In late March, ISS issued an updated Equity Compensation Plans FAQ. This development was largely eclipsed by the FASB’s issuance of ASU 2016-09, so I haven’t had a chance to get around to it until now. Here is a quick summary of the most significant updates:
Plan Amendments
FAQ 2 has been updated and a new FAQ 28 has been added to clarify that plan amendments may be evaluated under the Equity Plan Scorecard (EPSC), if the amendment could increase the potential cost of the plan. (By “cost,” ISS means dilution or shareholder value transfer; ISS is less concerned with the actual P&L expense.)
In other cases, i.e., amendments that don’t increase cost to shareholders, ISS evaluates the amendment based on whether it is favorable to shareholder interests, but without going through the whole EPSC.
Plans submitted for shareholder approval solely for Section 162(m) purposes fall into a separate category and ISS hasn’t changed or clarified anything with respect to these proposals.
Share Withholding
ISS suggests requesting new shares or extending the term of a plan as examples of the types of amendments that would trigger a new EPSC evaluation, but my guess is that this would also include amendments to allow share withholding for taxes up to the maximum tax rate when the shares withheld will be returned to the plan (my blog from last week explains why these amendments are necessary).
It’s possible that the timing of the release of these updated FAQs is not coincidental. It’s also possible I’m paranoid; hard to say. But then again, just because I’m paranoid, doesn’t mean ISS won’t apply the EPSC to your share withholding amendment. This issue is definitely a hot button for ISS. If your plan allows shares withheld for taxes to be returned to your plan, it’s a good idea to discuss this with whoever advises you on ISS concerns before you amend your plan.
Performance Awards
Previously, the FAQ provided that ISS would consider performance awards as being subject to accelerated vesting upon a CIC, unless the amount paid was tied to the performance achieved as of the CIC and was pro rated based on the amount of the performance period that was completed.
The new FAQ states that:
If a plan would permit accelerated vesting of performance awards upon a change in control (either automatically, at the board’s discretion, or only if they are not assumed), ISS will consider whether the amount of the performance award that would be payable/vested is (a) at target level, (b) above target level, (c) based on actual performance as of the CIC date and/or pro rated based on the time elapsed in the performance period as of the CIC date, or (d) based on board discretion.
I’m not sure this changes much, but it does seem to be a more nuanced position.
The FASB recently ratified an EITF decision and approved issuance of an Accounting Standards Update on “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period” (their words, not mine).
What the Heck?
I was completely baffled as to when an award would have a performance condition that could be met after the end of the service period. After all, isn’t the period over which the performance goals can be met the very definition of a service period? So I spoke with Ken Stoler of PwC, who translated this into English for me.
Turns out, it’s a situation where the award is no longer subject to forfeiture due to termination of employment but is still subject to some sort of performance condition. Here are two situations where we see this occur with some regularity:
Retirement-Eligible Employees: It is not uncommon for companies to provide that, to the extent the goals are met, performance awards will be paid out to retirees at the end of the performance period. Where this is the case, a retirement-eligible employee generally doesn’t have a substantial risk of forfeiture due to termination but could still forfeit the award if the performance goals aren’t met.
IPOs: Privately held companies sometimes grant options or awards that are exercisable/pay out only in the event of an IPO or CIC. The awards are still subject to a time-based vesting schedule and, once those vesting requirements have been fulfilled, are no longer subject to forfeiture upon termination. But employees could still forfeit the grants if the company never goes public nor is acquired by a publicly held company.
The EITF’s Decision
The accounting treatment that the EITF decided on is probably what you would have guessed. You estimate the likelihood that the goal will be met and recognize expense commensurate with that estimate. For retirement-eligible employees, the expense is based on the total award (whereas, for other employees, the expense is also commensurate with the portion of the service period that has elapsed and is haircut by the company’s estimate of forfeitures due to termination of employment).
For example, say that a company has issued a performance award with a grant date fair value of $10,000, three-fourths of the service period has elapsed, and the award is expected to pay out at 80% of target. In the case of a retirement-eligible employee, the total expense recognized to date should be $8,000 (80% of $10,000). In the case of an employee that isn’t yet eligible to retire, the to-date expense would be, at most, $6,000 ($80% of $10,000, then multiplied by 75% because only three-fourths of the service period has elapsed). Moreover, the expense for the non-retirement-eligible employee would be somewhat less than $6,000 because the company would further reduce it for the likelihood of forfeiture due to termination of employment.
