If you’ve read any of my prior blogs, it’s no secret that I’m a fan of employee education. Good employee education. Comprehensive employee education. Normally I don’t rant in the forum of the NASPP Blog, and today I will do my very best to avoid doing so, but I’m on the verge of it so be warned.
It’s Section 6039 reporting time, W-2s are on their way, cost basis reporting is on the brain (are employees going to figure this all out?) So my mind has naturally been on – education. Educating never stops, but it’s definitely at a peak this time of the year. Which then brings me to the question – did we educate enough? Did we put enough good information in our employees’ hands to help them navigate their questions without giving them the dreaded “advice” or leaving them short on facts?
Advice Gone Bad
Picture this: I’m thinking through all the questions I just posed above, when someone suggests that I check out a recent episode of a national radio broadcast. The topic of the show is financial advice. People call in, they get financial advice. Over the radio. Okay, so I’m already thinking – well, if someone calls in over a radio show to get financial advice, they probably should know that it’s really hard to know all the factors in that format, so take whatever it is with with a grain of salt, right? I listened to the show, and here’s that part that makes me want to vent. Someone calls in and asks a question about an Employee Stock Purchase Plan (ESPP). The caller wants to know if they should invest in their company’s ESPP plan. Oh yay, there’s a plug for ESPP! Except that the radio host got it all wrong. He asks if the discount is 15%, and then says something to the effect of “yeah, that’s the law – they’re all 15%.” Then he goes on to tell the person not to invest in it. He doesn’t ask about whether there is a look back, or if it’s a Section 423 plan or not, or how the company’s stock has performed. And, to those who know ESPPs, we know there is no “law” dictating a 15% discount. Then, the host went on to remind his audience about all the licenses he used to hold (I’m assuming investment licenses), which came across to this listener as an effort to boost his position on why ESPP was a no-no. I started frothing at the mouth.
I did some additional digging and found that this show has millions of listeners per week. Now, maybe not all are interested in investing in their ESPP, but I bet some have an ESPP. And then it hit me – how frustrating it would be if the caller (or listeners) were employees of my company, and my educational efforts were going up against a famous radio personality who has ESPP all wrong. And, this isn’t the first time the same show has put out incorrect information on ESPPs – I found another blog from 6 years ago highlighting the same issue from the same personality. It’s frustrating when someone in a position of influence and giving financial advice in the earshot of millions gets it wrong.
Own the Message
And then it hit me – although we can’t control what education (no matter how bad or inaccurate) comes from other sources, we can control our own messaging and we have to do a darn good job at it or someone else is going to do it for us. That’s the point of my blog today.
Let’s face it – there are great, good and bad advisers in every category. It’s safe to assume that many of our employees are going to turn outside the company (as we often encourage them to do) to seek advice. This definitely is not a knock against all the advisers out there that get it right. There are plenty of those inside this industry and outside – and they are a valuable resource to our participants. The hard part is when they get bad advice from advisers who don’t understand equity plans. My conclusion is this – we obviously can’t control if a radio host gives bad ESPP advice to millions of listeners. Or, which advisers our employees choose. What can control is what we put out there. We don’t want to leave our employees in the position of having to fill in the blanks. The advice line is a fine one, but I have to think there are ways to put out enough factual information that employees can take that and make sense (or not) of what they are being told from their advisers – even famous ones.
So where can employees go for good information? In addition to your own internal communication efforts, employees can also seek information from myStockOptions.com, your service provider web site (which may also offer them access to advisers who have equity compensation knowledge) and even sites like the IRS’s website. There are several consultants out there that would be happy to come in and educate your employees. And, don’t forget the NASPP also has an Employee Communications portal – we’re always looking for more sample communications that can be shared generically in the portal, so if you’ve got samples send them to me at email@example.com.
I’m hopeful that one communication effort at a time, we can equip our participants with the information needed to recognize inaccurate information and bad advice.
