The NASPP Blog

Monthly Archives: February 2010

February 25, 2010

Part-Time Policy

It may seem obvious that when an employee moves from full-time to part-time status, his or her salary changes to a part-time amount as well. The impact to equity compensation, however, isn’t so obvious.

Philosophical Differences

A company’s stock plan philosophy should be a pivotal component of all decisions around equity compensation to provide a cohesive stock plans program. Employees who get a consistent message regarding their equity compensation are more likely to understand and value it. When it comes to full-time employees changing to a part-time status, consider how equity compensation is promoted to employees. Is it a reward for past performance, part of compensation, or incentive for future performance? Also consider what outcomes the company is looking for (and, no, you don’t need to pick just one). It could be that the company wants to create an employee ownership environment, improve retention, align employees with shareholder interests, reduce cash salaries; whatever the desired outcomes are, the policy around part-time employee grants should be in alignment with that goal.

Weighing the Options

Most companies are not in a position where modifying vesting because of a move to part-time status makes sense. First, consider the consequences to the company for continuing vesting. It’s unlikely that enough employees will choose to go part-time holding enough unvested to create a material negative impact. Also, it’s possible to limit the impact from part-time employees by considering part-time employees ineligible for new grants. There are also minimal advantages to having a move to part-time status impact grant vesting; again because there shouldn’t be a huge number of employees making that move.

Then, take a good look at what the costs could be to cancelling grants or suspending vesting because of a move to part-time status. There’s the issue of employee morale. If grants are impacted by a move to part-time, it could feel punitive to the employee, especially if grants are promoted to employees as a reward for past services. Most likely, if an employee is eligible for equity compensation and is approved to move to part-time status, then the company truly wants to retain that employee keep him or her engaged in the success of the company. There’s also the issue of tracking and administering vesting changes, which can be time-consuming and involve a high level of manual adjustments in the stock plan administration database. With any manual data changes comes additional risk of error.

Managing Your Policy

If your company already has a policy in place to cancel, suspend, or modify grants due to a move to part-time status, it may be worth a thorough review. It’s good to understand why the policy is in place and examine if it still aligns with corporate and equity compensation philosophy. If it does, or you company is just not ready to make a change, here are some ways to make that policy successful.

First, work with your legal team to make sure that it is very clear which circumstances will be impacted. Like leaves of absence, there may be situations in the U.S., and especially internationally, where a move to part time either can’t impact vesting or where it is a grey area that could expose the company to risk if existing grants are impacted. Then, get your HR and IT involved to solidify how changes in status are tracked in the HRIS database and communicated to stock plan management. If there are situations where vesting won’t be impacted, it’s important that those employees are easily identified. Also, meet with your service provider to fully understand your policy can best be managed in the stock plan administration software. As with other areas of stock plan management, don’t assume that the process currently in place is the most efficient and effective one.

Submit Your Speaking Proposal

This is the very last blog where we can encourage you to submit a speaking proposal for the 2010 NASPP Annual Conference. The submission window closes tomorrow, so don’t miss your chance!


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February 23, 2010

One for You; Nineteen for Me – Part 2

I liked last week’s blog title so much, I’m using it again this week. It’s not often that I can work a Beatle’s lyric into a discussion of stock compensation. John Hammond of Computershare was the only person to get ten points for knowing the relevance of the reference (or the only one to read the blog the whole way through to know that it was worth ten points).

More on the UK Tax Changes
Last week I discussed impending tax increases in the UK and the need to take action quickly. This week I focus again on tax increases in the UK, but for the 2011-2012 tax year, which begins on April 6, 2011 (another ten points to anyone who can explain why the tax year starts on April 6 in the UK). At that time, National Insurance Contributions (NICs) are scheduled to increase to 13.8% (up from 12.8%) for employers and to 12% (up from 11%) for employees. Unlike Social Security in the United States, the employer’s portion of NICs is uncapped. Most of the employee’s portion is capped, although there is a lower rate that continues to apply after the cap has been reached–this rate is increasing to 2% (up from 1%).

The Problem with NICs 

The employer paid portion of NICs is particularly problematic because it is uncapped. Under US GAAP, this makes for an unpredictable and uncontrollable charge against earnings, not to mention cash outflow. This is also true under IFRS, with the added drawback that payroll taxes have to be accounted for as a liability, the amount of which is adjusted each period (with a corresponding adjustment to expense) until the liability is paid.

