For today’s blog, I have another exciting smorgasbord of random stock plan related tidbits.
IRS Issues GLAM on Stock Compensation Deductions and CICs In January, the IRS issued general legal advice memorandum AM2012-010 clarifying that when NQSOs and SARs are cashed out due to a change in control, the tax deduction is attributable to the acquired company. This is because the obligation to make the payments became fixed and determinable at the closing and the payments were for services performed prior to the acquistion.
Two things to note here:
This is unfortunate because chances are the target company isn’t all that profitable, making the deduction less than useful.
The acronym for this type of IRS pronouncement is GLAM. That makes the whole thing sound way cooler than it actually is.
For more information see the WSGR alert we posted on this development.
ISS Theme Song: Coming Around Again? I’m sure you’ve heard about this by now, but just in case, ISS has announced that it will replace the GRId analysis system with a new system called “QuickScore,” which does have the advantage of sounding niftier and friendlier. If you are thinking “what the heck, didn’t they just switch to the GRId system,” time must be flying by for you just as fast as it does for me. ISS switched to GRId back in 2010 (I blogged about it, see “Will ISS Red Light Your Stock Compensation?” March 23, 2010). Still, it does feel like ISS is changing systems almost as often as they change their name.
Under QuickScore, companies will receive a relative ranking from 1 to 10 (1 is good, 10 is bad) by region and industry, instead of the color coded (red, yellow, green) score companies received under GRId. Which is similar to ISS’s Corporate Governance Quotient system that was replaced by GRId. Sort like how ISS changed to RiskMetrics and then changed back to ISS.
Backdating Bad for Your Career A recent academic study found that CFOs that lost their job as a result of option backdating have had a tough time re-entering the workforce. Only 18.7% found a comparable position (compared to 35.1% of CFOs that had lost their job for other reasons) and only 48.4% found any full-time corporate position (compared to 83.8% of other CFOs).
Which was a little surprising to me because how would a potential employer even know that’s how you lost your job? You wouldn’t exactly put “falsifying corporate records to reduce expense” under the skills listed on your resume and, in my experience, companies don’t give out that kind of information about former employees. But I guess a quick Google search these days can be very revealing about job candidates.
Now that the scandal, media frenzy, investigations (internal and external), prosecutions, and shareholder litigation seems to be winding down, a recently published academic study suggests that backdated options may not have done much harm to shareholders after all.
The real cost of stock options to shareholders is dilution, which is disclosed via diluted EPS. This calculation takes into account the strike price of the option, whether backdated or not, therefore, shareholders were aware of the potential dilution caused by backdating.
The reduced exercise price is more valuable to employees than the company’s cost for the discount. Thus, companies that granted backdated options may have been able to grant smaller options that were less dilutive than the options they would have granted if the options had been at-the-money at grant.
A Case for Discounted Stock Options
I was excited to see the paper, not because I think backdating is okay, but because I am a fan of discounted options. Under ASC 718, discounting an option doesn’t necessarily result in a dollar-for-dollar increase in the fair value of the grant. This makes discounted options a bargain from a compensation standpoint: the expense for the discount is less than the value delivered to employees (for this same reason, I’m not a fan of premium-priced options). The paper does conclude that there are situations where discounted stock options can be beneficial to both the company and employees.
Unfortunately, the very real obstacle of Section 409A still stands in the way of actually granting discounted options and, from a tax-revenue perspective, there are some valid reasons to discourage discounting (see my blog entry “Discounted Stock Options: Inherently Evil or Smart Strategy?,” March 16, 2010), so I don’t see this changing any time soon, study or not.
Flaws in the Study
There are also a number of flaws in the study. First, the study assumes that the company never realizes a tax deduction for ISOs and that ISOs have to be subject to vesting requirements–any Level I CEP candidate knows that both of these premises are false. In addition, the study assumes that stock options never qualify as performance-based compensation under Section 162(m). The authors in general seem to be very confused as to the operation of this area of the tax code.
Word of the Day
I did learn a new word when reading this study: “Pareto-improving,” which refers to something which harms no one and benefits at least one person. The authors conclude that, at least in some situations, backdated options can be Pareto-improving. I still haven’t figured out what sunspot equilibria are, though.
Only a Few Days Left for NASPP Conference Early-Bird Rate The 19th Annual NASPP Conference early-bird rate expires this Friday, June 24. This deadline will not be extended–register for the Conference today, so you don’t miss out.
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.
Register for 19th Annual NASPP Conference (November 1-4 in San Francisco). Don’t wait; the new early-bird rate is only available until this Friday, June 24.
Attend the Silicon Valley NASPP Chapter All-Day Conference this Thursday, June 23. As I blogged about last week, I’ll be presenting on one of my favorite topics: Pumping Up Purchase Plans: Re-Thinking the ESPP. I hope to see you there!
Today’s blog looks at a couple of random topics that showed up in my recent Google alerts: 1) options backdating and lawsuits against auditors and 2) yet another study on stock options and employee performance.
Are Your Auditors Going to Get Fussier? Option backdating stories are few and far between these days, but a new development showed up in my Google alert this week. A federal appeals court has ruled that investors can move forward with a lawsuit against Ernst & Young over Broadcom’s option backdating scheme. The ruling reverses a lower court decision dismissing the case.
The lawsuit alleges that Ernst & Young should have investigated deficient and missing documentation relating to Broadcom’s option grants. At this point, the lawsuit has a long way to go–the ruling just allows the suit to proceed, there has been no finding or judgment against E&Y and perhaps there won’t ever be. Nevertheless, I think it’s intriguing that the lawsuits over option backdating have now extended to auditors. I’ve talked to many a stock plan administrator who has felt a bit put upon with respect to the documentation requested by their auditors, and that was before the options backdating scandal. I imagine the documentation requests have already gotten more onerous and, if this lawsuit goes much further, I can only anticipate that auditors will tighten up the documentation requirements even further.
