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                             NEW January 2006 Edition of
            Mergers, Acquisitions,
                  and Buyouts Levin
             by Martin D. Ginsburg and Jack S.

             We are proud to enclose the January 2006 edition of Mergers, Acquisitions, and Buyouts
           by Martin D. Ginsburg, Professor of Law at Georgetown University, and Jack S. Levin, a senior
           partner in the international law firm of Kirkland & Ellis LLP.
             Here is a summary, written by the authors, of major developments reflected in the new edition.

          Highlights of the New Edition

         • 2006 tax rates. 2006’s top corporate tax rate continues at 35%, with a 1 percentage point reduction
            (to 34%) for Code §199 “qualified domestic production activities [net] income,” increasing to 2 percent-
            age points (i.e., a 33% rate) for 2007 through 2009 and to 3 percentage points (i.e., a 32% rate) after
            2009. The §199 rate reduction is achieved by granting a deduction equal to 3% (2005-2006), 6% (2007-
            2009), and 9% (after 2009) of the taxpayer’s qualified domestic production net income.
              2006’s top individual tax rates continue at 35% for OI, 15% for normal LTCG, 14% for Code §1202
            LTCG, and 15% for qualified dividend income, with several qualifications:
            •   An individual’s qualified domestic production activities net income is subject to the same Code §199
                rate reduction as is a corporation’s similar income.
            •   The long-standing disallowance of an individual’s itemized deductions (equal to 3% of AGI in excess
                of $149,950 for 2005 [adjusted annually for inflation]) drops to 2% for 2006 and 2007, then to 1%
                for 2008 and 2009, then to zero for 2010, and back to a full 3% after 2010.
            •   The long-standing phase out of individual personal exemptions from $225,750 to $348,250 of AGI
                (adjusted annually for inflation) drops to a phase out of 2/3 of personal exemptions for 2006 and
                2007, then to 1/3 for 2008 and 2009, then to zero for 2010, and back to a full phase out after 2010.
                See discussion at ¶106.3 (additional rate issues) and ¶107.2.3.
         • Carve out IPO. The authors have expanded their discussion of a carve out IPO — where Bigco dis-
            poses of its subsidiary (S) through a multi-step sale program (often including one or more public offer-
            ings), while obtaining stepped-up basis (“SUB”) for S’s assets, and a tax-sharing agreement giving Bigco
            the benefit of S’s asset SUB — by (1) adding an analysis of the Code §197 anti-churning issues which
            may impede S’s ability to amortize its SUB in unlimited-life intangibles such as goodwill and (2) propos-
            ing several solutions to this anti-churning problem. See discussion at ¶206.5(2) and ¶302.8.
         • Expedited IRS ruling request. Effective for ruling requests after 9/14/05, IRS will (at taxpayer’s
           request) provide expedited treatment (generally culminating 10 weeks after IRS’s receipt of the ruling request)
           for a Code §368 or §355 transaction presenting a “significant issue.” See discussion at ¶601.2 and ¶601.2.1.
         • NQ Pfd. 2005 legislation adds to the NQ Pfd definition: “If there is not a real and meaningful likelihood
            that dividends beyond any limitation or preference will actually be paid, the possibility of such payments

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            will be disregarded in determining whether stock is limited and preferred as to dividends.” See discussion
            at ¶604.3.1.1.
         • Reorganization COI. In 9/05 IRS/Treasury at long last finalized regulations adopting (in an exam-
            ple) a 40%-is-good-continuity-of-interest (“COI”) approach for a reorganization.
               These 9/05 regulations also address whether and when COI satisfaction is determined by reference to
            the binding contract signing date (instead of the reorganization’s closing date). Explicitly, the regulations
            value P’s shares to be delivered in the transaction on the last business day preceding the first date there is
            a “binding contract” calling for fixed consideration in stock, money, and/or other property, for a transac-
            tion carried out pursuant to a binding contract entered into after 9/16/05.
                Consideration is not “fixed” if there is any “contingent” consideration, subject to several exceptions:
            •     A contract calling for contingent consideration is treated as “fixed” if (a) the contingent consideration
                  consists only of P stock and (b) COI would be met as of the day before the binding contract date even
                  if no contingent P stock consideration were ever delivered.
            •     “Consideration paid in escrow to secure [T’s] performance of customary pre-closing covenants or [T’s]
                  customary representations and warranties” does not constitute disqualifying contingent consideration.
            •     The presence of a customary anti-dilution clause does not prevent consideration qualifying as fixed,
                  and the absence of such a clause prevents consideration from qualifying as fixed if P in fact “alters
                  its capital structure” between binding contract date and closing date “in a manner that materially
                  alters the economic arrangement.”
            •     The possibility that some shareholders may exercise dissenters’ rights and receive consideration
                  other than as provided for in the binding contract does not constitute disqualifying contingent
            •     Cash in lieu of fractional shares does not constitute disqualifying contingent consideration.