The NASPP Welcomes Brian Stovall to Our Staff
The NASPP is excited to announce that Brian Stovall has joined the NASPP staff as our new Director of Client Relations. Brian has worked in the field of stock compensation for 20 years and has long been a supporter of the NASPP, serving on the NASPP’s Executive Advisory Committee and as the NASPP Regional Representative for the South. Brian also served as president of the Phoenix chapter for seven years, re-energizing the chapter after a period of inactivity and establishing an infrastructure that continues to contribute to the chapter’s success today. We are very excited to welcome him to our team.
The NASPP Is Hiring
The NASPP is currently looking for a motivated, enthusiastic self-directed candidate to join our team as our Programs Director. Check out our job listing in the NASPP’s Career Center.
We posted a several articles on performance awards:
To Do List
Here is your NASPP to do list for this week:
Tags: NASPP To Do List
Our first discussion of cost-basis reporting was posted back in 2009, yet, here we are, still talking about it half a decade later.
Why Am I Still Blathering On About This?
This is still a topic for discussion because the rules have changed again this year. For any shares acquired on or after January 1, 2014, brokers are no longer allowed to voluntarily include the compensation income recognized in connection with the option or award under which the stock was acquired in the cost basis reported on the Form 1099-B issued for the sale. This means that for any shares employees acquired under their options and awards this year, the cost basis reported on Form 1099-B is likely to be too low. Employees will have to report an adjustment on Form 8949 when they file their tax return to correct their capital gain/loss for the underreported basis.
When you sell stock, your cost basis in the stock is subtracted from your net sale proceeds to determine what your capital gain or loss is. For shares acquired under stock awards, your cost basis is the amount you paid for the stock, plus any compensation income recognized in connection with the acquisition (in the case of NQSOs and restricted/units) or disposition (in the case of ISOs and ESPPs) of the stock.
Brokers have been required to report a cost basis on Form 1099-B since 2011. Previously, brokers were allowed to voluntarily include the compensation income recognized in connection with the award in the reported cost basis. This was good because it meant that sometimes the basis reported on Form 1099-B was correct, making it easy in those instances for employees to report their sales on Schedule D and calculate the correct capital gain/loss. But it was also bad because there was no way to tell, when looking at Form 1099-B, whether the reported basis included the compensation income or not. The end result was a lot of confusion and possibly a lot of over-reported capital gains.
Where Are We Now
You might think the IRS would fix this problem by making brokers indicate whether the basis reported on Form 1099-B includes the compensation income. But you would be wrong. Instead, the IRS decided that the basis reported on Form 1099-B should only be the purchase price. This way everyone knows what basis is reported on Form 1099-B. It’s the wrong basis in most cases, but at least we know what it is. That’s a step in the right direction, I guess.
To make things more confusing, for shares acquired before January 1, 2014, brokers can still voluntarily include the compensation income in the basis reported on Form 1099-B (and still can’t indicate on the form if they’ve done this). And, for option grants, brokers can treat the grant date as the acquisition date. I think that most brokers are planning to apply the new rules to everything, regardless of when the shares were acquired/option was granted, but you should check with your brokers to verify what they are doing.
What This Means for Employers
Forms 1099-B will be issued around mid-February. You should plan on distributing some educational material to employees to explain this. The NASPP webcast “The New Forms 1099-B Are Coming! Are You Ready?” will provide more information on the topic. In addition, we’ve updated all the sample forms, flow charts, and FAQs in our Cost-Basis Reporting Portal for the new rules and the 2014 forms. New this year, we’ve added Cost Basis Cheat Sheets, featuring flow charts explaining how to calculate the adjusted cost basis for most types of stock awards.
