Last week I blogged about the SEC’s agenda for this year, which includes a heavy focus on continued enforcement actions. While this is certainly one area on our radars, I’m reminded that there are other areas of “action” that could cast scrutiny on our practices. One such area is litigation. A few months ago, I blogged about one type of litigation that had taken hold – the shareholder driven lawsuits that challenged proxy disclosures. What I didn’t explore was all of the other areas where we’ve seen “action” in the form of enforcement or litigation. In today’s blog I’ll explore other areas (including some you may not have thought about) that have been the subject of a lawsuit.
I had a great aid in preparing this blog. Thanks to Executive Pay and Loyalty, I was able to access a “cheat sheet” that literally organizes stock award litigation by topic, complete with corresponding court cases. The full document is available on our web site.
Litigation Lessons Learned
What lessons have been learned from litigation in recent years? Here are a few of them:
Termination of Employment: This is a sensitive area, one that I’m betting is ripe for litigation. Not so much because an employee is terminated (that’s more of an HR concern), but if the employee misses the opportunity to exercise vested in-the-money stock options, they may come forward wanting restitution or compensation. The filing of a lawsuit doesn’t automatically make it a valid claim, or mean that the company will lose. We are reminded that sometimes there are “nuisance” cases – particularly if an employee simply “missed” the key pieces of information that would explain post termination provisions. Whether or not the claim is a solid one, any litigation takes time, money and focus away from more constructive activities. I see a couple of ways to minimize litigation opportunities in this situation – one is an “auto-exercise” of the vested stock option (See my recent blog on “The Case for Auto-Exercise”, January 16, 2014); another is to proactively send terminated employees the key documents that remind them of post employment provisions.
Defining Plan Terms: The more defined your plan terms are, the better. According to Executive Pay and Loyalty, it is better to have a longer plan document with explicit definitions than not. Litigation involving ambiguities is likely to be resolved against the employer. If you’re seeing a plan provision that is repeatedly the subject of questions or challenge from employees, this may be something to raise to your legal counsel to see if further clarification is needed.
Option Expiration During Blackout Period: The cheat sheet I mentioned suggests that employers be wary of stock options that expire during a blackout period. It is a best practice for plans to expressly address this in order to avoid angering employees and former employees who lose value due to a black-out period that interferes with their final time to exercise a stock option. I have actually seen several plan documents that are silent on this issue, so if your plan is up for amendment or overhaul, this may be a good area to document a defined practice. If it’s not in the plan document, at minimum identify a consistent approach or procedure for options expiring during a blackout and communicate it to employees in writing.
The Bottom Line
All of the issues described above have been the subject of court cases, and the suggestions I outlined are based on the result of those lawsuits. For more information on specific cases and a list of the other areas affected by litigation (including 162(m), and director compensation), check out the full Stock Plan and Award Litigation: Risk Management Checklist I mentioned as the basis for this blog.
We know we’re entrenched in a world that is highly regulated, scrutinized, audited and evaluated. The more we evolve our practices to be preventative, the better equipped we’ll be to stand up to investigations, enforcement actions, lawsuits and other nuisances.
Today I have a grab bag of short topics for you, each worth mentioning but none are really long enough for their own blog.
The Most Ridiculous Section 162(m) Lawsuit Ever Last year, a Delaware federal court ruled in favor of a company that was the subject of lawsuit alleging that their incentive plan had not been properly approved by shareholders for Section 162(m) purposes. The plaintiff argued that because Section 162(m) requires the plan to be approved by the company’s shareholders, all shareholders–even those holding non-voting shares–should have been allowed to vote on it. Shareholder votes are governed by state law but the plaintiff attorney argued that the tax code preempted state law on this matter. Luckily the judge did not agree.
The plaintiff also argued that the company’s board violated their fiduciary duties because they used discretion to reduce the payments made pursuant to awards allowed under the plan. The plaintiff stipulated that this violates the Section 162(m) requirement that payments be based solely on objective factors. In a suit like this, the plaintiff attorney represents a shareholder of the company; it seems surprising that a shareholder would be upset about award payments being reduced–go figure. In any event, it’s fairly well established that negative discretion is permissible under Section 162(m) and the judge dismissed this claim.