Because of this, some companies require employees in the UK to also pay the company’s portion of NICs for their stock compensation. According to the 2008 NASPP International Stock Plan Design and Administration Survey (co-sponsored by Deloitte), 26% of companies transfer the company’s portion of NICs to employees for stock options and RSUs.

It’s Not too Early to Start Planning for the 2011-2012 Tax Year

With the NIC rates increasing, companies may want to take another look at their stock plans for UK employees.

Combined with the income tax rates that are going into effect for the 2010-2011 tax year, this means that by 2011, employees in the UK are going to be paying a lot higher taxes, even more so where employers pass their portion of NICs on to employees. It may be time to reconsider requiring employees to pay the company portion. If the company were to start picking up the tab on its portion of NICs, that would help offset the increase in the taxes paid by employees.

I wonder if it might be possible to split the difference. For example, maybe the company pays half and passes the other half on to employees. Or the company continues to require employees to pay up to 12.8% but the company picks up the 1% increase.

Another possibility is to offer a qualified plan in the UK, which generally would not be subject to NICs. Only 13% of respondents to NASPP survey offer a CSOP–the type of qualified plan that most closely resembles ISOs in the United States. While the number of shares that can be granted under a CSOP is relatively small, granting a portion of employees’ options in a CSOP might help offset the tax increases.

Thanks to Valerie Diamond of Baker & McKenzie for explaining NICs to me.

A Solution for Section 6039 Returns
Stock & Option Solutions is currently performing market research to determine if there is substantial market demand for a product to assist with e-filing the Section 6039 returns (Form 3921 for ISOs and 3922 for ESPPs) with the IRS. If you are interested in such a solution, be sure to complete their survey.

Domestic Stock Plan Design Survey Coming Soon
We are lauching the next edition of our Domestic Stock Plan Design Survey (co-sponsored by Deloitte, with survey systems support provided by the CEPI) in early March. We are implementing a new policy with this edition of the survey:  the results will be released only to those companies that participate in it.  Service providers that are ineligible to participate in the survey can qualify to receive the survey results by promoting the survey to their clients–contact Danyle Anderson, the NASPP’s Programs Director, if you are interested in participating.

Last Chance to Submit a Proposal for the NASPP Annual Conference
This is your last chance to submit a speaking proposal for the 2010 NASPP Annual Conference; all proposals must be completed by this Friday, February 26.  We begin reviewing proposals as soon as the submission period closes so we cannot make any exceptions to this deadline–no matter how dire the circumstances. If you feel a cold coming on now; plan accordingly!

NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog. 


February 18, 2010

Why Net Exercise?

FAS 123(R) (Now ASC 718) eliminated the adverse accounting consequences associated with net exercise that existed under APB 25, making it more feasible for companies to implement net exercise.

What exactly is a net exercise?

The concept of net exercise isn’t unfamiliar. Many companies already employ share withholding on restricted stock or even have a stock-settled SAR program. Like share withholding on restricted stock, a net exercise means that the employee tenders shares back to the company to cover his or her obligations from a transaction. Like a stock-settled SAR, the employee capitalizes on the appreciation in stock price without an output of cash for the exercise price and without a sale of shares.

In a net exercise, when a participant wants to exercise in-the-money shares, the company holds onto enough shares from the exercise to cover the exercise price and delivers the net amount remaining to the employee. For example, if an employee exercises 100 shares of an NQSO with an exercise price of $5.00 at a time when the current FMV is $10.00, then the company retains 50 shares and delivers 50 shares to the employee. Depending on the plan parameters, the shares tendered to the company may return to the stock plan or may be retired. Either way, the exercise does not result in a market sale. The company may also set up the net exercise program to include share withholding to cover the employee tax obligation.

When is net exercise a good fit?

There are many advantages to implementing a net exercise program. If those advantages are important to your company, then net exercise may be a good fit. If your company is concerned about dilution or wants to promote share ownership (especially if your executives are subject to holding or ownership requirements) then net exercise may be particularly appealing. For our top ten advantages of net exercise, check out the March-April 2008 issue of the Stock Plan Advisor.