              A contract is treated as binding notwithstanding a condition outside the parties’ control (e.g., regulatory
            approval) or customary conditions (e.g., shareholder vote). A tender offer subject to 1934 Act §14(d) is
            also treated as a binding contract.
               If a binding contract is modified before the closing date (as to the amount or type of consideration T’s
            shareholders will receive), the original contract drops away and the modified contract is the “binding
            contract,” so that the modification date is thus treated as the first date on which there is a binding con-
            tract. A similar rule applies when a tender offer is modified as to the amount or type of consideration to
            be received by T’s tendering shareholders.
               Although P shares deposited in escrow to protect P against breaches of customary T covenants, repre-
            sentations, and warranties initially count on the good side in measuring COI qualification, a regulatory
            example clarifies that any such P shares actually forfeited are not treated as good COI. Although the regu-
            lations are silent, the authors believe that to the extent T shareholders actually dissent and receive cash,
            such cash falls on the bad side of COI (just as P’s pre-planned voluntary repurchase of P shares for cash
            would fall on the bad side of COI). See discussion at ¶610.2.
         • Tax Court’s Tribune decision. In its 2005 Tribune Company decision the Tax Court held that a
            complex transaction failed to meet Code §368(a)(2)(E)’s Reverse Subsidiary Merger requirements for a
            tax-free reorganization. The transaction involved a reverse subsidiary merger in which T’s old shareholder
            exchanged T stock for stock of an acquiring corporation (P), the principal asset of which was 100% own-
            ership of a cash-rich LLC, with the parent of T’s old shareholder appointed as the LLC’s manager. The
            Tax Court viewed appointment of the parent of T’s old shareholder as manager of the cash-rich LLC as
            constituting boot with an FV exceeding 20% of the aggregate transaction consideration, thereby causing
            the transaction to fail the Reverse Subsidiary Merger 20%-maximum-boot definition, a conclusion not
            free from doubt. See discussion at ¶803 Example 9.

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         • Code §351 exchange for more than purely Newco stock. The authors explain the marked-
            ly different tax treatment of a Code §351 transfer of appreciated property depending on whether the trans-
            feror, in addition to receiving Newco stock, also receives cash, Newco debt, or liability relief:
            •   Cash boot causes immediate gain recognition to transferor (with immediate Newco basis step up for
                the transferred appreciated property).
            •   Newco debt often qualifies for Code §453 installment reporting (with deferred Newco basis step up
                for the transferred appreciated property).
            •   When Newco assumes transferor’s liability, transferor has no gain recognition unless the aggregate
                debt relief exceeds transferor’s aggregate basis in the transferred property and the relieved liabilities
                had already given rise to either deduction or property basis (but transferor’s basis for the Newco
                shares is reduced, unless the relieved liability will give rise to a future Newco deduction). See discus-
                sion at ¶901(5).
         • SCo 100 shareholder limitation. In determining whether a corporation has no more than 100
            shareholders and hence can qualify for S status, 2004 legislation allows members of a family unto the 6th
            generation to elect to be counted as one shareholder. 2005 legislation retroactively amends this rule by,
            inter alia, eliminating any requirement to make an election and adding a family member’s estate. See dis-
            cussion at ¶1102.1.1.1.
         • SEC’s all-holders best-price tender offer rule. Where T’s stock is publicly held and P is pur-
            chasing T stock from a number of holders, SEC’s tender offer rules require that (1) P’s tender offer must
            be open to all T shareholders and (2) “consideration paid to any security holder pursuant to the tender
            offer [must be] the highest consideration paid to any other security holder during such tender offer.”
              Where A is a key T executive who owns some T shares and P (or T) enters into a retention, employ-
            ment, consulting, or non-compete agreement (a “service agreement”) with executive A before P com-
            mences its tender offer for T’s shares, so that P (or T) is obligated to make a service payment to executive
            A after the close of P’s acquisition of T, the amount P (or T) pays executive A pursuant to the service
            agreement should not be covered by the all-holders best-price rule for two reasons: First, the payment
            under the service agreement is not for executive A’s T stock (but rather, so long as constituting reasonable
            compensation, is for executive A’s services) and second, neither the agreement to pay nor the payment
            occurred “during such tender offer.”
               Most courts adopted a bright-line test, holding that so long as execution of the service agreement
            between P (or T) and executive A occurs prior to the tender offer’s commencement, the service agreement
            is not covered.
               However, the Ninth Circuit held that a separate transaction with an executive which was an “integral
            part” of the tender offer must be viewed together with the tender offer, and district courts in the Ninth
            Circuit interpreted this decision as meaning that a service agreement which is an integral part of the ten-
            der offer must be taken into account if executive A is also a T stockholder, even where the service agree-
            ment is entered into before tender offer commencement, the payment is made after tender offer conclu-
            sion, and the amount constitutes reasonable compensation for executive A’s services. Under this interpre-
            tation the per share tender offer price to all T shareholders apparently must be increased by the amount of
            the service payment to executive A (even though constituting reasonable compensation) divided by the
            number of T shares owned by executive A.
