Full value awards have been a commonplace in our world of stock compensation for a while now. Yet, it seems there is always something new to learn when it comes to administering these vehicles. In fact, navigating the complexities of restricted stock units and awards is still such a hot issue that we’ve dedicated a Pre-Conference session this year, Advanced Issues in Restricted Stock, to the topic. One thing in particular that I’ve always found particularly annoying in administering restricted stock awards is something small in size and, if not approached thoughtfully, big on headaches: par value.
Par Value, Defined
The par value of a stock has no relation to a stock’s market value and, frankly, is a fairly outdated concept — initially introduced back when the markets were highly unregulated. In essence, the par value of a stock is the nominal value, which is determined by the issuing company to be its minimum price. Par value also has accounting purposes. It allows the company to put a de minimis value for the stock on the company’s financial statement.
In today’s world, many common stocks don’t have par values. Yet, there are still many that do (usually only in jurisdictions where par values are required by law). A typical par value is representative of the smallest quantity of money available, or a fraction thereof (e.g. 1 cent, or a fraction of a cent). Many states do not allow a company to issue stock below par value.
Par Value and Restricted Stock Awards
In administering restricted stock plans, there are a number of considerations around this pesky par value. Since the par value is the minimum acceptable price for shares of the company’s common stock (for companies subject to par value requirements), then, in theory, payment of par value must be collected from the employee when the company issues a restricted stock award.
1. Establish a collection method for par value: how will the company satisfy the obligation to collect the par value? The two most common methods today (at the discretion of the company and the language incorporated into the stock plans) are issuing treasury shares, and use of “past services”. The most common method is use of treasury shares. I’m guessing this is because since treasury shares have been previously issued into the market place (before the company bought them back on the open market); the idea is that the par value requirement has already been satisfied. By the time the company uses these shares to fund the restricted stock plan, they are not subject to the par value requirement. The second most popular choice is to use past services. Note that if you plan to use this method, you’ll need to ensure you use this for current employees who have a service history and not for new hires (since a newly hired employee wouldn’t have any history of service with the company). A small minority of companies use “future” service in satisfaction of par value, and an even tinier number collect cash.
2. Be sure to calculate the proper gain for income tax reporting purposes: depending upon with method you use to collect par value, you’ll calculate the “income” to be reported on the employee’s W-2 slightly different. If the employee paid the par value in cash, then it’s deemed to be a literal “payment” for the shares and the cost basis for the shares would be equal to the par value per share.
EXAMPLE: Par value is $.01 per share and an employee vests in 1,000 shares
Fair market value at vest is $25
$25 – $.01 = $24.99 per share of income
Total income on W-2: $24,990
If the employee satisfies the par value obligation using “past services”, then no cost basis is applied to the shares. One rationale I heard for this is that since the entire award has been issued as consideration for past services, you don’t make a distinction between the portion of services attributable to the par value and the balance of the award value. In the example above, if par value had been satisfied using past services, then the full $25 per share would be considered income.
3. In some cases, refund par value: If the employee has paid the par value in cash, you’ll need to remember to refund the par value payment if the shares are forfeited. Ideally it would be nice to include the refund in the employee’s last paycheck in order to avoid having to issue a check for such a small amount of money.
The Survey Says…
The NASPP does have data on what companies are doing with respect to par value. According to our 2010 Domestic Stock Plan Design survey, 93% of responding companies do have a par value associated with their common stock. Of those companies, when it comes to restricted stock, 43% issue only treasury shares (which are not subject to par value requirements), 36% utilize past services as payment, 12% use future services as payment, and only 6% collect cash (the remaining 3% replied “other”.)
As you can see, there are lots of considerations for such a seemingly small piece of the restricted stock pie. This topic and more advanced issues will be covered in the Advanced Issues for Restricted Stock Pre-Conference session, and it’s not too late to register!
One of the most common types of “unplanned” modifications I see in my consulting work, which we will cover in our presentation, is that of vesting modifications.
