The details surrounding exactly when tax deposits are due on stock compensation come up regularly in the NASPP Discussion Forum. In honor of our NASPP Ask the Expert’s webcast today on Restricted Stock and Unit Awards, I’d like to summarize the issue.
IRS $100,000 Deposit Rule
Most public companies that offer stock compensation are semi-weekly filers, meaning they must make tax deposits with the IRS two times each week. These deposits are due within three business days after the deposit period. For example, if your period includes Tuesday, Wednesday, and Thursday, then the tax deposit for those three days would be due the following Wednesday. This is the company’s normal deposit schedule.
However, once the total tax liability reaches $100,000 for any corporate entity the deposit is due the next business day. (See IRS Publication 15.) For example, if the entity’s total tax liability reaches $100,000 on a Tuesday, the IRS would expect that deposit to be made on Wednesday of the same week. For those of you keeping score, the total tax liability to the IRS includes all taxes that get reported on the company’s quarterly tax return–Form 941. That is the total of income tax and both employee and employer Social Security and Medicare after adjustments, although that is more of a detail for the payroll team than for stock plan managers. Also, the liability only accumulates beginning after a deposit period. For example, if your deposit period includes Tuesday, Wednesday, and Thursday, then you do not need to combine Thursday’s liability with Friday’s liability.
T+4
The IRS issued a Field Directive in 2003 instructing IRS auditors not to challenge tax deposits from “broker-dealer trades” (i.e., broker-assisted cashless exercises) made the business day after the settlement of the exercise, provided the settlement is no longer than three days. This doesn’t change companies’ tax deposit timeframe; it simply instructs auditors not to challenge these deposits. In spite of this technicality, most companies rely on this Field Directive for remitting taxes to the IRS on all same-day sale NQSO exercises.
Restricted Stock
RSUs and RSAs are where stock compensation and tax deposit liability get really tricky. There isn’t any specific rule, regulation, or even Field Directive or instruction that specifically addresses how to handle the timing of the tax deposit due on restricted stock. Rather, it’s the fact that it isn’t addressed as an exception that is most important. Until or unless it is addressed, it’s safest for companies to assume that the income for deposit timing purposes is paid out on the vest date. If the vest date falls on a day when the total tax deposit liability reaches $100,000 or more, the taxes from that vesting event are due to the IRS no later than the following business day.
Penalties
Yes, there are penalties for late deposits. Yes, the IRS does audit this. It is true that there are companies who still do not make timely deposits intentionally because they either can’t figure out how or have determined that the cost of compliance is higher than the potential fines. However, the penalties range from 2% to 15% of the late or unpaid tax amount, which could be very expensive if late deposits are a regular occurrence. Remember that the late deposit is the entire amount due, not just the amount in excess of $100,000. Of course, there are a litany of approaches to try and get the penalties reduces or recalculated. However, even if your company is successful at reducing the amount due it still has to pay someone to negotiate with the IRS and that does not come cheaply, either.
Time Crunch
The reality is that your payroll department needs processing time and your payroll service provider requires processing time. There is pretty much no way for you to send tax amounts to your payroll team after the close of market on the day that restricted stock vesting events have created a next-day deposit liability for your company and actually have that deposit made to the IRS before the close of business the next day.
So, aside from defining the FMV for restricted stock vests as some component of trading value three days prior to the vest, how do you make a timely tax deposit and avoid the penalties? Although it isn’t the only possible approach, the most common method for compliance according to the NASPP’s most recent Quick Survey on Restricted Stock is to estimate the tax liability in advance of the vesting event and then make corrections after the actual tax liability is known.
Companies impose trading blackouts prior to the public release of information that could influence trading decisions on company stock as a safeguard to avoid questionable trading in advance of significant corporate developments. Typically, these trading blackouts will regularly occur in advance of quarterly financial disclosures, but may also be imposed in advance of potential corporate transactions.
