Ding, ding, ding. That’s the sound of my inbox waking up to a flurry of alerts and articles about a recent Supreme Court decision that, turns out, affects stock compensation – sort of. On June 26, 2013, the high court ruled in the case of United States v. Windsor that Section 3 of the Defense of Marriage Act (DOFA) is unconstitutional. Section 3 of the DOFA was an attempt at uniformly defining marriage at the federal level, and that definition excluded same-sex marriages. The recent court ruling means that the definition of marriage is now back in the hands of the states, and there are currently 13 states and the District of Columbia that have enacted laws recognizing same-sex marriages. In jurisdictions where same-sex marriages are lawful, those in same-sex marriages are now considered to by married for purposes of any federal regulations or statutes that refer to one’s marital status.
How Does the Ruling Affect Stock Compensation?
The defeat of Section 3 of the DOFA means that we now must look at the various state statutes to determine the definition of “marriage” or “spouse” for purposes of employee benefits. Essentially, benefits subject to federal laws (ERISA, COBRA, Internal Revenue Code, etc.) fall under these provisions. According to a myStockOptions.com blog post on the subject, “While stock plans and nonqualified benefit plans are not affected by federal laws in the same way as qualified retirement plans (e.g. a 401(k) plan) or health and welfare plans, the changes that will be required in these other benefit plans will probably lead to similar modifications in stock plan documents.” Although there was nothing in the Supreme Court ruling that directly addressed stock compensation, it seems that when it comes to things like policies on divorce for purposes of stock options, or transferable options, death, and other situations where a “spouse” may be involved, it’s likely many companies would opt to align with practices in place for other benefit plans that are covered under the ruling. Therefore, even though stock compensation is not specifically covered under the ruling, it is indirectly affected. The possible areas that may need a review off the top of my head are:
Beneficiary designations
Plan Documents and Grant Agreements
Policies or communications on divorce and transferable options
The holding takes effect on July 21, 2013, so employers are working to immediately assess those plans affected. In addition, stock plan provisions and policies should be reviewed to align with changes being made to other covered plans (e.g. 401(k)). For example, if your stock plan mandates a default beneficiary of a “spouse” for stock options upon death, the term “spouse” may need to be redefined to include same-sex spouses where lawful. In addition, it’s likely that Human Resources and Legal are already working away to navigate this situation, so you may want to plug in now – things like employee communications and matters of policy going forward could be streamlined and should be addressed.
I’m still confused about some aspects of this – like is whether we need to look at the state where the marriage took place, or the state where the employee currently resides for purposes of applying state laws to the definition of marriage for employee benefit purposes. I guess that’s for the lawyers to figure out. Based on the number of alerts I got on this subject, they are already on that task. In a client alert, Paul Hastings gives a good description of the issues around determining applicable state laws and this entire situation in general.
The action item here is to talk to counsel and start reviewing your equity plan documents, policies and communications to determine where changes should be made. It seems logical that, just as we’ve migrated towards aligning with other benefit practices (401(k), etc.) in the past, it would make sense to similarly consider adjustments to stock plan matters in tandem with changes to required benefit plans. Just when it seemed summer was starting to fall into a rhythm of lazy, hot days (is there such a thing as a lazy day?), there’s never a dull moment.
We all know that life happens, and not in the way we always have planned. When it comes to stock compensation, things don’t always transpire like they are supposed to either. That’s why our stock plans have provisions that cover scenarios such as death, disability, and sometimes even divorce. We know these events might occur in our scope of working as stock administration professionals; yet, are we ready to put our best foot forward if and when the time comes? In today’s blog I’ll highlight some best practices in administering some of these live event scenarios.
Death
It’s not a pleasant topic, but, as one person put it: “nobody leaves this world alive.” So what does happen when a stock plan participant dies? Here are a few practices to minimize the pain of dispersing the stock plan grants/awards to the employee’s estate:
– Consider NOT Using Beneficiary Forms: In a previous blog, I talked about the pitfalls of using beneficiary forms. One main one is that employees often forget they exist, and don’t alter them to reflect their true intentions. In some cases, these forms were filled out years and decades before they were needed, and by then marriages, children and divorces had occurred, altering how the employee preferred to handle his or her estate. Beneficiary forms can override next of kin estate laws, so if you are going to use these forms, be sure to come up with a mechanism to remind employees they exist.
– Ensure Proper Time Frame to Exercise Stock Options: Navigating estate management can be time consuming and tricky. The last thing you want to have happen is a stock option expire unexercised because the estate couldn’t establish itself and execute the exercise in time. If your plan allows less than 6 months to exercise vested stock options post death, this is more than likely too short of a time frame. Consider offering at least 6 months (12 months is even better) in order to ensure enough time for the estate to exercise.
Disability
An employee goes out on disability leave – now what? Many companies take the approach of trying to stop vesting awards during long disability periods. While it may sound reasonable on paper, in reality it’s tough to administer. First of all, how do you determine which type of disability results in paused vesting, and which does not? There are many types of short and long term disabilities. Second, how do you track the changes to vesting? Remember, when an employee goes out on leave, most often you do not know the exact return date, and many times it changes. Having to stay on top of open leaves, tracking end dates and adjusting vesting can become a nightmare. Many companies are now moving away from adjusting vesting for leaves of absences, including those related to disability.