The text of the ASC 718 standard says this about modification accounting: Modifications of Awards of Equity Instruments
51. A modification of the terms or conditions of an equity award shall be treated as an exchange of the original award for a new award. …In substance, the entity repurchases the original instrument by issuing a new instrument of equal or greater value, incurring additional compensation cost for any incremental value. The effects of a modification shall be measured as follows:
a. Incremental compensation cost shall be measured as the excess, if any, of the fair value of the modified award determined in accordance with the provisions of this Statement over the fair value of the original award immediately before its terms are modified, measured based on the share price and other pertinent factors at that date. … b. Total recognized compensation cost for an equity award shall at least equal the fair value of the award at the grant date unless at the date of the modification the performance or service conditions of the original award are not expected to be satisfied. Thus, the total compensation cost measured at the date of a modification shall be (1) the portion of the grant-date fair value of the original award for which the requisite service is expected to be rendered (or has already been rendered) at that date plus (2) the incremental cost resulting from the modification.
But then the examples in ASC 718-20-55-111 through ASC 718-20-55-118 go on to delineate four, count them four, different types of vesting modifications, with two different treatments:
Type I: Probable to Probable: Recognize fair value of original award + incremental expense, if any.
Type II: Probable to Improbable: Recognize fair value of original award + incremental expense, if any.
Type III: Improbable to Probable: New fair value only. Reverse expense for any unvested shares.
Type IV: Improbable to Improbable: New fair value only. Reverse expense for any unvested shares.
Type II and Type IV are incredibly uncommon, but we DO see a good number of Type I and Type III. Type I are often triggered by option exchanges, or any modification to already vested shares, like an extension of exercise grace period at termination. Type III modifications are also quite common at the time of termination when unvested shares are accelerated.
How do you handle the modifications? First, decide if they are Type I or Type III. If the shares are vested, chances are good you are dealing with a Type I. If the shares would have been cancelled if not for the termination, then chances are good you have a Type III. If a Type I, perform two fair value calculations: one before the change, and one after, and compare the expense to determine your incremental expense. If a Type III, you need only one fair value calculation, using the attributes of the grant after the modification. Calculate how much expense has already been booked for the unvested shares in the grant and true up (or down) to the new fair value.
There is good news about most modifications, especially those at the time of termination: they are generally fairly simple one-time calculations where all the expense is booked immediately. Once and done. The bad news is that most systems have limited support for modification accounting and the inputs can be quite tricky. What is the expected term of an underwater option before it is exchanged for a new option? Is it the remaining expected term from the original grant date fair value? The remaining contractual life? An expected term calculated by a Monte Carlo simulation? Each company must decide for itself. A few examples in the standard seem to point to remaining contractual term, but the Monte Carlo simulation approach seems to fly past audit as well. No two audit firms, or audit partners, seem to have the same opinions.
Join me and my talented co-panelists in New Orleans as we wrestle modification accounting to the ground and give you a solid understanding of the required treatment and some varying interpretations. Laissez Les Bon Temps Roulez!
Two weeks ago, I discussed the Medicare tax rate hike that goes into effect next year (“The Supreme Court and Stock Compenation,” August 7). Today I discuss some additional considerations relating to that tax increase and other possible tax increases for 2013.
A Busier Second Half of the Year
Any time there is a tax rate increase on the horizon, tax advisors get on their soap boxes about accelerating transactions to take advantage of the current lower rates. In our world, that translates to employees possibly exercising their NQSOs this year, rather than waiting until next year or later.
Of course, here we’re only talking about an additional .9% in tax. Generally, tax considerations shouldn’t drive investment decisions and I would think that this is especially the case when we’re taking about such a small increase–on a gain of $1 million, that’s only $9,000 in additional tax. If you think the stock is going to increase in value, I’m not sure it’s worth it to exercise early just to save the $9K. But Jenn Namazi, the other half of the NASPP Blog, tells me that she has heard several advisors (including some very large, well-respected firms) suggesting this investment/tax strategy, so what do I know?