Stock Options=Lottery Tickets=Grateful, Hardworking Employees The debate over whether stock options incent employee performance slogs on. The latest rebuttal is the paper, “Stock Option Exercise and Gift Exchange Relationships: Evidence for a Large US Company” by management professor Peter Cappelli and Martin J. Conyon, senior fellow at Wharton’s Center for Human Resources.
The study posits that stock options motivate employees to work harder, but not in the way employers most likely hope. Instead of working harder to increase the stock price before they exercise, employees view options more like lottery tickets. But, if they get “lucky” and are able to exercise for a profit, employees will work harder in the period following their exercise–often for over a year–in gratitude to the company for the payout they received.
The study examined exercise patterns and job performance of 4,500 managers at a large U.S. public company (unnamed). While the sample size of employees certainly seems large enough, the results would be more interesting to me if the study had looked at more than one company. The authors don’t seem to acknowledge the differences that education (both in terms of the stock plan and company financials) and corporate culture might have on how employees view their stock options and how that influences their performance. It would also be interesting to know if the results translate to restricted stock or RSUs, which guarantee a payout to employees.
It’s Not Too Late for the Online Fundamentals The NASPP’s acclaimed online program, “Stock Plan Fundamentals,” began last Thursday, April 14, but it’s not too late to participate. All course webcasts have been recorded and archived for you to listen to at your convenience. This is a great program for anyone new to the industry or anyone preparing for the CEP exam. Register today.
Online Financial Reporting Course–Only Two Weeks Left for Early-Bird Rate There are only two weeks left to receive the early-bird rate for the NASPP’s newest online program, “Financial Reporting for Equity Compensation.” This multi-webcast course will help you become literate in all aspects of stock plan accounting, including the practical considerations and technical aspects of the underlying principles. Register by April 29 for the early-bird rate.
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.
Register for 19th Annual NASPP Conference (November 1-4 in San Francisco). Don’t wait; the early-bird rate is only available until May 13.
Register for the NASPP’s online Stock Plan Fundamentals program. Don’t wait–the course started last Thursday, but all webcasts are archived for you to listen to at your convenience.
When it rains, it pours. After months of ho hum news on options backdating, we see four colorful backdating cases come across our desks: the Comverse Technology storythat Barbara blogged about on Tuesday, Maxim Integrated Projects, Brocade Communications, and KB Homes.
Dead Men Tell No Tales
Former Maxim Integrated Solutions CFO, Carl Jasper, finds himself facing civil securities fraud charges that he deliberately attempted to mislead investors and knowingly signed off on false financial statements. His defense is not, like many, that he was unaware of the backdating. Rather, Jasper’s defense is that it was out of his control. He contends that former CEO, Jack Gifford, conducted more than a bit of arm-twisting in the orchestration of the whole backdating practice at Maxim. Instead of “I was not aware,” his defense is “it was out of my control.” What’s more, Mr. Gifford is regrettably unavailable to confirm or deny Jasper’s defense, as he passed away in 2009. (See this Law.com article.)
This story and the Comverse saga illustrate that if you’re being forced to go along with something you know is wrong, sometimes your best alternative is to just walk away. Otherwise, you could find yourself accountable for wrongdoing when the person who actually made the decision is either dead or remains a fugitive. Not a happy thought.
Déjà Vu
The first CEO to be convicted by a jury in the backdating crackdown was re-convicted on March 26th. A federal jury found former Brocade Communications CEO, Gregory Reyes, guilty of 9 out of 10 counts against him (finding him not guilty of only the charge of conspiracy). Although Reyes was originally convicted in 2007, the conviction was thrown out on the basis of prosecutorial misconduct. (See thisBloomburg article.)
Reyes’s defense has been that it was the finance executives who were in charge of complying with accounting rules and they failed to tell him that the backdating Reyes was a part of was illegal. The defense didn’t work the first time, and it didn’t work at the retrial. In fact, as a bit of irony, the crux of the overturning of the 2007 conviction was that the prosecutor stated that the finance department didn’t know about the backdating, Reyes did, while only calling the one person in the finance department willing to confirm. It’s a convoluted web of finger-pointing. Ultimately, I think the courts have grown weary of assertions that executives were unaware that their actions were illegal.
Never Look Back
Closing arguments are under way in the trial of former KB Home CEO, Bruce Karatz, who had been using the standby backdating “I had no knowledge of any wrongdoing” defense. Recently, however, the former KB Homes HR Director, Gary Ray, threw a wrench in the gears by testifying against Karatz. According to Ray, Karatz told him to “put the best interests of the company ahead of the truth” and cover up the instances of backdating. Even more colorful, Ray testified that Mr. Karatz told the company’s chief legal officer, “We don’t look back. We’ve never looked back. It’s not something we do in this company.” (See thisLA Times article.)
The moral? I guess it goes both ways. First, we can see that adequate controls will (eventually) uncover fraudulent practices. On the other side of the coin, trying to keep the knowledge of illegal practices within the company isn’t the best safety net and, ultimately, isn’t in the best interest of the company nor the individuals involved.
Today is the Day!
Barbara keeps a great “To Do” list at the end of each of her blog entries, but I want to really highlight the early-bird discount deadline. It’s today! Register now to get in on the $300 discount for our 18th Annual NASPP Conference.