One truly great aspect of net exercise is that it doesn’t require the company to grant new equity vehicles. Depending on how your company’s stock plan is structured, it may be possible to implement a net exercise program on existing option grants, in which case the company can realize the benefits of net exercise immediately. In fact, even if your plan doesn’t already include net exercises, it may even be possible to add net exercise without the need to obtain shareholder approval.

Net exercise is particularly useful with regards to your executives and Section 16 insiders. For one, because there isn’t a market sale of shares, no Form 144 needs to be filed for a net exercise (only on any subsequent sale). Additionally, the net exercise method provides Section 16 insiders a way to fund their exercise without risking short-swing profit recovery issues that must be considered with a came-day sale. Net exercise is also a particularly effective way to help your executives comply with company share holding or ownership requirements.

A really cool way to take advantage of net exercise is to implement a policy to process a net exercise on in-the-money options that are about to expire. This allows the company to obtain the tax deduction on options that have already been expense, prevents the participant from losing out on option shares they have earned, and doesn’t require brokers to impose a sale of shares that hasn’t been initiated by the account holder.

Issues to Consider

If you are contemplating whether net exercise is right for your company, there are several important issues to consider. Most importantly, take a good look at the goals of your equity compensation program and see if the benefits of net exercise facilitate those goals. If you really want to capitalize on the advantages of net exercise, you may decide to mandate net exercise for all or a portion of your employees.

Then, conduct a careful review of your plan document and grant agreements. In your plan document, check to see what exercise methods are permitted, any requirements around modifications to the plan, and if you have any pesky outdated language regarding the use of “immature” shares. You’ll also want to know if any of your grant agreements limit the methods of exercise that may be used.

The issue of incentive stock options and net exercise is murky. A conservative view is that the use of net exercise ISOs disqualifies the entire grant from preferential tax treatment; while the most aggressive argument is that the shares tendered in a net exercise were never issued, preserving the ISO status of both the delivered shares and the remaining unexercised shares. If you do not wish to exclude ISO grants from your net exercise program, then you’ll need to consult closely with your legal counsel and auditors to determine what your company’s position is.

Finally, your international employee population must also be considered. There may be jurisdictions in which net exercise is either prohibited or where the challenges outweigh the benefits. Before implementing net exercise outside the United States, consult with your advisors.

If you’re looking for more information on net exercise, refer to our practice alert on the benefits of net exercise, this handy net exercise comparison chart, or the session and materials from last year’s Conference session “The Roadmap: How–and Why–to Implement Net Exercises”. You can access the session on our 2009 Conference Materials page in the Plan Design and Redesign section (and don’t forget that you can purchase access if you weren’t able to attend last year).

NASPP Conference 2010

Speaking of our Conference, be sure to get your speaking proposals in for the NASPP Conference this year! You can submit your proposal HERE. If you are wondering how to put together a winning proposal, check out our Top Ten Tips For Creating A Successful Proposal.



February 16, 2010

One for You; Nineteen for Me

Do you know how much tax your employees in the UK are paying on their stock compensation? It’s about to get a lot higher and further rate increases are scheduled for next year as well. If you’ve been turning a deaf ear to the recent UK budget announcements, now is the time to start listening–before it’s too late to do anything for your UK employees.

Death and Taxes, UK Style
I recently attended the San Francisco NASPP chapter meeting, where Valerie Diamond, Barbara Klementz, and Jennifer George of Baker & McKenzie summarized recent developments in the UK and a few other countries. One of my key take-aways was that taxes in the UK, which are already high, are about to get a lot higher.

One for You; Nineteen for Me

For the 2010-2011 tax year, the maximum income tax rate will increase to 50%; this rate applies to employees earning over £150,000. In addition, for employees earning between £100,000 to £150,000, some of the current exemptions are being phased out, increasing their tax liability. Then you add in NIC and, for some companies, NIC pass-throughs, and the end result is that some employees could end up paying taxes as high as 68.8%–that’s right, the employee’s net, after-tax, take home could be less than a third of their gain.

No Time Like the Present

The 2010-2011 UK tax year starts on April 6; until then option exercises and RS/unit vesting events are still subject to the current rates. This is one of those rare situations where it could make a lot of sense to pay taxes sooner rather than later, because waiting is likely to make the taxes a lot higher.