               In 12/05 SEC at last proposed amendments to the all-holders best-price rule which (the SEC release
            states) will, when adopted, “clarify that the rule applies only with respect to the consideration offered and
            paid for securities tendered … and should not apply to consideration offered and paid according to a [ser-
            vice agreement] with [T] employees or directors … so that compensatory arrangements between [T]
            employees or directors and [P or T] are not captured by … the best-price rule.” See discussion at

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         • Corporate divisions. Rev. Rul. 2005-65 addresses and propounds a pro-taxpayer application of the
            4/05 §355(e) “plan” regulations where (1) although none of the Reg. §1.355-7 safe harbors applies (2) the
            distribution is motivated by a business purpose unrelated to the corporate acquisition and (3) regardless of
            the acquisition, demonstrably would have occurred at about the same time and in a similar form. See dis-
            cussion at ¶1010. Example 14.
              The 12/05-enacted Gulf Opportunity Zone Act of 2005 included a package of retroactively effective
            technical corrections, one of which eliminates a double-counting interplay between D’s gain-avoiding use
            of the same tax basis in applying §357(c) and Code §361(b)(3). See ¶1012.1 Example 6.
               Several significant Code §355 proposed amendments are presently pending with enactment viewed as
            likely (but not certain).
            •   The Tax Relief Act of 2005 (S. 2020), which passed the Senate 12/05 proposes to enact a new
                Code §355(g), effective for distributions after enactment date (with binding contract and other
                transition relief), excluding from §355 treatment so-called cash-rich split-offs. Under the bill,
                §355 would not apply if (1) either D or C is a “disqualified investment corporation” (“IC”) — in
                general, the FV of IC’s investment assets (including a partnership interest other than in a partner-
                ship furnishing a §355 active business, see Rev. Rul. 2002-49), not used in the active and regular
                conduct of a finance, banking, or insurance business, constitutes 75% or more by FV of all IC’s
                assets — and (2) immediately after the distribution any person owns a 50% or greater voting or
                FV interest (including by §318 attribution) in IC not held immediately before the transaction. See
                discussion at ¶1002.2.
            •   S. 2020 also proposes to enact a new Code §355(b)(3), generally effective for distributions after
                enactment date and before 1/1/10, modifying the active trade or business definition to treat all mem-
                bers of D’s affiliated group or C’s affiliated group (as defined in Code §1504(a), disregarding
                §1504(b)) as one corporation. See discussion at ¶1004.2.1.3.
            •   H.R. 4187, introduced 11/05, proposes to limit Code §355(e) so that it:
                  (1) applies only where the corporation acquired by P — identified as “the change in control com-
                      pany” — immediately after D’s §355 distribution of C’s stock (a) is “highly leveraged” and (b)
                      has “excess relative leverage” and
                  (2) limits D’s recognized gain to the lower of (a) such excess relative leverage or (b) D’s gain real-
                      ized on the distribution (i.e., excess of FV above D’s basis in C’s stock).
                Under the bill, highly leveraged means a debt-to-FV-of-equity ratio exceeding 2:1, treating debt-like
                Code §1504(a)(4) preferred stock as debt rather than as equity. Excess relative leverage means the
                change-in-control company’s indebtedness that exceeds its “maximum permitted indebtedness,”
                defined to mean the greater of (1) its debt up to a 2:1 equity ratio and (2) if (a) C is the change-in-
                control company, the amount of debt that would give C a debt-to-FV-of-equity ratio equal to D’s debt-
                to-FV-of-equity ratio plus 0.25 and (b) if D is the change-in-control company, then the reverse of (a).
                   However, if the change-in-control company’s debt-to-FV-of-equity ratio is 6:1 or greater, all lever-
                age requirements are deemed met and D recognizes the full amount of gain realized on the §355(e)
                distribution of C’s stock.
                   H.R. 4187 would be effective for distributions completed after enactment date and for previously
                effectuated distributions where a prearranged change in control of C or D is completed on or after
                enactment date. See discussion at ¶1010.
            •   H.R. 4187 also proposes to amend Code §362(f) (with the effective date described immediately
                above) to increase the basis of the change-in-control company’s assets (with a look-through to the
                assets of affiliated group subsidiaries) to reflect D’s §355(e) gain recognized. See discussion at

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         • Code §409A harsh deferred compensation rules. The 10/04 Act added Code §409A impos-
            ing strict tax rules on non-qualified deferred compensation, as broadly defined in the statute and IRS
            guidance. In early 2005 IRS issued Notice 2005-1, providing extensive guidance on definitional issues
            and transition rules, as discussed in prior editions of this treatise.
