Do your award agreements include the phrase “vesting commencement date” or a similar phrase? A recent lawsuit against Tesla hinges on what it means for vesting to “commence.”
The Lawsuit Against Tesla
A group of former Tesla employees have brought a lawsuit against Tesla, claiming that they should have been able to exercise their options at the time of their termination of employment, even though they had not yet fulfilled the one year of service required for the grants to begin vesting. At the heart of the lawsuit is the language in Tesla’s employment agreement, which states that vesting commences on the first day of employment. The employees have interpreted this to mean that the options were immediately vested at grant.
What Part of “One Year After” Don’t You Understand?
The whole claim seems rather disingenuous to me. As explained in The Recorder (“Trial Opens Over Tesla Options,” March 1, 2016):
The entire dispute turns on a single sentence in Tesla’s employment agreement letter, stating that employee stock options “will vest commencing upon your first day of employment.” But parenthetically added in the employment agreement is the following: “1/4th of the shares vest one year after the vesting commencement date, and 1/48th of the shares vest monthly thereafter over the next three years.”
Given the parenthetical, it seems hard to believe that anyone was really confused about when the options vested.
Key Takeaways
The problem with a lawsuit like this, however, is that no matter how disingenuous it might seem, it won’t go away by itself. Responding to a lawsuit often involves a lot of time, resources, and legal fees. It’s worthwhile to take some precautions to mitigate the company’s risk:
Make sure the language in your employment and grant agreements is clear. Avoid terms that are ambiguous, if possible. If you can’t avoid them, make sure they are clearly defined.
Take off your equity compensation hat once in a while. While a term like “vesting commencement date” might seem obvious to you, it might not be so clear to someone who doesn’t have a background in equity compensation. Plaintiffs’ attorneys are great at exploiting ambiguities.
Keep a record of all information communicated to employees about their awards. In a case like this, educational materials that further clarify how awards vest, possibly with examples, can help bolster the company’s defense.
Grant agreement distribution has become streamlined and simplified with the advances we’ve made in electronic processes. It seems we’ve got the distribution part covered. The part that seems a bit up in the air is the question of what happens if the grant agreement is not signed by the recipient? In today’s blog I’ll explore the issue and offer up my favorite solution.
Yes, Acceptance is Important
There’s a lot of investment that goes into creating grant agreements – some companies are investing thousands of dollars into customizing agreements to jurisdictional requirements, ensuring that agreements are relevant and comprehensive. Ultimately, the intent of the agreement is to inform that participant and protect the company. It seems most companies get this – 76% of respondents in our 2011 Stock Plan Administration Survey (co-sponsored by Deloitte) stated they require acceptance of grant agreements. Hopefully we’re all on the same page about the importance of these agreements, and the need to capture the recipient’s acceptance of the terms and conditions.
Simple for Options, Sticky for Awards
The collection of stock option agreement signatures should be fairly straightforward. Whatever policy your company adopts in this area, it’s relatively easy to enforce, because you have control over the participant’s ability to exercise their stock options. If the company wants to restrict the ability to exercise until the signed grant agreement is on hand, it can do so. The exercise of an option is not an automatic event – it must be initiated. If a participant initiates an exercise without a signed grant agreement on file, the company can simply block that transaction (often via predetermined settings with their third party vendor) from occurring until the agreement has been accepted.
Where things can get sticky is with award acceptances. The challenge is that the vesting of an award is automatic – either based on satisfaction of a service period or some type of performance condition. Unlike stock options, there’s nothing to initiate – the vesting event just happens, triggering income and taxes in many jurisdictions. If the agreement hasn’t been signed by the time the award vests, what should the company do?
We had a great webcast on this topic back in January 2013. If you’re a company muddling through this dilemma, it’s worth a look at the transcript or playback. That webcast offered up several options to the award acceptance conundrum. Today, in the interest of time and space, I’ll just pick my favorite to explore.
You Snooze, You Lose
First, let me just clarify that I haven’t seen an enforcement method for award agreements that is perfect. By perfect I mean without risk or some complexities. That said, I’m a fan of adopting a policy that requires acceptance within a specified period (e.g. 30-90 days) and then canceling the award if it hasn’t been accepted in the first place.
Canceling grants for non-acceptance was once viewed as an ultra-conservative penalty. However, in recent years, we’ve seen this emerge as an increasing trend, and I believe it will eventually emerge as a best practice. In a 2011 NASPP Quick Survey, 22% of companies reported using this approach.
