realm of possibility that this type of reform may be fairly significant if and when it happens.
New Investigation Focus
White says that as the SEC wraps up investigations stemming from the financial crisis, attention is now shifting to other areas of enforcement – namely financial reporting fraud and accounting irregularities amongst others. This is a good time to make sure our controls, checks and balances are operating full force. While we can’t control other areas of financial reporting beyond stock administration, we can ensure that the areas under our realm can stand up to the possibility of an intense audit or investigation. This seems particularly wise, since Chair White also said that “The coming year promises to be an incredibly active year in enforcement, as we continue to vigorously pursue wrongdoers and bring enforcement actions across the entire industry spectrum.”
It looks like the SEC continues on their roll of assertive enforcement actions and attempt to progress into more modern times. Let’s see what the horizon holds in that regard.
Tip #3 for Submitting a Winning Speaking Proposal My third tip for submitting a winning speaking proposal is to submit your proposal on time. I’ll be honest; we look at this as a test. If you can’t submit your speaking proposal on time, it indicates to us that you probably aren’t going to meet any of the other speaker deadlines on time either. We have close to 200 speakers at the Conference, so it’s critical that our speakers be responsible about meeting their deadlines with minimal prompting from us. Don’t bother asking for an extension; if you can’t get your speaking proposal in on time, this probably isn’t the year for you to speak.
Sign up for the NASPP’s acclaimed online Stock Plan Fundamentals course which will be offered this spring. This course is a great introduction to stock plan administration; register by February 14, 2014 for the early-bird rate.
Register for the 22nd Annual NASPP Conference. The Conference will be held from September 29-October 2, 2014 at the Mandalay Bay in Las Vegas. Don’t wait–the early-bird rate is only available until March 14.
As is often the case at this time of the year, a lot of tax related questions have been popping up in the NASPP Q&A Discussion Forum lately. For today’s blog entry, I try to quickly answer some of the questions I’ve seen the most frequently.
Former Employees You have to withhold taxes on option exercises by and award payouts to former employees and report the income for these stock plan transactions on a Form W-2, no matter how long it has been since they were employed by the company. The only exceptions are:
ISOs exercised within three months of termination (12 months for termination due to disability).
RSAs paid out on or after retirement (because these awards will have already been taxed for both income tax and FICA purposes when the award holders became eligible to retire). Likewise, RSUs paid out on or after retirement that have already been subject to FICA are subject to income tax only.
If the former employees did not receive regular wages from the company in the current year or the prior calendar year, US tax regs require you to withhold at their W-4 rate, not the supplemental rate. In my experience, however, few companies are aware of this and most withhold at the supplemental rate because the W-4 rate is too hard to figure out.
Changes in Employment Status Where an individual changes status from employee to non-employee (or vice versa) and holds options or awards that continue to vest after the change in status, when the option/award is exercised/paid out, you can apportion the income for the transaction based on years of service under each status. Withhold taxes on the income attributable to service as an employee (and report this income on Form W-2). No withholding is necessary for the income attributable to service as a non-employee (and this income is reported on Form 1099-MISC).
Any reasonable method of allocating the income is acceptable, so long as you are consistent about it.
Excess Withholding I know it’s hard to believe, but if you are withholding at the flat supplemental rate, the IRS doesn’t want you to withhold at a higher rate at the request of the employee. They care about this so much, they issued an information letter on it (see my blog entry “Supplemental Withholding,” January 8, 2013). If employees want you to withhold at a higher rate, you have to withhold at their W-4 rate and they have to submit a new W-4 that specifies the amount of additional withholding they want.
Also, withholding shares to cover excess tax withholding triggers liability treatment for accounting purposes (on the grant in question, at a minimum, and possibly for the entire plan). Selling shares on the open market to cover excess tax withholding does not have any accounting consequence, however.
ISOs and Form 3921 Same-day sales of ISOs have to be reported on Form 3921 even though this is a disqualifying disposition. It’s still an exercise of an ISO and the tax code says that all ISO exercises have to be reported.
On the other hand, if an ISO is exercised more than three months after termination of employment (12 months for termination due to disability), it’s no longer an ISO, it’s an NQSO. The good news is that because it’s an NQSO, you don’t have to report the exercise on Form 3921. The bad news is that you have to withhold taxes on it and report it on a Form W-2 (and, depending on how much time has elapsed, it might have been easier to report the exercise on Form 3921).
FICA, RSUs, and Retirement Eligible Employees This topic could easily be a blog entry in and of itself, but it doesn’t have to be because we published an in-depth article on it in the Jan-Feb 2014 issue of The NASPP Advisor (“Administrators’ Corner: FICA, RSUs, and Retirement“). All your questions about what rules you can rely on to delay collecting FICA for retirement eligible employees, what FMV to use to calculate the FICA income, and strategies for collecting the taxes are covered in this article.