Tags: 1099-B, capital gains, cost basis, Form 8949, Schedule D, tax basis, tax return
Here’s what’s happening at your local NASPP chapter this week:
Seattle: Dayna Harris of Farient Advisors and Kelly Reinholdtsen of Perkins Coie present “Preparing for the 2015 Proxy Season.” (Wednesday, January 28, 11:30 AM)
Michigan: Alex Willson from E*TRADE Corporate Services presents “Cost Basis Changes Relating to Equity Compensation.” (Thursday, January 29, 8:30 AM)
Tags: NASPP chapter meetings
The new session of Congress comes with agendas and proposals. Notably, one of the changes proposed by House Democrats (essentially a resurrection of last year’s proposal) sought to add a new section to 162(m), in addition to expanding its reach.
I was going to try and summarize this myself, when I came across an article by Steve Seelig and Puneet Arora of Towers Watson on the topic that summarized the issue better than I could, so I am just going to quote the article. Broc Romanek quoted them, too, in his CompensationStandards.com blog, so I guess we’re all on the same page.
As part of their alternative to the Republican agenda, House Democrats have dusted off last year’s proposal to limit the deductibility of executive pay to $1 million for companies that fail to increase their rank-and-file pay to keep pace with U.S. economic growth…This bill is part of larger democratic “action plan” focusing on the middle class that also would provide tax breaks to workers earning under $100,000 per year.
The House previously voted down Van Hollen’s procedural motion to consider the bill, but he’s expected to reintroduce the bill later this year. The Democrats appear determined to keep the CEO-versus-worker-pay issue in the news pending the Securities and Exchange Commission (SEC) release of final CEO pay ratio regulations, as evidenced in the “dear colleague” letter released by House Minority Leader Nancy Pelosi (D-Calif.) on the opening day of the new session.
The Van Hollen bill would take a different approach than the California bill we blogged about last year, which would have limited state tax deductions for executive compensation on a sliding scale depending on the ratio of executive pay to rank-and-file pay. (For more on the California proposal that was defeated in the state legislature, see “California Legislation Would Limit Tax Deductions for Companies Where the CEO Pay Ratio Is Too High,” Executive Pay Matters, May 1, 2014.) Instead, it would add a new section to existing Section 162(m) of the tax code to limit to $1 million the deductibility of compensation (including performance-based compensation) paid to any current or former employee, officer or director if the average pay of all of the company’s U.S.-based non-highly-compensated employees (as defined under the qualified plan rules, i.e., those below $115,000 for 2015) does not keep pace with the growth of the U.S. economy. U.S. economic growth would be based on the average of productivity growth (based on Bureau of Labor Statistic measures) plus adjustments in the cost of living under the tax code.
The bill would also expand the reach of Section 162(m) to cover certain nonlisted, publicly traded companies, make sure the CFO is re-included as a “covered employee” and make it clear that income paid to beneficiaries is included in an executive’s remuneration for 162(m) purposes.
There is a silver lining—according to Towers Watson:
Given the GOP’s wider majority in the House and control of the Senate in the new Congress, any democratic proposals are even more of a long shot than before.
If anything else surfaces on this front, we’ll be sure to keep you informed. At the present the proposed changes to 162(m) (at least stemming from this proposal) appear to be a remote possibility.
Last week, I discussed ISS’s new Equity Plan Scorecard. If you were hoping that the scorecard gave you a free pass on your burn rate, I have some disappointing news. The scorecard doesn’t eliminate the burn rate caps—the caps are a component of a plan’s overall scorecard rating.
The Word “Cap” Is So Limiting
One interesting change I noticed is that ISS is no longer calling them “caps”; now they are “benchmarks.” I’m not sure if this is to make them seem less restrictive or to make companies feel worse about exceeding them because the caps aren’t an arbitrary limit but a benchmark established by their peers.
According to ISS’s FAQ on the Scorecard, a plan gets max points when the company’s burn rate is 50% or less of the benchmark for its industry. The FAQs say that the burn rate score is “scaled,” so I assume this means that partial credit is available if the company’s burn rate is more than 50% of the benchmark but still below it. (If burn rates follow the pattern established in other areas, companies will get half credit if they are in this range. But don’t quote me on that; I didn’t find anything in the FAQs about this–I’m totally guessing). I’m also guessing that if you are over the benchmark, no points for you.
