Restricted Stock vs. RUs

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Restricted Stock vs. RUs Powered By Docstoc
					                   Restricted Stock

                     Lucas D. Schenck

           Lucas D. Schenck | 206.447.8908 |

Restricted Stock vs. Restricted Stock Units

• Restricted Stock
   • Grant of specific number of shares of stock
   • Actual ownership
   • Forfeiture if conditions are not satisfied: service,
     performance, hybrid
   • During restriction period: no transfer, allowed to vote,
     dividends - sometimes

Restricted Stock vs. Restricted Stock Units

• Restricted Stock Units (RSUs)
    • Contingent promise to deliver stock at future date
    • Delivery contingent upon: service, performance, hybrid
    • No voting rights, dividends sometimes (dividend equivalents that
      mirror those paid in restricted stock)

• Tax Treatment
    • Restricted Stock: Realize taxable compensation (ordinary income)
      when stock not subject to substantial risk of forfeiture
    • RUS’s: Realize taxable compensation (ordinary income) upon
      payment to settle the RSU – deferral without substantial risk of
      forfeiture – preserve §162(m) deduction for the company

Restricted Stock vs. Restricted Stock Units
• Tax Treatment (contd.)
    • Restricted Stock §83(b): election available to include realize taxable
      compensation (ordinary income) on date of grant despite substantial risk
      of forfeiture. Future gains taxed at lower capital gains rates
    • RSUs §83(b): not available
• Will earlier income recognition required?
    • When vesting and the lapse of a substantial risk of forfeiture do not
      coincide: risk of forfeiture determined taxation
    • Example: Restricted stock vests earlier of: (i) third anniversary, or (ii)
      employee’s retirement. Retirement is termination at or after age 60. Grant
      is to employee already age 60 and continues employment after age 63.
        • Taxable at date of grant
        • No risk of forfeiture at grant since employee immediately eligible to

Restricted Stock vs. Restricted Stock Units

• How to avoid immediate income recognition on
  future grants to retirement eligible employees?
   • No automatic vesting of restricted stock upon
   • Use RSUs: Term: RSU transfer shares earlier of (i)
     specified date (third anniversary of grant) or (ii)
     retirement. Retirement eligible employees do not need
     forfeit awards to avoid accelerated income tax

Restricted Stock vs. Restricted Stock Units

• §409A Treatment
   • Restricted Stock: unconditionally exempt
   • RSUs subject to §409A: terms can comply
      • Avoid §409A if settlement shortly after lapse of forfeiture
      • Payment upon earlier of (i) fixed calendar date or (ii)
        separation of service
      • Payment to “specified employee” at retirement (highest paid
        50) at a public company – delay six-months


To:                          DIRECTORS AND EXECUTIVE OFFICERS

From:                        Lucas D. Schenck

Date:                        May 22, 2008

Subject:                     10b5-1 Trading Plans

        Rule 10b5-1 Plans are common among officers and directors of public companies. They
are a way for officers and directors to shield themselves from insider trading liability. Until
recently, 10b5-1 Plans and the executives who use them have operated without regulatory
examination. The S.E.C. has begun to look closely at the operation and potential abuses of these
Plans. The S.E.C. said it will focus on disclosure practice, the use of multiple and overlapping
plans by a single executive, and “asymmetrical” disclosures regarding plans, such as the practice
of disclosing the creation of a plan but not its termination or modification.
        As reported in the NY Times, “Countrywide Stock Sales Scrutinized” by Gretchen
Morgenson, published on October 18, 2007, an anonymous source confirmed the existence of the
inquiry and its focus on Chief Executive Officer Angelo R. Mozilo’s trades of Countrywide
stock. The article notes that the director of enforcement at the S.E.C., Linda Chatman Thomsen,
said the agency was taking a closer look at the programs to make sure executives were not using
them for “illegitimate purposes.” The article further states that “Since October 2006, Mr. Mozilo
has twice raised the number of shares that could be sold under his plans. In December 2006,
when Countrywide shares were trading at $40.50, he increased the number of shares to be sold
each month to 465,000 from 350,000. Then in February, when shares hit a high of $45.03, he
increased the number of shares sold each month to 580,000.”

       The purpose and intent of 10b5-1 Plans is valid and executives should not be deterred
from creating them. When properly adopted and maintained, 10b5-1 Plans provide a effective
and safe path for directors and officers to trade their companies’ securities.