There are several situations where the blackout period could be problematic for both the company and employees–other than the obvious inconvenience of having to wait for an open trading window. One of these issues is what to do about restricted stock vests. When a restricted stock unit or award vests, taxes are due on the income from that vest. If trading is absolutely prohibited during the blackout, the issue of how to cover the taxes due becomes a problem. There are, however, a few solutions to consider.
First, you can try to ensure that no vesting ever takes place in a blackout. This means not only timing your vesting, but ensuring the vesting is never modified by a leave of absence or change in status. This also doesn’t help if you have an unscheduled trading blackout. However, this strategy is still a good idea in general even if your company is employing other approaches because it will reduce the number of instances where restricted stock is vesting in a blackout period.
Second, you can require employees to remit shares back to the company to cover the tax obligation, either for every vest or only for vests that take place in a blackout period. It is easier to get your legal counsel and auditors to be comfortable with a required share withholding because there is no market transaction. There are, of course, considerations for this tax remittance such as calculating minimum statutory tax rates and the availability of cash that may make this an undesirable choice for your company.
Third, you can disallow any choice in the tax withholding method. You may or may not want to also have Rule 10b5-1 language built into your grant agreements to help secure an affirmative defense against allegations of insider trading. If you allow a choice it is conceivable that this could be manipulated, particularly if the company permits a choice between paying cash for the taxes and another method. For example, if a person knows that the company stock will fall as a result of an upcoming announcement and happens to have restricted stock vesting, she could choose to sell or trade shares for taxes instead of pay cash knowing that this would be the best price she’ll get for the shares for a while. More likely, however, is that an employee would make that decision based on personal circumstances like an unexpected expense. If an employee changed from paying cash to selling shares and then the stock happened to fall drastically after financial disclosures, there would be a risk of the appearance of making that decision based on inside information. By removing the choice, you help to eliminate the appearance of insider trading.
You may also have a combination of these methods, such as having a default tax payment method, but not permit any change inside a blackout period. This may work for your non-insiders, but may require special attention for your Section 16 insiders. If this isn’t enough for your legal team or auditor, consider requiring Section 16 insiders to include the restricted stock vests as part of a Rule 10b5-1 trading plan.
Also, whatever your approach is, don’t forget to check the verbiage in your insider trading policy. If you will be permitting remitting selling shares to cover taxes in a blackout period, it’s best if your insider trading policy clearly indicates this exception.
Don’t miss our Ask the Experts: Restricted Stock and Unit Awards webcast on May 26th for all your restricted stock questions. In fact, it’s not too late to submit a question for our experts to address!
I recently attended a San Francisco NASPP chapter meeting that featured a presentation by Yana Plotkin of Towers Watson on trends in equity compensation. Yana included some data from the Towers Watson “2010/2011 Report on Long-Term Incentives, Policies and Practices.” Here are a few highlights:
Portfolio Approach
More companies are granting at least two types of awards–73% of respondents indicated this practice, an increase of 10% from 2009. Larger companies are more likely to utilize three types of awards than smaller companies.
Pay for Performance
Towers Watson is seeing a strong trend towards performance awards, which are now the second most common type of long-term incentive offered by survey respondents, ahead of stock options. Full value shares (RS/RSUs) were the most common type of LTI offered. In the NASPP’s 2010 Stock Plan Design and Administration Survey (co-sponsored by Deloitte), we also saw a strong trend towards performance awards, although we did not see them outpace the usage of stock options.
Full Value Awards
Towers Watson reports that full value awards have outpaced stock options for grants to employees at the manager/individual contributor level. In the NASPP survey, we also saw an increase in full value awards and even performance awards to employees at these levels, but many respondents were still granting stock options.
Award Sizes
For employees earning under $200,000, award sizes (as a percentage of salary) remained flat from 2009 to 2010 in the Towers Watson survey. But for employees at higher salary levels, award sizes increased, although not quite to 2008 levels.
Award Design
In terms of performance award design, Yana mentioned that they are seeing interest in awards with shorter performance periods, e.g., two years, and some sort of trailing service requirement after the performance goals have been met. I am a proponent of this design; for executives, it helps facilitate compliance with ownership requirements and clawback provisions and, for everyone, it can simplify tax withholding procedures.
