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 18th edition includes updates and clarifications throughout the book, including on accounting and Section 409A deferred compensation issues.
"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, meaning those in which shares are sold before the statutory holding period has elapsed, 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 are disqualified as ISOs and must be treated as NSOs.
Note that Treas. Reg. § 1.422-3(e) states that calculation of fair market value for these purposes may be made by 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. 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.
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?
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.
At about the same time that the FASB released FAS 123(R), the International Accounting Standards Board (IASB) proposed an accounting standard that was similar, but not identical. The IASB is an independent standards-setting body whose member countries are free to adopt its standards, known as international financial reporting standards (IFRS). The IASB does not have the authority to set accounting standards for individual countries, but its member countries have sought to standardize their accounting requirements to make it easier for investors and others to assess company financials across country lines. The FASB has a stated goal of shifting the U.S. from U.S. GAAP to international accounting standards, but progress has been slow and many issues remain to be addressed. Until such time as adoption by the U.S. takes place, many companies must still grapple with the requirements of IFRS for foreign subsidiaries reporting in countries that have adopted the standards while continuing to use GAAP at the U.S.-company level.
In March 2016, the FASB released Accounting Standards Update 2016-09 (ASU 2016-09), which amended ASC 718 in several key areas. Under it, companies are allowed to account for forfeitures as they occur instead of estimating expected forfeitures. The update also changes tax accounting and diluted EPS calculations. Public companies must adopt the changes for the first fiscal period that begins after December 15, 2016. Private companies must adopt for the first fiscal period that begins after December 15, 2017. Companies can choose to adopt sooner and in an interim period. More details on some of the changes and the required transition methods are included later in this chapter.
From Chapter 16, "Reloads, Evergreens, Repricings, and Exchanges" (footnotes omitted)
Although publicly traded companies may have to seek shareholder approval to meet exchange listing requirements, no special shareholder approval requirements are connected with repricings for securities law purposes. However, the employer has many other obligations under the Exchange Act with respect to a repricing. First, any participation in the repricing by Section 16 insiders will be reportable events under Section 16(a). Second, any participation by a named executive officer must be discussed in the narrative accompanying the Summary Compensation table in the company's proxy statement. Third, in the early 21st century, the SEC focused on the application of the "tender offer rules" to employee repricings and exchange offers, reasoning that such exchanges (unlike normal option grants) require optionees to make individual investment decisions. Under the Exchange Act, an issuer making a tender offer must comply with a variety of complex substantive and procedural rules relating to nondiscrimination and disclosure with respect to the terms of the offer. Offers that are conducted for compensatory purposes are exempt from compliance with the nondiscrimination requirements of Rule 13e-4. An issuer may take advantage of the exemption if:
- it is eligible to use Form S-8, the options subject to the exchange offer were issued under an employee benefit plan as defined in Rule 405 of the Exchange Act, and the securities offered in the exchange offer will be issued under such employee benefit plan;
- the exchange offer is conducted for compensatory purposes;
- the issuer discloses in the offer to purchase the essential features and significance of the exchange offer, including the risks that optionees should consider in deciding whether to accept the offer; and
- it otherwise complies with Rule 13e-4.
However, the issuer must still satisfy a number of hurdles to effect a valid exchange offer, including providing certain financial materials to both employees and the SEC, making various SEC filings, holding analyst calls (where appropriate), and providing a withdrawal period of at least 20 business days to offerees.