        Rule 10b5-1 creates an affirmative defense to charges of insider trading by creating a
plan for future sales of stock. Rule 10b5-1 says that, so long as the plan is adopted at a time when
the seller has no inside information, the seller is protected from insider trading liability even if he
has come into possession of material non-public information by the time sales actually occur.
TEL:  206.447.4400   FAX:  206.447.9700   1111 THIRD AVENUE, SUITE 3400,  SEATTLE, WASHINGTON  98101‐3299   WWW.FOSTER.COM 
May 22, 2008
Page 2

To be effective, a Rule 10b5-1 plan must be in writing and state the following:
      •      Number of shares to be bought or sold. This can be designated as a number of shares,
             as a percentage of the executive’s holdings, or as the number of shares needed to produce
             a specific dollar amount. Rule 10b5-1 even allows the number of shares to be generated
             by an algorithm or computer program.
      •      Prices at which the shares will be bought or sold. This can be designated as a specific
             dollar price, a limit order price, or as the prevailing market price. Prices can also be
             determined by an algorithm or computer model.
      •      Timing of the purchases or sales. This can be designated as a specific date or time, or as
             the time at which a specific event occurs.
        Rule 10b5-1 plans are easy to implement and use. Most brokerage firms have pre-printed
Rule 10b5-1 plans. Once a plan is in place, a broker can and should execute the plan’s
instructions without further assistance from the executive.
        Rule 10b5-1 plans, if properly prepared, can help executives comply with SEC trading
regulations, such as sections 13 and 16(b). They can also allow executives to trade outside
company “trading windows.” Many companies have insider trading policies specifically
permitting transactions made pursuant to Rule 10b5-1 plans to occur outside trading windows
and without compliance with other limitations, such as pre-clearance requirements. Transactions
made pursuant to Rule 10b5-1 plans can executed while the executive possesses inside
information such as, upcoming financial results and new products.
       The main restriction on the use of Rule 10b5-1 plans is that, to be valid, they must be
adopted while the executive does not possess material non-public information. (The executive’s
broker also cannot be in possession of inside information when the plan is adopted.) The
executive must also refrain from attempting to influence how, when, or whether transactions will
be made pursuant to the plan.
       Rule 10b5-1 also has a general “good faith” provision that gives the SEC the right to
challenge the affirmative defense created by Rule 10b5-1 when it suspects abuse. Executives
should refrain from modifying or canceling plans once they are in place (although modifications
are permitted by Rule 10b5-1 and may be appropriate).The Plan should include a automatic
termination clause which will suspend trading upon the company’s merger or acquisition, an
underwritten public offering, or a change in the executive’s employment status, marital status or

May 22, 2008
Page 3

        10b5-1 Plans are flexible to accommodate many financial or business objectives. The
10b5-1 Plan can also be designed to avoid stock sales at undesirable times or at unfavorable
prices. The Plan can be straightforward: “sell 10,000 shares at the market price on the 5th
business day of every month for the next 18 months.” It could also provide for sophisticated
trades to meet a particular financial situation.
Consider the following strategies for maximizing a Rule 10b5-1 plan:
      •      Short duration. Rule 10b5-1 plans can be of any duration. However, 10b5-1 Plans with
             6-9 month terms allow flexibility if conditions change.
      •      Small percentage of holdings. Plan can cover a small portion of holdings. Plan can also
             provide for sales of a small amount on a regular schedule and for sales of a larger portion
             if certain price targets are reached. CAUTION: executives should not to trade outside a
             active plan. Trades outside a plan lose all the protections available under Rule 10b5-1 and
             are difficult to explain as part of a pre-planned diversification strategy.
      •      Minimum Price “Floors.” Create minimum price floors in every Rule 10b5-1 plan.
             Multiple price floors, which increase over specified periods of time, can also be used.
      •      Multiple Price Targets. Create a matrix of future price targets. Sales of certain
             numbers of shares at achievable price targets, and additional sales in the event that more
             aggressive price targets are achieved.
      •      Indices, Price Gaps, and Industry Moves. Sales can be executed based on how an
             executive company’s stock performs relative to various market or industry indices.
      •      Personal Financial Milestones. Stock sales can be triggered by personal financial
             considerations, such as home purchases or remodels or college tuition payments.

Best Practices

Consider these practices when implementing a 10b5-1 Plan:

      •      Company pre-clearance before officers and directors enter into plans.

      •      Enter the Plan during the “window is open” period.

      •      Prohibit sales for a period of time after the plan is entered into.

      •      Limit the term of Plans to 18 months or less.

May 22, 2008
Page 4

      •      Give the Company the authority to terminate the Plan during events such as mergers and
             acquisitions or securities offerings.

