Frederic W. Cook & Co., Inc.
New
York · Chicago · Los Angeles
March 29, 2001
Summary of 2000 Regulatory
and Other Developments
Affecting Executive Compensation
Year 2000 could easily be coined the year of
“interpretations.” Just when we thought
the Financial Accounting Standards Board (FASB) concluded its 3½-year project
on providing guidance on how to interpret Opinion 25 with the release of
“Interpretation 44” on March 31, 2000, the Emerging Issues Task Force (EITF)
was back in two months to “interpret” Interpretation 44. The result is a trail of over 30 practice
issues and questions, some of which have been addressed and others that are
awaiting yet another meeting. As a
review, we will highlight Interpretation 44, as well as discuss the most
significant developments (our personal “Top Ten List”) that the EITF has
interpreted this year.
Interpretation 44 is intended by the FASB to provide
additional clarification and guidance, within the existing framework of Opinion
25, in several areas of accounting for stock compensation that have emerged in
practice over the past years. The
Interpretation is effective as of July 1, 2000 and applies to grants of new
stock awards and changes that occur on or after that date (Exceptions: stock option repricings and grants to nonemployees that
occur after December 15, 1998 and stock options modified to add a reload
feature after January 12, 2000).
While the FASB, EITF, and the SEC issued many
rulings dealing with stock compensation, many of these rulings affect few
executive compensation professionals because of the limited applicability of
the situations in which they apply.
Here is our list (through March 31) of the ten rulings that have the
most far-reaching impact on stock option practices.
(1) Direct and
Indirect Repricing: EITF guidance provides that variable award accounting is required for
otherwise fixed stock options that are modified to directly or indirectly
reduce the exercise price of the award.
For example, granting new stock options with an exercise period that
expires upon the earlier of (1) 10 years, or (2) 30 days after the date at
which the company’s stock price reaches the exercise price of previously
granted “underwater” stock options. In
addition, the EITF clarified that variable award accounting would not apply to
time-based restricted stock issued in exchange for canceling an option.
(2)
Retroactive Reload Feature: EITF guidance provides that adding a reload feature
to an already outstanding grant results in variable accounting, not only for
the existing grant but also for the reload.
(3) Modifying
Terms/Conditions of Outstanding Award: EITF guidance provides that changing the terms and
conditions of an outstanding grant results in either a new measurement date or
variable accounting. A new measurement
date occurs if further changes to the exercise price/number of shares will not
occur in future, and variable award accounting applies if there is not a
practical way to ascertain whether further changes to the exercise price/number
of shares will occur in the future.
(4) Exchange
of Parent Options for Subsidiary Options (and Vice Versa): EITF guidance provides
that exchange of parent options for subsidiary options in a “reciprocal”
transaction (e.g., as part of an initial public offering of the subsidiary’s
stock) results in a new measurement date but not variable award
accounting. Two conditions must be
met: (1) no increase in aggregate “intrinsic
value” (or decrease in aggregate intrinsic loss), and (2) no reduction in the
ratio of exercise price per share to market price per share.
(5) Change in
Status: EITF
guidance provides that a new measurement date must be derived if employees
retire and continue to vest in their stock options while providing services to
the company. There is no impact if
there are no continued services and continued vesting was part of the original
terms.
(6)
Stock-for-Tax Withholding: EITF guidance provides that variable award accounting applies if more
than the minimum required statutory withholding is allowed in a stock-for-tax
withholding transaction at volition of employee or consistently by grantor
company.
(7)
Privately-Held Company Grants: EITF guidance provides that privately-held
companies must grant stock options at the fair value of the stock to avoid a
P&L charge and ensure that shares issued upon stock option exercises are
not repurchased within six months of exercise if the company wants to avoid
P&L charges for the options.
(8) Non-Employee Directors Really Employees: EITF guidance provides
that non-employee directors are considered employees for purposes of stock
option accounting under Opinion 25.
(9)
Consolidated Subsidiaries: EITF guidance provides that parent company stock grants to employees
of consolidated subsidiaries qualify for favorable option accounting under
Opinion 25. However, parent company
grants to employees of non-consolidated subsidiaries result in accounting under
FAS 123.
(10) Stock
Option Rescission: EITF guidance provides that rescinding a stock option exercise and
reinstating the original option will result in variable accounting for the
reinstated option.
NONSHAREHOLDER
APPROVED STOCK OPTION PLANS
As a result of the SEC’s approval of the New York
Stock Exchange’s (NYSE) “broadly-based” definition on June 4, 1999, shareholder
concern persisted around potentially unlimited dilution that could result from
nonshareholder approved employee equity plans.
In response, the SEC requested that the NYSE work with the Nasdaq to
develop acceptable shareholder approval requirements for broadly-based plans
during a pilot period that was to last until September 30, 2000 (now under
extension).
The NYSE has developed and submitted for review to
Nasdaq a proposal that would potentially replace the existing exemptions for
broadly-based plans with more rigorous standards. The main points of the NYSE proposal include the following:
(1)
Requiring
shareholder approval of all stock option plans in which officers and directors
participate
(2)
Capping
the number of shares in nonshareholder approved plans and arrangements
(including broadly-based plans, new hire grants, and merger awards) at 10% of
aggregate shares currently available in all shareholder-approved programs
maintained by the company
(3)
Requiring
grants funded through treasury shares to be subject to shareholder approval
requirements, i.e., elimination of the “treasury stock” exemption (which
currently exists only at the NYSE)
But before responding to the SEC, the Nasdaq has
requested public comment on the proposal and is now developing its response.