Good News for (Most) Russell 3000 Companies; Not So Good News for S&P 500 Companies
The most significant change is that ISS has broken out S&P 500 companies from other Russell 3000 companies for purposes of determining the burn rate benchmarks. For S&P 500 companies, this results in significantly lower burn rate benchmarks. In a number of industries (energy, commercial & professional services, health care equipment & services, pharmaceuticals & biotechnology, diversified financials, software & services, and telecommunication services), the benchmark dropped more than two points below the cap that S&P 500 companies in these industries were subject to last year.
For most of the Russell 3000 companies that aren’t in the S&P 500, ISS increased the burn rate benchmark slightly. For non-Russell 3000 companies, burn rate benchmarks dropped for the most part (only seven out of 22 industries didn’t see a drop), so I’m guessing that the benchmarks for the Russell 3000 would be lower if the S&P 500 companies hadn’t been removed.
How Does This Play Into the Scorecard?
Burn rate is just one part of one pillar in the scorecard, the grant practices pillar, which is worth 35 points for S&P 500/Russell 3000 companies (25 points for non-Russell 3000 companies). All three types of companies can also earn points in this pillar for the duration of their plan (shorter duration=more points). S&P 500/Russell 3000 companies also earn points in this pillar for specified grant practices. Thus, even if a company completely blows their burn rate benchmark, the plan can still earn partial credit in the grant practices pillar.
In a worst-case scenario, where a plan receives no points at all for grant practices, there’s still hope in the form of the plan cost and plan features pillars. For S&P 500/Russell 3000 companies, plan cost is worth 45 points and the plan features pillar is worth 20 points. That’s a potential 65 points, well over the 53 required to receive a favorable recommendation.
Tags: burn rate, EPSC, Equity Plan Scorecard, institutional investors, ISS, Plan Design, proxy advisors, proxy advisory firm, proxy voting, RiskMetrics, shareholder approval, shareholder vote
Here’s what’s happening at your local NASPP chapter this week:
Nashville: Alex Willson from E*Trade Financial Corporate Services presents “Cost Basis Changes Relating to Equity Compensation.” (Thursday, January 22, 7:30 AM)
Florida: The chapter hosts a presentation on understanding the new cost-basis reporting requirements. (Friday, January 23, 8:30 AM)
Tags: NASPP chapter meetings
In December 2013, I blogged about a mistake that garnered public attention when daily deal website Groupon exceeded their plan’s limit for shares granted in a calendar year with an RSU award to their Chief Operating Officer (“Share Limit Lessons the Hard Way“, December 19, 2013). Just when I started to think it couldn’t happen twice, nearly a year to the day of my first blog another oops! occurred. This time it involved technology company Advanced Micro Devices (“AMD”).
In an 8-K filed with the SEC on December 29, 2014, AMD disclosed that they’d exceeded their equity plan’s limit on shares granted to an individual in a calendar year when issuing a series of awards to their new Chief Executive Officer. As a result of the technical error, the chipmaker decided to void and rescind most of the CEO’s newly issued awards. In their evaluation of the situation, AMD’s board of directors affirmed that the value of the CEO’s compensation package that included the awards was appropriate and in line with shareholder interests. Given that some of the awards were negotiated as part of an employment contract with the CEO, I wonder how the company now will deal with the fact that they can’t issue the grants that were contractually promised to the CEO. I’m no lawyer, so I’ll throw the question out there with no intention of trying to answer it myself. AMD did mention in their filing that they intend to “return Dr. Su’s equity compensation to the level it should have been prior to the action to void and rescind the equity awards described above at or near the earliest practicable opportunity available to the Company, subject to law and the terms of the 2004 Plan.”
