November 4, 2008
Volume 1, No. 4

In this Issue:

SOS Excellence Award Nominations

SOS Focus: Option Exchanges

Free Webinar November 19th: Year-end Stock Plan Practices and Procedures

NASPP 2008 Conference Recap

SOS Xposé

Top Three NASPP “Surprises”

409A Deadline Nearly Here!

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SOS Excellence Award Nominations
If you cannot see this e-mail, please open the following link: SOS Xtra: Volume 1 No. 4

SOS is now accepting nominations for the SOS Excellence Award for 2008. This is the inaugural year for this award which is designed to recognize an equity compensation professional who has contributed to the stock plan profession in 2008 above and beyond the call of duty.

Your nominee can be from an issuing company or from a service provider (brokerage, outsourcing firm, consulting, legal firm, industry association, etc.). Anyone can submit nominations (but please don’t nominate yourself!).

On the nomination form, we ask for the name, company, and contact information for the nominee and a short paragraph on why you feel they deserve the award for 2008. After compiling the nominations, we will solicit your votes in December and announce the recipient at the end of the year.
Nominate Today!

*Please feel free to forward this newsletter on to others who might be interested in the content. You can join the SOS Xtra mailing list by clicking here.

SOS Focus: Option Exchanges
As we mentioned last month in our SOS Perspective article, option exchange programs are really heating up. With the stock market down, Financial Week reported in August that “options are underwater at nearly 40% of Fortune 500 companies” and “one in every 10 companies now has options that are more than 50% underwater”, and with the much more favorable, predictable, and manageable accounting treatment under FAS 123(R), more and more companies are considering an “exchange program” of one sort of another. It seems we and our partners are being approached every day by companies wanting to evaluate solutions and the potential cost of an exchange program.

(We use the term “exchange program” rather than the historically more common term of “repricing” for two reasons: 1) many of these programs are not truly “repricings” since they are an exchange of underwater options for restricted stock or for cash and 2) the term repricing has, for several years now, had often undeserved negative connotations.)

At SOS we firmly believe, along with many of our partners, that an option exchange program can, if properly evaluated and executed, be structured to be beneficial to all concerned parties with a relatively minimal amount of expense to the company. However, these programs are quite complex and challenging to manage and should not be undertaken lightly or without sufficient analysis and planning.

A very high-level sketch of a few of the important issues to keep in mind include:

• Which type of exchange should your company do?
Exchanges of options for cash payouts are suddenly getting more attention. Survey data shows that they are historically less frequent, but we are hearing from more and more companies that are considering them. Why? With the market so volatile, some companies and participants seem to have “lost faith” in options and that the market value of their company will go back up in the short- or mid-term. For many companies, accelerating the expense into the current quarter when their financials are already challenging, rather than continuing to expense it over the service period makes a good deal of sense. Also, cancelled shares are generally returned to the plan, conserving them for future use. Wendy Davis, an attorney for Cooley Godward Kronish LLP, says “We have clients approaching us daily about exchange programs. These programs are not one size fits all - increasingly, I'm seeing clients consider value-for-value exchanges (in an endless variety of flavors) and even cash-out programs in lieu of repricings. In short, each company must carefully analyze and work to address its unique needs.”

Exchanges for restricted stock were the most popular in 2007, again perhaps due to disillusionment with options and the desire to keep shares in-the-money despite market performance. Shares can also be conserved somewhat since fewer shares are almost invariably issued. However, issuing firms should consider what sort of message this might send to the market.

Option-for-option exchanges have made a bit of a comeback in 2008, based on a recent analysis by Cooley Godward Kronish LLP. These sorts of exchanges are generally easier to explain to participants since most already understand stock options, and more leverage can be retained by the optionee, since more shares are generally granted than in exchanges for restricted stock.

Some companies have even done exchanges of options for executives, who theoretically have the most control over the performance of the company stock price, while allowing rank-and-file employees to exchange options for restricted stock units.