For those employees that hold vested, in-the-money stock options, consider a quick educational program to make sure they understand how the impending tax rates could increase their tax liability and can make an informed decision about whether they want to exercise before April 6.

You also may need to take a look at your withholding rate in the UK. Since there isn’t a flat rate, if UK employees are subject to tax at higher rates, this can impact the rate of withholding they are subject to. The phased out exemptions can make it particularly problematic to figure out the correct rate; now would be a good time to check in with your UK payroll group about this.

Accelerating Vesting

It’s also worth considering accelerating vesting on unvested awards and options. This would ensure that awards are taxed now, before the tax rates would go up, and would at least give employees an opportunity to exercise their stock options.

So long as employees aren’t required to give up any benefits in exchange for the acceleration, the modification shouldn’t be viewed as a tender offer. But, if you do require employees to give up a benefit, such as requiring them to agree to exercise their options before April 6 or agreeing to pay the company portion of NIC, that would likely require compliance with the SEC’s tender offer requirements. At this point, you don’t have time to manage that compliance, so don’t try to get fancy with the acceleration.

What’s This Going to Cost?

The accounting ramifications should be minimal under both ASC 718 (formerly FAS 123(R)) and IFRS 2. Under ASC 718, there might be some cost for the portion of the awards that were expected to be forfeited absent the acceleration, equal to their current fair value, but I wouldn’t expect there to be any additional cost for awards that were expected to vest anyway.

As I understand it, IFRS 2 doesn’t include all that gobbledy-gook about types I-IV, probable-to-probable, improbable-to-probable, etc., modifications, so the accounting is a little more straightforward. At worst, the end result would be the same as under ASC 718 and it’s possible there might not be any additional expense for the acceleration.

Of course, under both standards, any remaining unamortized expense would be recognized in full in the period the acceleration occurs. In addition, setting aside the possibility of incremental cost, the company’s overall stock plan expense will be increased to the extent that shares that would otherwise have been forfeited due to future terminations will be vested.

There also could be required disclosure for the acceleration. ASC 718 requires disclosure of any “significant” modifications. Materiality would most certainly be impacted by the number of awards and employees and the amount of expense involved. But these days, “significant” can also be a qualitative analysis; for example, if an executive officer is included in the modification, it might be considered significant even if the amounts involved are relatively small. IFRS 2 is not as specific on the required disclosures, but I expect that the same general principles apply.

Practice for the United States?

Similar, although not quite as drastic, changes have been proposed by the Obama Administration for the United States. The tax rate increases here wouldn’t go into effect until 2011, but the top income tax rates would increase (by 3-5%) and tax deductions/exemptions would be reduced. Here in US, the tax rates are lower to begin with, the increases aren’t as significant, FICA doesn’t come close to NIC, and company’s can’t make employees pay the company portion of FICA–all of which makes the situation significantly less dire. Even so, you may be looking at some of the same issues for your US employees once the end of the year rolls around.

For more information on the tax changes in the UK, see the UK page in NASPP’s Global Stock Plans Portal.

Other Tidbits

  • NIC taxes are going to increase for the 2011-2012 tax year. We’ve still got some time on that, so I’ll cover it in next week’s blog.
  • This has nothing to do with the UK, but I also learned from the team at Baker that the Australian government is flat-out, stark raving mad (my words, not Baker & McKenzie’s). If you haven’t been paying attention to recent tax changes in Australia, you’ll want to take a look at the Australia page in our Global Stock Plans Portal.
  • Ten bonus points to anyone that knows the relevance of the title of this blog entry–no fair Googling it!

NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog. 


February 11, 2010

10b5-1 Plans: Modifications and Terminations

Last week I explored the connection between the affirmative defense provided under Rule 10b5-1(c) and appropriate timing of Rule 10b5-1 trading plans. The same interpretive guidance that got me thinking about creating 10b5-1 trading plans also clarified some issues around the modification or termination of trades under existing Rule 10b5-1 trading plans.

Modifying a Transaction

Any investor may have situations where they want to change their trading behavior based solely on circumstances that are not connected to insider information, including your company’s own insiders. For example, an insider may have an existing plan that includes the sale of 20,000 shares, intending to use the cash generated from the sale to cover a balloon payment that is due on his or her mortgage. If the stock price drops unexpectedly before the trade takes place, the insider may wish to increase the number of shares being sold under the trading plan. In fact, the SEC does say that modifications made “in good faith” may be acceptable.