Here’s what’s happening at your local NASPP chapter this week:
Seattle: Iveth Durbin of Perkins Coie and Carolyn Harper of Towers Watson present “Preparing for the 2014 Proxy Season: Executive Compensation Highlights.” (Monday, January 27, 11:30 AM)
Houston: Emily Cervino and Jeremy Boraks of Fidelity Investments present “What’s Happening: Hot Topics in Equity Compensation.” (Thursday, January 30, 12:00 noon)
Portland: Danielle Benderly of Perkins Coie and Tracy Bean of Mercer present “Hot Topics for 2014 Proxy Season for Stock Plan Professionals!” (Thursday, January 30, 12:00 noon)
Many companies have settled into a routine when it comes to furnishing information statements and filing the IRS returns required under Section 6039 of the Internal Revenue Code. Whether you have a solid routine, or this is the first time you’re facing Section 6039 compliance, there are a few areas where companies should verify that they are fully satisfying 6039 requirements as they near the deadlines for 2013 tax year reporting.
Review Non-U.S. Employees
Non-resident aliens who do not receive a W-2 are not subject to Section 6039 reporting. If a non-resident alien does receive a W-2, then 6039 statements would also need to be furnished.
U.S. citizens who are working abroad are subject to Section 6039 reporting, so companies should not rely on address filters alone to determine whether or not an employee should receive an information statement.
Implement a New ESPP?
Did your company implement a new ESPP recently? It’s important to note that the trigger for filing Form 3922 (for ESPP shares) is the first transfer of legal title for the shares, not the purchase or exercise of the shares. The moment of first legal transfer includes the deposit of shares to a brokerage account in the employee’s name upon purchase, like many companies do via a captive broker. If you had ESPP purchases in 2013 and deposited purchased shares immediately into a brokerage account for the employee, then you’ll need to report the transaction(s) this season. Note that issuances into book entry at a transfer agent or in certificate form do not constitute a legal transfer of title. Those shares would be reported once deposited to a brokerage account, gifted, or sold. Of course, this doesn’t only apply to new ESPPs, but most companies with existing ESPPs are already aware of this requirement. It’s possible that those implementing a new ESPP may overlook this “first legal transfer of title” requirement if not looking at the nuances carefully.
More Transactions this Year?
The IRS doesn’t require companies to file 6039 returns electronically unless there are 250 or more of them. The 250 number is per form type, so if you have 251 Form 3921 returns and 249 Form 3922 returns, only the Form 3921 returns need to be filed electronically. For quantities less than 250 per form type, companies may elect to file electronically or via paper. Even if you didn’t have to file electronically in the past, you’ll want to look at each year’s quantities anew to make sure you’ve assessed the threshold correctly. The deadline for paper filings is February 28, 2014. The deadline for electronic filings is March 31, 2014.
No Chump Change for Failures and Mistakes
Failing to furnish information information statements is no laughing matter. The IRS penalty for not furnishing an information statement, or, for providing an incomplete or incorrect statement to a participant is up to $100 per statement. In addition, a separate penalty is assessed for issues with 6039 returns that should be filed with the IRS – up to $100 per return for those not filed or incomplete/incorrect returns. As a result, you’ll want to make sure you are really auditing the entire process – even if it’s outsourced, to ensure there are no failures. There is a cap of $1.5 million on each penalty type, but that’s high enough to want make doubly sure that the proper reporting is done accurately and timely.
For more information, the NASPP has an excellent Section 6039 portal, available on our web site.
I have another grab bag of topics for you this week.
2013 Say-on-Pay Results Just in time for the 2014 proxy season, Steven Hall & Partners has published a quick summary of the Say-on-Pay vote results for last year’s proxy season. Here are a few facts of interest.
73 companies failed (out of a total of 3,363 companies that held votes. This seems to be up from 2012. Oddly, even with a Google search, I could not find an apples-to-apples comparison, but it seems like just over 60 companies had failing votes in 2012. It’s possible the increase is partly due to more companies having held Say-on-Pay votes.
In the category of “Not Getting the Message,” 15 of the companies with failing votes had failures in prior years.
At one company, Looksmart, 100% of the votes on their Say-on-Pay proposal were against it (which makes them look not so smart). That’s right, even the board voted against their own Say-on-Pay proposal. Apparently there was a complete board turnover, all the executives were fired, and the new execs didn’t own any stock.
New HSR Act Filing Thresholds New HSR Act filing thresholds have been announced for 2014. Under the new thresholds, executives can own up to $75.9 million of stock before potentially having to make the HSR filings. See this memo from Morrison & Foerster for more information. If you have no idea what the HSR Act is, see the NASPP’s excellent HSR Act Portal.
NASDAQ Amends Rules on Compensation Committee Independence NASDAQ has amended its rules on compensation committee independence to provide that compensatory fees (consulting, advisory, et. al.) paid by the company to board members should be considered when evaluating eligibility to serve on this committee, rather than prohibiting these fees outright. The NYSE has always imposed the more lenient standard and apparently NASDAQ received feedback that their more stringent standard might make them less popular. This alert from Cooley has more information.