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The Employee Ownership Update

Corey Rosen

March 30, 2001

(Corey Rosen)

How Option Companies Are Dealing With the Market Downturn

To read the press reports, stock options have become about as popular as Bill Clinton at a Wall Street Journal editorial conference. Fortunately, the press is wrong. First, they are wrong in assuming that most employees getting options in broad-based plans work (or worked) for dot.com companies or even technology companies, the stock of which has been hit hardest of late; most actually work for large, non-technology companies whose stock price has generally been affected less severely. More important, the press is wrong that companies are abandoning their plans, or even making wholesale changes in them. While that has been our strong impression from all the companies we talk to on a regular basis, we now have firmer evidence of that from a recent email survey of our consultant members who specialize in these plans.

The survey respondents included consultants representing hundreds of broad-based stock option companies, ranging from small high-tech businesses to large multinationals. Most said that none of their clients was currently planning to alter their option plans in response to market declines. Those who said some of their clients were doing something generally pointed to relatively minor changes. The most common was to make additional grants, sometimes to replace existing options that are then canceled. Although it is impossible to provide precise numbers based on the survey, it appears fewer than 10% of the companies overall have done this so far, although many more are considering it. Some companies are accelerating the issuance of options already scheduled to be issued, although, again, this would be a distinct minority. Other strategies are rare, including repricing, issuing new premium priced options, or issuing new options shorter with vesting schedules.

Other data come from a survey of 100 new economy companies by iQuantic, a compensation consulting firm. The survey found that 20 of the companies had changed their plans more than once since the market downturn and 90% planned to do something about stock price declines. Most of the respondents are either accelerating planned options, issuing additional options, or replacing existing options with new options promised six months and one day from the cancellation of the old ones.

IRS Approves Extension of 90-Day Period for Reinvestment in Company Stock in an ESOP

In PLR 200108043, the IRS ruled on a case in which a subsidiary of a holding company with various operating subsidies went public. The holding company had been closely held, and none of the members of the holding company had been publicly traded. The holding company had an ESOP, which included employees of the subsidiaries. The holding company itself had no employees. After the subsidiary went public, the stock held by the ESOP in the holding company would no longer qualify as employer securities because there was a publicly traded class of stock owned by one of the operating subsidiaries of the company. So the holding company ESOP would have to exchange its stock for stock in the now-public subsidiary. The company normally would have 90 days to do so, but it requested an extension because of the expected volatility of the stock after the IPO and because the holding company ESOP did not have the liquid assets needed to acquire the shares. The IRS approved this extension.

Supreme Court Denies Review of Options Case Arbitration

The U.S. Supreme Court declined to review a lower court's ruling that an arbitration award in a stock option case was warranted (Coleman Co. v. Brown, U.S. No. 00-1051, cert denied, 2/26/01). An appeals court had agreed with American Arbitration Association's rules that allow an arbitrator to reject the specific terms of a contract if enforcing the contract would violate other court holdings concerning granting equitable relief. An employee argued that the court did not have this authority; the Supreme Court declined to review the case.

Appeals Court Affirms Option Deadline Ruling

The U.S. Court of Appeals for the First Circuit affirmed a lower court finding that an executive who missed the deadline for exercising options was not entitled to compensation (Ostler v. Codman Research Group, Inc., 1st Cir., No. 99-2367, 3/2/01). David Ostler, the president of the company, had options that would expire in 1998. Ostler left the company in 1995; in 1998, he requested information concerning the valuation of the closely held company's stock. The company sent him some information, but Ostler contended it was inadequate and took the matter to court. The company provided additional information in response. The day before Ostler's options would expire, the company extended his deadline by 48 hours, and then granted him another 48 hours after that. They informed him that the company was negotiating a possible sale. Ostler did not exercise his options, however, and they lapsed.

Ostler's argument became peculiar after that. He sued the company, arguing that the company did not have the right to extend his deadline, and therefore the information they provided him was irrelevant and thus did not satisfy the company's disclosure obligations. The initial court ruled that Ostler had been given the chance to exercise his options and chose not to do so, so there was no further obligation on the company's part. The appeals court affirmed that ruling.

New Study Indicates 17.7% of 401(k) Funds in Company Stock

A new study by the Employee Benefit Research Institute and the Investment Company Institute shows that 17.7% of all 401(k) plan assets are invested in company stock. Not all plans offer company stock, however. In general, only publicly traded companies do so. These companies allow employees to invest in company stock, may match employee deferrals in the form of stock, or both. Where company stock is an option, 32.6% of the assets are in company stock. Where the employer determines part of the mix of plan assets by making matching contributions the employee cannot change, 47.6% of all assets are in company stock in those companies where company stock is an option. Plans in which employees have full control over the investments show 29.3% of their assets in company stock in those companies where company stock is an option. Most investment advisors would say that these percentages are too high.

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