However, modifications of trades under a Rule 10b5-1 trading plan are not a good practice for insiders. The interpretive guidance from the SEC makes it very clear why. In response to question 120.16, the SEC clarifies that the modification of a trade is the same as terminating the existing trade and entering into a new plan for that trade. Since the modified transaction is considered to be under a new trading plan, the new plan is subject to the same requirements in order to qualify for the affirmative defense under Rule 10b5-1(c), the insider should not be in possession of material nonpublic information at the time of the modification.

One Transaction, One Plan

What’s more, in response to question 120.19 the SEC clarifies that the termination of one or more transactions within a plan is the same as terminating the entire plan and entering into a new plan for all transactions under the plan. Therefore, at the point of the termination of one transaction, all the remaining transactions must still meet the requirements of Rule 10b5-1(c) in order to rely on the affirmative defense. Because this is virtually impossible for your company’s insiders during a closed window, it’s a good idea to require pre-clearance for both modifications and terminations of trades within a plan to ensure that the “new” trading plan created by the modification or termination of a trade still falls within the parameters of your insider trading policy.

Terminating the Entire Plan

So, what about the termination of an entire plan? In isolation, there isn’t necessarily an issue with terminating an entire plan. However, in most cases, an insider terminating a plan will want to enter into a new one. This is where the concept of “good faith” comes into play. In addition to not being in possession of material nonpublic information at the creation of a Rule 10b5-1 trading plan, the insider may not enter into a plan that is “part of a plan or scheme to evade” the prohibitions under Rule 10b5-1(c). Therefore, what happens after the termination of a Rule 10b5-1 trading plan will be key to determining if the termination of the plan was in good faith. In real terms, that means that the insider will want to avoid any appearance that the plan was terminated based on inside information.

As an example, let’s assume that an insider has an existing Rule 10b5-1 trading plan that includes a market sale of 10,000 shares. At some point prior to the sale, that insider learns about an upcoming acquisition that is anticipated to greatly increase the value of the company’s stock. In response to this knowledge, the insider terminates the existing plan and enters into a new plan in the next open trading window, after the acquisition has been disclosed or completed and when the company share price has gone up. The new plan has all the appearances of meeting the requirements for a Rule 10b5-1 trading plan. However, in this case the old plan wasn’t terminated in good faith, and the affirmative defense of Rule 10b5-1(c) may not be available.

Cooling Off Period

One of the reasons that a “cooling off” period between the creation of a Rule 10b5-1 trading plan and the first trade under that plan is highly recommended is to maintain the appearance of good faith. So, what about a situation where an insider wishes to terminate an existing plan and enter into a new one for the purposes of adding a new transaction to the plan and one or more of the original transactions is set to take place almost immediately? Obviously, each situation needs to be analyzed individually, but in most cases this shouldn’t cause an issue with complying with Rule 10b5-1(c). Even though each of the transactions within the new plan, including those carried over from the old plan, are subject to the prohibitions under Rule 10b5-1(c), your company should be able to take the position that trades carried forward unmodified from an old plan are considered to be made in good faith.

You can find more information on Rule 10b5-1 trading plans on our Rule 10b5-1 portal.


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February 9, 2010

More on ESPP Operational Errors

Last week, I blogged about operational errors in Section 423 ESPPs. This week, I follow up that discussion with more on the potential impact of errors and an explanation of how separate offerings can be used to minimize the impact of errors.

Impact of Disqualification

When a purchase fails to meet the requirements of Section 423, it is treated as the exercise of a non-qualified stock option. The spread on the purchase is treated as compensation income, subject to tax withholding (and company matching payments) and reportable on Form W-2. Where an entire offering is disqualified from Section 423, this treatment applies to all purchases made under the offering (by US employees, that is; non-US employees are still subject to whatever tax treatment applies under the laws of their own tax jurisdiction).

The penalties for failing to collect the withholding taxes can be up to 100% of the amounts that should have been withheld, plus interest. The penalties for failing to report the income on Form W-2 can be up to $100 per form–$50 for the return filed with the IRS and another $50 for the statement issued to the employee (subject to annual maximums of $250,000 for the returns filed with the IRS and another $100,000 for the statements issued to employees). 

