What do you do when someone has inadvertently been omitted from the grant approval process? You really can’t just slip the grant into the approval documentation, fully disclosed or clandestinely, and write it off to an “administrative error.” The bad news is that each situation has the potential to be unique, which makes it unlikely that you can create a standard response to a missed grant. For this reason, your grant policy probably can’t (even shouldn’t) attempt to address every potential circumstance surrounding a missed grant. The good news is that you can prepare yourself to evaluate the responses available to you in the event you do find a missed grant. These are my top five considerations:
Vesting
If a grant is left out of the approval process and needs to be approved at a later date, you need to know if the delay in approval will impact vesting. If your plan or grant policy already bases the vesting off a date other than the approval date or is flexible on the issue, it is possible that the grant can maintain the intended vesting dates.
Approval
It’s important to have a solid understanding of your plan and approval process under any circumstance, but when it comes to a missed grant, there are additional considerations. If the delayed approval will result in a grant that is different from your typical grants either in size or vesting schedule, you need to know who has the authority to approve the grant. If standard grants are approved by an officer, such as the CEO, it’s likely that a modification to standard terms will cause the grant to fall outside the parameters of the officer’s approval authority and may need to be referred to the compensation committee for approval.
Stock Price
If the grant in question is an option, then the stock price has likely moved on since the original approval date. If the price has dropped, it is easy to sell your employee on a grant of equal size and vesting with a better exercise price, but it may not be advisable to provide a disproportionately advantageous position to just one employee. Provided your plan permits it, it is possible to approve the option with the intended (i.e., higher) grant price.
If the stock price has increased, you have the opposite issue to contend with–the employee really shouldn’t be penalized for an administrative error. However, approving the grant at the lower exercise price would most likely result in a discounted option, making it subject to 409A. You can, however, develop a policy on how the company may compensate for this change in FMV such as increasing the number of shares or providing a cash payment to make up the difference.
If an RSU has slipped through the cracks in your approval process, making up for lost time can be less of a burden provided you have the flexibility in your plan to keep the intended vesting schedule. But, make sure that if your grant policy doesn’t lock in grant size based on the date of approval (e.g.; a value of $1,000 based on the FVM on date of approval).
Timing
Ideally, you never have to deal with a missed grant. Hopefully, if you do encounter one, the error is discovered virtually immediately. However, it is a good idea to think about what the company can do if a significant amount of time has passed between the date the grant should have been approved and the discovery.
One possible issue is vesting; if the grant should have already vested by the time the error is discovered. Like compensating for a higher exercise price, the company could choose to increase the number of shares or provide a cash payment to compensate for a missed sale opportunity. This is risky business because you are using counterfactual history–there is no way to know at what point the employee would have sold the shares.
Another issue comes up for companies that use a “total rewards” type compensation standard and one or more annual grants have been approved before the original missed grant is discovered. In a total rewards model, annual grant size would typically be based on a target total equity value or total compensation level. If the missed grant is not included in the calculations, then an annual grant approved after the error is likely to be larger to accommodate the value “missing” from that employee’s total equity value or compensation level.
Communication
Regardless of the circumstances leading up to a missed grant, communication is going to be key. No matter how you cut it, employees don’t appreciate being left out and bristle at the idea of being penalized for an administrative error, whether that idea is well-founded or not. This might sound a little like running a customer service call center, but it’s not a bad idea to have some apology verbiage ready that can fit most administrative issues; something that can help to reassure the employee that the company will “make it right” without actually obligating the company to provide recompense it isn’t prepared or able to accommodate. Whatever your response is to a missed grant, keep the employee abreast of the process as much as possible. Also, it’s probably best to avoid detailing the circumstances of the oversight even if you are trying to reassure the employee.
Form 4 filings can be complex. Ideally, your company has a process in place that is designed to mitigate the risk of erroneous data ending up on a Form 4. However, if an error is discovered, it may be necessary to amend the original filing with a footnote explaining the reason for the amendment. When filing an amended Form 4, there is no need to restate the original Form 4 in its entirety. Rather, the amended Form 4 can include only the line items that are being updated. Additionally, there is no need to amend inaccurate Form 4 filings resulting from the original error that took place between the original erroneous filing and the amendment. Upon discovery of a filing error, the company will need to determine if it is something that must be disclosed in the proxy statement per the requirements of Item 405 (which requires disclosure of late reports and known failures to file required reports).
