A little blurb in the Wall Street Journal blog caught my eye this week. As it turned out, daily deal website Groupon had to rescind a portion of a restricted stock unit award to its Chief Operating Officer because the award exceeded a plan limit on share issuances to an individual – by 200,000 shares. I’ll cover the topic and the associated lesson that we need to reconcile, reconcile, reconcile awards and grants against all of the limits established in a plan.
What Happened?
In January 2013, Groupon’s COO was granted 1.2 million shares under a restricted stock unit award. From their own account in an 8-K filed with the SEC, the award exceeded a then-in-place 1 million share calendar year per person limit on awards – meaning the COO’s award exceeded that limit by 200,000 shares. It appears the error was not detected until a deep dive into the plans was done in conjunction with shareholder litigation. As a result of the discovery, Groupon rescinded the portion of the grant that exceeded the limit – 200,000 shares. This occurred just days before a portion of the award was scheduled to vest.
The Good News
The good news is that the error was detected in advance of shares vesting/sold. Had the shares vested and subsequently been sold, this would have made the situation more complicated to rectify. Even if not sold, had taxes been collected and the error gone unnoticed, the correction of the tax withholding could have gotten very complicated. Aside from the fact that the error was caught in advance of the vesting date, I can’t really think of any more “good news” in this situation.
The Bad News
This leaves me wondering how the error – for such a sizable, high profile grant – was not detected earlier. It seems to have gone unnoticed during quarter close and other periods where reconciliation seems to be likely. In fact, it appears that nearly a year went by without a blip on the stock plan radar. In addition, the correction involved public disclosure – another negative in this situation.
What Did We Learn?
Anytime there’s a negative involving errors and public announcements, I think it’s a prime opportunity for us to seek the lesson to be learned. In this case, this is a solid reminder that reconciliations need to extend beyond overall plan balances. It’s not enough to stop your analysis at the overall outstanding plan balance at the end of the quarter (which usually reflects beginning balance, plus any shares returned to the plan and minus any issuances). If your plan has internal limits on share types, maximum shares per award, or overall grants within a period of time, these parameters must be audited regularly. Examples of common limits within stock plans may include:
Limit on shares granted per award type: for example, no more than 3 million shares may be granted as restricted stock awards/units.
Limit on shares granted per option/award: for example, a grant to any individual cannot exceed 1 million shares.
Limit on shares granted within a specific window of time: for example, no more than 2 million shares in a calendar year.
If you have any of these types of share limits within your plans, you’ll want to ensure you are comparing grant and award activity to these limits. Ideally, this should initially be done at grant, and then double checked during the monthly or quarterly reconciliation process that follows. Year-to-date reconciliations should always be performed with each reconciliation process – in addition to the current month or quarter’s activity.
Groupon is probably not thrilled to publicly correct an award. However, the silver lining is the message in this for all of us – that monitoring plan share limits regularly and consistently is important. If you haven’t performed these reconciliations for 2013, you may want to do so now. Correcting errors that cross calendar years can often be tricky – or sometimes impossible, especially if a disposition of the shares is involved.
The NASPP’s own Robyn Shutak, along with Jim Vincent of E*TRADE & Leigh Vosseller of Genoptix, gave one of the top presentations I’ve seen on reconciliation best practices. Someone in the audience asked a very fabulous question…what exactly is this tick and tie everyone keeps talking about?
So, here it is, the tick and the tie as it relates to stock plan administration. The term tick and tie (or tic and tie) is a staple for CPAs and other financial or audit professionals. In the most general terms, it’s the numbers equivalent of “dot your i’s and cross your t’s.” I have absolutely no idea where it originated, but at this point it is commonly used to refer to the financial audit process. But, there are some tick and tie steps that can apply to any audit you are conducting in stock plan administration that make it easier to validate your conclusions.
Summarize
When you are conducting a reconciliation, you will be confirming two or more independent sources of data. If you are using Excel to reconcile or present the audit data, it’s best to consolidate the independent sources onto separate sheets within one Excel file using one sheet for each source. Then, on a completely separate Excel sheet, you can create a summary data from each source, effectively proving that the sources all match. It is from this summary data that the tick and the tie come into play.
Tie
Taking the phrase back to front, I’m going to start with tie. Each field on your summary sheet should point back to the original source. For example, let’s assume that have 50,000 shares granted to employees in a specific cost center and you are confirming that between your approval documents and the stock plan administration database. Rather than typing in or copy/pasting the numbers, you actually point back to the field on another sheet where that total is housed. This helps prevent manual mistyping and also provides quick tracking for anyone reviewing the reconciliation.