Interestingly, Towers Watson reports that 35% of respondents to their survey measure performance relative to peers or a market index. For the NASPP survey, this was about the same (41% of respondents). Both surveys also agree on how commonly TSR is used as a performance metric (25% of respondents in the Towers Watson survey, 29% of respondents in the NASPP Survey). Yana indicated that Towers Watson is seeing more companies use TSR than in the past and that certainly aligns with the buzz I am hearing from compensation consultants, etc.
Performance Awards Are the Future
The biggest takeaway I got from Yana’s presentation is that the Say-on-Pay, the disclosures required under the Dodd-Frank Act, and shareholder expectations are making performance awards the hottest thing going today in terms of equity compensation. If you aren’t fully up to speed on them, don’t miss the pre-conference session, “Practical Guide to Performance-Based Awards,” to be held on November 1 in San Francisco, in advance of the NASPP Conference. Register by May 13 for the early-bird discount!
Online Fundamentals Starts in Two Weeks–Don’t Miss It! The NASPP’s acclaimed online program, “Stock Plan Fundamentals,” begins on April 14. This multi-webcast course covers the regulatory framework and administrative best practices that apply to stock compensation; it’s a great program for anyone new to the industry or anyone preparing for the CEP exam. Register today.
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.
Today we have a fabulous installment in our Ask the Experts series of webcasts, “Tax Reporting for Stock Compensation.” I thought I’d shake things up and take a look at tax filing from the employee’s perspective.
Income and capital gains associated with equity compensation can be pretty daunting for the average employee. These are my top five reporting mistakes. Your personal top five may differ based on your company’s equity compensation program and the education you provide around taxation.
No Schedule D
Employees who do not understand capital gains at all could have this problem when it comes to reporting any sale. However, it’s much more common when there is a cashless exercise or sell-to-cover transaction, particularly if the company defines the FMV as the sale price. The employee may know that the income is reported and the associated taxes are withheld by the company, assume that the exercise (or vest) and the sale are the same transaction because they happened simultaneously and not even consider the need to report the sale. Alternatively, the employee may understand that the sale price and the FMV on the exercise or vest date is the same and assume that there is nothing to report.
Partial Sale Confusion
When an employee sells only some of the shares from an option exercise or restricted stock vest, it is surprisingly easy to misunderstand what should go on the Schedule D. This is more of a problem for employees doing a sell-to-cover transaction, but can happen even if the sale is from held shares. When referencing the exercise or vest statement, the employee reports all exercised/vested shares as being sold and/or reports the cost basis for the total shares acquired as the cost basis for the shares that were sold. The most likely result is a calculation on the Schedule D that shows a sizable capital loss on the sale. Hopefully, cost basis reporting will eventually help prevent this error.
ESPP – Qualifying Disposition
Qualifying dispositions of ESPP shares are confusing because there is still (in most cases) an income element if there was a discount at purchase. Unfortunately, the most common mistake for employees is not reporting that ordinary income when or if the company fails to do so. The income element of a qualifying disposition is the lesser of the discount as if the purchase took place at the beginning of the offering period (which should now be reported to employees on Form 3922) or the spread between the purchase and sale prices. Failure by the company to report that income doesn’t exempt the employee from reporting it.
The exception is that when the sale price is lower than the purchase price, there is no ordinary income on the qualifying disposition–and that means that employees in this unhappy situation are actually more likely to report it correctly.
Reporting Gain Twice
The most common reason for this error is a misunderstanding of restricted stock vests. The employee reports $0 as the cost basis, effectively reporting the spread at vest twice: once as income and once as capital gains. This can happen with options as well if the employee uses the exercise price as the cost basis for the shares when reporting the sale. Double reporting may also happen if an employee doesn’t realize that the income resulting from a disqualifying disposition of ISO or ESPP shares is already included in the Form W-2 (assuming your company is aware of the disposition and reports it correctly).
Failure to Report an ISO Cash Exercise
Employees with ISO grants have a host of tax concepts to familiarize themselves with, but none is quite as mysterious as the issue of AMT. AMT is such a nebulous issue for most people that it is often given only a brief explanation in equity compensation communications.