• International considerations
While certain types of exchanges may be effective from a US tax/accounting perspective, they may have negative results in non-US jurisdictions. We have assisted several companies in identifying potential issues (e.g. employee is taxed upon cancellation of options for the exchange in a non-US location) in connection with tender offers. It is important to complete such a review prior to implementation.

• Whom to include and exclude?
Should you include or exclude directors and officers? Many are choosing to exclude them. The recent analysis by Cooley Godward Kronish LLP found that in 2008 (through July), 33% of exchanges excluded only directors, and an additional 27% excluded officers and directors). However, if you do choose to include them, generally you should ensure that they have little-to-no input over the design of the exchange.

• Which options should you include and exclude?
It seems almost moot to point out that including options that are only slightly out-of-the-money sends a negative message to shareholders and the market in general. But how far out-of-the money should they be? A recent survey by Radford Surveys + Consulting found that of companies that have exchanged in the last three years, the median multiple is 1.3 and the average multiple is 1.7. (If you have a current stock price of $10, you’d exchange only grants with prices $13 or $17 or higher, respectively.) In addition, a recent development is that the 2008 Risk Metrics ISS Governance Services Guidelines require that you exchange only options with prices above the 52-week high and options more than one-year old (see page 38 of the guidelines).

• Tender offer process
Exchange programs invariably require that your employees be offered the choice to participate: a tender offer. Tender offers can be extremely challenging to manage if some form of automation is not utilized. Collecting and processing the elections of your participants manually while being prepared to update your executives and other interested parties on the status of the exchange at a moments’ notice can tax the patience of even the calmest stock plan manager. “The SOS Tender Offer website made our exchange program so much easier to manage. I’m not sure how I would have survived without it!” says Wendy Jennings, of Riverbed Technology.

• Employee communication You don’t want to put all the time and effort into an exchange program and then not have enough optionees take advantage of the offer. But, at the same time, you can’t advise your employees to accept the offer. And any and all communications to employees must also be filed as part of the tender offer on the Schedule TO. We’ve seen and helped companies put together FAQs, onsite presentations, and even call centers to field participant questions (though care must be taken not to communicate anything not filed as a part of the TO).

• Modification accounting
Exchanges require modification accounting under FAS 123(R), but can be structured to minimize (or even eliminate) the “incremental expense” that must be recognized. You compute the value of the exchanged option and the value of the new grant, and the excess of the new grant over the exchanged grant is the incremental expense. The trickiest part of this, it seems, is computing the “expected term” of the underwater grant. Some companies have used the remaining contractual life of the grant, but that is actually the most aggressive approach (producing the lowest expense) and some audit firms have begun to push back on this approach. Terry Adamson, of Radford Surveys + Consulting, recommends the use of a Monte Carlo simulation to produce a supportable expected term.

Other Sources of Information on Exchanges:
   SOS Tender Offer Website
   Underwater Exchange Portal (Radford)
   Dealing with Underwater Stock Options(Towers Perrin)
   Webinar on Exchanges for Restricted Stock (Equity Methods)
   NASPP Website (requires membership to access)
      Interview with Craig Rowley of the Hay Group
      Underwater Stock Options (Across Our Desk…)
      Blog on Underwater Options

Questions about exchange programs or our tender offer website? Please e-mail us at:

Free Webinar on A Good Year … End: Practices and Procedures to Help You Thrive – November 19th

Follow this link to register for our next webinar,

Please join us for our next free webinar on Wednesday, November 19th at 11am Pacific Time.

This panel of experts will provide advice that will help you not only survive, but thrive over year-end. Topics include: audit/reconciliation, reporting, system resets, employee communications, working with your vendors, and ideas and best practices for minimizing the headaches. Years of real-world hands-on experience will be boiled down into practical strategies you can use this year and for years to come!

• Marianne Snook, Principal, Stock & Option Solutions, Inc.
• Danyle Anderson, Programs Director, NASPP
• Paula Woodman, Director, Client Services, Charles Schwab Corporate Services

(One hour of CEP continuing education credit is available for attending. See the CEPI website for more information on continuing education requirements.)

