I know that many of you are eagerly anticipating the 18th Annual NASPP Conference (I certainly am). To give you a taste of the topics that will be presented at the Conference, this week we begin a series of guest blog entries by Conference speakers. For our inaugural entry in this series, we feature Jennifer Namazi of Stock & Option Solutions on Finding and Foiling Fraud in Equity Compensation Plans.
Finding and Foiling Fraud in Equity Compensation Plans By Jennifer Namazi, Stock & Option Solutions
I’m really excited about our “Foiling Fraud” panel at the NASPP Conference because the issue of potential fraud is an interesting complexity, and let’s admit it, a mysteriously scandalous topic in the world of administering equity plans. While I’m sure we’d all like to believe the best about everyone, let’s be realistic–fraud does exist.
In recent years, we’ve been privy to several high profile fraud cases around equity plans as they played out in the media, some of which will be presented as case studies in our panel presentation. The great part is that we’re going to talk not only about what went wrong in these cases and how to detect and foil fraud, but we’ll also discuss how to prevent ever getting there in the first place.
When I first explored the various fraud cases, I was surprised to find out that most fraud is NOT planned carefully in advance, but rather the seizing of an opportunity at hand. I guess I envisioned fraud as something committed by shady characters that somehow slip through the hiring screening process. I changed my perspective when I read or watched several interviews from various people who got caught in the act–the vast majority appeared to be solid citizens living everyday lives and said they didn’t set out with the intention to commit fraud–it was that the situation presented a set of circumstances and they either eased themselves or jumped in. Hmmm, something to think about–note to self: “not all fraud starts out as a single blatant act.”
After digging into the case studies, I made my own conclusion that fraud occurs most often in cases where (let’s use the cliché here) you’d least expect it. When I say least expect it, I mean the type of fraud AND the characteristics of the person committing the fraud. As far as I can tell, there is no single “profile” that one could use to proactively screen and identify potential fraud artists. Even really benign and seemingly routine process areas, such as issuing control numbers at the time of a DWAC (as you’ll learn from one of our case studies), can present opportunity for fraud. I was amazed to learn how many times the immediate supervisor of the person who committed the fraud was simply astounded. It was implausible, right?
This is a point I think will apply to many of us–we have decent controls and checks and balances. The question is do we have enough of the right ones? Are we monitoring them at the right frequency and with the appropriate level of oversight? Do we have loopholes in areas we’ve never thought about? Is the segregation of duties structure conducive to fraud?
Make sure you join us at the NASPP Conference as we talk about types of fraud, case studies (mistakes leading to fraud and lessons learned), how to detect and unravel fraud, and–perhaps most importantly–how to shore up your practices to ensure that circumstances don’t present an opportunity for temptation. I’m looking forward to seeing everyone at the Conference! Enjoy a safe and relaxing summer (while keeping up with the NASPP blog, of course!).
Who doesn’t love a good mystery? Filled with intrigue and suspicious characters, Jennifer’s session, “Finding and Foiling Fraud in Equity Compensation Plans,” promises to be one of the most suspenseful panels at the 18th Annual NASPP Conference–don’t miss it! The Conference will be held from September 20-23 in Chicago. Register today!
Based on a recent IRS announcement and alerts we’ve received from law firms, the IRS is stepping up audit activity on executive compensation and employee benefit plans.
Employment Tax Audits On November 9, the IRS announced an employment tax research study that will include audits of 6,000 companies over the next three years. The study is expected to help the IRS determine areas of greatest compliance risk, which will aid in selecting and auditing future employment tax returns. Companies file employment tax returns to report taxes that have been withheld on employee wages.
According to an alert issued by Pillsbury, the audits will focus on worker classifications (i.e., employee vs. non-employee), fringe benefits, executive compensation, and qualified employee benefit plans. Levine & Baker also mention the impending audits in their January 2010 client newsletter, warning that companies would be ahead to review their tax practices now, before they get an audit notice and still may have an opportunity to address inadvertent errors.
409A Audits Started Already According to a Jones Day alert that we posted on Naspp.com, the IRS has already started auditing deferred compensation arrangements for compliance with Section 409A. Recent Information Document Requests issued to companies undergoing audits have included items related to §409A compliance.
As described by Jones Day, the information requested by the IDRs includes:
Identification of arrangements that the company does not consider to be subject to §409A, but that create a legally binding right to compensation that won’t be paid until a later year. Stock options and restricted stock, of course, are prime examples of these types of arrangements. They also include plans that are exempted from §409A under the short-term deferral rule.
Terms and deadlines for making deferral elections, re-deferrals, and any payment accelerations.
The names of “specified employees” and payments made to them upon separation of service.
Certain information on stock options and SARs that may be subject to §409A.
Any §409A violations and whether the company participated in the §409A corrections program.