Divorce
Our next Compliance-O-Meter (due out the beginning of July) will address some practices for managing divorce scenarios. One area I suspect many companies struggle with is tax withholding. Here are a few areas to inspect to ensure compliance with tax withholding requirements relative to divorce:
– FICA Withholding Takes into Account Employee’s YTD: Did you know that when a non-employee ex-spouse exercises stock options, the amount of FICA to be withheld (yes, you need to withhold FICA) is calculated based on the employee spouse’s wages and YTD FICA withholding? Even though the employee spouse may have had nothing to do with the exercise, the FICA calculation still is based on their wages/withholding. That means if the non-employee spouse would have owed $2,350 in FICA, but the employee had already paid $2,000 year-to-date in FICA withholding, then the non-employee spouse would only have $350 withheld on their transaction. In addition, the FICA needs to be reported on the employee spouse’s Form W-2.
– Medicare: Medicare is withheld from the non-employee spouse, but is also reported on the employee spouse’s W-2.
– Form 1099-MISC: The company needs to issue a 1099-MISC to the non-employee spouse, reflecting the transaction and income taxes withheld.
For more on death and disability, check out our current Compliance-O-Meter. For more on divorce, be sure to watch for our next Compliance-O-Meter.
Final Words (no pun intended)
Lastly, while some events are more uncommon than others (death), other events will occur over and over again during your stock plan reign (divorce). If you lack a formal policy on these events, it’s best to sit down with your internal business partners and develop a guidelines that will dictate how you will proceed. Particularly in divorce situations, where a variety of creative ways may be explored to divide up stock compensation, you’ll want to have a consistent approach. You’ll also want to know up front what the company can and can’t do to support these scenarios. I highly recommend a divorce checklist that outlines company policy; it can be made available to employees so that they will know in advance how to approach the division of their stock plan benefits.
Whatever the scenario, it’s best to put some parameters in place up front. This will save hours of heartache and headaches for all involved.
A divorce case involving stock options that has some potential lessons for stock plan administrators recently came to my attention. The case involves grants that were divided in a divorce settlement and then later cancelled due to the employee’s termination.
Divorce is Expensive–Especially If Options Expire Unexercised
Under the terms of the divorce settlement, the employee’s options and SARs were split equally between him and his ex-spouse. The grants were non-transferable, so the employee was required to hold half of the grants in constructive trust for the ex-spouse. Upon exercise of that portion of the grants, the employee would then have to pay over the proceeds to the ex-spouse.
After the settlement was final, the employee terminated his employment and, as a result, the period in which the grants could be exercised was curtailed. The employee did not exercise the grants within that period and the grants were cancelled. The employee’s ex-spouse then claimed that the employee owed her the value of her half of the grants–about $15,000–because, by failing to exercise the options/SARs within the prescribed period, the employee had deprived her of the opportunity to realize this gain.
The employee had been under the impression that he could take the options/SARs with him. I’m sure anyone involved in stock plan administration can read the subtext here: the employee likely asked his (uninformed) best buddy at work what would happen to the grants and never bothered to check his grant agreements, exit paperwork, or even call stock plan administration to ask about the grants. I imagine that it’s even possible that this lack of follow-through was a contributing factor in the divorce in the first place.
The end result is that the court agreed with the ex-wife and the employee now owes her about $15,000.
Lesson 1: Appropriate Cancellation Procedures
In this case, the options/SARs were non-transferable and were all still held by the employee. Thus, when the employee’s termination was entered into the stock plan database, it was likely automatically applied to all of the options/SARS. Where the options are transferable and have been assigned to the ex-spouse in the company’s stock plan database, this procedure might not work quite so efficiently. If you are transferring grants divided in a divorce settlement to an ex-spouse, it is critical that you remember to cancel those grants along with the grants held by the employee when the employee terminates.
Lesson 2: Cancellation Notification
The second lesson here is to make sure that, in the event the employee does terminate, it isn’t your job to notify the ex-spouse that the grants he/she has a right to are subject to cancellation. At the time that you receive notice of the divorce settlement, make sure that any responsibility for providing subsequent notices about any change in the status of the grants (due to termination, change-in-control, repricing, stock split, etc.) falls squarely on the employee’s shoulders and that the employee is aware of it. You have enough to do keeping track of employees; you don’t need to take on their ex-spouses as well.
Lesson 3: Stay Out of It
I think this case is a good argument for not allowing transfer of options and awards upon divorce. By not permitting the transfer and requiring the employee to exercise the options/SARs on behalf of the ex-spouse, the company effectively distanced itself from all of the proceedings related to the grants. This also helped to clarify that the employee was responsible for alerting the ex-spouse to the fact that the options/SARs were going to cancel as a result of his termination. Where the company has transferred grants to an ex-spouse and is in communication with the ex-spouse about them, the lines may get a little blurry.
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