Many employees hear the words “no income” and assume that is synonymous with “no reporting obligation.” However, any exercise of ISOs (assuming the shares are held at least through the remainder of the tax year) means that the employee must complete and attach Form 6251 to their tax return, even if she or he is not subject to AMT. If the employee is subject to AMT and fails to report the exercise, this is (of course) potentially a much bigger issue than if the employee simply fails to prove she or he is not subject to AMT.
So, what’s the top five for your company? If you don’t know, start thinking about it now.
Here’s a better question: How do you figure out what mistakes your employees are making? First, anything that you don’t personally understand 100% is bound to be even more difficult for employees. Also, anything comes to you as a question is a potential for a reporting problem. Keep your ears open for horror stories–if it’s happened to one person, it could happen to your employees. Finally, if you’re really ambitious, you could survey a sample of your employees with example scenarios to see if they know how to report different transactions.
One of the fundamental principles behind deferring payout on awards is the desire to lessen the potential time gap between the point at which an executive is rewarded for his or her policies and the point at which the company realizes the consequences or benefits of those same decisions. The deferral is one way to help keep executives focused on the long-term impact of business strategy.
Advantages
As Barbara pointed out in her August 17th blog entry, deferring the payout of shares can be particularly useful when used in conjunction with a clawback provision or to supplement the company’s ownership guidelines. A deferral may also be valuable for performance awards if there is the possibility of a future negative adjustment exists.
With clawbacks and potential negative adjustments on performance award payouts, it can be very difficult to recover shares or income after the fact, even with carefully constructed provisions. If the company must take back vested shares, it is obviously easier to do if the shares have not been disposed of, yet.
Depending on the parameters of a company’s holding requirements or ownership guidelines, it may be advantageous to an executive subject to these policies to also be subject to deferral on certain grants. The deferral may effectively delay the income event out to a point that either coincides with or is closer to the point at which the executive can dispose of the shares.
Considerations
Of course, any deferral program should be compliant with 409A. However, because there is no deferral election, designing within the parameters of 409A is easier. Another consideration is whether or not the deferral would require, or even be best suited for, a non-qualified deferred compensation program into which the vested shares may be deposited. Visit our Section 409A portal or Bruce Brumerg’s new site, www.myNQDC.com, for more on this issue.
In conjunction with 409A compliance, the general timing of the deferral is a key issue. On one hand, the deferral should be far enough into the future to align the executive’s risk on that potential income with the company’s risk. However, executives are making policy that could impact the company far into the future; there is little incentive for income that is delayed indefinitely. A compromise must be reached to find an appropriate period of time that is effective as a risk-mitigation technique that does not negate the incentivizing power of the reward.
Taxation
Some RSU programs permit participants to elect to defer the payout of shares to a future date, presumably a time when the participant’s tax bracket is lower than in the year of the original vest. 409A has made elective deferral programs more cumbersome, but they do still exist. A non-elective deferral does not give the participant control over whether or not receipt of the vested shares is deferred. As our panelists in the Conference session “Risk Mitigation for Stock Compensation” pointed out, we are at a point when income tax rates are likely to increase in the near future, which makes deferring income less appealing right now. A company implementing a required deferral of RSU or performance shares should carefully consider how to communicate the program’s goals and application to executives or other employees who will be subject to the deferral.
On a more practical administrative level, deferral of the share payout only defers the income tax withholding requirement. FICA withholding, along with the associated FUTA contribution, are due at the vest date.
Quick Survey on 6039 Returns and Information Statements
Take our quick survey on filing Forms 3921 and 3922 to report ISO and ESPP transactions to the IRS and on distributing the associated information statements to plan participants. Find out how other companies are planning to comply with these new requirements.
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.
We are about half-way through the first tax year in which employers have known the income reporting, tax withholding, and valuation requirements for employees in India. Last year (2009/2010) was quite a scramble, with retroactive updates and guidance being provided late into 2009.