In addition, the SEC is proposing revisions to proxy
disclosure requirements contained in Regulation S-K. Currently, companies do not have to disclose the total number of
securities they have authorized for their equity compensation programs on an
ongoing basis (unless “material” in which case disclosure is necessary under
GAAP), unless new plans are proposed or modified.
In response, the SEC is proposing equity
compensation plan information to be disclosed in an amended table format to
include:
(1)
Number
of securities authorized for issuance under each plan, whether shareholder
approved or not
(2)
Number
of securities awarded plus the number of securities to be issued upon exercise
of options, warrants or rights granted during the last fiscal year
(3)
Number
of securities to be issued upon exercise of outstanding options, warrants or
rights
(4)
Number
of securities remaining available for future issuance
These changes would result in shareholders and
analysts receiving more detailed information on stock option and other equity
plans in which dilution calculations could be conducted easily.
Effective October 23, 2000, the SEC has adopted Rule
10b5-1 to help clarify issues related to insider trading. This new ruling allows insiders and other
investors (such as top executives and board members) to buy or sell stock in
their companies regardless of the inside information they have as long as they
have committed in advance with no insider information at the time of the
commitment.
The SEC provides three instances in which executives
can buy or sell securities and not violate insider trading laws:
(1)
Executive
enters into a binding contract to purchase or sell the security prior to their
becoming aware of inside information
(2)
Executive
demonstrates that the trade was executed in advance of becoming aware of the
information
(3)
Executive
demonstrates that a written plan for trading securities was adopted prior to
becoming aware of the information
The new insider trading rule remains consistent with
Section 10(b) of the Securities Exchange Act of 1934 in which it is unlawful
for any person to employ any deceptive or manipulative device in connection
with the purchase or sale of a security.
The rules allow executives to be free from prosecution if it can be
demonstrated that material nonpublic information was not a factor in making a
trading decision. The new policy will
allow large shareowners (e.g., founders) to use a formulaic policy to sell
shares over a period of time. This
could potentially help companies avoid large “sell-offs” that adversely affect
stock price, which can occur when a large shareowner retires.
OTHER LEGISLATIVE ISSUES
WORKER ECONOMIC OPPORTUNITY
ACT
The Senate passed a bill titled “Worker Economic
Opportunity Act” that would exempt stock option gains from overtime
calculations proposed by the Fair Labor Standards Act (FLSA) on broadly-based
grants if the terms and conditions of the program included:
(1)
Communication
to employees when they were hired or when they received the grant
(2)
Options
and SAR would have a minimum six month vesting period and a purchase price of
at least 85% of the stock’s fair market value on the date of the grant
(3)
Participation
is voluntary
(4)
Awards
cannot be dependent on future performance of any individual
The legislation is a win for the business community
as companies will be able to continue granting stock options throughout broadly-based
employee groups without including stock option gains in the base rate to
calculate overtime pay for their employees.
* * * *
* *
Please refer to the alert letter reference in the
footnotes for more detail on these topics.
General information can be obtained by contacting Malia Mixon in our
Chicago office at (312) 332-0910 or any other member of the firm. This letter and other published materials
are available on our Web site, www.fwcook.com.
“Alert” Letters Referenced
Sorted by Date
|
Congressional
Hearing on Including Stock Option Gain in Base Rate for Overtime Pay May Lead
to New Legislation 3/14/00 |
House
Ways and Means Subcommittee Holds Hearing on Employee Stock Option Plans 10/19/00 |
|
Another
Perspective On The Cost of Stock Options
4/19/00 |
Nasdaq
Stock Market Requests Public Comments on Shareholder Approval Issue 12/14/00 |
|
Senate
Passed Bill That Would Exempt Stock Option Gains From Overtime
Calculations 4/19/00 |
An
Advisory to Compensation Professionals on the Use of Compensation Survey
2001 12/15/00 |
|
FASB
Interpretation No. 44 – Accounting for Certain Transactions Involving Stock
Compensation 5/1/00 |
Issues
Related to the Accounting for Stock Compensation under APB Opinion No. 25 and
FASB Interpretation No. 44 1/9/01 |
|
Summary
of FASB Interpretation No. 44 5/10/00 |
EITF
Continues to Issue New Guidance on Accounting for Stock Compensation 1/9/01 |
|
Bill
for New Form of Tax-Favored Employee Stock Purchase Plans Introduced 8/2/00 |
SEC
Issues Accounting Guidance for Stock Option Exercise Rescissions 2/16/01 |
|
FASB
and EITF Issue Rulings on Accounting for Stock Compensation 9/15/00 |
Proposed
SEC Disclosure Rules for Equity Compensation Plans 2/23/01 |
|
EITF
Resolves Several Stock Option Accounting Issues 10/11/00 |
Issues
Related to the Accounting for Stock Compensation under APB Opinion No. 25 and
FASB Interpretation No. 44 3/7/01 |
|
New
Insider Trading Rule to Provide Clarity for Insiders 10/18/00 |
EITF
Continues its Deliberations on Issue No. 00-23 3/7/01 |