I like this approach for many reasons. First, it’s pretty straightforward to administer. The grant is just canceled if not accepted within the proper time frame. It also eliminates 409A issues that are front and center in some of the alternatives (e.g. delay releasing shares until the agreement is signed). Since the award is canceled, there is no concern about the timing of share delivery – the shares no longer exist. There are no major accounting concerns – the expense under ASC 718 would be accrued just like any other RSU. The key accounting question with this approach is what to do if the award is canceled, and the answer depends on whether the company is using the board approval date as the “grant date” or deferring the grant date until the date the agreement is signed. In the latter scenario, the company might be able to argue that there was never a grant. In the former scenario, the company would accrue expense just like any other RSU, but note that it’s unlikely any of the already recognized expense would be reversed upon cancellation.
Companies who consider this approach do need to be aware of the impact this may have in jurisdictions outside the U.S. Some locations do tax awards at grant (either employee or employer), and those taxes may not be recoverable if the award is subsequently canceled. In addition, a robust communication and follow up plan is a must, because the last thing you’d want is an executive who realizes the “mistake” in canceling his grant and asks for a reversal of the cancelation. If the company doesn’t comply with the request, it’s possible that there may be litigation. As with any policy, there are other considerations as well – but these are the major pros and cons.
My guess is that with the threat of cancelation, most employees will pay attention and accept their agreement terms before the deadline. Companies who have adopted this method report few cancelations. It’s definitely worth considering if you are exploring ways to enforce your grant agreement acceptance requirements.
In our world of stock compensation, we’re well versed in keeping up with the laws and regulations that govern our universe. Many of us are also in tune with doing what it takes to keep our employee customers informed and happy. Sometimes in the quest to tighten up policies or service the employee, seemingly good practices are utilized, only to learn later on that they weren’t such a hot idea after all. In today’s blog, I’ll explore a few common, well-intentioned practices that may come back to later haunt the stock plan administrator.
3 Practices With Potential Pitfalls
1. Thinking Beneficiary Designations are a Must: Contrary to some stock plan urban myth that says it’s a good idea to allow employees to designate a beneficiary for their stock plan shares, the use of beneficiary forms for stock plan shares is not considered a best practice. Why? Well, this is an area where I could rant a long laundry list of “whys”, but in the interest of space I’ll keep it short. One reason? There’s a good chance that the designated beneficiary may not be the intended beneficiary. These forms are usually completed when someone is new to a stock plan, and then later forgotten. Years go by – marriages, divorces, other life events. It’s quite possible that the name written on the beneficiary form is not the person who would have been the intended recipient. Another reason to ditch these forms: many non-U.S. jurisdictions don’t even consider beneficiary forms to be valid or enforceable. According to a recent white paper published by Baker & McKenzie on this subject (and available in our NASPP Practice Alerts), it’s better just to simply provide for a refund of unused ESPP contributions in the event of death, and other stock plan rights, such as those to stock options, go to the employee’s estate. Another option may be to allow the use of beneficiary designations at the stock plan administrator’s discretion (to allow for one-off situations that may warrant such a designation), but not as the rule.
2. Believing that Unsigned Grant Agreements Can’t be Enforced: Many companies do distribute grant agreements to grant/award recipients, and the vast majority require a signature (including electronic signature or acceptance) on the document. According to the 2011 NASPP/Deloitte Stock Plan Administration survey, 76% of participating companies reported requiring grant acceptance (although 24% of respondents said that they don’t enforce the requirement). In a recent California Court of Appeals case, an unsigned stock option agreement was deemed to be valid. The facts surrounding the case are lengthy and detailed, so that will have to be reserved for a future blog. However, one lesson learned from the decision was that, absent language that indicates acceptance or signature is required or presumed at a certain point, it is possible for an unsigned agreement to be considered an agreement. I’m guessing a good number of companies operate on this belief, at least those that aren’t requiring acceptance or enforcing their acceptance policies. However, there may be a segment of companies that believe that there’s a black and white difference between signed and unsigned agreements, leading to a false sense of security about only having a true agreement if and when it’s actually signed. The recent court case seems to blur that line. If you are concerned about making sure the company and employee are on the same page about what’s being offered and the terms and conditions of the award, it’s a good idea to require acceptance or signatures. In addition, having a policy or requirement is just the first step. Perhaps even more important is consistency in enforcing the policy. No one wants to to lose a valid dispute based on a technicality. At minimum, be aware of the potential for enforcement of unsigned agreements.