Designating Separate Offerings to Protect Against Disqualification

The final regs view each offering under the plan as independent of any other offerings. Consequently, operational errors may disqualify a single offering but are unlikely to ever disqualify an entire plan. For example, if a company prohibits an eligible employee from participating in an offering, that would disqualify that offering, but it wouldn’t disqualify prior offerings under the plan (provided the employee either wasn’t eligible to participate in those offerings or was allowed to participate in them), nor would it impact the status of future offerings under the plan (assuming that the error is addressed for those offerings).

I see a fair amount of operational errors with respect to the participation of non-US employees. To protect US participants from the possible ramifications of these errors, separate offerings can be established for non-US participants, where those participants are employed by a separate corporate entity (non-US employees of the US parent have to be allowed to participate in the same offering as US employees). I don’t think it matters much whether you have one separate offering for all non-US employees or separate offerings for each distinct corporate entity, just so long as the employees of non-US entities aren’t participating in the same offerings as US employees.

It may make sense to designate separate offerings for each distinct corporate entity within the United States, as well. One situation where I commonly see eligible employees excluded from participating in the ESPP is when they transfer between corporate entities. HR/payroll processes the transfer as a termination, causing the transferred employee to be withdrawn from the plan. If separate offerings are established for each corporate entity, then this error is a problem only for the offering for the corporate entity that the individual is now employed by; it doesn’t jeopardize the tax treatment for all US employees.

Additional Controls

Given the seriousness of the consequences of this type of error, a control procedure for your ESPP might be to review records of all employees transferred between corporate entities to make sure none have been inappropriately withdrawn from the ESPP.

For more information on the final regs under Section 423, see our alert “Final ESPP Regs Issued.”

NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog. 


February 4, 2010

Rule 10b5-1c: Exploring Affirmative Defense

Heading into the new year, many companies will be starting the annual grant process. If your insiders are due for a new grant this year, they may be looking to modify their Rule 10b5-1 Trading Plan or enter into one for the first time. So, now is the time to review your company’s policy and make sure that it’s solid.

Affirmative Defense

Section 10(b) of the Securities Exchange Act of 1934 prohibits the use of any “manipulative and deceptive device” in connection with the purchase or sale of securities. In 2000, the SEC released Rule 10b5-1, clarifying that trading on the basis of material nonpublic information is just such a “device”. Additionally, the Rule states that entering into a trade while aware of material nonpublic information constitutes trading on the basis of that information. Fortunately, paragraph c of Rule 10b5-1 provides an affirmative defense that basically allows an individual to demonstrate that she or he is not trading on the basis of material nonpublic information.

In order to rely on the affirmative defense, an individual must enter into a contract, instruction, or plan to trade at a point in which she or he isn’t in possession of material nonpublic information. And that is the problem. When exactly is an officer of your company not privy to some piece of nonpublic information? When can an insider enter into a Rule 10b5-1 trading plan?

Timing of Plan Creation

In May of last year, the SEC published interpretive guidance on Rule 10b5-1. Question 120.20 really caught my eye. The question is whether or not the Rule 10b5-1 affirmative defense is available if an individual is aware of material nonpublic information at the time the plan is created, but the trade doesn’t take place until that information is made public.

The SEC answered with a single word: no. Just no. What that means is that no length of “cooling off period” is long enough; in order to garner the protection provided by Rule 10b5-1 a person simply must not be in possession of material nonpublic information at the creation of the trading plan.

When is That Even Possible?

So, what does that mean for companies trying to create a solid policy on Rule 10b5-1 trading plans? How is it even possible that insiders can find a period of time when they are not in possession of information that would negate the affirmative defense? To help me with this dilemma, I called on one of our fabulous panelists from the “10b5-1 Plans: Practical Advice and Implementation” session at our 2009 Conference, Michael Andresino of Boston’s Posternak Blankstein & Lund. (If you missed this session, take time to listen to it now!)

First, I still feel very strongly (and Michael agrees) that companies should require at least their Section 16 insiders to trade exclusively through a plan designed to comply with Rule 10b5-1. You have zero chance of relying on the Rule 10b5-1 affirmative defense if there is no plan in place. Second, the most basic precaution to take on the timing of the creation of these plans is to only allow insiders to enter into a plan after the company has made its quarterly financial disclosures; during an open trading window after the quarterly or annual press release (and conference call) is complete. A lot of companies take the position that at that point all material information has been made public.