For better clarity, you can use the comment field to confirm where the data originates or any other information that an auditor might need to know about the data. For an electronic or soft copy review of the data, you can leave the comment field hidden. For a hard copy review, you can make the comment field viewable so that someone looking over the data can tie it back without having to think about where to go.
Tick
I am taking a bit of poetic license with this part of the phrase so that it fits a good reconciliation and audit process for stock plan administrators. I think of this as being verifying the validity of data in the reconciliation. Any good reconciliation process includes a final audit by someone who did not contribute to the original data. So, first, there should be a checklist of each essential part of the data that must be reviewed. The person, or people, involved in creating the reconciliation should verify that each item has been reviewed. Then, the person validating the reconciliation should run down the same checklist and sign off on it.
Full Emersion
Now that you’ve stepped into the world of finance, get the full picture with the NASPP’s Financial Reporting for Equity Compensation course that begins on July 14. Learn all the ways that equity compensation data impacts your company’s financial statements in five weekly sessions lead by leading accountants, valuation practitioners, and seasoned stock plan professionals.
As a stock plan administrator, you should be running regular audits of the underlying data in your stock plan database. Regular plan share reconciliation can uncover transactional issues such as late reported terminations or exercises that were entered after the period-end. Most, if not all, stock plan administration software has some type of data check that can uncover incongruous data such as a termination date that is prior to a hire date or grants that have more exercised shares than vested shares. Both periodic plan share reconciliation and running the software’s built-in data check should absolutely be a part of your regular procedures. However, neither of these is a substitute for a periodic audit of underlying data.
Here are the top five additional data audits that you should complete on a regular basis:
1. Active employees
This is a fast check, and with the right IT team can be easily automated. Simply run all your current, active employees from each database (I recommend your HR, Payroll, and stock plans databases) and confirm that each has the same list. Do this audit for both the employee ID and the SSN or other identifier to help catch rehires who have accidently been assigned a new employee ID.
If your stock plan administration database stores the history, match up the new hire, termination, and rehire dates for employees in your database against the HR records. If your company has a policy that re-instates grants when the rehire takes place within a set period of time, then this check will be particularly important for catching changes in rehire date that could impact the status of grants.
2. Changes in employee status
Audit your employee records to confirm that changes in employee status reflect correctly in your stock plan administration database. This includes leaves of absence, changes from and to part-time, moving from employee to non-employee status, and any other changes that may impact eligibility for equity compensation. Most HR databases will record the current status of employees and transmit this information to at least the payroll department. If you are unable to do a full employee status history audit, then at a minimum check to see that the current status is accurate.
3. Fair market value
Hopefully, you (or your service provider) complete a daily verification of the share prices that are entered into your database as the fair market value for company’s shares. These values may be used to determine grant size, exercise price, ESPP purchase price, and income/tax amounts for transactions. In addition to your daily check, it is a good practice to do a periodic audit of the values in your stock plan database against two outside sources. Occasionally, important share prices such as the day’s high, low, or closing price are corrected after market close. If your daily confirmation takes place prior to the change, you will not know about it without this additional audit. Additionally, you should confirm that all sale prices for same-day sales as well as applicable ISO and ESPP sales fall between the high and low share price for the transaction date.
4. YTD supplemental income and social security paid
The year-to-date supplemental income and social security paid for your U.S. employees can impact the appropriate tax withholding amounts for their transactions. The best practice is for year-to-date supplemental income and social security tax amounts to be communicated automatically from your payroll database to your stock plan administration software. Regardless of whether or not your company has automated this data upload, a regular audit of these amounts can help uncover corrections made in payroll that either were not loaded to the stock plan administration software or were not corrected in a timely manner and data that is simply incorrect in the stock plan adminstration software. In addition to your regular audit of these amounts, you should have a process in place to catch transactions that are transmitted to payroll with a tax withholding rate that is either too high or too low based on the current payroll information.
5. Employee demographic fields
Your company should be tracking key employee demographics in the stock plan administration software. These may include department, work location, cost center, or other identifying factors. These fields must be accurate for your expense allocation, tax deductions, future cost projections, and most one-off reports that other departments may request.
Keep in mind that all of these data audits can be automated or incorporated into regular exchanges of data. Work with your service provider(s) and your IT to see what opportunities for automation you may be overlooking. Even if the automation simply alerts you to inconsistent data points, it can simplify your audit process. Remember, these pieces of data are the foundation for all the information that comes out of your stock plan administration software. Including these audits in your regular procedures will help you remove bad data before it shows up as an issue in your periodic reporting.