              In 10/05 IRS issued very extensive proposed regulations under §409A addressing definitional issues,
            providing guidance on §409A’s deferral election, distribution trigger, and no-acceleration limitations, and
            extending the effectiveness of certain transition relief rules through 12/31/06.
               Although the 10/05 proposed regulations are not scheduled to be effective until 1/1/07, taxpayers may
            rely on them, or in the alternative may continue to rely on Notice 2005-1 (and apparently may rely on
            selected provisions of each set of rules), prior to the final regulations’ effective date. Regarding matters
            covered by both the 10/05 proposed regulations and Notice 2005-1, the 10/05 proposed regulations differ
            from Notice 2005-1 in certain important respects, including:
              • Short-term deferral exception. Under Notice 2005-1’s “short-term deferral” exception, pay-
                ment of an amount during the 21/2-month period immediately following the end of the year in which a
                service provider first obtains a vested legal entitlement to the amount is not subject to §409A only if
                (among other conditions) the amount is “required to be paid” (in addition to actually being paid) dur-
                ing such 21/2-month period. The 10/05 proposed regulations eliminate this “required to be paid” con-
                dition, so that a payment actually made during the 21/2-month short-term deferral period can qualify
                for the short-term deferral exception even though not required to be paid during such period (so long
                as the service provider did not previously elect to defer the compensation beyond the 21/2-month
                short-term deferral period).
              • Taxable year. The 10/05 proposed regulations adopt the position that the term “taxable year” as
                used in §409A generally refers to the service provider’s taxable year. However, both Notice 2005-1
                and the 10/05 proposed regulations apply the term “taxable year” in a taxpayer-favorable manner for
                purposes of the 21/2-month short-term deferral rule by permitting payments to qualify under the rule
                if made (and, under Notice 2005-1, only if required to be made) by 21/2 months after the end of the
                employer’s or the service provider’s first taxable year in which there is no SRF.
              • SAR. Under Notice 2005-1, a stock appreciation right (an “SAR”) is subject to §409A even if not
                in-the-money at grant unless the SAR (a) satisfies a narrow exception for SARs on publicly traded
                shares payable only in such shares or (b) is granted pursuant to a program in effect on or before
                10/3/04. The 10/05 proposed regulations, on the other hand, conform the treatment of SARs to the
                treatment of NQOs and accordingly generally exclude from §409A an SAR not granted (or subse-
                quently modified) when in-the-money.
              • NQO with cash-out feature. Under Notice 2005-1, it appeared that an NQO (and possibly
                even an ISO) containing a cash-out feature could have been treated as an alternative SAR and there-
                fore as §409A-tainted. However, since the 10/05 proposed regulations generally take the position that
                a not-in-the-money-at-grant SAR is excluded from Code §409A, the inclusion of a cash-out feature
                in an NQO’s (or ISO’s) terms should not cause the NQO or ISO to be §409A-tainted.
              • Service recipient stock. Notice 2005-1 generally excludes from §409A an NQO not granted
                (or subsequently modified) when in-the-money without regard to the nature of the stock underlying
                the NQO, but the 10/05 proposed regulations limit the NQO-not-in-the-money-at-grant exclusion
                (and the corresponding SAR exclusion) to an NQO (or SAR) on “service recipient stock.” “Service
                recipient stock” is generally defined as (a) common stock readily tradable on an established securities
                market or, if none, (b) that class of common stock that (1) has (or has substantially similar economic
                rights to the class of common stock having) the greatest aggregate value of the corporation’s issued
                and outstanding common stock and (2) is not preferred as to liquidation or dividend rights.
                  Where a non-public company has outstanding a class of “participating preferred” stock (treated as
                common stock for, e.g., Code §305 preferred OID or §351 NQ Pfd tax purposes) that is more valu-

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                able than its outstanding common stock, this definition arguably may be read to preclude the com-
                mon stock (as well as the participating preferred stock) from qualifying as “service recipient stock,” a
                result that is neither sensible nor consistent with the preamble’s stated reason for limiting the
                NQO/SAR exception to NQOs and SARs on service recipient stock.
                   It is, however, arguable that the service-recipient-stock definition looks to state corporate law
                (rather than to federal tax principles like Code §305 and §351) to distinguish common from preferred
                stock, so that the common stock (but not the participating preferred stock) would be the common
                stock class with the greatest value, because the participating preferred stock would not be viewed as
                common stock for this purpose.
              • Material terms set forth in writing. The 10/05 proposed regulations somewhat surpris-
                ingly take the taxpayer-hostile position that deferred compensation cannot be §409A-compliant if
                the material terms of the deferral arrangement are not set forth in writing, generally no later than
                the end of the taxable year in which the service provider first obtains a legally binding right to the
              • Partnerships and LLCs. The extent to which Code §409A applies to a compensation arrange-
                ment between a partnership/LLC and an equity owner is uncertain, since the 10/05 proposed regula-
                tions reserve a place for future guidance on such arrangements and the preamble states that
                Treasury/IRS “continue to analyze the issues raised in this area.”