Valuations
One issue that companies continue to work with is the calculation of FMV, as a Category 1 Merchant Banker valuation is still required for companies not listed on a recognized exchange (Neither NASDAQ nor NYSE are recognized exchanges.). There were several months where it was unclear whether or not Merchant Banker valuations would be required. If your company reported and withheld based on the market value of your stock during the 2009/2010 tax year, you should have adjusted your reporting at this point.
Frequency
When it comes to Merchant Banker valuations, frequency is still a key consideration (and one that will remain so long as these valuations are required). The regulations state that valuations are only required every 180 days, so it is possible to only value your company’s shares two times a year. However, this may not right for your company, especially if the trading value of the shares has decreased significantly since the most recent valuation.
Double Standard
The difference between the Merchant Banker valuation and the trading value of the stock will remain an ongoing issue regardless of how often your company has a valuation performed. If your stock plan administration software does not permit more than one FMV on a trading date, you may have to provide custom employee communications to accommodate the FMV that was used to calculate income.
Australia
Reporting Obligations
Generally speaking, most options and RSU grants in Australia awarded after July 1, 2009 are taxable at vest. There is no withholding obligation for employers, but there is a reporting obligation of Employee Share Scheme (ESS) statements to both the employee and the Australian Tax Office (ATO). They are not unlike the U.S. Section 6039 information statements in theory; presumably they will help employees better understand how to complete their own tax returns and will help the tax authorities determine if income is being properly reported on tax returns, which they will be auditing (See this alert from Deloitte.)
Valuation
For RSUs, the trading value of the shares at vest may be the FMV for income calculation. However, options are considered an “unlisted right” and might require a valuation method (e.g.; Black Scholes) to determine the market value of the shares on date of the taxable event.
30 Day Rule
One tricky piece of determining the FMV on the taxable date in Australia is the 30 day rule. If an employee sells shares from an RSU vest or option exercise within 30 days of the original taxable event date, then the sale date might be considered the taxable event, provided the company is aware of the sale.
Employees
Individual tax returns for the 2009/2010 tax year are due by October 31, 2010. Employees may still be trying to understand the ESS statements provided to them by the company.
Taking Action
Many companies appear to have moved away from granting options in Australia as a result of the reporting obligations. We completed a Quick Survey on this in September; only 20% of respondents were continuing to grant options in Australia, 38% were not granting options to begin with, and a significant 42% were moving to share grants (like RSUs) or some type of cash compensation.
I was fortunate to be the moderator for one of the Conference sessions, “QUALCOMM and Microsoft: Gold Standards in Employee Communication.” It was very exciting to see all the top-notch communications policies and practices in place at these two companies! I can’t share them all with you in just one blog entry, but today I share my absolute favorites.
Custom Alerts
Custom communications are a fantastic tool for alerting employees to important events or necessary actions. What impressed me the most about the alert systems that used by both of these companies is that they are able to send out alerts for upcoming events from an internal email address. Your broker may be able to help with some or all of these alerts. However, the cool thing about taking it in-house is that when essential messages come directly from the stock plan services team, employees are trained to pay attention to both their equity compensation and other communications from the team.
There are a number of alerts and notifications that may be useful to employees. These three really stood out:
Countdown to Grant Acceptance Deadline
If you have a grant acceptance policy with teeth (e.g.; recipients forfeit the grant if not accepted within a specific timeframe), this particular alert is particularly important. Even if there are no defined consequences for failure to accept a grant, reminding an employee periodically that there is a grant that requires acceptance is a best practice. Targeting employees who have this on their “to do list” greatly increases the odds that they will complete the grant acceptance process.
Upcoming RSU Vest
An upcoming RSU vest is a time for planning, both for the stock plan services team and the employee. Including action items in an alert to employees helps them prepare. If there are any choices or actions that have a deadline (like broker selection, tax payment method, or grant acceptance), this type of alert may be your last chance to get their attention.