All this talk of tax withholding got me thinking about the reconciliation challenges that surround your employee tax withholding on equity compensation. As your Payroll team prepares to send out Form W-2s or 1099s, and their equivalents internationally, the stock plan management team should be involved in efforts to confirm the income and withholding amounts for stock plan transactions. This can be a pretty daunting task if you’ve saved it all up for the end of the year, so hopefully you have been reconciling periodically throughout the year. You may be able to find some relief with employees in countries where the tax year does not end in December (such as the UK); these employees may be set aside until after you have reconciled for the deadlines coming up immediately in the new year. Here are some areas that you should focus on:
Income Reported
You will want to make sure that the income amounts reported in each payroll system match the income amounts reflected in your stock plan administration database. If your company is tracking different sources of income separately (restricted stock vs. options or ESPP), then the separate sources will need to be balanced separately. However, the total income amounts should also be reconciled as a confirmation. Pay special attention to employees who may have transferred between payroll groups during the year. This would include not only your globally mobile employees, but also local transfers or administrative transfers (for example, if you have a subsidiary locally or if employees from an acquisition stayed under their own payroll for a period of time). You will want to confirm that no employee income has fallen through the cracks or been double-reported. However, in the case of income from globally mobile employees, you may have situations in which the double-reporting of income is correct and intended, which you will need to also track and confirm.
Tax Withholding
Reconciling the tax withholding amounts can be trickier than reconciling income. This is because there are more situations in which the amount of withholding reported should not equal the amount actually withheld at the transaction because of an administrative policy. For example, there are U.S. states where withholding amounts are difficult to determine in advance (like Kentucky) where your company has chosen to true-up through payroll. This is also true internationally; your company may be withholding at a higher rate on the transaction and then refunding excess through the local payroll either because you have implemented a foreign disbursement process that requires a 100% sell or because you have difficulty obtaining individual tax rates. Hopefully, your company has thoroughly researched these decisions and is not creating unnecessary exposure by withholding shares in excess of statutory minimums or other issues on excess withholding (see Barbara’s past two blog posts here and here). You should know in advance what these standard exceptions are and account for them in the reconciliation process.
There are also the unusual exceptions (typically, these are mistakes that have been made). These may include over or under withholding from timing issues on communicating capped social taxes between payroll and stock plan services or situations where an incorrect tax withholding was made and later corrected through either payroll or stock plan services, but not both. You should be identifying and resolving these throughout the year, but also keeping a list for your reconciliation. Sometimes, the reconciliation itself brings these issues to light!
Special Circumstances
There are circumstances like death, divorce, change in status between employee and non-employee participant, and cross-border income and taxation that may require special attention during your reconciliation. In the case of the death of a U.S. employee, you should not be withholding federal income tax on any transactions executed by the estate or beneficiary. You should only be withholding FICA on transactions that take place in the same tax year as the death, and the FICA amount should be reported on the employee’s final Form W-2. Divorce is a little more complicated depending on the divorce settlement arrangements. Be sure that you are carefully tracking any options in which the company’s withholding obligations have been impacted from the divorce–have them flagged in some way and have a notification policy in place for both parties should they transact on those grants. When an employee becomes a contractor or non-employee director (or vice versa), you will need to pay close attention to how the income and tax withholding is handled. This reconciliation process is a good time for you to confirm that you have not withheld on non-employee income for these individuals. You will also need to divide the W-2 income from the 1099 income when reconciling. Cross-border income reporting and tax withholding can be complex. Whatever your policy has been on reporting and withholding for cross-border situations, you will need to set these aside and reconcile them separately at year-end.
Whatever your process is, start early and engage your payroll team(s) as early in the year as you can. For more information on tax withholding, check out our Tax Withholding and Reporting portal. Also, if you missed Barbara Baksa and Robyn Shutak’s 2nd Annual Webcast on Tax Reporting this week, keep an eye out for the transcript and materials to be posted on our Audio/Video Webcasts Archive. All NASPP members should be taking advantage of these free webinars–it’s a fantastic perk to your membership! Our next webinar is on December 18th and will be presented by Frederic W. Cook: Moral Hazard and Executive Compensation – Balancing Risk and Reward.
You can find more information about good practices for year-end in the NASPP’s Year-End Procedures portal. Also, Robyn Shutak and I will be presenting a FreeSMARTs webcast on year-end reporting next Wednesday, December 17th at 1:30 pm EST. Register with Computershare here.