If your company provides equity compensation to employees in China, then you are likely grappling with the complexity of obtaining and maintaining compliance with your company’s SAFE filing. One important ongoing issue is the requirement that proceeds from the sale of shares be repatriated. China isn’t the only country that has a repatriation requirement. However, it does, to my knowledge, have the most rigorous enforcement of it.
China puts the onerous on the company to repatriate proceeds from the sale of shares acquired through equity compensation programs. In order to maintain compliance, companies need to tackle creating a process for ensuring repatriation.
Immediate Sale
One way to ensure that proceeds from sales are sent back to China is to force an immediate sale of shares at the original acquisition (e.g., at option exercise or RSU vest). By doing this, the company does not need to worry about tracking shares after they are acquired by the employee. Depending on the functionality provided by your designated broker, this approach may also make quarterly reporting easier, which I’ll address below. However, forcing the immediate sale of shares denies Chinese employees the ability to capitalize on any future increase in the value of those shares. Arguably, the value of this arrangement is no more advantageous to the employee than cash compensation that is tied to share value. In addition, the terms of outstanding grants may not give the company the flexibility to require the immediate sale.
Tracking Shares
Many brokers now have the ability to place a hold on proceeds from sales made through specific employee accounts and remit those funds back to a corporate account. This makes it possible for China plan participants to hold shares and sell them at a date of their choosing and still comply with the repatriation requirement. Of course, you will need to confirm that employees can’t transfer the shares out of the employee account at any time, even after termination. You’ll also want to fully understand how employees are identified as subject to the hold and have appropriate safeguards in place to make certain those identification markers are accurate.
Converting to RMB
Regardless of the method in which proceeds from sales are repatriated to China, funds are sent to the company’s bank account in China in U.S. dollars and must be converted to RMB. Your company must decide if this conversion is done by the company or by the employees individually. If the company is transacting the exchange through the dedicated bank account, the RMB can be distributed to the employee through individual bank accounts or through payroll. However, the company may need to receive approval from the local SAFE office for each conversion and there may be limitations on the number of times that the currency may be exchanged each year. If the company will be disbursing U.S. dollars, then employees must have a U.S. dollar account.
Quarterly Reporting
Regardless of your approach, SAFE offices require information about the source of the incoming funds, including the original acquisition date of the shares, to be reported on a quarterly basis. Some brokers have the functionality to provide this data to clients already. At a minimum, you will need to know the total proceeds net of broker fees associated with each employee and the number of shares sold, in which case you must create a policy and procedure on associating the sales with specific acquisitions (e.g. option exercises or RSU vests). Talk with your broker to understand what information can be provided at this time.
Last week while I was thinking about the ongoing issues for companies with equity compensation in India, the Federation of Indian Chambers of Commerce & Industry (FICCI) was considering the ongoing issues for employees. This week, FICCI issued a letter to the finance ministry asking that the taxation of ESOPs (Employee Stock Option Plans) be amended (See the press release here.).
In the proposal, FICCI asks that the discount value at grant, as opposed to the spread at exercise, be taxed as income. FICCI argues that only the discount provided by the company at grant represents the consideration given to the employee by the company; any increase in value after that is more like investment income. FICCI maintains that taxing the spread at exercise as a perquisite is counter to the SEBI guidelines for stock options.
The press release focuses on the section of the SEBI guidelines that stipulates the fair value of an option should not be adjusted for “changes in the price of the underlying stock, volatility, the life of the options, dividends on the underlying stock, or the risk-free interest rate.” Although the FICCI proposal does mention that SEBI guidelines define the FMV of an option as the market price prevalent on the grant date, it fails to mention that this “market price” referenced in the guidelines is actually the trading value of the option, or estimated trading value based on a valuation model (e.g., a Black-Scholes valuation). At any rate, this is merely a request to the finance ministry at this point. It remains to be seen whether or not the finance ministry will even entertain the idea. Because it would probably result in a decrease in tax revenue, my gut tells me no…but stranger things have happened!