Unexercised Option Expiration
An automated alert sent directly to employees notifying them of an in-the-money option that is about to expire is great for them and can reduce risk for the company. Notifying them of a deeply underwater option that is about to expire, on the other hand, is just rubbing salt in the wound. Create parameters that weed out the options that have no hope of being in the money before expiration and you’ve got yourself a stellar communications practice!
Rolling out a new plan
Many companies are changing the way they look at equity compensation. This presentation offers many unique practices for rolling out a new plan or compensation philosophy to employees. If your company is considering changing the compensation mix, introducing a new equity compensation vehicle, or expanding performance grants to a larger population, this presentation has some essential tips for you. These three ideas were my favorites:
Blog
This one really is timeless. Having information available on the intranet is great. Actually, it’s essential in my book. A blog that employees can either subscribe to or go for the latest updates and archived of information and FAQs gives you a forum that is dynamic and current. Implement it when rolling out something new, and keep it up to feed employees information in bite-sized pieces later on!
Webcasts by Location
Again, this is another idea that is fantastic for communicating a new plan, but doubles as an ongoing tool that is especially helpful for new hires. Webcasts can be saved for download on the intranet or aired at special meetings or new hire orientations. Customizing the information to fit each country or location, including translation if necessary, really personalizes equity compensation in a way that one generic presentation simply can’t. This way, employees will see grant sizes, tax implications, and brokerage information that is applicable to them.
Practice Communications
I was totally tickled by this idea! You start by creating focus groups to find out what verbiage and format gets the best results. Then, test out your dissemination process on another group. The example from the presentation is a “cascading” communications strategy, an advanced version of “train the trainer”. The information starts with the VPs and moves on down the organizational chart with each level speaking to the employees directly under them. This can be a highly effective communications strategy, but it could turn out like a bad game of “telephone.” Taking a dry run lets you see what your end result is with your test group and gives you time to make necessary adjustments before implementing the communication process for the entire company.
What do you do when someone has inadvertently been omitted from the grant approval process? You really can’t just slip the grant into the approval documentation, fully disclosed or clandestinely, and write it off to an “administrative error.” The bad news is that each situation has the potential to be unique, which makes it unlikely that you can create a standard response to a missed grant. For this reason, your grant policy probably can’t (even shouldn’t) attempt to address every potential circumstance surrounding a missed grant. The good news is that you can prepare yourself to evaluate the responses available to you in the event you do find a missed grant. These are my top five considerations:
Vesting
If a grant is left out of the approval process and needs to be approved at a later date, you need to know if the delay in approval will impact vesting. If your plan or grant policy already bases the vesting off a date other than the approval date or is flexible on the issue, it is possible that the grant can maintain the intended vesting dates.
Approval
It’s important to have a solid understanding of your plan and approval process under any circumstance, but when it comes to a missed grant, there are additional considerations. If the delayed approval will result in a grant that is different from your typical grants either in size or vesting schedule, you need to know who has the authority to approve the grant. If standard grants are approved by an officer, such as the CEO, it’s likely that a modification to standard terms will cause the grant to fall outside the parameters of the officer’s approval authority and may need to be referred to the compensation committee for approval.
Stock Price
If the grant in question is an option, then the stock price has likely moved on since the original approval date. If the price has dropped, it is easy to sell your employee on a grant of equal size and vesting with a better exercise price, but it may not be advisable to provide a disproportionately advantageous position to just one employee. Provided your plan permits it, it is possible to approve the option with the intended (i.e., higher) grant price.
If the stock price has increased, you have the opposite issue to contend with–the employee really shouldn’t be penalized for an administrative error. However, approving the grant at the lower exercise price would most likely result in a discounted option, making it subject to 409A. You can, however, develop a policy on how the company may compensate for this change in FMV such as increasing the number of shares or providing a cash payment to make up the difference.
If an RSU has slipped through the cracks in your approval process, making up for lost time can be less of a burden provided you have the flexibility in your plan to keep the intended vesting schedule. But, make sure that if your grant policy doesn’t lock in grant size based on the date of approval (e.g.; a value of $1,000 based on the FVM on date of approval).