Glass Lewis Policy Update Glass Lewis has posted their updated policy for 2014. For US companies, the policy was updated to discuss hedging by execs (spoiler alert: Glass Lewis doesn’t like it) and pledging (they could go either way on this). With respect to pledging, Glass Lewis identifies 12–count ’em, that’s 12–different factors they will consider when evaluating pledging by execs.
The policy was also updated to discuss the SEC’s new rules related to director independence and how the new rules impact Glass Lewis’s analysis in this area. Although we now have three perfectly good standards for director independence (Section 16, Section 162(m), and the NYSE/NASDAQ listing standards), Glass Lewis has developed their own standards and they’re sticking to ’em. I’m sure I’ve asked this before, but really, how many different standards for independence do we need? I’m not sure director independence is the problem here.
Should Your Plan Limit Awards to Directors? As you are getting this year’s stock plan proposal ready for a shareholder vote, one thing to consider is whether to include a limit on awards to directors. In 2012, a court refused to dismiss one of the plaintiff’s claims in Seinfeld v. Slager because the plan did not place sufficient limits on the grants directors could make to themselves and, thus, were not disinterested in administration of the plan, at least with respect to their own grants.
Today I discuss recent litigation over mishandled FICA taxes on a nonqualified deferred compensation plan that could also have implications for RSUs.
The Lawsuit
The case involved a company that failed to collect FICA taxes on benefits paid under a nonqualified deferred compensation when the taxes were due. Because of this, and because the applicable statute of limitations during which the company could go back and amend the return for the year in which FICA should have been paid had elapsed, the company was obligated under IRS regulations to collect FICA when the benefits under the plan were paid out. The payouts occurred after the employees had retired.
The plan provided for payouts to occur in increments over a period of years, and, because the retirees were no longer actively employed, they had no other wages subject to FICA. As a result, the payouts were subject to Social Security. If the company had collected FICA when it should have, the payouts might not have been subject to Social Security because 1) the retirees would have still been employed and would have possibly met the wage cap for Social Security in those years; 2) the wage cap would have been lower; and 3) the entire amount would have been subject to Social Security in the same year, rather than in small increments over many years. A retiree brought suit against the company essentially claiming that because this was the company’s error and the error increased the amount of FICA tax that he has to pay, the company should have to pay his FICA tax for him.
This situation could also come up in the context of RSUs. Certainly it could apply where RSUs are subject to deferred payout, but more commonly it is likely to be a concern where RSUs provide for accelerated/continued vesting upon retirement and are granted to or held by employees that are eligible to retire. In that circumstance, the RSUs are substantially vested and are subject to FICA before they are paid out.
I learned a couple of important things from this that are applicable to RSUs.
There Is a Statute of Limitations
Who knew? If you screw up on FICA withholding for RSUs, you have a limited period of time in which to go back and fix this. That time is approximately three years (although the actual calculation of the statute of limitations is a little more complicated so if this applies to you, talk to your tax advisors).
FICA Taxes Revert Back to Payout
Even more interesting, if you don’t find the error and correct it before the statute of limitations runs out, your only choice is to collect FICA when the awards are paid out. Again, I say, who knew?
No Need to Panic, Yet
All this is interesting, but, of course, our primary interest is whether companies could be liable to participants for mishandled FICA taxes on RSUs. At this point, it’s hard to tell. Although there has been one decision in favor of the retiree, this case is far from over (that decision just allows the case to proceed), so who knows if the retire will prevail. And even if he does, the situation in this case isn’t fully analogous to RSUs. For one thing, the retiree is claiming a violation of ERISA, which typically doesn’t apply to RSUs.
Moreover, RSUs typically pay out at the time of retirement, not over a period of years after retirement. Thus, in the case of RSUs, there wouldn’t be a question of the payments being subject to Social Security when they otherwise wouldn’t have if FICA had been collected on time. The error would only increase FICA taxes through an increase in the stock price (which would mostly apply only to Medicare since Social Security is capped), an increase in the Social Security wage cap, and maybe differences in compensation levels (but only for employees that don’t otherwise normally earn enough to max out on Social Security). Even where employees are subject to tax at the higher 2.35% Medicare rate, it seems unlikely that any of those things would be worth suing over.
When public companies are contemplating changes to their stock compensation programs, it is not uncommon to ask the NYSE (or Nasdaq, depending on where their stock is trading) for an informal opinion as to whether the changes require shareholder approval. Today I blog about a recent Delaware court ruling that calls the authority of these informal opinions into question.