The same concept applies in the case of the awards that are exercisable only in the event of an IPO/CIC, except that, in this situation, the IPO/CIC is considered to have a 0% chance of occurring until pretty much just before the event occurs. So the company doesn’t recognize any expense for the awards until just before the IPO/CIC and then recognizes all the expense all at once.
Doesn’t the EITF Have Anything Better to Do?
I had no idea that anyone thought any other approach was acceptable and was surprised that the EITF felt the need to address this. But Ken tells me that there were some practitioners (not PwC) suggesting that these situations could be accounted for in a manner akin to market conditions (e.g., haircut the grant date fair value for the likelihood of the performance condition being met and then no further adjustments).
I have no idea how you estimate the likelihood of an IPO/CIC occurring (it seems to me that if you could do that, you’d be getting paid big bucks by some venture capitalist rather than toiling away at stock plan accounting). And in the case of performance awards held by retirement-eligible employees, my understanding is that the reason ASC 718 differentiates between market conditions and other types of performance conditions is that it’s not really possible for today’s pricing models to assess the likelihood that targets that aren’t related to stock price will be achieved. Which I guess is why the EITF ended up where they did on the accounting treatment for these awards. You might not like the FASB/EITF but at least they are consistent.
I’m on the east coast, and we’ve had a long and brutal winter this year (at least by this California girl’s standards). So you may be able to imagine that I (along with millions of others oppressed by the frigid weather) breathed a huge sigh (not to be confused with a sigh of relief) when the famous groundhog, Punxsutawney Phil, saw his shadow on this year’s Groundhog Day (February 2nd). The folklore says that when the groundhog sees his shadow, winter will continue at least another 6 weeks – not welcome news for those of us who have been freezing for way too long.
What does Groundhog Day have to do with stock plans? What I wanted to suggest is that if there were a groundhog used to forecast stock plan activity (perhaps a cousin of the weather predicting one in Pennsylvania), I would bet that this year he’d be seeing his M&A shadow, suggesting a blockbuster year is ahead for M&A activity. The buzz is virtually everywhere from the Wall Street Journal to firms like Morgan Stanley and issuer companies themselves (to name only a few – there are many others) predicting a very robust M&A market this year.
Why We Care About M&A
Stock plan professionals know that a merger or acquisition often involves stock plans. Grants from an acquired company may be assumed or cancelled. New grants may be issued to incoming or existing employees as a result of the transaction. Not only is there likely to be stock plan activity, but it is possible we could be seeing record volumes and values of grants. Last week’s acquisition of WhatsApp by Facebook included $3 billion in restricted stock unit shares alone.
Why You Should Care About M&A
It’s important that stock plan administrators get a seat at the table in M&A task force meetings or discussions. Historically, it was not uncommon for the stock plan group to be among the last to know about the latest M&A activity, sometimes after the terms of the deal had been finalized. If stock plan shares are going to be a component of the transaction in any form, the stock plan group needs to be involved.The last thing you want is to find out that a deal is done, and the terms are just too challenging to administer. Or, they can be handled, but only with great effort and time consuming labor involved.
Brush Up On Your M&A Needs and Wants
Here are a few suggestions to get your brain working on the M&A front:
Put your feelers out. M&A may or may not be a present internal topic of discussion, but you can start the discussion. Let key decision makers know that you want to be involved from the get-go should the M&A bug take hold in your company. It’s not too soon to have a conversation – even if you’re not aware of any imminent activity.
Brush up on what you’d actually need if an M&A transaction landed on your doorstep. Sure, you may not be able to predict everything you’d need right now, but you can remind yourself of the key things that you’d likely want to know if someone was standing at your door informing you that your company just acquired that XYZ company down the block. It’s not uncommon for there to be little or no advance warning for a merger or acquisition. In thinking through the types of things you’d need to know, you’ll be much better prepared if and when that day comes.
With the most promising M&A season in years upon us, now is a great time to revisit the NASPP’s M&A portal. There are articles to remind you of what you need to know if you find yourself handling M&A activity. There is also a sample M&A Conversion Checklist and other tools to ease you through the process.
