As most of my readers know, the FASB has amended ASC 718 to expand the exception to liability treatment that applies to shares withheld to cover taxes to include withholding up to the maximum individual tax rate. This has led many companies to consider changing their tax withholding practices for stock compensation.
Plan Amendment Likely Necessary
As noted in my blog entry “Getting Ready for the New Share Withholding” (May 5, 2016), companies that are interested in taking advantage of the expanded exception face an obstacle in that virtually all stock plans include a prohibition on using shares to cover taxes in excess of the minimally required statutory withholding. Where companies want to allow shares to be withheld for tax payments in excess of this amount, the plan must first be amended to allow this.
Shareholder Approval Not Necessary
In the aforementioned blog entry, I had noted that it wasn’t clear if shareholder approval would be required for the plan amendment, particularly if the shares withheld will be recycled back into the plan. I have good news on this question: both the NYSE and Nasdaq have amended their shareholder approval FAQs to clarify that this amendment does not require shareholder approval, even if the shares will be recycled.
Nasdaq (ID number 1269, it should be the last question on the second page. Or do a keyword search for the word “withholding” and the relevant FAQ should come right up.)
For a while, there was still a question as to whether the NYSE required shareholder approval when shares withheld from restricted stock awards would be recycled. In late December, John Roe of ISS arranged for the two of us to meet with John Carey, the Senior Director at NYSE Regulation, to get clarification on this. Just prior to our meeting, the NYSE updated their FAQs to clarify that shareholder approval is not required even in the case of share withholding for restricted stock awards, even when the shares will be recycled.
ISS Still Not a Fan of Share Recycling
It should come as no surprise that, where the withheld shares will be recycled, ISS isn’t a fan of amendments to allow shares to be withheld for excess tax payments. Now that it’s clear shareholder approval isn’t required for the amendment, this likely isn’t a significant concern for most companies, unless they are submitting their plan for shareholder approval for some other reason. It isn’t a deal-breaker, but it could enter into ISS’s qualitative assessment of the plan. This would particularly be an issue if ISS’s recommendation is tied to more than the plan’s EPSC score.
Not a Modification for Accounting Purposes
There also has been some question as to whether the amendment would be considered a modification for accounting purposes if applied to outstanding awards. Based on the FASB’s recent exposure draft to amend the definition of a modification under ASC 718 (see “ASC 718 Gets Even Simpler,” November 22, 2016), the FASB doesn’t seem to think modification accounting is necessary. The comment period on the exposure draft ended on January 6. There was little opposition to the FASB’s position: only 14 comment letters were received, one letter clearly opposed the change, 12 supported the change, and one was “not opposed” but not enthusiastic. Given that response, hopefully the FASB will finalize the proposed update quickly so that this question is settled.
In my blog entry this week titled “Other ISS Policy Amendments,” I said that ISS no longer permits the 5% carve-out with respect to minimum vesting requirements. This statement was not correct. ISS will still permit up to 5% of shares granted under a stock plan to vest quicker than required under the plan’s minimum vesting requirements. I apologize for my error and any confusion it created; I have corrected my original entry.
On November 29, I discussed ISS’s amendments related to dividends paid on awards (ISS Targets Dividends on Unvested Awards), but that’s not the only amendment to their 2017 Proxy Voting Guidelines that impacts stock compensation programs. For today’s blog entry, I discuss the other amendments.
Minimum Vesting Requirements
The plan must specify a minimum vesting period of one year for all awards to receive full points for this test under the Equity Plan Scorecard. In addition, no points will be earned if the plan allows individual award agreements to reduce or eliminate this vesting requirement (note, however, that ISS still permits an exception for up to 5% of shares awarded).
Anyone who listened to my podcast “Five Things Barbara Baksa Learned About the ISS Equity Plan Scorecard” knows that I’m not a fan of this test in the EPSC because I’m convinced it is just a compliance disaster waiting to happen. And now that the plan can’t allow any exceptions to it all, I like it even less.
Plan Amendments
Although ISS didn’t deem this change significant enough to include it in the Executive Summary, the policy with respect to how plan amendments are evaluated has also been updated. For most types of substantive amendments (i.e., amendments that aren’t purely administrative or that aren’t solely for purposes of Section 162(m)), the plan will be reevaluated under the EPSC and ISS will assess the amendments on a qualitative basis.