      •      Keep Plans simple so they are easy to apply or understand.

      •      Disclosure of the adoption of Plans.

      •      Note on Form 4 filings that reported trades were made pursuant to a 10b5-1 Plan.

      •      Adopt Plans with regular and frequent sales over a period of time. These are easier to
             defend in litigation than Plans which resulted in large sales shortly after adoption.

      •      Use a broker for execution and one with which the executive does not have regular
             contact to prevent allegations of influence.


                                             Lucas D. Schenck
                                            FOSTER PEPPER PLLC 
                                        1111 Third Avenue, Suite 3400 
                                           Seattle, WA 98101‐3299 

1. What happens to a nonqualified deferred compensation plan that is subject to 409A
   does not comply to 409A?

             Current income inclusion

             20% penalty tax


                                   Penalty and interest borne by employee

2. What is a Nonqualified Deferred Compensation Plan (NQDC) for 409A purposes?

             Any plan that provides for deferred compensation where the service provider has a
             legally binding right to compensation that has not been actually or constructively
             received and included in gross income and is payable to the service provider in a later tax


                Qualified Employer Plan
                Bona Fide: vacation, sick, disability, comp time, or death benefit plan
                Incentive Stock Options and option granted under Employee Stock Purchase Plans
                Nonqualified stock options and stock appreciation rights if the exercise price is never
                less than fair market value of the underlying stock when the option or right is granted
                Short term deferrals of amounts paid by (i) a date that is 2-1/2 months from the end
                of the service provider’s first tax year in which the amount is no longer subject to a
                substantial risk of forfeiture, or (ii) as date that is 2-1/2 months from the end of the
                service recipient’s first tax year in which the amount is no longer subject to a
                substantial risk of forfeiture
                Compensation subject to a substantial risk of forfeiture
                Separation pay agreements

3.           409A Requirements: Distribution, Acceleration and Election

             Distribution: Compensation deferred under the plan cannot be distributed until:
                  Participant’s separation from service;
                  Date participant becomes disabled;
                  A time or schedule fixed under the plan as of the date of the deferral;
                  Change in ownership or control; or
                  Unforeseen emergency (illness, accident).

      Public company specified employees- if payment is made due to separation of service,
payment must be delayed at least six months.
                    Specified Employee means:
                    ♦ Officers with annual compensation greater than $130,000 (limited to 50
                    ♦ 5% owners; and,
                    ♦ 1% owners with annual compensation greater than $150,000.

             Acceleration: No acceleration of payment.
                  Accelerated Vesting of an unvested right. Lump sum payment upon separation
                  after 10 years of service. Employer reduces vesting to 5 years and employee
                  becomes vested and qualifies for payment. 409A compliant.
                  De Minimus Cashout of no more than §402(g) amount ($15,500 in 2008) of the
                  payment (i) with termination of participant’s interest in plan; (ii) made before the
                  later of (a) 12/31 of the calendar year in which the participant separates service, or
                  (b) the date 2-1/2 months after the participant separates service.
                  Payment of FICA
                  Payment of taxes for 457(f) plan

             Elections: Plan must provide that compensation for services performed during a tax year
             can be deferred at participant’s election is no later that the close of the preceding tax

                  Performance pay compensation based on a period of at least 12 months, deferral
                  election may be made no later than 6 months before the end of the election,
                    ♦ Services performed continuously from a date not later than the date the
                      performance criteria are established; and,
                    ♦ Deferral election must be made before compensation is both substantially
                      certain to be paid and readily ascertainable.

4.           Severance Pay May Be Subject to 409A

             Involuntary Termination and Voluntary Termination with Good Reason. Plans that
             provide severance pay upon involuntary termination not deferred compensation if
             amounts are paid by March 15 of the next year after the severance. There is a safe harbor
             definition for “good reason”.
                    ♦ Separation pay exception can be used with “Specified Employees” of public
                    companies to make payments earlier the six-month delay rule
                    ♦ Short-term deferral exception available
             Voluntary Termination without Good Reason. Plans that provide severance pay upon
             voluntary termination are Nonqualified Deferred Compensation Plans and subject to
             Exceptions: Severance pay is excluded upon involuntary termination to the extent:
                    ♦ Separation pay does not exceed twice the lesser of: (a) employee’s annual
                      compensation for the calendar year immediately preceding the year of
                      termination; or, (b) Section 401(a)(17) limit (the limit of pensionable earnings
                      in tax qualified plans, $230,000 in 2008)
                    ♦ Separation pay must be paid by December 31 of the second calendar year
                      following the year of termination