Only time will tell if our fictional stock plan groundhog would have been right. Given the accuracy of the groundhogs so far this year, perhaps it’s time to get ahead of the game on this one.
For today’s blog, I have another exciting smorgasbord of random stock plan related tidbits.
IRS Issues GLAM on Stock Compensation Deductions and CICs In January, the IRS issued general legal advice memorandum AM2012-010 clarifying that when NQSOs and SARs are cashed out due to a change in control, the tax deduction is attributable to the acquired company. This is because the obligation to make the payments became fixed and determinable at the closing and the payments were for services performed prior to the acquistion.
Two things to note here:
This is unfortunate because chances are the target company isn’t all that profitable, making the deduction less than useful.
The acronym for this type of IRS pronouncement is GLAM. That makes the whole thing sound way cooler than it actually is.
For more information see the WSGR alert we posted on this development.
ISS Theme Song: Coming Around Again? I’m sure you’ve heard about this by now, but just in case, ISS has announced that it will replace the GRId analysis system with a new system called “QuickScore,” which does have the advantage of sounding niftier and friendlier. If you are thinking “what the heck, didn’t they just switch to the GRId system,” time must be flying by for you just as fast as it does for me. ISS switched to GRId back in 2010 (I blogged about it, see “Will ISS Red Light Your Stock Compensation?” March 23, 2010). Still, it does feel like ISS is changing systems almost as often as they change their name.
Under QuickScore, companies will receive a relative ranking from 1 to 10 (1 is good, 10 is bad) by region and industry, instead of the color coded (red, yellow, green) score companies received under GRId. Which is similar to ISS’s Corporate Governance Quotient system that was replaced by GRId. Sort like how ISS changed to RiskMetrics and then changed back to ISS.
Backdating Bad for Your Career A recent academic study found that CFOs that lost their job as a result of option backdating have had a tough time re-entering the workforce. Only 18.7% found a comparable position (compared to 35.1% of CFOs that had lost their job for other reasons) and only 48.4% found any full-time corporate position (compared to 83.8% of other CFOs).
Which was a little surprising to me because how would a potential employer even know that’s how you lost your job? You wouldn’t exactly put “falsifying corporate records to reduce expense” under the skills listed on your resume and, in my experience, companies don’t give out that kind of information about former employees. But I guess a quick Google search these days can be very revealing about job candidates.
One misperception I often encounter among private companies is that the rules don’t apply to them. And by “rules,” I’m referring to just about everything from tax and accounting to securities laws. A recent SEC enforcement action, however, highlights that even private companies can be the subject of SEC scrutiny.
Securities Laws: They’re not Just for Public Companies
“It would look really bad to have my 2 sons award me a whole bunch of additional stock right before a sale of the company at a stock price many times the price used to calculate my stock.” – Charles Stiefel, CEO of Stiefel Labs, in email to his sons (Stiefel and his sons were the only members of the compensation committee).
Really? Ya think?
The SEC complaint alleges that Stiefel Laboratories, a small family-owned business, undervalued its stock when buying stock back from employee shareholders and failed to disclose information to employees that would have alerted them to the fact that the price they were receiving was too low. At the time of the buybacks, the company had received purchase offers based on valuations of the company’s preferred stock that were 50% to sometimes 300% higher than the price offered to employees.
The company employed a third-party accountant to value their stock, but failed to disclose numerous key facts to the accountant, including that management was actively shopping the company for sale. The company also represented to employees that it would remain privately-held, so employees had no expectation that there would be any opportunity to sell their stock other than through the company buyback program, and the company misrepresented how the stock was valued.
The SEC is seeking disgorgement of profits, civil monetary penalties, and to bar Charles Stiefel, the CEO, from serving as an officer or director of a public company.
The Enforcement Process
The company was acquired by GlaxoSmithKline in 2009. Now, I know what you are thinking: “If the company doesn’t exist anymore, how can the SEC pursue an enforcement action against it.” I’ll admit it, I was wondering that as well. Alan Dye explained to me that when a company acquires another company, it also acquires all of that company’s liabilities, including, apparently liabilities that haven’t even come to light at the time of the acquisition. So the SEC will pursue GlaxoSmithKline in the matter. If, as part of the merger agreement, GlaxoSmithKline received representations and warranties from the folks in control of Stiefel (i.e., Charles Stiefel and other officers) that there were no violations of law and the SEC successfully proves that there was a violation of law (thus making the representations false), then GlaxoSmithKline can sue the folks that made those representations for damages.
