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Equity Awards Granted to U.S. Participants by Non-U.S. Entities Can Lead to Unintended Consequences

Because of the various benefits, securities, and tax laws that apply to equity awards, what may be permissible (and even commonplace) in one jurisdiction, may be problematic in another. Accordingly, whenever an issuer desires to issue equity awards to service providers (e.g., employees or contractors) in a different jurisdiction, the issuer should engage benefits, securities, and tax counsel in all relevant jurisdictions early in the process to avoid any unanticipated issues that could negatively impact the value or purpose of the awards. For example, a common issue occurs when the issuer is an entity outside of the United States, but equity awards will also be made to service providers in the United States. Under U.S. tax law, there are specific requirements for determining the exercise price of stock options and stock appreciation rights (under Section 409A of the U.S. Internal Revenue Code (“Section 409A”)) that require the exercise price to… Continue Reading

Ordinary Employee Benefits Issues That Can Cause Extraordinary Problems in M&A Deals

Employee benefits rarely drive corporate transactions, but if the benefits of a target company are not reviewed carefully, they can sometimes derail the transaction.  Even some of the most routine facets of benefit plan administration can result in significant potential financial exposure (e.g., additional employer contributions, taxes, penalties, and fees as well as fees associated with the preparation and filing of IRS and DOL correction program applications) that could negatively affect the overall value of the target company. By identifying issues early in the transaction, the seller can prevent costly purchase price reductions and identify issues that need correction, while the buyer can avoid overpaying for a target and ensure that representation and warranty insurance will be available to cover potential claims. Some of those routine compliance issues include, but are not limited to, the following: Failing to timely file an annual Form 5500.  The DOL can assess a penalty… Continue Reading

Proceed with Caution When Modifying Equity-Based Performance Awards

Most equity-based performance awards for employees that will vest at the end of 2020 were granted well before the COVID-19 pandemic began (in fact, many were granted two years or more before the pandemic), and none of the performance metrics for these awards likely anticipated the havoc the pandemic has caused to the companies’ financial and stock performance. In many cases, the pandemic has rendered these equity-based performance awards worthless to employees because the performance metrics are not even remotely achievable. Yet, employees have been working harder than ever to meet the challenges of the pandemic. Some employers looking for ways to continue to reward and retain employees are eyeing modifications of existing equity-based performance awards to either lower the target and stretch performance goals or to eliminate the performance requirement completely, at least for awards vesting in 2020 (making the awards solely time-based). Before proceeding with any such modifications,… Continue Reading

IRS Issues Memorandum Providing Guidance on Income Inclusion, FICA, and Income Tax Withholding for Stock-Settled Equity Awards

The IRS recently issued Generic Legal Advice Memorandum No. AM 2020-004 (the “GLAM”) to address when income from nonqualified stock options, stock-settled stock appreciation rights, and stock-settled restricted stock units is (i) includable in an employee’s gross income, (ii) subject to FICA taxes, and (iii) subject to federal income tax withholding. In addition, the GLAM provides a discussion of the deposit rules for FICA and income tax withholdings that have been withheld with respect to such equity awards, including the “One-Day” rule (or the Next-Day Deposit Rule) that requires employers to deposit employment taxes on the next banking day after $100,000 or more in employment taxes have been accumulated. The GLAM provides a series of illustrative examples and analyses of such issues. The GLAM does not, however, address the impact of an employer’s ability to defer employment tax deposits under Section 2302 of the Coronavirus, Aid, Relief and Economic Security… Continue Reading

Evaluating Performance Goals and Incentive Compensation in Light of COVID-19

Boards and compensation committees will be reevaluating their incentive compensation arrangements in light of the COVID-19 pandemic and the resulting market uncertainty. Both long-term and short-term incentive plans can lose motivational and retention value if the performance goals are unachievable or if they do not align with market reality. Companies that have not yet established performance goals for their 2020 equity and bonus awards should carefully consider market conditions and shareholder perception before establishing goals, focusing on motivating their executives with pay for performance that aligns with shareholders’ interests, while giving the company flexibility to navigate through uncharted territory. To the extent possible, companies should also consider delaying the issuance of incentive compensation awards until there is more stability in the business and in the financial markets. Companies that have already established goals for their 2020 awards (or that are evaluating the continued effectiveness of performance goals for prior year… Continue Reading