How Does This Happen?
There’s been no information on “how” the oversight occurred, and I wouldn’t expect that we’d be privy to the specifics. The fact is that it happened. What stands out to me in this case is that, just like the Groupon case, the violation of the plan limit appeared unnoticed until AMD’s own shareholders filed a lawsuit over it. I’m thinking about all the checks and balances in a grant approval process, and wondering how it was left to shareholders in both cases to catch the mistakes.
While plan share limits seem on the surface to be a simple concept to embrace, there seems to be a trend, or at least a pattern in oversights of these limits. I’m guessing there are more situations like this that are caught before shareholder lawsuits occur. A common trigger for awards that exceed the limits outlined in the plan appears to large grants (or a series of grants) to executives or key employees.
We hear more and more about shareholders looking for prime litigation opportunities. As a group, they definitely have become more assertive in monitoring disclosures and finding opportunities to litigate perceived wrongs. With that in mind, I turn the focus to what we can learn from these high profile, public mistakes. I put myself in the position of asking “If I worked for this company, what would I do to avoid this in the future?” A few ideas come to mind:
- Use these examples (AMD and Groupon) as the basis to have a training session or discussion with your internal Human Resources (HR) executives. Since the HR executives are typically the ones involved in discussing CEO and other executive compensation with the board, go right to those executives and educate them on any share limits (and other parameters) within the plan that may be triggers for violations of plan terms. If external compensation consultants are also in a position to have discussions with the Board on executive compensation decisions, it’s a good idea to make them aware of the plan limits as well.
- Audit, audit, audit. Even if an oversight occurs at the HR/board level, the next stop should be the plan administrator. Anytime new grants come through, it’s best to have a check and balance in place that compares those grants to plan limits. Keep a running total of grants to date (whether it’s year to date or some other measurement outlined in the plan). Remember there are varied types of plan limits. Common limits include the number of shares that can be granted to an individual in a calendar year, the number of shares that can be cumulatively granted from the plan in a calendar year, and limits on the number of shares related to certain types of awards that can be made within a period of time (for example, a cap on the number of shares that can be issued as full value awards in a calendar year).
- Advocate for contact with the board of directors. While it’s a good step to educate those who are in contact with the board (HR executives and compensation consultants), why not see if you can gain your own opportunity to educate the board? Whether it’s in person or via a communication that is presented to the board, this may be an opportunity to go straight to the decision makers. Even if it’s not the full board, the Compensation Committee of the board is an ideal target for these communications.
Nobody wants their mistakes made public. And, while there may not be a sole person responsible for the oversights at Groupon and AMD, these certainly were preventable mistakes. I hope this will be my last blog on this topic and companies will take to heart the importance of monitoring any and every aspect of the terms of their equity plans. Let’s not leave it to shareholders to discover the next mistake.
As I noted on October 21 (“ISS Changes Stock Plan Methodology“), ISS is changing how they evaluate stock plan proposals. Just before Christmas, ISS released additional information about their new Equity Plan Scorecard, including an FAQ. For today’s blog entry, I take a look at how the scorecard works.
What the Heck?
Historically, ISS has used a series of tests (Shareholder Value Transfer, burn rates, various plan features) to evaluate stock plan proposals. Many of these tests were deal-breakers. For example, fail the SVT test and ISS would recommend against the plan, regardless of how low your burn rate had been in the past or that fact that all the awards granted to your CEO vest based on performance.
Under the new Equity Plan Scorecard (known as “EPSC,” because what you need in your life right now is another acronym to remember), stock plans earn points in three areas (which ISS refers to as “pillars”): plan cost, grant practices, and plan features. Each pillar is worth a different amount of points, which vary based on how ISS categorizes your company. For example, S&P 500 and Russell 3000 companies can earn 45 points for the plan cost, 35 points for grant practices and 20 points for plan features. Plans need to score 53 points to receive a favorable recommendation. [I’m not sure how ISS came up with 53. Why not 42—the answer to life, the universe, and everything?] So an S&P 500 company could completely fail in the plan cost area and still squeak by with a passing score if the plan got close to 100% in both the grant practices and plan features area.