Technical Corrections to Section 423 Regs Turns out the IRS makes typos just like the rest of us. Technical corrections to the final regulations under Section 423 were issued on December 22, 2009. Nothing substantive, though, just a couple of minor textual errors. Just because I thought it would be cool, I’ve annotated the PDF of the final regs that we have posted here on Naspp.com with the corrections; see §1.423-2(a)(1) (pg 15), §1.423-2(d)(3) (pg 24), and §1.423-2(i)(5) Example 5 (pg 39). The full text of the corrections is on pg 46.
ShareComp 2010 The NASPP is happy to announce its support of ShareComp 2010, a fully virtual conference on stock compensation. NASPP members can attend the event for free using the sponsor pass “naspp”; feel free to share this sponsor code with others at your company.
ShareComp 2010 will be held live on February 23, 2010 and all presentations, documents, and booths will be available on-demand for a year afterwards. Presentations, solutions, and providers will focus on the needs of professionals in executive roles, finance, human resources, compensation, accounting and stock administration positions. Benefits of attending include:
16 hours of live global interactive learning and networking
Best practices for designing, implementing and managing stock compensation programs
Instructional sessions that will share real-world examples, tactics and lessons learned
Facilitated discussion forums with experts and practitioners
A searchable library, including presentations, Q&A sessions and booth materials
A year of access to the conference center and the materials
To find out more about, visit www.sharecomp2010.com. Register today for this no-risk, high-impact event (be sure to enter sponsor pass “naspp” for free registration). While you are attending the event, we hope you’ll stop by the NASPP booth.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
Don’t miss Alan Dye’s webcast on Thursday January 28, on Section 16 developments.
As a stock plan administrator, you should be running regular audits of the underlying data in your stock plan database. Regular plan share reconciliation can uncover transactional issues such as late reported terminations or exercises that were entered after the period-end. Most, if not all, stock plan administration software has some type of data check that can uncover incongruous data such as a termination date that is prior to a hire date or grants that have more exercised shares than vested shares. Both periodic plan share reconciliation and running the software’s built-in data check should absolutely be a part of your regular procedures. However, neither of these is a substitute for a periodic audit of underlying data.
Here are the top five additional data audits that you should complete on a regular basis:
1. Active employees
This is a fast check, and with the right IT team can be easily automated. Simply run all your current, active employees from each database (I recommend your HR, Payroll, and stock plans databases) and confirm that each has the same list. Do this audit for both the employee ID and the SSN or other identifier to help catch rehires who have accidently been assigned a new employee ID.
If your stock plan administration database stores the history, match up the new hire, termination, and rehire dates for employees in your database against the HR records. If your company has a policy that re-instates grants when the rehire takes place within a set period of time, then this check will be particularly important for catching changes in rehire date that could impact the status of grants.
2. Changes in employee status
Audit your employee records to confirm that changes in employee status reflect correctly in your stock plan administration database. This includes leaves of absence, changes from and to part-time, moving from employee to non-employee status, and any other changes that may impact eligibility for equity compensation. Most HR databases will record the current status of employees and transmit this information to at least the payroll department. If you are unable to do a full employee status history audit, then at a minimum check to see that the current status is accurate.
3. Fair market value
Hopefully, you (or your service provider) complete a daily verification of the share prices that are entered into your database as the fair market value for company’s shares. These values may be used to determine grant size, exercise price, ESPP purchase price, and income/tax amounts for transactions. In addition to your daily check, it is a good practice to do a periodic audit of the values in your stock plan database against two outside sources. Occasionally, important share prices such as the day’s high, low, or closing price are corrected after market close. If your daily confirmation takes place prior to the change, you will not know about it without this additional audit. Additionally, you should confirm that all sale prices for same-day sales as well as applicable ISO and ESPP sales fall between the high and low share price for the transaction date.
4. YTD supplemental income and social security paid
The year-to-date supplemental income and social security paid for your U.S. employees can impact the appropriate tax withholding amounts for their transactions. The best practice is for year-to-date supplemental income and social security tax amounts to be communicated automatically from your payroll database to your stock plan administration software. Regardless of whether or not your company has automated this data upload, a regular audit of these amounts can help uncover corrections made in payroll that either were not loaded to the stock plan administration software or were not corrected in a timely manner and data that is simply incorrect in the stock plan adminstration software. In addition to your regular audit of these amounts, you should have a process in place to catch transactions that are transmitted to payroll with a tax withholding rate that is either too high or too low based on the current payroll information.
5. Employee demographic fields
Your company should be tracking key employee demographics in the stock plan administration software. These may include department, work location, cost center, or other identifying factors. These fields must be accurate for your expense allocation, tax deductions, future cost projections, and most one-off reports that other departments may request.
Keep in mind that all of these data audits can be automated or incorporated into regular exchanges of data. Work with your service provider(s) and your IT to see what opportunities for automation you may be overlooking. Even if the automation simply alerts you to inconsistent data points, it can simplify your audit process. Remember, these pieces of data are the foundation for all the information that comes out of your stock plan administration software. Including these audits in your regular procedures will help you remove bad data before it shows up as an issue in your periodic reporting.