It isn’t clear to me why the EPSC isn’t enough by itself (since it would be enough for a new plan). Apparently ISS just doesn’t like some stuff that companies do with their equity plans and they want to be able to recommend that shareholders vote against amendments that would add those features to your plan, even if they would be allowed under the EPSC.
Where private companies are submitting a plan to shareholders for the first time, the plan will have to pass the EPSC even if no new shares are being requested (e.g., if the plan is submitted solely for Section 162(m) purposes) and ISS will make a qualitative assessment of any amendments.
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.
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.
Companies that grant stock options know that there are a few core challenges that have maintained their existence throughout the life span of these types of equity arrangements. Among them: how to handle the impending expiration of an in-the-money, unexercised grant.
Does it Really Happen?
Stock plan education site, myStockOptions.com, cites the issue of expiring options as one of the “top mishaps with stock options that can cost you money”. This issue of lost dollars creates a conundrum for many companies – if the option expires, there is risk for a disgruntled employee who may decide to litigate. Even if litigation doesn’t happen, many employees who find themselves in that situation often beg for reinstatement of the option, which is not without cost to the company (in the form of additional compensation expense that would need to be incurred for the reinstated option, which would be treated like a new grant in-the-money grant for accounting purposes). These scenarios usually motivate employers to prevent the options from expiring.
Preventing Expiration
While the issue of expiring options remains relatively unchanged – as long as there are stock options, there will be concern around the impending expiration of in-the-money grants – the approaches to handling this situation continue to evolve. The most common practices include outreach programs to remind optionees that their grant is about to expire. This communication can be performed by the company, or, via a third party service provider. Although these programs seem to reduce the number of expired grants, there are no guarantees that a grant will be exercised – the action still falls squarely upon the participant.
New Ideas
In recent years, a new approach has emerged as a practical solution to this age old problem: the auto-exercise. The essence of the auto-exercise is that an in-the-money, otherwise unexercised stock option will automatically be exercised at or shortly before the close of the market on the date of expiration. The “type” of exercise that will be executed is usually determined by the company in conjunction with the service provider who will perform the exercise, in compliance with the company’s plan terms. I don’t have any formal survey data on which auto exercise types are most popular, but I’d say net issuance and sell-to-cover are on my radar as the most logical methods, with an edge to net issuance.
This is not a new concept – auto exercise has been used for publicly traded options for years. However, in adopting this approach for internal stock plans, there are considerations – some of which were recently highlighted in a Fidelity memo titled “Safeguarding Your Employees’ Stock Option Grants“, available on the NASPP web site. This particular article heavily advocates the use of net issuance in these situations; I’ll recap some of the concepts (with my own flavor added) from that angle:
Cash Flow: Companies need to carefully consider their cash flow when determining which auto exercise method to use. Withholding of shares (net exercise) to cover the exercise costs means that the company will need to remit the tax payment, from its own coffers, to the IRS.
Plan Provisions: Again, regardless of which exact method is chosen, it’s important to ensure the chosen method is permissible under the plan terms. If there is no provision, it may be necessary to secure a plan amendment.
Treatment of Existing Options: When implementing an auto exercise program, a determination must be made as to whether this applies to all grants (existing and new) or only on a forward basis (new grants). Addition of this type of feature to an existing grant is considered a Type 1 modification for accounting purposes, but would be no incremental expense.
Threshold for Automatic Exercise: A determination needs to be made as to how far the options need to be “in-the-money” in order for the auto exercise to execute. Usually a threshold to net one share would be the minimum amount, since most plans and service providers wouldn’t permit a fractional share issuance in these scenarios.
What if the Employee Doesn’t Want Auto-Exercise?
Lastly, there’s the scenario of an employee who actually didn’t want to exercise their in-the-money options and complains that the company has now created a taxable event on their behalf. While that is a consideration, Fidelity points out that “the result of exercising in-the-money options still provides a net financial benefit to the employees, even after accounting for taxes. Moreover, companies routinely create taxable events by paying out full-value stock awards to employees, so a case can be made that the automatic exercise of in-the-money options should be treated no differently.”
Do YOU Have Auto-Exercise?
I do think this solution is slowly gaining traction. Let’s test that thought – take the quick poll below. I think it’s definitely worth consideration, especially for companies that seem to have a significant number of in-the-money options expire.