Plan cost is our old friend, the SVT analysis but with a new twist. The SVT analysis is performed once with the shares requested, shares currently available under all plans, and awards outstanding, then performed a second time excluding the awards outstanding. Previously, ISS would carve out options that had been outstanding for longer than six years in certain circumstances. With the new SVT calculation that excludes outstanding options, this carve out is no longer necessary (at least, in ISS’s opinion–you might feel differently). The points awarded for the SVT analysis are scaled based on how the company scores against ISS’s benchmarks. Points are awarded for both analyses (with and without options outstanding), but the FAQ doesn’t say how many points you can get for each.
The grant practices pillar includes our old friend, the burn rate analysis. But gone are the halcyon days when burn rates didn’t really matter because companies that failed the test could just make a burn rate commitment for the future. Now if companies fail the burn rate test, they have to hope they make the points up somewhere else. Burn rate scores are scaled, so partial credit is possible depending on how companies compare to the ISS’s benchmarks. This pillar also gives points for plan duration, which is how long the new share reserve is expected to last (full points for five years or less, no points for more than six years). S&P 500 and Russell 3000 companies can earn further points in this pillar for certain practices, such as clawback provisions, requiring shares to be held after exercise/vest, and making at least one-third of grants to the CEO subject to performance-based vesting).
This seems like the easiest pillar to accrue points in. Either a company/plan has the features specified, in which case the plan receives the full points, or it doesn’t, in which case, no points for you. There are also only four tests:
- Not having single-trigger vesting upon a CIC
- Not having liberal share counting
- Not granting the administrator broad discretionary authority to accelerate vesting
- Specifying a minimum vesting period of at least one year
That’s pretty simple. If willing to do all four of those things, S&P 500/Russell 3000 companies have an easy 20 points, non-Russell 3000 companies have an easy 30 points (more than halfway to the requisite 53 points), and IPO/bankruptcy companies have an easy 40 points (75% of the 53 points needed).
Alas, this does mean that companies no longer get a free pass on returning shares withheld for taxes on awards back to the plan. Previously, this practice simply caused the arrangement to be treated as a full value award in the SVT analysis. Since awards were already treated as full value awards in the SVT analysis, it didn’t matter what you did with the shares withheld for taxes. Now you need to be willing to forego full points in the plan features pillar if you want to return those shares to the plan.
Lastly, there are a few practices that result in a negative recommendation regardless of how many points the plan accrues under the various pillars. These include a liberal CIC definition, allowing repricing without shareholder approval, and a couple of catch-alls that boil down to essentially anything else that ISS doesn’t like.
For more information on the new Equity Plan Scorecard, see the NASPP alert “ISS Announces New Equity Plan Scorecard and Burn Rates.”
Tags: burn rate, EPSC, Equity Plan Scorecard, institutional investors, ISS, Plan Design, proxy, proxy advisors, proxy advisory firm, proxy voting, RiskMetrics, shareholder approval, shareholder value transfer, shareholder vote, SVT
Here’s what’s happening at your local NASPP chapter this week:
Chicago: Terry Adamson and Daniel Coleman of Aon Hewitt present “Who Doesn’t Love a Discount? Accounting Discounts for Holding Restrictions.” (Tuesday, January 13, 7:30 AM)
Denver: The chapter presents its 2nd Annual Compensation and Proxy Season Update. (Tuesday, January 13, noon)
Connecticut: Amy Reina and Kunal Patel of Deloitte Tax present “Mobility: Taxability, Traceability, Payroll-ability, Survivability.” (Thursday, January 15, 9:30 AM)
Tags: NASPP chapter meetings