NASPP 2008 Conference Recap & Winners!
The NASPP conference in New Orleans this past month boasted nearly 2,000 attendees, star-studded vendor events, a jam-packed exhibit hall, a fabulous line up of accomplished speakers and informative sessions, and of course, last but not least: the SOS booth, which won the “coolest booth award” – see the video on the NASPP blog (scroll down to the bottom of the page)!

We played darts; we rolled dice; we gave away Bose Earbuds, Mogo Mouses, Bluetooth headsets, lumbar support cushions, magnetic dartboards, a flip videoer, and luggage scales. But of course, the cash drawing drew the largest crowds. At 3pm on Wednesday and Thursday, SOS gave away $2,500 in cash to 12 lucky winners. And the winners were…

Day One: Andrea Albanis, CA Inc.; Janet Smith, FedEx; Beth Sullivan, McDonald's Corp; Terri Gibbons, Whole Foods Markets, Inc.; Linda Webber, Jazz Pharmaceuticals; Connie Greenfield, H&R Block;
Day Two: Susan Balsley, Scripps; Kathy Lietz, USG; Heidi Haynes, GE; Chandra Holcomb; and Monica Pardo, Amerigroup; Elizabeth Regar, The Hershey Company (not pictured)

SOS Xposé
…tender tidbits about people and players in our industry…

Congrats!... ... Leslie Leeming of Charles Schwab and Brian Flynn were married the Saturday before the NASPP Conference. Leslie, however, attended the conference and is now honeymooning in a tropic locale. She’s been assured by experts that her deferral raise won’t raise any 409A concerns… … Mark Shimomura, of SOS, is preparing for an addition to the family in early March… Tracy de Swiet, also of SOS, is back from maternity leave after welcoming Luke Thomas to the SOS family on June 7th.

Sheila Lyons, of BNY Mellon Shareowner Services, participated in the Los Angeles AIDS Walk with The Bank of New York Mellon team on October 19th… Laura Verri, of ETRADE Corporate Services, walked 60 miles in the San Francisco Breast Cancer 3-day Walk and raised over $8,000!

On the Move!...
Shaun McLaughlin has begun work at Transcentive as the Vice President of Sales… Jeff Davitt has taken the role of Manager of Stock Administration at Sapient… Kristi Oberson has joined Prologis in Denver, Colorado… Arnie Kingsberg has joined Mission MPower as COO... and Mark Clem has moved into a new role, in Schwab's Center for Financial Research; as Director of Financial Fitness, he's responsible for the study and use of financial fitness, which includes developing tools, conducting studies, and educating on financial fitness…
Events!… The CEP Symposium has two events coming up in Santa Clara, CA: On December 1st, GPS training: Equity Compensation Plans: Risks and Internal Controls and on December 2nd, The Fifth Annual CEP Symposium.

Have something to Xpose?
Email me! (But keep it clean, people!)
(All of the content included in SOS Xposé has been approved by the firms/people discussed.)

Top Three “Surprises” from the NASPP Conference
SOS personnel presented at and attended many different sessions at the NASPP 2008 Conference in New Orleans. Based on the number of questions raised about and audience reactions to some of the topics, we’ve compiled a list of issues that seemed to “surprise” the audiences the most:

1. Retirement eligibility provisions on restricted stock programs can accelerate the taxable event
Though this is a well-known issue now for tax practitioners and consultants, it seemed to catch a number of attendees off guard. If you grant restricted stock or restricted stock units and your plans contain a retirement-eligibility provision that either accelerates vesting at retirement or allows continued vesting (the participant will not forfeit the shares), the taxable event is accelerated from the vesting date to the date the participant becomes retirement-eligible. This occurs because the taxable event is deemed to occur when there is no longer any “substantial risk of forfeiture”. Since a retirement-eligible employee can choose to retire at any time, and since they will not forfeit the shares when they choose to retire, there is no longer a substantial risk of forfeiture and the participant owes tax immediately. The good news is that if the instrument is a restricted stock unit rather that restricted stock, only FICA/FUTA taxes are due in the year of retirement-eligibility. Federal and state taxes will only be due at the time the shares are released/delivered. For restricted stock, however, all the tax is due at the time the participant becomes retirement-eligible.