This week, I’d like to address a few common errors. Obviously, this blog entry shouldn’t be taken as advice. Only your legal counsel (or the SEC) can confirm the appropriate action that you should take when it comes to specific erroneous data in a Form 4 filing. If you subscribe to Section16.net or the Romeo and Dye Section 16 Treatise and Reporting Guide, you can find additional common errors in form filings along with fantastic guidance on correct reporting and best practices.
Duplicate Grant
If a grant is inadvertently reported twice, removing the duplicate can be done by filing an amended Form 4 with the correct details of the grant along with a footnote clarifying that the grant was originally reported twice. There is no need to show a “disposition” of the erroneous duplicate.
Incorrect Grant Type
If a Form 4 is filed with an incorrect title of derivative security listed in Column 1 of Table II, the correction can be made by filing an amended Form 4 with the correct grant type in Column 1 and a footnote to explain the discrepancy. This is not the same as an amendment to an existing grant, which is considered the disposition of the original grant and acquisition of a new grant. In the case of an incorrect ISO/NQ split, as long as all the other details on the grants (grant date, exercise price, etc.) are the same, then both the ISO portion of the grant and the NQ portion of the grant can be reported on the same line and a correction to share allocation between the two may not require an amendment.
Incorrect Securities Beneficially Owned
If there was an error in the number of shares reported in Column 5 of Table I or Column 9 of Table II, the amended filing is pretty straight forward as long as the total holdings are not incorrect because of an error in or omission of an actual transaction. An amendment with the correct holdings can be filed with a footnote explaining the correction. Likewise, if holdings are incorrectly reported as directly or indirectly held, the same amendment filing would apply. Even if the issue is simply that direct holdings are reported as indirect (or vice versa), it may be best to file an amended Form 4 to show both line items with the correct number of shares. It’s also important to note that the number of shares reported in Column 9 of Table II should only reflect the total of the same class as the derivative security being reported on that line, not the total number of all derivative securities held by the filer.
Immaterial Details
Some errors may not require an amended Form 4 at all because they are not material enough to warrant an amendment. Of course, you’ll want to work closely with your legal counsel to determine the most appropriate course of action in each case. Examples of some details that most likely would not require an amended filing are using the incorrect title, including an incorrect mailing address, failing to disclose that a transaction took place under a Rule 10b5-1 Plan, or accidentally putting the wrong vesting schedule in a footnote.
Section 16 Updates
At the beginning of each year, Alan Dye partners with the NASPP to provide our members with valuable Section 16 updates. NASPP members can access our archive recordings of Section 16 update webcasts in the NASPP Webcast Archive.
Ask the Experts
Speaking of fantastic NASPP programs, mark your calendar for June 29th at 4:00 EST. We will be airing our Latest “Ask the Experts” webcast, Estimating, Applying and Reconciling Forfeiture Rates! If you have a specific issue you would like to have our experts address, it’s not too late to submit your question to the panel.
The end of December is the end of a purchase period for many companies. If December 31 is a purchase date for you, then you are in the last stages of preparation for the big day. Here’s hoping you have a smooth and stress-free purchase day; and to help you with that, these are my top five last-minute ESPP audit items. Don’t let these be the “gotcha” that gets ya! If it’s already too late, and you find yourself on the correction end of an ESPP blooper, you may want to check your 2008 Conference materials for the “Oops! Fixing ESPP Problems” session.
Plan Parameters
Before running your purchase, confirm that the plan parameters are set correctly in your stock plan administration software. This is especially important if either your software or your plan parameters have changed. If your company has added, or will be adding, an individual purchase limit to the plan in response to the final ESPP Regulations, pay special attention to this setting. One of the most important points to verify is that the purchase price is being calculated correctly. A great way to confirm that the plan parameters are correct is to run a “practice” purchase prior to the actual purchase date, giving you the opportunity to confirm that the purchase price is being calculated correctly as well as the chance to verify all the important data points in your purchase like contribution amounts and limits. Treat the practice purchase as if it is the actual final purchase by performing all the same audits and verifications.