3. Mobility Tax Calculation Assumptions: Not all countries have the same mentality when it comes to calculating their share of the tax pie for mobile employees. The tax authorities of many countries are still trying to figure out how to tax mobile employees, and this an ever-evolving area. Some companies find themselves trying to take a one-size-fits all approach to streamline mobility related tax allocations. This simply won’t work – there are too many differences amongst jurisdictions, and if that wasn’t enough, the interpretations and policies keep changing. For example, the Canadian Revenue Agency recently changed its position on the calculation of cross-border stock option benefits, clarifying some aspects of its policy on how stock option income should be allocated. This was a positive change, providing some clear guidance in an area that previously had ambiguity. These types of clarifications or updates are becoming commonplace, and companies do need to accept that the approach to mobile employees still needs to be determined on a jurisdictional or case-by-case basis.
Sometimes it’s not the big changes that matter, but the little shifts in our practices or thinking. It’s quite possible to make a big difference with a simple change in policy or practice. Hopefully in today’s blog you gained a couple of nuggets that may prompt some small shift in approach, netting rewards down the road (and avoiding the haunting I referred to at the beginning of this blog).
For today’s blog entry, I highlight results from the NASPP’s 2011 Stock Plan Design and Administration Survey (co-sponsored by Deloitte). If you missed our webcast highlighting the results, you can still catch the audio archive (and the transcript will be up in a couple of weeks). The full results will be published later this month; I’ll cover more highlights from the results in future blog entries.
The 2011 Domestic Stock Plan Administration Survey The last time the Domestic Stock Plan Administration Survey was conducted was in 2007, when it was part of the Domestic Design survey. This is the first time the Domestic Administration survey has been conducted and published independently.
Respondent Demographics
We received 603 responses, compared to 428 responses in 2007. High-tech companies still comprised the single largest industry in the survey, but dropped from 43% of the respondents in 2007 to only 34% of respondents in 2011. We picked up respondents in the “other” industries categories, which is a mish mash of industries that don’t fit into any of the other categories (one thing I like about writing a blog is that I can use words like “mish mash” that I can’t use in anything else I write). Respondents from the western region also dropped from 35% in 2007 to only 29% in 2011. We picked up respondents primarily in southeast and a little in the northeast. 37% of respondents are Fortune 500 companies (this was almost the same as in the 2007 survey).
Staffing and Outsourcing
A question I am asked a lot is what department stock plan administration is located in. 60% of respondents reported that HR/Comp & Benefits has primary responsibility for administering the company’s stock and option plans. This was up from 57% in 2007. I was surprised to see the number of companies that locate primary responsibility for stock plan administration in Treasury/Finance drop from 16% in 2007 to just 5% in the current survey. 9% of respondents task accounting with primary responsibility for stock plan administration, which did not change from the 2007 survey.
The percentage of companies that have no personnel dedicated solely to administering their stock and option plans increased from 31% in 2007 to 39% in 2011. At the same time, the number of companies outsourcing more than 75% of stock plan administration increased to 41%, up from 33% in 2007. Perhaps the increase in outsourcing contributed to the decline in staffing.
The Electronic Age
Companies continue to move to electronic processes. The percentage of respondents distributing grant agreements in paper format dropped to 33%, from 47% in 2007. 47% of respondents permit a digital signature on grant agreements for some or all employees, up from 34% in 2007.
Participant Communications
76% of respondents require employees to accept their grant agreements, which did not change significantly from 2007. Enforcement practices also did not change significantly, but an additional 4% (19%, up from 15% in 2007) of respondents cancel grants if they aren’t acknowledged within a specified period.
We are seeing more companies notify employees of expiring in-the-money options. Only 20% of respondents don’t provide this notice, down from 25% in 2007. And more companies are relying on a third-party to provide the notice (45% of respondents, up from 31% in 2007). I expect that this is the result of the brokers and other third-party administrators developing the functionality to provide these notices to employees and more companies getting comfortable with relying on the brokers to provide this notice.
See You in San Francisco! I hope to see all of my readers at the 19th Annual NASPP Conference, which is scheduled for November 1-4 in San Francisco. The last Conference in San Francisco sold out a month in advance–and that was without the reality of Dodd-Frank and mandatory Say-on-Pay hanging over our heads. With Conference registrations going strong–on track to reach nearly 2,000 attendees–this year’s event promises to be just as exciting; register today to ensure you don’t miss out (and make your hotel reservations, because the hotel is close to selling 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.