Ads by Google: Or, “An ESOP by Any Other Name”
While reading an article on the FICCI proposal, Google ads saw a great acronym and gave me a targeted add for the ESOP Association. Because of that, I learned that October is Employee Ownership Month, which, I must admit, caught me by surprise. Although employee ownership is a foundation for most equity compensation, Employee Stock Ownership Programs (ESOPs) in the United States are specific programs under which shares of company stock are placed in a trust. Shares in the trust are allocated to employees based on whatever parameters have been set up by the company. The allocated shares typically vest over time, but vested shares are not actually issued to the employee until termination.
October has been Employee Ownership Month for more than 20 years; it’s a month set aside to educate the public (not just employees) about the benefits of employee ownership (i.e., ESOPs). According to the ESOP Association, “…companies celebrate with picnics to honor their employee owners, hold roundtable discussions with local public officials and organizations to spread the word about employee ownership, and some hold awards ceremonies to honor outstanding employees.”
So, I searched and searched, but I couldn’t find anyone that celebrates an “Equity Compensation Month.” With the cyclical nature of bad press on equity compensation, I certainly think we could benefit from one. Wouldn’t it be great if companies everywhere celebrated equity compensation at the same time?
When it rains, it pours. After months of ho hum news on options backdating, we see four colorful backdating cases come across our desks: the Comverse Technology storythat Barbara blogged about on Tuesday, Maxim Integrated Projects, Brocade Communications, and KB Homes.
Dead Men Tell No Tales
Former Maxim Integrated Solutions CFO, Carl Jasper, finds himself facing civil securities fraud charges that he deliberately attempted to mislead investors and knowingly signed off on false financial statements. His defense is not, like many, that he was unaware of the backdating. Rather, Jasper’s defense is that it was out of his control. He contends that former CEO, Jack Gifford, conducted more than a bit of arm-twisting in the orchestration of the whole backdating practice at Maxim. Instead of “I was not aware,” his defense is “it was out of my control.” What’s more, Mr. Gifford is regrettably unavailable to confirm or deny Jasper’s defense, as he passed away in 2009. (See this Law.com article.)
This story and the Comverse saga illustrate that if you’re being forced to go along with something you know is wrong, sometimes your best alternative is to just walk away. Otherwise, you could find yourself accountable for wrongdoing when the person who actually made the decision is either dead or remains a fugitive. Not a happy thought.
Déjà Vu
The first CEO to be convicted by a jury in the backdating crackdown was re-convicted on March 26th. A federal jury found former Brocade Communications CEO, Gregory Reyes, guilty of 9 out of 10 counts against him (finding him not guilty of only the charge of conspiracy). Although Reyes was originally convicted in 2007, the conviction was thrown out on the basis of prosecutorial misconduct. (See thisBloomburg article.)
Reyes’s defense has been that it was the finance executives who were in charge of complying with accounting rules and they failed to tell him that the backdating Reyes was a part of was illegal. The defense didn’t work the first time, and it didn’t work at the retrial. In fact, as a bit of irony, the crux of the overturning of the 2007 conviction was that the prosecutor stated that the finance department didn’t know about the backdating, Reyes did, while only calling the one person in the finance department willing to confirm. It’s a convoluted web of finger-pointing. Ultimately, I think the courts have grown weary of assertions that executives were unaware that their actions were illegal.
Never Look Back
Closing arguments are under way in the trial of former KB Home CEO, Bruce Karatz, who had been using the standby backdating “I had no knowledge of any wrongdoing” defense. Recently, however, the former KB Homes HR Director, Gary Ray, threw a wrench in the gears by testifying against Karatz. According to Ray, Karatz told him to “put the best interests of the company ahead of the truth” and cover up the instances of backdating. Even more colorful, Ray testified that Mr. Karatz told the company’s chief legal officer, “We don’t look back. We’ve never looked back. It’s not something we do in this company.” (See thisLA Times article.)
The moral? I guess it goes both ways. First, we can see that adequate controls will (eventually) uncover fraudulent practices. On the other side of the coin, trying to keep the knowledge of illegal practices within the company isn’t the best safety net and, ultimately, isn’t in the best interest of the company nor the individuals involved.
Today is the Day!
Barbara keeps a great “To Do” list at the end of each of her blog entries, but I want to really highlight the early-bird discount deadline. It’s today! Register now to get in on the $300 discount for our 18th Annual NASPP Conference.