Material Nonpublic Information

After that, it’s important to keep in mind that it isn’t just any nonpublic information that creates an issue with the Rule 10b5-1 affirmative defense. The problem is with material nonpublic information. It may be difficult to decide what information is material and what is not. An obvious distinction is that if the information could lead to an event that must be disclosed on a Form 8-K, then it’s reasonable to consider that information to be material. For example, if an individual is aware that your company is in the middle of negotiating a merger or acquisition, then it may be inadvisable for that person enter into a trading plan at that point. On the other hand, if the individual is aware of regular ongoing sales deals or the status of the new widget a company is producing that is part of the normal course of business, these pieces of information may not be considered material.

Situations must be considered on a case-by-case basis. Some companies approach this issue by requiring individuals to disclose to the legal department any nonpublic information that they are aware of at the time they enter into a new plan. This allows the legal department to help insiders determine if that information could be considered material before approving the plan.

How Does Your Policy Measure Up?

Does your company’s insider trading policy address Rule 10b5-1 trading plans? If not, now is the perfect time to have that conversation with your legal team. If you do have a policy, check to see what it says about the timing of the creation of new plans. Confirm that the policy contains components that help ensure that the insider may rely on the Rule 10b5-1 affirmative defense and review those components with your legal team to be sure that everyone is still comfortable that they are adequate.


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February 2, 2010

Operational Errors in Section 423 Plans

Another area of the final regulations under Section 423 that I think is significant is the guidance on the impact of various operational errors. Section 423 qualification is fragile–one inadvertent error can sometimes disqualify an entire offering.

Excluding an Eligible Employee

One error with the gravest consequences is the inadvertent exclusion of an employee that should be eligible to participate in the plan. Under §1.423-2(a)(4), if an eligible employee isn’t permitted to participate in an offering, the entire offering is disqualified under Section 423. This means that none of the purchases under the offering would qualify for preferential treatment under Section 423.

This is an error that I see happen with some regularity, especially when employees transfer between corporate entities. If you’ve experienced problems in the past with eligible employees being inadvertently excluded from the ESPP, now would be a good time to implement some controls to prevent this from happening in the future.

Inclusion of Ineligible Individuals

The flip side of excluding an eligible employee is allowing someone that isn’t eligible under the plan to participate in an offering. Here the consequence are much less dire; that individual’s purchase won’t receive preferential tax treatment, but the overall status of the offering isn’t impacted.

Purchases in Excess of Plan Limits

Another common error is allowing employees to purchase shares in excess of either the $25,000 limitation or a plan limit. The regs make it clear that where a purchase doesn’t comply with the terms of the plan or offering, that purchase is no longer under the umbrella of the ESPP, even if it would otherwise qualify under Section 423 (for example, where a purchase exceeds a plan limit but not the $25,000 limitation). Purchases that aren’t under a qualified ESPP can’t receive preferential treatment under Section 423.

The regs also clarify that where the terms of the option under which the purchase is made originally complied with both the terms of the plan/offering and Section 423 and the purchase ends up violating the original terms of the option, only the purchase is disqualified; it doesn’t impact the status of the entire offering. (By contrast, granting an option with terms that violate the plan/offering or Section 423 does likely disqualify the entire offering because the eligible employee that received the offending option now hasn’t been allowed to participate in the qualified offering.)

In the NASPP’s recent webcast on the Section 423 regs, Helen Morrison from Treasury felt that a situation where a employee is allowed to purchase in excess of a plan limit or the $25,000 limit would likely fall under this treatment. The purchase itself–the entire purchase, not just the shares in excess of the limit–is disqualified but the status of the rest of the offering is unharmed.

For more information on the final regs under Section 423, see our alert “Final ESPP Regs Issued.”

Speaking Proposals for the 2010 NASPP Annual Conference
We are accepting speaking proposals for the 2010 NASPP Annual Conference through Friday, February 26.  We begin reviewing proposals as soon as the submission period closes, so we cannot grant any exceptions to this deadline.  See our Proposal Submission Website for more information.

We aren’t yet ready to announce the dates and location of the Conference; I hope to have that information in the next month or so.   

NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.