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In recent years, the level of legal, accounting, and regulatory complexity associated with employee stock options has continued to grow. This book, written by attorneys Alisa Baker and Alison Wright, and writer and editor Pam Chernoff, CEP, presents a straightforward, comprehensive overview of both the big-picture issues and the technical details related to designing and implementing stock option plans and employee stock purchase plans. The book also looks at hot issues and provides illustrative exhibits, a glossary, a bibliography, and primary source materials, plus a seminal article by Corey Rosen on plan design.
The 20th edition includes numerous updates and clarifications throughout, including new sections on qualified small business stock and accounting for modifications.
"Anyone involved with the design or administration of employee stock option programs, from the inexperienced stock plan administrator to the seasoned compensation professional, will appreciate this useful reference tool."
- Tim Sparks, President, Compensia, Inc.
"This book should be on the desk of every stock option professional."
- Robert H. (Buff) Miller, Cooley Godward Kronish LLP
Table of Contents
Part I: Overview of Stock Options and Related Plans
Chapter 1: The Basics of Stock Options
Chapter 2: Tax Treatment of Nonstatutory Stock Options
Chapter 3: Tax Treatment of Incentive Stock Options
Chapter 4: Plan Design and Administration
Chapter 5: Employee Stock Purchase Plans
Chapter 6: Trends in Equity Compensation: An Overview
Part II: Technical Issues
Chapter 7: Financing the Purchase of Stock Options
Chapter 8: Overview of Securities Law Issues
Chapter 9: Tax Law Compliance Issues
Chapter 10: Basic Accounting Issues
Chapter 11: Tax Treatment of Options on Death and Divorce
Chapter 12: Post-Termination Option Issues
Part III: Current Issues
Chapter 13: Legislative and Regulatory Initiatives Related to Stock Options: History and Status
Chapter 14: Cases Affecting Equity Compensation
Chapter 15: Transferable Options
Chapter 16: Reloads, Evergreens, Repricings, and Exchanges
Appendix 1: Designing a Broad-Based Stock Option Plan
Appendix 2: Primary Sources
From Chapter 3, "Tax Treatment of Incentive Stock Options" (footnotes omitted)
If an option is disqualified from ISO treatment by a modification or cancellation before the year in which it would have become exercisable, then it is not considered when calculating the $100,000 limit. But if the modification or cancellation happens any time in the year the option would have become exercisable, the option is counted for purposes of the limit for that year. Disqualifying dispositions do not prevent those options from being counted toward the $100,000 limit.
Acceleration of the vesting of an ISO does not disqualify the option, but accelerated options are counted toward the $100,000 limit in the year of acceleration. This can get tricky if a change of control trigger or performance trigger allows exercise if a change of control occurs before vesting or disallows exercise until a performance target is met. If there is such an acceleration provision, then options first exercisable during a calendar year pursuant to an acceleration clause do not affect the application of the $100,000 rule for options exercised before the acceleration provision was triggered. All of these prior options can be exercised, up to the $100,000 limit, even if the accelerated options are exercised in the same year. However, any options from the accelerated group that are in excess of $100,000 minus the fair market value at grant of the previously exercised options that year must be treated as NSOs.
Note that fair market value for these purposes may be calculated using any “reasonable method,” including independent appraisals and valuation in accordance with the gift tax rules.
From Chapter 10, "Basic Accounting Issues"
Equity compensation awards are treated as an expense on a company’s income statement.
One of the largest issues in accounting for options and ESPPs is the need to assess (often at the time of grant) a current value for awards whose ultimate value to the participant (if any) is known only years later. Calculating a value often requires challenging assumptions and formulas, but the core idea is simple: What would an investor pay today for an award with the same characteristics? What is the “fair value” of the award?
Before 2005, it was possible to grant stock options that did not result in an accounting expense, even though restricted stock and other kinds of equity awards did. But those days ended with the 2005 and 2006 implementation of a revised accounting standard for equity compensation. The impetus behind the accounting changes was to enhance the information in financial statements in order to give shareholders a better idea of just how much equity awards actually “cost” the company. The Financial Accounting Standards Board (FASB), which is the private-sector body that sets U.S. accounting standards, wanted this form of compensation to appear on the income statement, just as other compensation does. This was a controversial project that took many years to complete. Many companies argued that options have no cost to the company (they contended the cost to shareholders consists purely in dilution to share value) or are a balance sheet, not an income statement, issue. However, the FASB did ultimately implement the changes.
The standard that required that options be expensed was called Statement of Financial Accounting Standards 123 (revised 2004), or FAS 123(R), until September 2009, when the FASB shifted U.S. generally accepted accounting principles (GAAP) to a codified system that led to the renumbering of all authoritative standards and guidance. Under codification, most of FAS 123(R) became Accounting Standards Codification Topic 718 (ASC 718), while EITF 96-18, relating to awards granted to nonemployees, became part of ASC 505. The numbering change did not affect the basic content of the standard but did consolidate many different interpretations and other accounting pronouncements into a single source. In 2018, the FASB released ASU 2018-07, which brought accounting for awards granted to nonemployees under ASC 718, meaning accounting for nonemployee awards was brought into line with the accounting for employee awards.
From Chapter 16, "Reloads, Evergreens, Repricings, and Exchanges"
Evergreen provisions permit an annual increase in the number of shares available under the plan with a one-time shareholder approval (i.e., at the time the evergreen provision is approved). The evergreen provision may be for a specific number of additional shares or may be a percentage increase based on outstanding shares at a designated date, and it may continue for the life of the plan or for a limited period of years (i.e., five years). Note that even where the evergreen is automatic, the S-8 registration statement for the plan will need to be amended each year to reflect the annual increase before any shares are issued to participants.
A key advantage of an evergreen provision is that once approved, it reduces both the technical and pragmatic issues involved with going back to the shareholders to ask for additional shares. As an initial matter, the board of directors must be encouraged to use special vigilance in computing the number of shares necessary to fund its plans for a foreseeable period. In recent years, shareholders (particularly institutional shareholders) have been increasingly reluctant to approve automatic additions to employee stock plans.
Based on this reluctance, practically speaking, only privately held companies or public companies with limited institutional investors are in a position to use an evergreen. Pre-IPO companies may adopt an evergreen provision prior to the IPO for use after the IPO; however, in recent years this strategy has been used more frequently with ESPPs than with omnibus plans.