Here is the sequence of events:
A company wants to grant a large ($120 million) “performance award” to its CEO that will vest only upon continued service; the stated purpose of the award is retention. The company’s stock plan doesn’t allow grants of performance awards that vest merely on continued service, so this requires a plan amendment.
The company asks the NYSE if the plan amendment requires shareholder approval and an NYSE staffer tells the company that the amendment doesn’t require shareholder approval.
The company proceeds with the amendment and issues the grant.
The grant quickly garners a lot of negative attention from the media.
A shareholder (a large pension fund) sues the company’s board and CEO, alleging that the plan amendment was illegal. The gist of the argument is that shareholder approval of the amendment is required under the NYSE listing standards and that, because the plan has a provision in it requiring shareholder approval of amendments when such approval is required by the exchange on which the company’s stock is traded, the amendment isn’t legal under the terms of the plan.
The lawsuit has along ways to go before we get an actual decision, but the Delaware Chancery Court has allowed the lawsuit to proceed, despite the fact that the company has an informal opinion in writing (an email) from an NYSE staffer stating that the amendment did not require shareholder approval.
My synopsis here is based on the very excellent Sullivan & Cromwell memo summarizing the case that is posted on Naspp.com. In addition to the highlights I’ve covered here, the memo includes a great discussion of some of the key factors the judge considered in issuing the ruling. If you are going to be seeking informal guidance from the NYSE or Nasdaq, you should definitely check it out–you might pick up a couple of pointers to make the opinion you receive a little more reliable.
I Have a Couple Questions
This saga raises a couple of questions for me (and since the company involved does not appear to have any NASPP members, I feel unfettered in my contemplation of them).
First, why didn’t the company just amend the plan to allow for the grant of RSUs, rather than the seemingly much more convoluted and backwards amendment to allow the grant of performance awards that don’t vest based on performance. Honestly, in today’s “pay-for-performance” world, that just seems like asking for trouble. The plan already allows the grant of restricted stock that vests based purely on service and question C-3 of the NYSE’s FAQs on the shareholder approval requirements specifically states that where a plan already allows the grant of restricted stock, an amendment to allow the grant of RSUs is not material. Seems like not only might this have avoided the lawsuit (or at least the ruling allowing the lawsuit to proceed) but the company also wouldn’t have had to bother with the informal opinion from the NYSE. I’m sure there must be good reason, but I’m completely baffled as to why the company didn’t approach the amendment this way.
Second, how much do you have to pay your CEO to get him to stay? $120 million seems like a lot, just to get the guy to stick around. And, in this case, the CEO’s last name happens to also be the name of the company, which isn’t a coincidence–he’s the son and nephew of the co-founders of the company. And it takes $120 million to get him to stick around? That just seems wrong.
Some Barbara Trivia
One interesting piece of trivia is that the company involved is a large real estate investment trust that happens to own the shopping mall that was my sister’s and my favorite when we were growing up. We spent a lot of time at that mall. (What? We lived in the suburbs and that’s what suburban kids did back then–they went to the mall).
For today’s entry, I have several follow-up items relating to a few of my recent blog entries.
Your Favorite Words 10 pts. to Sheila Jan of Life Technologies for accepting my challenge in “Holiday Fun” (December 18, 2012) and submitting her own favorite word with an example of how it might be used at a holiday gathering. Sheila’s submission:
Tranche: I’m going to help myself to a second tranche of the mashed potatoes!
A Little More on Excess Withholding Susan Eichen of Mercer reminded me that allowing employees to use share withholding to cover more than just the statutorily minimum required tax payment will trigger liability treatment under ASC 718, even if the proscribed W-4 procedures are followed (see my blog entry from last week, “Supplemental Withholding“). If the difficulty of the W-4 withholding process wasn’t enough, this makes one more reason to prohibit excess withholding for restricted stock and units (for NQSOs, where shares are generally sold on the open market, rather than withheld, to cover taxes, this is less of a concern).
