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.
Does your company issue grants to outside directors out of the same plan that you issue grants to executives and other employees? If do you, does the plan expressly limit the number of shares that can be granted to directors over a specified period of time?
If it doesn’t, you aren’t alone. According to the NASPP/Deloitte Consulting 2014 Domestic Stock Plan Administration Survey, 77% of respondents’ plans don’t include a limit on grants to outside directors. But a recent spate of litigation, including a lawsuit that Facebook recently agreed to settle, suggest that maybe companies should rethink this practice.
What Litigation?
The lawsuits cover a range of issues related to stock and executive compensation. Some suits allege excessive compensation and some allege deficiencies over stock plan disclosures or proxy disclosures. In addition to Facebook, companies that have been targeted in these suits include Republic Services, Citrix Systems, Goldman Sachs, Cheniere Energy, and Unilife. One common denominator in all of these suits, however, is that the plaintiffs allege that because the company’s outside directors can receive unlimited awards under the plans, they aren’t disinterested administrators of the plan.
Why Is Disinterested Administration Important to these Lawsuits?
These lawsuits are all “derivative” actions (which are lawsuits brought by a shareholder on behalf of the corporation, usually alleging that management is doing something that is to the detriment of the corporation). In a derivative lawsuit, the plaintiff has to meet a “demand” requirement for the suit to proceed. Demand means that the plaintiff asked the company to investigate the matter and the company either refused to investigate or the shareholder doesn’t agree with the outcome of the investigation. In a lot of cases, these suits never get past the demand stage.
But, there is an exception to the demand requirement in lawsuits over stock compensation plans. Can you guess what it is? Yep, that’s right, the demand requirement is excused if a majority of the directors administering the plan lack independence. Plaintiffs are claiming that directors who can receive unlimited awards under a plan aren’t disinterested.
What Happened with Facebook?
Well, first of all, once a suit gets past the demand stage, it gets expensive. So the first thing is that Facebook had to spend a bunch of money on their own lawyers. That, in and of itself, is reason enough to want to keep any of these suits from getting past the demand stage.
The settlement Facebook agreed to includes the following provisions:
Corporate governance reforms, including (A) an annual review of all compensation (cash and equity) paid to outside directors, (B) engage a compensation consultant to advise the company on this review and on future compensation to be paid to outside directors, and (C) use the results of the review to make recommendations to the board on future compensation to outside directors.
Submit the 2013 grants to outside directors to shareholder vote (these grants were the subject of the lawsuit). Hopefully the shareholders approve them–I’m not sure what happens if they don’t (but I’m pretty sure it would make a good blog entry).
Submit an annual compensation program for directors to shareholders for approval. The program has to include specific amounts for equity grants and has to delineate annual retainer fees. As far as I can tell, this is a one-time requirement, for Facebook’s 2016 meeting; if I understand the settlement correctly, the board is allowed to make changes to the program in the future, commensurate with the results of the annual review required under #1 above.
Pay an award of attorneys’ fees and expenses to plaintiff’s counsel not to exceed $525,000 (this is, of course, in addition to whatever Facebook has paid to its own counsel).
A Simple Fix
The simple fix to avoid all of this is to have a limit on the awards that can be issued to outside directors in your plan. If your company is submitting a stock plan to shareholder vote this year, it is worth considering adding a limit like this to your plan.
Thanks to Mike Melbinger of Winston & Strawn for providing a handy summary of the Facebook settlement, as well as a number of the other lawsuits, in his blog on CompensationStandards.com (see “Follow-Up on Facebook Litigation Settlement,” January 29, 2016).
Today I look at recent litigation relating to the use of non-compete provisions in award agreements. The case (Newell Rubbermaid v. Storm) involves an employee, Sandy Storm (yes, that’s her real name), of Newell Rubbermaid. Storm was responsible for the sale of infant and juvenile products (sold under the Graco brand) by Newell Rubbermaid to Target. In 2013, Storm signed an RSU agreement that included a number of post-employment restrictive covenants (e.g., relating to confidentiality, use of trade secrets, and non-solicitation) that effectively prohibited her from competing with Newell Rubbermaid. In 2014–you guessed it–she resigned from Newell Rubbermaid to work for one of their competitors (Artsana) selling infant and juvenile products (including to Target).
What is interesting here is that the Delaware Chancery Court agreed that the restrictive covenants are enforceable and issued a temporary restraining order against Storm. In today’s entry, I discuss some other aspects of the case that I think are interesting.
An Online Agreement and Acceptance
The agreement was distributed online and Storm consented to it with an electronic signature. The court did not seem to view this any differently than if the agreements had been in paper format and she had manually signed them, saying “Agreements may, of course, be made online.”