Attend your local NASPP chapter meetings in Florida, Houston, Ohio, San Diego, Silicon Valley, and Wisconsin. Robyn Shutak, the NASPP’s Education Director, will be at the San Diego meeting and I’ll be at the Silicon Valley meeting; we hope to see you there!
With the year-end quickly approaching, I thought that the final versions of Forms 3921 and 3922 would surely be waiting upon my return from my vacation last week, providing foddor for the NASPP blog (the IRS, along with the SEC and FASB, seem to have a knack for releasing stuff when I’m on vacation). But, to my surprise, the final forms still aren’t available. So instead, this week I blog about a recent case in the Maryland Court of Appeals relating to a company’s right to cancel options upon an executive’s resignation, which reminded me of a few best practices to ensure that, when employees terminate, stock awards receive the treatment the company intends.
Forfeiture of Awards Upon Termination of Employment: Not Always As Clear Cut As You Think The case involved an executive who voluntarily resigned but continued to work while severance negotiations were ongoing. The negotiations failed and the company terminated the executive–just eleven days prior to when his options would have vested. The county court (where the case was initially tried) assigned a value of around $850,000 to the options, presumably based on the spread on the vesting date or the date the executive tried to exercise the options. Given the sum involved, I can only imagine that the eleven days ate at the executive–resulting in his lawsuit claiming that the options were “wages” owed to him under Maryland’s Wage Payment and Collection Law.
To those of us in the business, this might seem like a no-brainer in favor of the company, but the court in which the case was initially tried found in favor of the executive. It all worked out in the end, at least from the company’s perspective, because the appellate court decided against the executive. Even so, lawsuits are expensive, especially those that end up in appeals, so this wasn’t exactly a landslide for the company. The case brings to mind a few best practices.
Dot the I’s and Cross the T’s
Proper documentation is key. This lawsuit is exactly why your attorneys want you to require employees to sign their grant agreements–so that, if necessary, the company can prove that employees knew the terms and conditions of their grants. I’ve read about numerous lawsuits relating to the treatment of stock compensation upon termination and a large percentage of them hinge on whether or not the employee was informed of the vesting and forfeiture conditions.
In addition to having a signed grant agreement, retain copies of any communications to employees that notify them of the terms of their grants and, in particular, any communications relating to their stock compensation that are provided at the time of termination. I’ve read about one case disputing termination provisions where there wasn’t a signed grant agreement on file, but where the subsequent communications that the company was able to produce were sufficient to decide the case in the company’s favor.
Proper documentation is especially important in sensitive circumstances, such as when an executive is leaving on bad terms (as in this case), an employee is terminated for cause, or a reduction in force.
Don’t Be Late
It is critical that stock plan administration receive timely notice of terminations. In this case, the executive actually tried to exercise his options and wasn’t able to because a block had been placed on his account. If the notice of termination had been received just a couple of weeks late, the exercise might have been permitted. Trying to unwind that transaction and force the executive to disgorge the amounts realized on it would have made things infinitely more complicated (and that much more expensive for the company).
Be Prepared
When a reduction in force is planned, it’s a good idea to check for vesting dates that occur shortly after the expected last date of employment. In this case, the employee was voluntarily resigning, so this wasn’t as much of an issue. But where employees are involuntarily terminated, forfeiture of awards that would have vested shortly after their termination date can be problematic. At best, it leaves everyone feeling even worse than they already do. At worst, it can look like the company purposely terminated employees to avoid having to pay out the awards–especially if a large group of the terminated employees had awards vesting on the same date. It might be best to accelerate vesting of the awards in question.
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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.
A significant portion of stock plan administration involves employee communications. Communications break out into four basic categories: standard education materials, plan documents and agreements, individual statements and alerts, and correspondence. It is important to not only document delivery of (or access to) many communications, but also archive them so that they are accessible in the future. Plan documents and grant agreements receive the most scrutiny when it comes to documentation and archival procedures. It’s more difficult to know which of the other communications may either be the focus of a misunderstanding or the resolution to it.
Standard Education Materials
This is what your plan participants look to for answers regarding their own equity compensation. As you update educational materials, be sure to document the dates and locations that older versions were available. This is true for both printed and electronic materials. For printed versions, ensure that outdated versions are no longer available at any location within your company. It’s a good idea to date each printed version of your educational materials, with a note that the current version supersedes any previously distributed version(s). If your materials are posted on the intranet or otherwise available online to plan participants, be sure that there no outdated materials or links remain accessible after they have become obsolete. In addition, alert participants to updated materials so that they are aware of changes being made.