2. Federal income taxes are due the next business day for any transactions other than a same-day sale of a non-qualified option if your cumulative tax liability exceeds $100,000
Though many people are aware of the requirement to remit taxes the next business day when cumulative Federal payroll taxes exceed $100,000, what seemed to surprise people is that the widely-relied upon exception to this rule based on an IRS field directive that allows you to remit taxes within one day after settlement from the brokerage firm (generally the day after T+3) does not apply to any restricted stock transactions, nor to any transactions that are not a same-day sale of a NQ option. The field directive very specifically names NQ stock options, so if your taxes are due from a large vesting of restricted stock or units or from any other transaction, such as a net exercise (where a same-day sale is not involved), proceeds are due nearly immediately.

3. You must withhold at the statutory minimum rate or the W-4 rate for the participant. No other rate is permissible
By even SOS personnel, this area had been considered a “gray area” in equity compensation for many years. Is it permissible to allow your participants to withhold at a different rate than either the 25% flat rate or their W-4 rate for supplemental wages under $1,000,000? Some issuing firms allow their participants to increase their withholding from the flat 25% rate to a higher rate for a single exercise or share release/delivery by allowing them to enter a higher rate when they enter the transaction on the brokerage website (or even just by written communication with the stock plan group). Some tax practitioners said it was not permissible to request a higher rate, unless you file an amended W-4 with your company, but many companies allowed it, based on input (or lack thereof) from their own counsel. Barb Baksa, of the NASPP, finally cleared this up at the conference in her session “The Dark Side of Tax Withholding & Reporting”:
"Publication 15 (Circular E) Employer’s Tax Guide specifically states
             (on page 13) that no other rate is permitted."

For more information on any of these topics or on our strategic products and services, please contact us at

409A Deadline is Nearly Here!
The following article was contributed by BDO Seideman LLP.

Please feel free to call Peter Klinger (415) 490-3214 or Andy Gibson (404) 979-7106 with questions.

The December 31, 2008 deadline for compliance with Internal Revenue Code Section 409A is almost here. Companies must make all necessary revisions to any “deferred compensation plan” to comply with Code Section 409A. The penalties for failure to timely comply are significant and include immediate taxation to the employee of vested deferred amounts, a 20% additional tax and an interest penalty.

With respect to equity compensation, stock options that are issued with an exercise price that is less than the fair market value of the shares on the grant date are subject to Section 409A and must be brought into compliance prior to the deadline. For example, private companies may need an independent valuation to confirm their fair market value for pricing their option awards. Additionally, restricted stock and units are generally exempt from Section 409A, but units may be subject to Section 409A if the shares are paid after vesting.

Currently, some of the most common issues that can subject equity compensation to Section 409A taxation include:

• Discounting Stock Options
• Restricted Stock Unit plans with deferral features
• Company valuation compliance errors
• Grant date administrative errors
• Acquisition related modifications
• Stock Options where the underlying stock is not service recipient stock

Also, be aware of certain elections to deferral stock awards (RSUs) beyond the vesting date. Elections must be made in the fiscal year before the fiscal year in which the award is granted, which may not be practicable in many cases, unless certain conditions are met.

In addition to Employee Equity Plans, it is important to remember that Section 409A and its severe penalties can also cover other arrangements. Please select this link to view the rest of this article.

Information provided in this newsletter is designed for educational and entertainment purposes only and is not provided as professional service or advice. Moreover, this newsletter should not be relied on as legal, accounting, auditing, or tax advice. Anyone reading this newsletter should not act upon this information without seeking professional counsel and/or input from their advisors. The preceding information does not necessarily represent the official views of Stock & Option Solutions, Inc. with respect to any of the issues addressed.