In addition to NQSO exercises, you also may find more of your insiders selling stock in the latter half of this year. This is because, in addition to the rate hike I described last week, a completely new Medicare tax also goes into effect next year. This is a 3.8% tax that applies only to “unearned income” in excess of the same $200,000/$250,000 threshold. Unearned income sounds like something bad, like you it is income you don’t deserve, but it really just refers to income you didn’t earn by toiling away for your employer. Primarily, this is income from investments, such as capital gains realized on the sales of stock.
3.8% is a little more significant (actually about four times as significant) than .9% (it amounts to $38,000 on a gain of $1 million). On top of that, if Congress doesn’t take action to extend the Bush-era tax cuts, the long-term capital gains rate is going to increase from 15% to 20%. Consequently, long-term capital gains that would currently be taxed at 15% might be taxed as high as 23.8% next year. That’s the sort of tax rate increase that I expect to be more likely to change investment strategies.
Of course, there’s no tax withholding on long-term capital gains and this applies to the new Medicare supplement as well. There’s also no matching company payment, so the company doesn’t have any reporting or withholding obligations with respect to this tax.
But, where the sellers are executives, the sales could have other impacts to the company. At a minimum, the sales have to be reported for Section 16 purposes. And where executives have Rule 10b5-1 plans set up, you might find a flurry of changes to increase sales under these plans, which most companies would need to review/approve.
Shareholder optics are also a consideration; having several executives (or all executives) suddenly appear to be dumping company stock around year-end may not be the best thing for the company’s stock price. Your investor relations group may want to get out in front of this one.
This year’s NASPP Conference is just weeks away and will mark a very special milestone: our 20th Annual Conference. It’s hard to believe 20 years of learning and networking have passed since our first conference (not to mention how many other things have transpired during the past 20 years, but that would require another blog just to explore them). As we celebrate this significant anniversary (what better way to do it than New Orleans style?), and all that has transpired in the stock compensation industry during that time, we’ve created a fun way of reliving the memories of conferences past: The NASPP 20th Annual Conference Anniversary Trivia.
Do you remember the hot topics from last year’s conference? How about 3 or 5 or 10 years ago? Which cities have you traveled to the most as you’ve faithfully attended the conference each year? Whether you’ve just joined the industry or are a seasoned veteran, the trivia will be sure to trigger reminiscences. Available on our NASPP home page, we’ve got many questions lined up and will be changing them frequently, so be sure to stop by often in the coming weeks. It only takes a moment to test your conference knowledge! To get the party started, I’ve included three trivia questions in today’s blog:
1. Which band was the featured entertainment (hosted by Fidelity) at the 15th Annual Conference, held in San Francisco?
c. The Mamas and Papas
d. The Village People
2. What was the title of the keynote address from the 14th Annual Conference, held in Las Vegas?
a. “A Roadmap to IFRS 2”
b. “Behind the Scenes of the FASB”
c. “How to Avoid the Next Scandal (and Protect Yourself)”
d. “The IRS and Treasury Speak”
3. Excluding this year’s conference, when was the last time New Orleans played host to an NASPP conference?
d. The conference has never been held in New Orleans
The answers are below; how did you do? As you venture into fall and the weeks leading up to what is sure to be our best conference yet, take a few moments along the way to take the trivia challenges and revisit your favorite conference memories! If you’re not yet registered for this year’s conference, it’s not too late – you can register today!
I’m looking forward to seeing everyone in New Orleans!
DC/VA/MD: Bob Webb will moderate a webinar by Michael Meissner and Matthew Secrist of Squire Sanders on “Obama, Romney or ? – Planning Strategies for Equity Compensation Pending Changes in the Code.” (Tuesday, August 21, Noon to 1:00 PM)
Phoenix: Jim Vincent of E*TRADE Financial will present on “A Plethora of Performance Perplexities.” (Wednesday, August 22, 11:30 AM)
Western PA: John Hammond of AST and the NASPP’s own Jen Baehr will present on “Top Ten Ways to Simplify Administration Processes through New Technology.” Be sure to say hello to Jen. (Wednesday, August 22, 8:00 AM)
Houston: Lance Froelich and Jessica Schuster of BDO will present “A Fundamental Guide to Equity Award Design.” (Thursday, August 23, 11:30 AM)
Life is full of risks; it is what makes life so interesting. It is how you navigate through the tidal wave of challenges that these risks pose that measure the quality of your success. Well, like everything in life, equity compensation plans involve many different types of risks. As an issuer’s plan administrator, you are responsible for understanding those risks and taking any action possible to mitigate them. It is a daily game of covering your…assets. This includes protecting your job, your reputation, your company, your executives, your shareholders and your most valuable resources–your employees.