Timing
Ideally, you never have to deal with a missed grant. Hopefully, if you do encounter one, the error is discovered virtually immediately. However, it is a good idea to think about what the company can do if a significant amount of time has passed between the date the grant should have been approved and the discovery.
One possible issue is vesting; if the grant should have already vested by the time the error is discovered. Like compensating for a higher exercise price, the company could choose to increase the number of shares or provide a cash payment to compensate for a missed sale opportunity. This is risky business because you are using counterfactual history–there is no way to know at what point the employee would have sold the shares.
Another issue comes up for companies that use a “total rewards” type compensation standard and one or more annual grants have been approved before the original missed grant is discovered. In a total rewards model, annual grant size would typically be based on a target total equity value or total compensation level. If the missed grant is not included in the calculations, then an annual grant approved after the error is likely to be larger to accommodate the value “missing” from that employee’s total equity value or compensation level.
Communication
Regardless of the circumstances leading up to a missed grant, communication is going to be key. No matter how you cut it, employees don’t appreciate being left out and bristle at the idea of being penalized for an administrative error, whether that idea is well-founded or not. This might sound a little like running a customer service call center, but it’s not a bad idea to have some apology verbiage ready that can fit most administrative issues; something that can help to reassure the employee that the company will “make it right” without actually obligating the company to provide recompense it isn’t prepared or able to accommodate. Whatever your response is to a missed grant, keep the employee abreast of the process as much as possible. Also, it’s probably best to avoid detailing the circumstances of the oversight even if you are trying to reassure the employee.
Restricted stock units and awards carry a unique risk when it comes to grant acceptance. It’s easiest to understand this risk in contrast to stock options. In most countries and situations, the taxable event on a stock option is the exercise. Employees must personally take action in order to exercise a stock option, which gives companies the opportunity to have their undivided attention when it comes to grant acceptance and simply prevent exercise until the grant has been signed. Restricted stock awards and units, on the other hand, are taxed on either the vest date or even at grant (depending on the country and circumstances). For the purpose of simplification, I’m going to focus on RSUs granted in the U.S. that do not have accelerated or continued vesting after retirement.
Policy #1: Time’s Up!
Some companies take a conservative approach to this issue by actually enforcing a grant acceptance requirement with a policy under which employees forfeit their grants if acceptance isn’t completed within a specific timeframe. In this approach, the highest risk is in ensuring adequate communication regarding the timeframe and consequences of not accepting the grants. In addition to including a warning in all communications leading up to the grant, it’s a good idea to also send out reminders to employees as they approach the deadline for acceptance.
Policy #2: It’s Yours Whether You Know it or Not
Some companies default to the philosophy that grants will continue to vest regardless of the grant acceptance status, even if they have a policy that theoretically requires grant acceptance without actually enforcing it. Hopefully, this is a well thought-out policy and not just a head-in-the-sand reaction to the issue of grant acceptance. For example, it could be that the comany’s legal team concluded that allowing shares to vest before the terms and conditions have been accepted poses less risk to the company than cancelling unaccepted grants. Regardless of the reason behind adopting this policy, the best way to make it effective is to make sure that grant documents, communications, and company policy accommodate how tax withholding is executed. The smart approach is to have a default tax withholding method which does not require action by the employee such as share withholding. Another advantage of share withholding over other methods is that, in the event the employee ultimately wants to decline the grant, the odds of being able to “unravel” the vest are much higher.
Policy #3: What?!
The riskiest approach of all is to ignore the issue until it’s too late. Of course, it’s entirely tongue-in-cheek to call this a policy at all. A company might fall into this situation because of poor planning, inadequate documentation, or a sudden increase in the number of RSU recipients. This could lead to a situation where taxes are due, but the company has no way to collect them because there either isn’t a default tax withholding method, or the default isn’t possible without action from the employee. Companies that find themselves in this position must scramble to get grant acceptance and/or collect taxes, possibly delaying the tax remittance or actual delivery of shares. Because it’s likely not possible to consider a late delivery of shares as a delay in constructive receipt of the shares in, delayed tax remittance could result in penalties incurred by the company.