                   However, under the 10/05 proposed regulations’ preamble, a partnership/LLC payment (or alloca-
                tion) to an equity owner for services performed in a partner capacity, structured as salary or as a
                bonus not calculated with respect to partnership income, is covered by Code §409A “until further
                guidance is issued,” but “only … where the … [equity owner] providing the services does not include
                the payment in income by the 15th day of the third month following the end of the taxable year of the
                [equity owner] in which the [equity owner] obtained a legally binding right to the …. payment or, if
                later, the taxable year in which right to the … payment is first no longer subject to a substantial risk
                of forfeiture.”
                   Such a salary or bonus to an equity owner constitutes a “guaranteed payment”—defined in long-
                standing Code §707(c) as a “payment ... to a partner for services” “determined without regard to the
                income of the partnership”—subject to special income and expense timing rules based on the entity’s
                (cash or accrual) method of accounting. Under those rules, an equity owner deferring salary or bonus
                from an accrual method partnership/LLC is required to include the deferred salary or bonus in tax-
                able income in the vesting year if the entity is entitled to claim a deduction for the compensation in
                the vesting year, which is the case if (1) all events necessary to establish the legal entitlement have
                occurred (including performance of the services to which the compensation relates) and (2) the
                amount of the compensation can be determined with reasonable accuracy. In such case, §409A does
                not apply to the deferred compensation since the equity owner must include the deferred compensa-
                tion in income in “the taxable year of the [equity owner] in which the [equity owner] obtained a
                legally binding right to the … payment or, if later, the taxable year in which right to the … payment
                is first no longer subject to a substantial risk of forfeiture.”
                   On the other hand, §409A may apply to deferred salary or bonus payable by a partnership/LLC
                to an equity owner later than 21/2 months following the vesting year where (1) the entity uses the
                cash method of accounting or (2) the entity uses the accrual method of accounting but does not
                satisfy the requirements for claiming a deduction for the deferred compensation by the end of the
                vesting year.
              The 10/05 proposed regulations also tackle a broad array of issues not addressed in Notice 2005-1,
            including (a) application of §409A to severance arrangements and (b) application of §409A’s deferral
            election timing, distribution trigger, and no-acceleration limitations. The 10/05 proposed regulations
            include many taxpayer-favorable rules designed to make the distribution trigger limitations more work-
            able. For example, payment during the calendar year in which a permitted distribution trigger event occurs

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            or (if later) by the 15th day of the third month following the date the permitted distribution trigger event
            occurs is treated as payment upon the occurrence of such distribution trigger event (and therefore compli-
            ant with the distribution trigger rules).
               The Gulf Opportunity Zone Act of 2005 made technical amendments to Code §409A, including an
            amendment expanding the effective date of §409A(b)’s deemed funding rules to apply after 12/31/04 to
            all deferrals, whether occurring before, on, or after 12/31/04.
              A §409A-tainted NQO (i.e., an NQO in-the-money at grant and not structured to comply with §409A’s
            requirements) should not again subject the holder to tax under Code §83 when exercised except to the
            extent the spread value at exercise exceeds the amount previously included in taxable income under Code
            §409A, under the general income tax principle that the same income is not taxed twice to the same tax-
            payer (once under Code §409A and then again under Code §83). Unfortunately, neither Code §83 nor the
            regulations issued thereunder preclude such a double-tax result, and IRS has not yet issued guidance on
            the tax treatment of §409A-tainted NQOs. Hopefully such regulations, when issued, will prevent income
            reported under §409A (with respect to a §409A-tainted NQO) from being taxed a second time under
            Code §83, and we believe taxpayers are entitled to take that position in the absence of guidance.
              The authors have extensively revised ¶1505’s description of §409A as well as discussion of executive
            compensation throughout Chapter 15 to reflect the 10/05 proposed regulations and the 2005 technical
         • §83 SRF. A 2005 revenue ruling makes clear that a service provider’s award or purchase of Newco stock
            is not subject to an SRF merely because (1) the Newco stock, when acquired by the service provider, is
            subject to a contractual lockup preventing the service provider from selling the stock for a specified peri-
            od (e.g., a lockup imposed by an underwriter which assisted Newco in effectuating a public stock offer-
            ing), or (2) Newco prohibits its executives from selling stock outside a specified (e.g., 20-day) window
            period following each filing of a Newco 10-Q or 10-K with SEC (with a threat of employment termina-
            tion for violation) and the service provider receives the Newco stock outside such a window period, or (3)
            the service provider, when receiving the Newco stock, is in possession of material non-public information
            about Newco, so that sale of such stock would violate SEC rule 10b-5 under the 1934 Act. Rather, in
            these circumstances the service provider’s Newco stock is merely subject to a temporary lapsing restric-
            tion with no forfeiture of the stock for failure to perform services (or refrain from performing services) or
            based on a condition related to a purpose of the stock transfer. Thus, there is no postponement of the ser-
            vice provider’s OI on account of such a restriction. See discussion at ¶1502.1.1.