You Really Should Read All Those Online Agreements
Storm had not read the agreement, so she didn’t know about the restrictions. She knew that other employees had been asked to sign separate non-compete agreements, so, before resigning, she checked several other sources for prohibitions against working for a competitor (including her personnel file and the company intranet) and didn’t find anything. But she didn’t think to check her RSU agreement. And who can blame her–she thought that agreement related solely to her RSU award, which she was going to forfeit anyway because it wasn’t vested, and she’d signed RSU agreements in 2011 and 2012 that didn’t contain these provisions.
The court didn’t care, saying “Storm is understandably unhappy that she did not read the 2013 Agreements…She altered her post-employment rights in a manner she appears to regret now, but it was her choice to modify her rights without fully investigating the terms to which she agreed.” Harsh! Something to keep in mind the next time you accept an online service agreement without reading it.
Enforcement Went Beyond Forfeiture of the Award
What we typically see with non-compete provisions in awards is that the award is forfeited (or, if vested, clawed back) if the employee violates the provision. The employee essentially has a choice of (A) keeping the award or (B) competing. That wasn’t the case here. The restrictive covenants apply regardless of whether the award is forfeited. In fact, the award had not yet vested by the time Storm terminated, so she forfeited it regardless of where she went to work after leaving Newell Rubbermaid. The question is not whether she gets to keep the award but whether she can work for Newell Rubbermaid’s competitor at all. It’s a lose-lose situation for her; she already forfeited the award and now she’s out of work.
New Possibilities and Challenges
This certainly opens up some new possibilities for award agreements. Mike Melbinger of Winston & Strawn and blogger at CompensationStandards.com thinks, given Storm’s level in the organization and access to sensitive information, this particular scenario might even withstand a challenge in California.
But a provision like this would be a darn good reason for an employee to refuse to accept an award. Storm’s future employment opportunities were limited as soon as she accepted the award agreement (without even reading it!). Enforcing acceptance of award agreements is already a challenge (see the NASPP webcast “Is Silence the Answer? Acceptance of Grant Agreements“), giving employees a legitimate reason to decline them makes this process even harder.
Moreover, a key consideration for the court was that Storm checked a box labeled “I have read and agree to the terms of the Grant Agreement,” and clicked a button labeled “Accept.” The court reviewed screen shots of the page that Storm used to accept the agreement and emphasized this in its decision. I’m not sure that the court would have sided with Newell Rubbermaid if Storm hadn’t had to voluntarily take action to accept the award. And many companies don’t get serious about enforcing acceptance until awards are about to vest. Storm’s award hadn’t vested yet; if Newell Rubbermaid had taken that approach, Storm would probably be happily working at their competitor today.
At the same time that the IRS released regulations designed to clarify which restrictions constitute a substantial risk of forfeiture under Section 83 (see my blog entry “IRS Issues Final Regs Under Section 83,” March 4), a recent tax court decision casts doubt on the definition in the context of employees that are eligible to retire.
Background
As my readers know, where an employee is eligible to retire and holds restricted stock that provides for accelerated or continued vesting upon retirement, the awards are considered to no longer be subject to a substantial risk of forfeiture, and, consequently, are subject to tax under Section 83. This also applies to RSUs, because for FICA purposes, RSUs are subject to tax when no longer subject to a substantial risk of forfeiture and the regs in this area look to Section 83 to determine what constitutes a substantial risk of forfeiture.
Although there’s usually some limited risk of forfeiture in the event that the retirement-eligible employee is terminated for cause, that risk isn’t considered to be substantial. As a practical matter, at many companies just about any termination after achieving retirement age is treated as a retirement.
Austin v. Commissioner
In Austin v. Commissioner however, the court held that an employee’s awards were still subject to a substantial risk of forfeiture even though the only circumstance in which the awards could be forfeited was termination due to cause. In this case, in addition to the typical definition of commission of a crime, “cause” included failure on the part of the employee to perform his job or to comply with company policies, standards, etc.
Implications
Up until now, most practitioners have assumed that providing for forfeiture solely in the event of termination due to cause is not sufficient to establish a substantial risk of forfeiture, regardless of how broad the definition of “cause” is. Austin seems to suggest, however, that, in some circumstances, defining “cause” more broadly (e.g., as more than just the commission of a crime) could implicate a substantial risk of forfeiture, thereby delaying taxation (for both income and FICA purposes in the case of restricted stock, for FICA purposes in the case of RSUs) until the award vests.
On the other hand, there are several aspects to this case that I think make the application of the court’s decision to other situations somewhat unclear. First, and most important, the termination provisions of the award in question were remarkably convoluted. So much so that resignation on the part of the employee would have constituted “cause” under the award agreement. There were not any special provisions relating to retirement; all voluntary terminations by the employee were treated the same under the agreement. In addition, the employee was subject to an employment agreement and the forfeiture provisions of the award were intended to ensure that the employee fulfilled the terms of this agreement.
Finally, the decision notes that, for a substantial risk of forfeiture to exist, it must be likely that the forfeiture provision would be enforced. I think that, for retirees, this often isn’t the case–the only time a forfeiture provision would be enforced would be in the event of some sort of crime or other egregious behavior. Termination for cause is likely to be met with resistance from the otherwise retirement-eligible employee; many companies feel that, with the exception of circumstances involving clearly egregious acts, it is preferable to simply pay out retirement benefits than to incur the cost of a lawsuit.