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).
I often hear that liberal share counting–i.e., allowing shares tendered to the company for net exercises and tax withholding–is a deal-breaker with ISS. Turns out, this isn’t always the case. For full value awards, allowing shares tendered for taxes to return to the plan is okay. Moreover, if you don’t have a flexible share reserve (or a cap on the number of shares that can be issued as full value awards), liberal share counting is also okay.
This is because the only impact of a liberal share counting provision is that ISS will treat all options and SARs as full value awards in their shareholder value transfer analysis. But full value awards are already treated as full value awards in that analysis, so there’s no reason not to use liberal share counting for these awards. And without a flexible share reserve or a cap on the number of shares that can be issued as full value awards, ISS assumes that all shares under the plan will be issued as full value awards.
Black-Out Periods and Post-Exercise Grace Periods
It is possible for stock plans to provide that, where a black-out period occurs during the post-termination exercise period for stock options, the exercise period is automatically extended. This ensures that all former employees have the same amount of time to exercise their options without having to modify the options (and perhaps take an accounting hit) at the time of termination. I imagine it also might head off lawsuits that might be filed if former employees aren’t able to exercise due to a company-imposed blackout. (Of course, in no event, should the extension allow the option to be exercised beyond the original contractual term of the option.)
Shareholder Voting Bias
One consideration in the decision to amend vs. adopt a new plan is that shareholders might have a slight bias for new plans. Just a slight bias–when considering this decision, W.W. Grainger was advised that approval rates for new plans were maybe 1% to 2% higher than for plan amendments–but still, every little advantage helps.
Majority for NYSE Companies
For stock plan proposals, NYSE companies need a majority not just of the votes cast but of their total votes outstanding. That’s a much higher bar to acheive and, since brokers can’t vote on stock plan proposals without receiving direction from shareholders, could be a challenge for companies with high levels of lackadaisical shareholders, e.g., retail investors and probably even employees. When stock plan proposals are in your proxy statement, make sure employees are aware of them and vote.
You’re Not Getting Away With Anything
You may have some older plans with a lot of unused shares still available for grant–maybe even an non-shareholder approved plan that you slipped in before Nasdaq and the NSYE tightened up those requirements–and you (or your execs) may think those plans are flying below the radar. Not so. Your shareholders, particularly institutional investors, and their advisors, are aware of those plans (after all, you are disclosing these plans under Item 201(d) in the proxy statement) and these plans are likely to impact how shareholders will vote on current stock plan proposals. If you aren’t using these plans, maybe it’s time to get rid of them.
The Early-Bird Gets the Vote
You might have been thinking that this webcast was timed oddly–really too late to do anything about stock plan proposals for this year’s proxy season. But, in fact, the webcast was timed just about right for getting started on next year’s proposals. If you expect to go out to shareholders with a proposal that is significant enough that it warrants consideration of amending an existing plan vs. adopting a new plan, you want to start that process about a year ahead of time. Even better would be to start two years ahead of time and get the proposal into your proxy statement a year early, so you have another chance if the proposal fails.
These were just a tiny portion of the many great practical tips presented during the webcast. If you missed it, the audio archive is now available and the transcript will be posted in a couple of weeks.
Online Financial Reporting Course–Only a Few Days Left for Early-Bird Rate There are only a few days left to receive the early-bird rate for the NASPP’s newest online program, “Financial Reporting for Equity Compensation.” This multi-webcast course will help you become literate in all aspects of stock plan accounting, including the practical considerations and technical aspects of the underlying principles. Register by this Friday, April 29, for the early-bird rate.
2011 Domestic Stock Plan Administration Survey The NASPP is excited to announce the launch of our 2011 Domestic Stock Plan Administration Survey, covering administration and communication of stock plans, ESPPs, insider trading compliance, outside director plans, and ownership guidelines. You must participate in the survey to receive the full survey results. Register to complete the survey today–you only have until May 20 to complete it.
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.
Register for 19th Annual NASPP Conference (November 1-4 in San Francisco). Don’t wait; the early-bird rate is only available until May 13.
Register for the NASPP’s newest online course, “Financial Reporting for Equity Compensation.” Don’t wait; the early-bird rate is only available until this Friday, April 29.