              Where Newco’s stock is publicly traded and the service provider is an “insider” subject to 1934 Act
            §16(b), the six-month §16(b) restriction period constitutes an SRF for Code §83 purposes. However,
            SEC’s §16 regulations have since 5/91 treated the service provider’s acquisition of an option to acquire
            stock as an acquisition of the underlying stock, so the six-month §16(b) period begins to run from option
            grant, rather than (as it did before 5/91) from option exercise. See discussion at ¶1502.1.2.1.
         • GAAP accounting for stock-based executive compensation.
              • New FASB 123R. After years of controversy, FASB 123R has become effective (1) for a
                public company’s first accounting year beginning after 6/15/05 and (2) for a non-public compa-
                ny’s first accounting year beginning after 12/15/05 (i.e., 2006 for both public and non-public
                calendar year companies), covering an award granted, modified, repurchased, or cancelled after
                such effective date.
                  After the effective date, a public company is also required to apply FASB 123R to an award
                granted before the effective date (but after 12/15/94) that remains outstanding and unvested after
                the effective date, so that the public company recognizes compensation expense under FASB 123R
                for the portion of the grant-date FV of the pre-effective date award attributable to the portion of
                the service period after the effective date. Hence where a public company took steps prior to FASB
                123R’s effective date to cause early vesting for an option, the option does not generate an FASB

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                123R compensation charge after the effective date, and so long as the option was out-of-the-
                money, the vesting acceleration triggered no current APB 25 accounting charge in the pre-effective
                date period.
              • Pre-123R GAAP rules. Pre-123R GAAP rules long allowed a company two choices in account-
                ing for stock-based executive compensation. Under APB 25, if the stock-based compensation met
                numerous complex requirements for a fixed (rather than a variable) award, there was no GAAP
                charge (i.e., future appreciation in the stock did not result in a GAAP charge), but where the stock’s
                FV at the time of the stock sale, stock award, or stock option grant exceeded the sale or award price
                or option price, there was a GAAP charge for the spread, less expected tax saving from deducting the
                spread. If the stock-based compensation was a variable award, the aggregate GAAP charge was equal
                to the spread at exercise, less expected tax saving from deducting the spread, i.e., post-grant apprecia-
                tion did increase the GAAP charge.
                   Under FASB 123 a stock sale or stock award (with no fixed/variable distinction) resulted in no
                GAAP charge (except to the extent the stock’s FV at the time of the stock sale or award exceeded the
                sale or award price), but a stock option resulted in a GAAP charge based on the FV of the option
                privilege, calculated by Black-Scholes or other method (generally 20% to 40% of the option stock’s
                FV for an option granted at the money), less in both cases expected tax saving.
              • Current GAAP rules. After FASB 123R’s effective date (discussed above), a company is required
                to use an FASB 123-like approach, determining the accounting charge for stock-based compensation
                based on (1) the stock’s FV at time of the stock sale or award or the option grant, plus (2) in the case
                of an option grant, the estimated FV of the option privilege at time of grant, less (3) in each case the
                company’s expected tax saving from any deduction (up to the amount of the company’s accounting
                compensation expense).
                   The date of a sale, award, or grant (when GAAP compensation expense is generally measured) is
                generally the “date at which an employer and an employee reach a mutual understanding of the key
                terms and conditions of a share-based payment award.” However, such date generally cannot occur
                prior to the receipt of any necessary approvals of the award or the plan under which the award is
                granted (other than certain approvals deemed to be a mere “formality” or “perfunctory”). Where an
                award is granted unilaterally (i.e., without negotiation between employer and employee), the grant
                date is generally the date on which the “award is approved in accordance with the relevant corporate
                governance requirements,” so long as the “key terms and conditions of the award are expected to be
                communicated to an individual recipient within a relatively short time period from the date of
                  Although FASB 123R supercedes old APB 25 and FASB 123, under the complex transition rules
                (described above) old ABP 25 and FASB 123 continue to apply to certain pre-effective-date stock-
                based grants for some period into the future.
                  FASB 123R requires a non-public company to estimate its stock price volatility and abolishes the
                “minimum value method” (i.e., an option pricing model with zero stock price volatility) previously
                permitted by FASB 123 for a non-public company, thus generally increasing the GAAP charge for a
                non-public company.
                  For FASB 123R purposes, a company is public if it (a) has equity securities trading in a public
                market, (b) makes a regulatory filing in preparation for the sale of equity securities in a public mar-
                ket, or (c) is a subsidiary of a company described in (a) or (b). A company with publicly traded debt,
                but no publicly traded equity and no regulatory filing to sell publicly traded equity, is not a public
                company for this purpose (so long as not a subsidiary of a public company).
