Equity Compensation in a Down Market: Repricing, Accounting, ESPP, and Employee Communications Issues

From "Addressing Underwater Options: Measured Responses to a Contentious Problem"

Underwater option exchange offers are complex programs that require a well-defined communication and administration strategy. Some have compared the effort required to execute these programs to an open enrollment campaign for health and welfare benefits. In both cases, program details have to be explained and incumbent-by-incumbent elections must be tracked. It is important that the company not recommend to employees a course of action, or try to influence their decision to participate. To remain at arm's length, some organizations choose to use a third party to communicate plan terms and administer elections.

Making the process even more burdensome is the requirement that it be treated as a tender offer under SEC rules. In a tender offer, any information that is material to the employee's decision to participate must be publicly filed. Due to the logistics and costs associated with making SEC filings, this means that all information that is intended to be shared with employees should be finalized before the program begins (legal offer description, employee presentations, e mail announcements, enrollment forms, frequently asked questions). Employees must be given at least 20 business days to consider program participation, and the company cannot recommend any course of action to option holders.

Any introduction of new material information after the program has started, or a change to the information originally provided, may require the company to file a tender offer amendment and restart the required 20-day election period.

Finally, eligibility for employees outside the United States must be examined on a country-by-country basis to avoid creating unnecessary tax and securities burdens for the company and program participants. Advice from local tax and securities experts should be obtained before deciding whether to include these locations in such programs. The costs and complexities of implementing a stock option exchange in a country without critical headcount and limited underwater option shares may mean such an approach is infeasible. In such circumstances, underwater options outside the United States can be addressed with supplemental equity awards that don't require the tender offer process.