In a prior installment of this blog, I explored the renewed interest in mandatory holding periods for equity compensation post vest. In today’s blog, we’ll look at some of the scenarios where this makes the most sense.

To catch everyone up, make sure you read Post-Vest Holding Periods – Part 1 (February 19, 2015).

We’ve looked at some general reasons why companies may find it attractive to implement a requirement for a participant to hold shares after they are vested. Among the top considerations are ease of facilitating clawbacks, good corporate governance, points on the ISS Equity Plan Scorecard, and the possibility of a reduced fair value accounting expense. I now want to dive into the nuances of where these holding periods seem to make the most sense.

Does One Size Fit All?

While there are many compelling reasons to implement a post vest holding period, a closer look suggests that this may not be a one size fits all approach. This means that not all employees and not all forms of equity compensation are considered “equal” in determining if and how to apply mandatory holding periods. Let’s cover the “who” first, and then the “what.”

Who Should be Subject to Post-Vest Holding Periods?

In contemplating the intent behind the post-vest holding periods (ease of clawbacks, good governance, ISS scorecard points, etc.) it becomes clear that the ideal target for mandatory holding is the executive population. Not only are they the subject of most of the logic behind the holding periods, but this is also a population that tends to have significant amounts of equity compensation. Beyond that level within the organization, there are likely to be varied opinions about who else should be subject to mandated holding periods. There may be a case to include other levels of management, such as middle or senior managers who receive equity compensation. Should post-vest holding periods be broad based? Probably not. Employees who have no equity have nothing to “hold” and those with limited equity (such as only via participation in the ESPP and/or a limited amount of stock options) don’t appear to fit the profile that supports the “why” behind implementing holding periods. Additionally, employees within the non managerial ranks of the organization have tend to have no influence over governance practices, are not subject to clawbacks, and don’t typically represent a significant piece of the accounting expense pie.

What Types of Equity Compensation Make the Most Sense?

We’ll explore three major categories of equity compensation: restricted and performance awards, employee stock purchase plans (ESPPs) and stock options. According to the sources I’ve heard from on this topic, stock options are the least likely candidate for a post-vest holding period. Any mandatory holding period would be tied to the shares post exercise and since the vast majority of stock options are exercised in a same-day-sale transaction, there are most often no shares to tie to a holding period.

With stock options generally off the table, we are left with ESPP shares and restricted stock and performance awards. In my opinion, ESPPs fall into the “maybe” category. Certainly a company could implement a post purchase holding period. However, a key question is whether the population most engaged in ESPP is the same population that would be targeted by post-vest holding periods. We’ll explore the “who” should be affected shortly, but that is a key question in determining whether ESPP shares should be subject to such a mandated holding. Even if executives participate in the ESPP, they are most often likely to have other forms of equity compensation that would be more significant targets for holding periods. Additionally, employees contribute their own funds to the ESPP, and this may be an additional concern in evaluating whether a holding period makes sense (not so much at the executive level where it’s usually deemed good to have skin in the game, but at the mid or lower levels of the company).

The last category is restricted stock and performance awards/units. This appears to be the most likely area of focus for post-vest holding periods. In considering subjecting these types of award to mandatory holding post-vest, companies will need to consider the timing of taxation for awards and units. Restricted stock awards (absent an 83(b) election) are taxed upon vest, and the existence of a mandatory holding period can complicate matters if the participant is not permitted to sell shares to cover the taxes. Restricted stock units are subject to income tax when the award is distributed, making it more attractive to attach these types of awards to post-vest holding. Since income tax isn’t due until the shares are released to the employee, companies could delay settlement until after the post-vest holding period, eliminating the question of how to pay taxes if shares can’t be sold. FICA/FUTA taxes will still be due at vest for both awards and units, but there are ways to collect those taxes over time (such as using the IRS’s Rule of Administrative Convenience) or via payroll deduction from other cash compensation.

Scratching the Surface

This blog can only be so long, and I’ve only scratched the surface on the considerations for post-vest holding periods. One significant evaluation that I left out is the potential for a discount on the fair value for equity compensation subject to mandated hold after vest. This week I was fortunate enough to catch the DC/MD/VA Chapter meeting which (by pure coincidence) was on this exact topic. Terry Adamson of Aon Hewitt and Gustavo Dalanhese of E*TRADE did a great job of bringing companies up to speed on all of these considerations, including a deeper dive into the fair value savings. One thing I learned is that (several factors considered, including stock volatility) the discount can be significant. This is not a minor perk, but could be a strong driver in a company’s evaluation of whether or not to implement a post-vest holding period. We’re out of time today, but the good news is that next week’s NASPP webcast (March 11th) will explore this in much more detail. Be sure to tune in. And, for a quick run down, check out our Hold After Vest podcast episode (it’s much shorter than the webcast, so not as much detail, but definitely a great primer on this topic).

-Jenn