Residual Contribution Amounts
At the end of each purchase, there will be excess contributions associated with each participant. These could be just the ‘fractional share’ amount (an amount too small to purchase one whole share), or an excess resulting from a plan limit. Although most companies carry forward the fractional share amount to the next purchase, if you refund this excess amount back to the participant, then confirm that there are no residual contribution amounts in your stock plan administration software. If you carry the excess forward and apply it to the next purchase, then verify that the residual contribution amount associated with each participant is equal to the excess contribution amount recorded after the previous purchase. Additionally, check that anyone who has withdrawn from the plan after the previous purchase has had their excess contribution amount refunded to them (and that it no longer reflects in the stock plan administration software). This audit helps to prevent you from purchasing an extra share for participants or, if the purchase price for the current purchase is less than the prior period purchase price, one share for an employee who is no longer participating in the purchase at all.
Actual Contributions
As you collect the contribution amounts recorded by each of your payroll groups, you will be confirming that the contribution amounts are correct. One reconciling item you should included, but may have overlooked, is reconciling the total contribution amounts recorded by payroll against the contribution amounts deposited into the clearing account where actual contributions are held. If you have a plan in a country that requires contributions to be held in a separate account, this may mean that you need to reconcile against more than one account. This verification will help insure that the contributions used to calculate purchased shares are correct. If there is a discrepancy between the payroll record and the clearing account, it may indicate that there is an error in a contribution amount, which you can address prior to the purchase.
Eligibility
Qualified ESPPs must provide equal rights and privileges to all eligible employees. One particularly obvious violation of this requirement is when an employee enrolls in the plan, but is prevented from participating in the purchase due to an administrative error. This could be because the enrollment record did not get communicated correctly to payroll, because contributions were not withheld, because the contribution amounts were not communicated to the stock plan management team, or any number of other administrative issues. There are two really great ways to proactively minimize the likelihood of excluding an eligible participant from your purchase. First, send out a communication to all eligible employees confirming whether or not each is currently enrolled (and the contribution level for those enrolled in the purchase). By including employees who are not contributing in this communications, you give them the opportunity to notify you if their enrollment is not reflecting in your system. Second, check your enrollment records against your payroll contribution records prior to the purchase to confirm that each individual who enrolled in the purchase period also has contributions. Uncovering any participants that may have been incorrectly excluded prior to the purchase will give you the opportunity to take corrective action.
Terminations and Withdrawals
As part of your final purchase audit, take a close look at participants who enrolled at the beginning of the period, but who have withdrawn from the plan either as an active withdrawal or because of a termination. You will want to pay special attention to problem situations like mobility, when contribution records may not be transferred over to the new payroll location, or changes in status, when contributions may be inadvertently discontinued or the employee record may be incorrectly treated as a termination. In this audit, your objective will be to match either a termination record or withdrawal record to any employee who has an enrollment record, but is not on the final contribution list that you recieve from payroll. Be sure that you understand exactly how employees transferring from one location to another will reflect in your HRIS database so that you can confirm all termination records are legitimate. This will help you to identify any employees that were marked as withdrawn from the plan when they moved from one payroll location to another. If you allow employees to reduce their contribution amount to zero without withdrawing, then add this to the possible scenarios as you confirm the termination and withdrawal records for your purchase.
Bonus for International Plans: Exchange Rates
Whether you receive contribution amounts from your international payroll teams already converted to U.S. dollars, or you must apply an exchange rate to the contribution amounts directly, take a moment to verify that the correct exchange rate is used. Don’t forget to check for silly, but costly, mistakes like an inaccurate decimal point or a formula that is pointing to the wrong field in your spreadsheet.
As you know, the final regulations for Section 423 ESPPs are out. Although the actual tax code can be a pretty dry read, the regulations are pretty straightforward and the examples provided are really good. Don’t be intimidated by them; take the time to review them yourself and then join us on January 20th for our webcast, Final Regulations on Sections 6039 and 423: Implications and Action Items.
Happy New Year to you all! We wish you the very best and look forward to a spectacular year in 2010!