Employees that sold their stock back to Stiefel at the depressed prices can also sue for damages, unless the SEC recovers those damages for them through disgorgement.
Don’t Cheat, Don’t Lie, Pay Attention
The first lesson here is that even private companies must comply with securities laws and can be subject to SEC enforcement. The action demonstrates how important it is for private companies to obtain qualified and accurate valuations of their stock and that they inform the practitioners performing the valuations of all relevant facts. Finally, the action demonstrates that it is important for private companies to be honest with employees about the company’s business strategy, particularly to the extent that this strategy impacts the value of the company’s stock and employees’ investment decisions. Companies that aren’t prepared to be honest with employees about valuation and strategy should probably stick to cash-based compensation.
And for acquirers of private companies, part of your due diligence should include reviewing the company’s stock valuations for reasonableness. Seems like maybe GlaxoSmithKline should have noticed that Stiefel’s valuations were significantly lower than Glaxo’s own valuation of the company.
20th Annual NASPP Conference in New Orleans I’m excited to announce that the 20th Annual NASPP Conference will be in New Orleans from October 8-11, 2012. New Orleans is always a fabulous location for us and this year’s event is sure to be fantastic. Look for information on early-bird registration later this week and submit your speaking proposal by March 2.
NASPP followers on Twitter and Facebook knew the dates and location of the Conference last Friday. Follow the NASPP on Facebook and Twitter to make sure you don’t miss our next big announcement.
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 local NASPP chapter meetings in Los Angeles, Orange County, Philadelphia, and Silicon Valley. Larry Reynolds of E*TRADE and I will be presenting on cost-basis reporting at the Silicon Valley meeting. I hope to see you there!
Last Tuesday, January 25, the SEC issued final regulations on Say-on-Pay votes. For the most part, the SEC adopted the proposed regulations, with only a few minor adjustments.
As expected the regulations require three non-binding votes:
Say-on-Pay: Shareholders must be permitted to vote on executive compensation every one, two, or three years. The first vote must be held at the company’s first annual meeting on or after January 21, 2011. Shareholders will be voting on the compensation paid to executives as disclosed in the proxy statement.
Say-on-Pay-Frequency: Shareholders must also be permitted to vote on how frequently the company holds a Say-on-Pay vote. This vote must occur at least every six years, with the first vote occurring at the company’s first annual meeting on or after January 21, 2011.
Say-on-Parachutes: Shareholders must be permitted to vote on golden parachute arrangements. If these arrangements have not previously been voted on, this vote must be included in the proxy statement relating to the merger (or similar transaction) for which the compensation will be paid. This requirement applies to filings on or after April 25, 2011.
McGuireWoods provides a good summary of the final regulations; we’ll be posting an alert with links to additional memos as we receive them.
Other Dodd-Frank Rulemaking Delayed As Broc Romanek mentioned in his blog (“Four of Corp Fin’s Dodd-Frank Rulemakings Delayed,” January 27, 2011), the SEC has pushed back its estimate of when proposed rules will be issued for the following projects:
Pay-for-performance disclosure (how compensation is related to financial performance)
Pay ratios (ratio of CEO pay to median employee pay)
Clawback policies (clawback of officers’ compensation upon financial restatement)
Hedging policies (whether the company has a policy regarding the ability of directors and employees to hedge)
Based on the SEC’s revised timeline for implementing the Dodd-Frank Act–the proposed rules now aren’t expected until August, at the earliest, and possibly as late as December–Broc speculates that rules for these projects may not be finalized in time for the 2012 proxy season.
A More Social NASPP The NASPP has boarded the social networking train: you can now follow us on Twitter or like us on Facebook. We’ll be posting announcements whenever we post new content on Naspp.com–it’s a great way to keep up with all the content we have on the website.
NASPP Members Eligible for Discount on CEP Exam If you’ve been thinking about enrolling for the Certified Equity Professional exam, now is the time to do it. Because the NASPP serves on the CEP Institute Advisory Board, we are able to offer NASPP members a $200 discount on the June 4, 2011 exam.*
The CEP program is the certification standard for the equity compensation industry, comprised of a three-level, self-study program in the technical regulatory issues affecting equity compensation.