Individual Statements and Alerts
In the case of individual statements and alerts, aside from confirming the accuracy of all information delivered, possibly the most important factor is being able to prove delivery. Your broker may be able to assist with this for statements delivered via the individual brokerage account. Confirm what technology is available and for how long.
If you send alerts or statements to employees internally, consider how you will document delivery. See if you can use a return receipt, or if it’s possible to deliver via the intranet and archive access records. In addition, it’s best if you can archive the actual statements and alerts rather than relying on your stock plan administration database to reproduce it at a later date.
Correspondence
Of these four, correspondence generally receives the least amount of scrutiny and is least likely to be archived. It’s not feasible to have your legal team approve each and every response that you provide to participant inquiries, and so the risks of communicating information that is inadvertently incorrect, misleading, or could be taken as tax or investment advice. Additionally, it’s likely that some correspondence takes place outside the stock plan management team.
Ideally, your company would have a common repository for interaction records with employees that could be easily referenced by employee, date, or subject. Since I don’t actually know of one single company that has a system like this in place, I’ll scrap the ideal for now. If all you have is Outlook, then devise a strategy for archiving sent e-mails, including which types of correspondence qualifies as important enough to archive. It could be by location, topic, or whatever makes the most sense for you and your team. Don’t forget to document your strategy for future reference!
Why Bother?
This all might sound like a lot of work, but there are two very good reasons to have a robust communications archiving practice. First, it may be necessary to recover communications in the event of a legal or compliance issue. Second, it can serve as a way to calm an agitated employee who feels that the stock plan management team failed to provide enough information. This is particularly true for alerts–if you can tactfully show an employee that they actually did receive a “missing” alert, she or he will be less likely to focus anger and frustration at the stock plan management team. Also, that employee will be way more likely to pay attention to communications from the stock plan management team in the future!
A Cautionary Note
The flip side of diligence in archiving communications is that they can be made available in the event your company is involved in a lawsuit. Depending on the issue and how closely it relates to equity compensation, it could obligate the stock plan administration team to a significant amount of time dedicated to retrieving archived communications.
Companies, regulators, and even employees are changing the way they look at equity compensation. We’ve seen new equity vehicles, changes to taxation of equity compensation, a more global and more mobile participant population, and more rigid attention being paid to compliance when it comes to tax withholding and reporting. Companies are finding that they need to consider a broader scope of implications when granting and managing stock plans. In the spirit of casting a broader net on managing equity compensation, here are two ways to protect your company by building flexibility into your grant agreements.
Global Grant Agreement
At industry events over the past few years, I have heard more advisors and companies recommending the use of a global grant document. The way this works is to create a general grant document with appendices that cover the country-specific language. The most important reason to use a global grant document is that it helps cover the issue of mobile employees. If an employee is granted in one country and moves to another country with country-specific requirements, then you have the protection of having provided those limitations, definitions, or tax withholding requirements already laid out in the original grant agreement. This can afford the company some protection to maintain compliance and also give the employee the opportunity to better understand the impact the move will have on his or her grant. As an added bonus, having a global grant agreement can reduce the administrative burden of designating the appropriate grant package to participants. If you would like to see what this kind of grant document might look like, check out this example posted to our NASPP Document Library.
Exercise and/or Tax Payment Methods
Giving employees the ability to choose which exercise price and tax withholding method will be applied to their transactions isn’t as attractive as it may sound at first. This flexibility can be confusing to employees and may create a large administrative burden. However, your plan and grant agreements both include language that affords the company the flexibility to apply as many payment methods as possible. You can incorporate language that permits all available payment methods in the documents and use policy to clarify which will be actually be available to employees. This helps to permit the company to respond to new regulations, restrictions, or other unforeseen circumstances. Include the flexibility to withhold tax even for jurisdictions in which you do not currently need to withhold in case the company’s obligation to withhold taxes changes later.
Don’t miss our webcast today on tax reporting for stock compensation. Today’s session is one of our popular “Ask the Experts” series. Our panel of experts will cover everything you need to know to fulfill U. S. tax reporting requirements for all forms of stock compensation and address specific questions submitted by NASPP members. Don’t miss out! Join in at 4: 00 p.m. Eastern.