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Divorce: The Impact on Equity Awards - Part 2

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November 07, 2019 | Jennifer Namazi

Divorce: The Impact on Equity Awards - Part 2

Last week, I blogged about whether companies should have a transfer policy in place for handing stock plan awards/shares in a divorce scenario ("Divorce: The Impact to Equity Awards - Part 1"). In a follow up to that blog, this week I’ll cover some of the considerations around allowing actual transfers of shares versus transfers of only the economic interest in stock plan holdings.

Economic Interest vs. Actual Transfer: What’s the Difference?

When it comes to dividing stock plan holdings in a divorce, there are two primary approaches: transfer the actual awards (if permitted), or, transfer the economic interest in the awards. A transfer is how it sounds – the paper ownership and control of the awards/shares transfers to another party. In the transfer of economic interest, the shares don’t change ownership on the books – but the non-employee ex spouse gains the right in the divorce settlement to direct the exercise of stock options and receive shares upon vesting of awards. So which is the best choice for companies in considering a transfer policy? There are pros and considerations to each approach. Let's examine each one in more detail: 

Transfer of Economic Interest

  • Grantee ex-spouse continues to hold awards in his/her name*
  • Transferee ex-spouse can direct exercise of options he/she is awarded an economic interest in and will receive shares upon exercise/vesting of awards*
Pros: 
  • Easy administration for plan sponsors, since they are dealing with the employee spouse only.
  • May be a good choice for Incentive Stock Options, since an outright transfer would automatically disqualify ISOs from preferential tax treatment.
  • No change in how fair value of award is calculated or expensed for accounting purposes (not a modification).
  • Exempt from Section 16 reporting; consider footnote disclosure of balances changes at next filing.
Considerations: 
  • Requires communication between ex-spouses, since the employee spouse will have to execute transactions on behalf of the non-employee ex-spouse.
  • Employee spouse retains the award for tax purposes and will pay taxes on the award, creating a need for employee to potentially have to pursue reimbursement of withheld taxes from ex-spouse.
  • Potential liability issues for employee upon termination of employment and forefeiture of unvested awards. 
  • Non-employee spouse subject to employee spouse’s limitations on trading – e.g. blackout periods.

Transfer of Awards

  • Grantee ex-spouse ceases to hold all or a portion of awards*
  • Transferee ex-spouse becomes holder of all or a portion of awards*
Pros:
  • Each spouse controls their own stake in the awards/shares/options.
  • Employee does not have any income reportable event at transfer
  • Employee does not have to report income for NQSOs exercised by ex-spouse
  • Divorce transfers are not considered a disposition of ESPP shares
  • No change in how fair value of award is calculated or expensed for accounting purposes (not a modification).
  • Generally no issue for insider trading purposes, since no sale or purchase takes place
  • Generally exempt from Section 16 reporting; consider footnote disclosure of balances changes at next filing (cash exercises may be exception, if employee deemed to have retained pecuniary interest in the shares; if not then applies to cash exercises also.)
Considerations: 
  • Companies with significant global populations have requirements of multiple jurisdictions to consider.
  • Company required to report income for the non-employee ex-spouse (process and resource considerations).
I won't advocate for one approach over the other, because I think companies need to take the pros and considerations into account relative to their employee demographics and resources. However, one of the most significant factors in determining whether to prohibit transfers is consideration for the processes and resources that would be needed to support actual transfers. Since a transfer introduces the non-employee spouse into the picture, the company now needs to figure out how to handle things like income reporting - which is not likely done through Payroll. If your company has multiple payrolls, different processes may be needed. These are not light considerations and should be evaluated carefully in determining how the company will approach implementing (or enhancing) a transfer policy around divorce. 

For more information on this topic, the audio recording of the session “Divorce, Death and the Impact on Equity Awards” from our 27th Annual NASPP Conference earlier this year is available on our NASPP website.

-Jennifer

*Primary source of pros and considerations: Divorce, Death and the Impact on Equity Awards session of the NASPP’s 27th Annual Conference.

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