Visit the CEPI website for more information on the program. To take advantage of the NASPP member discount, contact the CEPI at (408) 554-2187. Don’t wait; registration closes on April 22.
* The Fine Print: Eligible registrations include new Level 1, Level 2 or Level 3 registrations for individuals who are involved in administering or managing their own company’s equity programs. Deferrals and re-tests are not eligible for a discount. Individuals already registered are not eligible for a retroactive discount. Candidates from service providers do not qualify. Questions regarding eligibility can be directed to the CEPI at (408) 554-2187.
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.
If you are in the San Diego area, attend the San Diego NASPP chapter meeting on Wednesday, Feb 2. Robyn Shutak, the NASPP’s Education Director will there; be sure to say hello!
These were the words uttered recently by a stock plan manager in reference to managing a “small and simple” merger project internally with no additional resources.
Relatively few stock plan managers found themselves in this situation last year. We saw a dramatic decrease in M&A activity in 2009, which is no surprise given the condition of our economy. However, the second half of the year did bring with it increased M&A activity, and news sources are all abuzz with anticipation for 2010.
Even though a merger or acquisition may be exciting for shareholders and a great way for a company to grow, it can be a serious undertaking for a stock plan manager. If an acquisition or merger is potentially in your future, start brainstorming now on what that project management will look like for you and your team.
The Left Hook
What’s the big deal, you ask? Just give me the employee and grant data along with the terms of the transaction, and I’ll throw it in Excel, work my magic and have the imports ready to process. (I mean, you should see how smooth my annual grant procedures are!) Well, if there’s one thing you can guarantee about a merger or acquisition, it’s that some part of the process of gathering and crunching your data will not go as planned. It could be something as clear cut as a spreadsheet with mismatched data (say names matched with the wrong SSNs) sent to you by the other company or a real doozy like finding out that the grants in an international location were actually all out of compliance with regulations in that country.
So, expect the unexpected when projecting the amount of time you’ll need to process the transaction and leverage your friends and peers who’ve gone through a merger or acquisition themselves. In fact, ask around at the next NASPP chapter meeting you attend and find out who’s had experience with M&A (even if you’ve done a few yourself) and ask them for just one issue they encountered in their transaction that they weren’t expecting. You can tuck those thoughts away in your “just in case” file and pull them out if your company brings you a merger or acquisition this year. If you’re looking for a more comprehensive approach to being prepared, enroll in our online education program, “Tackling Equity Compensation Issues Related to Mergers and Acquisitions,” and get a heavy dose of the due diligence considerations that you’ll want to know to put together a smooth transaction.
The Decision Dilemma
If you will be assuming any portion of the outstanding stock grants, then there are a lot of issues to consider. Converting grant data means really identifying the administrative, tax, and financial accounting consequences your decisions and finding the best balance for your company. For example, will you be converting just shares outstanding or including historical data as well? It may make sense to convert both outstanding and historical grant data because you will be acquiring ISO grants and dealing with shares purchased from an ESPP. Having the historical data makes tracking disqualifying dispositions easier. However, the “new” historical data will impact reports you run for periods prior to the transaction and you will need to accommodate the additional shares that will appear to be granted from your plan. For many issues, you will find that there all your choices have a downside. Decide what works best for your company by bringing other departments (like payroll and finance) in on the conversation and testing your strategies out in a mirror database before going live.
Think Outside the Box
So, that brings me back to the idea of how to manage your resources on a merger or acquisition. If you have a large stock plan management team and are dealing with a relatively small acquisition, you might be able to allocate enough resources to complete the transaction internally. However, if you are a one-person team or one that is already pushing the envelope on time commitment, you should give outsourcing a serious look.
Of course, you want to make the most of your consulting dollar! That means getting multiple quotes and asking the right questions. Ideally, if you’re getting help on your merger or acquisition, the individual or firm you bring in on the project will have experience with a similar transaction. However, no two transactions are the same. You know your company’s history, administrative priorities, and database best. It’s possible that you are the best person for the job or that your company is just not comfortable with handing over any part of the transaction to an outside resource. If that’s the case, you can still get help for your project. Think outside the box and bring someone in to help with your standard administrative responsibilities and free yourself up to focus on the merger or acquisition.