                   Under FASB 123R (as under the predecessor rules), the charge to the company’s accounting net
                income is accrued (i.e., recognized as expense for accounting purposes) over the executive’s service
                period, generally the vesting period.

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                   Stock FV or stock option FV is not reduced based on the possibility the executive will not vest in
                the award and hence will forfeit the compensation; rather, compensation expense is recognized only
                for an award that ultimately vests. The company estimates the portion of its awards expected to vest
                and subsequently adjusts its estimate from time to time in light of vesting expectations and ultimately
                actual vesting results.
                  If a vested option expires unexercised (e.g., because the option is out-of-the-money), there is no
                downward adjustment to compensation expense.
                   FASB 123R treatment for award classified as liability. FASB 123R’s general rules
                (described above) apply where a stock-based compensation award constitutes an “equity instrument,”
                as is usually the case with plain vanilla stock sales, stock awards, and stock options. In contrast,
                where an award is treated as a “liability” (rather than an equity instrument), FASB 123R requires the
                company to recognize compensation expense equal to the liability’s FV “remeasured at the end of
                each reporting period until settlement” so that the cumulative compensation cost is equal to the liabil-
                ity’s ultimate FV on the settlement date. A stock-based compensation award is treated as a liability
                under FASB 123R if:
                (a) with respect to an option or similar instrument, the company “can be required under any circum-
                    stances to settle the option or other instrument” for cash or other assets (including an instrument
                    treated as a liability), rather than for stock.
                    • Under this company-can-be-required-to-settle-for-cash-or-other-property-under-any-circum-
                      stances rule, liability treatment results even if Newco’s cash settlement obligation is contingent
                      on a future event. For example, if Newco is required to settle an option for cash in the event of
                      a Newco change in control, the option is apparently a liability under the rule as currently draft-
                      ed, regardless of the likelihood of a Newco change of control when the option is granted.
                          However, in 1/06 FASB responded to criticism of this rule by proposing to amend FASB
                       123R (generally effective with a company’s initial adoption of FASB 123R) so that a contin-
                       gent cash settlement feature does not result in liability treatment so long as (i) the contingency
                       is “outside the employee’s control” and (ii) the contingency is not “probable” to occur. Thus, if
                       the amendment is finalized in its proposed form, an option calling for cash settlement on a
                       Newco change of control, or allowing the employee to elect cash settlement on a change in
                       control, will be treated as an equity instrument at grant so long as a Newco change of control
                       during the term of the option is not “probable.”
                          Under the proposed amendment, an option with a contingent cash settlement feature that is
                       treated as an equity instrument at grant (i.e., because the contingency is out of the employee’s
                       control and is not “probable” to occur) may become a liability if the contingency subsequently
                       becomes “probable.” In such case, Newco’s cumulative compensation cost for the option is
                       generally the greater of (i) the FV of the option at grant date (i.e., the FV of the option as an
                       equity instrument) and (ii) the ultimate FV of the liability when settled. An option which is
                       settled for cash equal to the spread in the option pursuant to a contingent cash settlement fea-
                       ture at a time when the spread in the option exceeds the option’s grant date FV generally
                       results in a greater compensation charge than a similar option (i.e., an option with the same
                       economic terms, but without a contingent cash settlement feature) that Newco voluntarily set-
                       tles for the same amount of cash.
                (b) with respect to stock issued with put or call features, either the put or the call “permits the
                    employee to avoid bearing the risks and rewards normally associated with equity share ownership
                    for a reasonable period of time [i.e., 6 months or more] from the date” the share is issued or
                    vests, whichever is later, or it is “probable” that the company “would prevent the employee from
                    bearing those risks and rewards for a reasonable period of time from the date” the share is issued
                    or vests, whichever is later,

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                (c) the instrument would be treated as a liability under FASB 150 (treating certain financial instru-
                    ments, including mandatorily redeemable preferred stock, as liabilities),
                (d) in cases not within (a) through (c), the instrument would be treated as a liability under GAAP, or
                (e) the instrument is “indexed to a factor in addition to the entity’s share price … [and] that addition-
                    al factor is not a market, performance or service condition.”
                While at first blush FASB 123R abolishes APB 25’s variable approach (under which accounting
                expense grows as stock FV increases after grant), in reality FASB 123R retains the variable approach
                for any stock-based compensation classified as a liability, with significant uncertainty as to the
                meaning and scope of FASB 123R’s liability definition.
                  FASB 123R treatment for SAR. An SAR payable in stock is treated under FASB 123R like
                an option so that the company’s only compensation expense is the FV of the SAR arrangement mea-
                sured at grant, i.e., the amount (if any) by which the SAR is in-money at grant plus the value of the
                option privilege.
                   In contrast, an SAR payable in cash is treated as a liability under FASB 123R and results in cumu-
                lative compensation expense equal to the ultimate cash payment (accrued as the stock rises in value).