Never-the-less, it is worth noting that 26% of respondents to the NASPP’s recent quick survey on retirement provisions believe that awards held by retirees are subject to a substantial risk of forfeiture.
This week I attended the annual CEP Symposium hosted by the Certified Equity Professional Institute at Santa Clara University. This was no ordinary CEP Symposium – it was the Institute’s 10th annual event, and also celebrated the Institute’s 25th anniversary. With so many great sessions at this event, it was hard to choose some tidbits to share in today’s blog. Finally, I decided to share with you 5 things I learned from Mark Borges, who delivered this year’s keynote address (and, by no coincidence, delivered the keynote at the first CEP Symposium years ago).
1. Performance-based pay is the new “norm.” That’s probably not surprising to many of us who are in the trenches of administering these programs, but the part that caught my attention is that shareholders are also catching on to the mainstream prevalence of these awards. The bottom line: if you are not using performance-based pay (which includes awards), your shareholders are likely to say something – now or in the near term future.
2. The proxy statement has become a “communication” tool, rather than a “compliance” tool. Some of the bigger brands have caught on to this concept and are investing in magazine-like layouts, looks and feels in designing and delivering their proxies. For examples, check out this year’s proxies from General Electric and Coca-Cola.
3. Executive pay litigation isn’t over. We’ve been through a couple phases of litigation initiated by shareholder plaintiff attorneys. The first round mostly focused on failed say-on-pay votes. The second round turns to inadequate proxy disclosures – mostly around stock plan proposals. Where is the litigation moving next? The eye seems to be turning to the technical non-compliance with the qualified performance based exception under Section 162(m).
4. Say-on-pay disclosures may be headed towards inclusion of more supplemental or responsive insights. It’s not far fetched to envision a table in the proxy that reports detailed results of shareholder say-on-pay votes and a matrix to address concerns raised by shareholders. 5. Don’t forget about the impending CEO pay ratio disclosure requirements coming from the SEC. The Commission is still scheduled to adopt rules this year, with a likely effective date somewhere in 2014 and implementation in 2016. These disclosures are expected to be both informative and inflammatory.
All in all, this year’s Symposium was a great event. I remember the first one – attended by somewhere around 75 people. This year’s attendance appeared to be just over 400. Congratulations to the Santa Clara University and the CEPI on their 25th anniversary in supporting the equity compensation profession, and for another successful event!
It’s once again proxy season and many companies will be asking their shareholders to vote on proposals relating to their stock plan. Most of these proposals probably add more shares to the plan, but there are a number of other plan amendments companies might seek shareholder approval for, including:
To add a new type of award that can be granted under the plan
To change the employees eligible to participate in the plan
To increase the limit on the number of shares that can be granted to one employee or some other plan limit
To extend the term of the plan
In some cases, companies aren’t making any changes at all to the plan, but are merely seeking shareholder approval to preserve the plan’s exempt status under Section 162(m) (where a plan doesn’t state the specific performance conditions that awards will be subject to, the plan has to be approved by shareholders every five years).
To Bundle or Not Bundle
It is not unusual for a company to have two or more changes to their stock plan that they are asking shareholders to approve. Where this is the case, the company can bundle all the changes into one proposal or can present each change as a separate proposal subject to a separate vote.
Bundling presents shareholders with an all-or-nothing proposition; they either approve all the changes or they approve none of them. It seems to me that this could go either way for the company. If shareholders are a little opposed to some of the changes but mostly supportive, they might overlook their niggling doubts and vote for the proposal. On the other hand, if shareholders strongly oppose one of the changes, they might vote against the entire proposal and the company doesn’t get any of the changes that it wanted.
Shareholders Wanting Their Cake and Eating It Too
Mike notes in his blog that there have been some recent lawsuits alleging improper bundling of changes (and expresses hope that the SEC’s new CDI will help resolve/prevent these suits), particularly where one of the changes is beneficial to shareholders. This is interesting to me because my guess is that where a company bundles a shareholder-friendly change with another change, the shareholder-friendly change is probably included solely to pave the way for shareholders to approve the other change.
For example, a company might bundle a proposal allocating new shares to the plan with an amendment to restrict the company from repricing options without shareholder approval. The repricing restriction is likely included because the company has received negative feedback from shareholders on this issue (repricing without shareholder approval is considered a poor compensation practice by ISS) and is afraid the share allocation won’t be approved without it. The two proposals have a symbiotic relationship: the company isn’t willing to agree to the repricing amendment unless shareholders agree to the share allocation. Forcing companies to unbundle the two amendments means the company could end up having to implement the shareholder-friendly amending without getting the other change that it wanted.
A Poll
I conclude this blog with a short poll on how you are handling your shareholder proposals this year.
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.