Proposed Regs on New Medicare Tax The IRS has issued proposed regs on withholding the additional 0.9% Medicare tax that applies to wages in excess of $200,000 for individuals/$250,000 if married filing jointly. No surprises here, the procedures are as I described them back in August (“The Supreme Court and Stock Compensation“):
The company withholds the additional 0.9% tax on any wages in excess of $200,000 that are subject to Medicare, regardless of the employee’s filing status or wages paid to his/her spouse.
Any overpayments or underpayments as a result of the employee’s filing status/spousal income will be sorted out on the employee’s tax return. The company has no obligations here.
Employees can’t request that the company withhold additional Medicare tax (for example, if they have received wages of less than $200,000 but know that their wages, when combined with their spouse’s wages, will exceed $250,000). In this case, employees should submit a new Form W-4 to increase their withholding for federal income tax purposes. This will then offset the deficit in Medicare withholding when they file their tax returns.
Follow-up on Lawsuits Targeting Stock Plan Proposals On November 6 (“Martha Steward and Your Proxy Statement“), I blogged about a new type of shareholder lawsuit that seeks to extract plaintiffs’ attorney fees from companies by alleging that the disclosures in connection with their stock plan proposals (e.g., adopting a new stock plan or allocating shares to an existing plan) are inadequate. There now have been over 30 of these suits filed, with no end in sight as proxy season ramps up. We’ve posted a new alert, “Shareholder Lawsuits Target Stock Plan Proposals,” that collects several law firm memos on the suits as well as a interesting commentary on them from Stanford (“Shareholder Lawsuits: Where Is the Line Between Legitimate and Frivolous?“). It’s worth your time to catch up on this issue.
If you are an issuer that will be submitting a request for additional shares for your stock plan to a shareholder vote in the upcoming proxy season, you need to read this blog. I’m filing this under “don’t say I didn’t warn you.”
What Does Martha Stewart Have to Do With This?
A while back, a short blurb about Martha Stewart Living Omnimedia caught my eye and I put it in my back pocket for a future blog entry if I ever figured out what the heck it was about. The blurb appeared in Mark Borges’ proxy disclosure blog on CompensationStandards.com:
Martha Stewart Living Omnimedia Inc. was the target of a shareholder class action lawsuit alleging that the company’s disclosure in connection with a proposal to increase the share reserve of its omnibus stock plan was inadequate.
This intrigued me because:
In my other, non-stock compensation life, I secretly want to be Martha Stewart (but with better hair and no insider trading scandal), so I’m fascinated by anything involving her. (Don’t scoff–I’m very crafty! I make all my own window treatments, can refinish a dining room table, and can whip up some pretty tasty jams and jellies.)
It involved the company’s stock plan, which falls squarely into the category of “things I care a lot about.”
Now, thanks to Mike Melbinger’s Oct 26 blog entry on CompensationStandards.com, I’ve finally figured out the implications of the lawsuit and determined that, if you are an issuer, it should be something you care a lot about as well.
Lawsuit Over Stock Plan Disclosures Could Delay Shareholders Meeting
There have now been several similar lawsuits filed. The lawsuits allege that the company’s disclosures relating to stock plan or Say-on-Pay proposals are inadequate and seek to delay the shareholders meeting. As Mike explains it:
[Companies] are forced to decide between (a) paying the class action lawyers hundreds of thousands of dollars of attorneys’ fees and issuing enhanced disclosures or (b) fighting the matter through a preliminary injunction hearing, which may have the effect of delaying [their] shareholder meeting (and create additional legal fees).
One company has already paid $625K to plaintiff attorneys to settle a similar lawsuit and, while they didn’t have to delay their entire annual meeting, they still had to delay the vote on their stock plan and file a supplement to their proxy statement with additional disclosures about the plan.
What Can You Do?
Mike asks “Does that sound like Armageddon?” and I’d say that it sure sounds like that me. Mike says that it is too soon to panic but suggests taking extra care in drafting your disclosures relating to any stock plan proposals and your Say-on-Pay propoals. A recent memo we posted from Orrick has suggestions for fortifying both types of disclosures against attack. Here are their suggestions for disclosures relating to any stock plan proposals:
Disclose the number of shares currently available for issuance under the stock plan and explain why the existing share reserve is insufficient to meet future needs. Consider citing your current burn rate and anticipated shares needed for new grants over the next year.
Explain how the remaining shares in the reserve and the new shares will be used and how long the new share reserve is expected to last.
Describe how you determined the number of shares you are requesting approval of.