Though I have spoken at many conferences, including several local NASPP chapter events, this is my first time on the “big stage” at the national conference. I am very excited to present with a great and diverse panel with years of experience in plan administrative services along with in-house administration, education, compliance, tax and legal services. I have the honor and privilege to present with Emily Cervino of Fidelity Investments, Renee Deming of Cooley and Lori Brennan of UBS Financial Services.
When putting this panel together we wanted to make sure the audience would walk away with a list of suggested procedures to verify or put in place to help mitigate risk. We wanted to ensure this wasn’t like other risk-based sessions we’ve seen over the years that simply scared you with the consequences of risk but really didn’t talk about how you can help mitigate the risks. Our topics will range from grant issuance to taxation and data flow to communication. We’ll also discuss some differences between in-house administration versus plan outsourcing scenarios with a strong emphasis that outsourcing your plan does not diminish your responsibilities for oversight and risk mitigation.
An interesting thing happened on the way to submitting our slide deck to the NASPP. We too ran into a risk situation due to the content of our presentation. The risk was identified by an internal process established by one of the firms represented on this panel. Since our presentation title includes the name “Risky Business” we couldn’t resist putting some pictures from a certain famous ’80’s movie into our slide deck. We were sad when we were told our presentation would create a copyright risk and all the pictures had to be removed. At the same time, it reminded us that risk review policies like this are imperative. This means our funny pictures of Joel, Lana, Barry and even Guido have been replaced with boring pictures of dice–sorry.
Make sure you join us for what should be a very interesting and informative panel. “Risky Business: Ten Ways to Protect Your Equity Programs” is session 4.2 on Tuesday October 9. See you there!
If you have concerns or comments that you’d like to voice to ISS about their policies, now is your chance. ISS’s policy survey, the responses to which will be used to formulate their corporate governance policies, is open through the end of this week (Friday, August 17). Speak now or forever hold your piece (well, not really “forever,” presumably they’ll do another survey next year).
This Year’s ISS Policy Survey
The only questions on the survey I noticed that directly address stock compensation were a couple of questions that ask about single-trigger acceleration of vesting of stock awards in the event of a change-in-control. A few other topics in the survey that could indirectly have an impact on stock compensation include:
ISS’s determination of peer groups
How pay should be measured (always a challenge for stock compensation)
Types of performance metrics (e.g., TSR vs. internal metrics)
A few last topics ISS focuses on in the survey that could have an even more indirect impact on stock compensation include director qualifications, director independence, and pledging (e.g., allowing executives to use company stock as collateral for margin accounts or other loans). There also were a bunch of topics that fall under the heading of “Things I Don’t Care About,” so I didn’t read those questions (e.g., corporate lobbying, proxy access, sustainability performance measures).
A Preview of Policy Changes to Come?
The issues covered in the survey are likely indicative of the areas where ISS is considering revising its corporate governance policies for next year–otherwise why would they be asking about these topics? ISS changed its peer group determinations as part of last year’s overhaul of the pay-for-performance analysis (see my blog entry “ISS Policy Updates for 2012,” November 29, 2011); now it looks like ISS may be considering further changes to peer groups. (But probably only for the pay-for-performance analysis; ISS didn’t change peer groups for burn rate purposes last year so I don’t think they’ll change burn rate peer groups for this year either.)
The ISS survey will close this Friday. ISS will hold round-table discussions of the topics covered in the survey during August and September and expects to release the survey results in September. ISS will then accept comments on the results until October and will release its final policy update in November.