                   An SAR payable in cash or stock at the executive’s choice is treated as a liability, while an SAR so
                payable at the company’s choice is treated as an option unless the company ultimately pays cash or
                the company has a practice of honoring executives’ requests for cash.
                   FASB 123R treatment for stock purchased for note. While an executive’s stock pur-
                chase for a recourse note is treated as a stock sale, an executive’s stock purchase for a non-recourse
                note is generally treated as an option grant, so that FASB 123R’s accounting charge is increased by
                the option privilege’s FV.
                   FASB 123R treatment for partnership/LLC interest. Where the company is a partner-
                ship/LLC and the company sells or grants a partnership/LLC interest to an executive, FASB 123R
                requires the company to recognize compensation expense based on the partnership/LLC interest’s FV
                (not liquidation value as generally applies for a partnership/LLC for tax purposes). Thus, where the
                company grants a profits interest to an executive, the company is required to recognize GAAP com-
                pensation expense equal to the profits interest’s FV, generally calculated using pricing models similar
                to those used to value options.
                   FASB 123R treatment of award modification. If the company modifies the terms or
                conditions of an equity award (including a stock option), the company and the executive are treated
                for FASB 123R purposes as exchanging the original award for a new award, in which case the com-
                pany generally (a) continues to recognize any unrecognized compensation cost based on the original
                award’s FV at grant and (b) recognizes incremental compensation cost equal to the excess, if any, of
                the modified award’s FV over the original award’s FV immediately before modification, taking into
                account any impact the modification has on the number of awards expected to vest. Any additional
                compensation is (a) recognized immediately if the modified award is vested and (b) recognized
                (together with any unrecognized cost from the original award) over the executive’s remaining service
                period if the modified award is subject to further vesting.
                  If (before modification) the original award is not expected to vest, the company’s aggregate com-
                pensation cost for the original and modified awards is generally the modified award’s FV and com-
                pensation cost related to the original award is eliminated.
                   If the company reprices a stock option held by an executive by lowering the exercise price (e.g., where
                the company’s stock price has declined since the original option grant), the repricing is a modification.
                Thus, the company continues to recognize any previously unrecognized compensation expense with
                respect to the original option and recognizes incremental compensation expense equal to the excess of
                the modified option’s FV over the old option’s FV (determined immediately before repricing).
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                   If the company agrees to accelerate vesting of an award, the acceleration is a modification, with
                results similar to an award modification as discussed above.
                   FASB 123R’s treatment of fully vested stock-based compensation. FASB 123R
                states that it ceases to apply to an instrument “when the rights conveyed by the instrument to the
                holder are no longer dependent on the holder being an employee of the entity (that is, no longer
                dependent on providing service),” so that the accounting treatment of the instrument thereafter to the
                extent it remains outstanding, is governed by other more general provisions of GAAP.
                   In 8/05, citing a pending FASB project to reconsider the distinction between debt and equity,
                FASB deferred application of this rule. Thus, until FASB issues further guidance, stock-based com-
                pensation continues to be governed by FASB 123R “throughout the life of the instrument, unless its
                terms are modified when the holder is no longer an employee.” See discussion at ¶1502.2.
         • Code §162(m) executive compensation deduction limitation. For purposes of Code
            §162(m)’s $1 million per executive compensation deduction limitation for a public company’s top
            (“covered”) employees (unless the compensation falls within an exception), IRS focuses on the specif-
            ic summary compensation table filed by a publicly held corporation with SEC pursuant to Reg. S-K
            Item 402(a)(3) to identify the corporation’s “covered” employees. Because a “foreign private issuer”
            (generally a publicly held non-U.S. company (a) at least 50% of whose voting securities are held by
            non-U.S. persons and (b) that does not exceed certain U.S. presence thresholds) is not required to file
            a summary compensation table with SEC pursuant to Reg. S-K Item 402, IRS takes the position that
            such a foreign corporation does not have any covered employees (even though such corporation is
            required to and does file a similar summary compensation table under non-U.S. law). See discussion
            at ¶1507.1.4.1.
              Similarly, where a “foreign private issuer” (as described above) has one or more U.S. subsidiaries (the
            stock of which is not publicly held), IRS takes the position that neither such foreign parent corporation
            nor such U.S. subsidiary has any covered employees. See discussion at ¶1507.1.4.2.
         • HSR. The entire HSR discussion has been updated to reflect annual inflation adjustment of all the HSR
            tests and thresholds, effective 2/17/06. See discussion throughout ¶1707.
         • Sample acquisition agreements. Volume 4’s sample acquisition agreements have been revised to
            reflect developments concerning (1) representations, warranties, and covenants dealing with computer
            technology and security, (2) representations, warranties, and covenants dealing with foreign workplace
            standards, and (3) tax law changes regarding IRS COI reorganization standards (now 40%).
         • . . . and much, much more.