Recent Guidance on Compensation Practices from Glass Lewis in Light of COVID-19

On March 26, 2020, Glass Lewis released its governance report discussing its approach to corporate governance in light of the COVID-19 pandemic. According to the report, Glass Lewis expects all governance issues to be impacted by COVID-19 and will be taking a pragmatic approach to corporate governance and voting on affected proposals, prioritizing disclosure and timing and certainty on such matters, and exercising discretion as appropriate. Glass Lewis states in the report that: “The stark reality is that for many workers, including executives, they should not expect to be worth as much as they were before the crisis, because their free market value as human capital has now changed. There is a heavy burden of proof for boards and executives to justify their compensation levels in a drastically different market for talent . . . Trying to make executives whole at even further expense to shareholders and other employees is… Continue Reading

IRS Provides Initial Guidance on New Tax Benefits Under Code Section 83(i)

The Tax Cuts and Jobs Act of 2017 amended Section 83 of the Internal Revenue Code by adding a new Section 83(i) (“Code Section 83(i)”), which allows certain employees of privately-held corporations to defer the recognition of income (for up to five years) attributable to the vesting or receipt of certain qualified company stock transferred to such employees upon the exercise of stock options or the settlement of restricted stock units. On December 7, 2018, the IRS released Notice 2018-97, which provides initial guidance on certain aspects of Code Section 83(i). In particular, the notice provides guidance on (i) the application of the requirement in Code Section 83(i)(2)(C)(i)(II) that equity grants be made to at least 80 percent of all employees who provide services to the corporation in the United States, (ii) the application of tax withholdings on the deferred income related to the qualified company stock, and (iii) the… Continue Reading

Delaware Supreme Court Adopts Fairness Standard of Review for Discretionary Equity Compensation for Directors

On December 13, 2017, the Delaware Supreme Court held that discretionary equity compensation grants to directors are subject to an “entire fairness” standard of review, rather than the more deferential “business judgment” rule, even if the equity incentive plan has been adopted and approved by the company’s stockholders. Specifically, the Delaware Supreme Court held that when stockholders have approved an equity incentive plan that gives the company’s directors discretion to grant themselves awards within general parameters, the directors will be required to prove the fairness of their awards to the corporation and will not be able to rely on the business judgment rule unless (i) the directors submit specific compensation decisions related to equity grants to themselves for approval by fully informed, un-coerced, and disinterested stockholders, or (ii) the plan is self-executing (i.e., the plan grants awards to directors over time based on fixed criteria, with the specific amounts and… Continue Reading

Limits Set in Equity Plans Yield Less Stringent Standard of Review

In a recent Delaware Court of Chancery case, stockholders brought suit against a company’s directors alleging breach of fiduciary duty for awarding themselves “grossly excessive compensation.” The excessive compensation in question included equity grants issued pursuant to the company’s equity incentive plan. The terms of the stockholder-approved plan provided limits on the number of shares that the company could issue as stock options, restricted stock, and restricted stock units and on the number of shares the company could award to employees and directors. The court held that the specific equity awards could be reviewed pursuant to the business judgment rule, which is the standard used to review executive compensation approved by a disinterested committee rather than a more stringent standard required for “self-dealing.” In applying the business judgment rule, the court found that it was critical that the director-specific limits set forth in the plan differed from the limits that… Continue Reading

Israeli District Court: Costs of Equity-Based Compensation Should Be Included in Cost-Plus Transfer Pricing Arrangements

In this case, an Israeli subsidiary provided certain research and development services to its U.S.-based parent under a transfer pricing agreement that established the subsidiary’s income as an amount equal to its costs plus a 7 percent margin. Employees of the subsidiary received various stock awards under the “capital gains course” of Section 102 of the Israeli Tax Ordinance (“Section 102”). Section 102 generally applies to Israeli resident companies and non-Israeli companies that have a permanent research and development center in Israel. The subsidiary did not include accounting expenses for employee stock awards in its cost base and retroactively amended the transfer pricing agreement with its parent to reflect this treatment. The Israeli Tax Authority (“ITA”) disagreed with the exclusion of these expenses. The Tel Aviv District Court agreed with the ITA, ruling that (i) the accounting expenses for employee equity-based compensation should be included in the subsidiary’s cost base… Continue Reading

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