Level 2 Equity Plan Design, Analysis and Admin

Question 1

RSA/RSU Share Issuance & Deferral

Short-Term Deferral Period

Answer 1

Deferring release to a period no later than two and a half months after the calendar year when the vesting would normally occur.

Question 2

RSA/RSU Share Issuance & Deferral

Deferrals for RSUs that do not vest for at least one year after grant

Answer 2

deferral elections can be made within 30 days AFTER the grant date (provided the election is made at least one year before the unit vests).

Question 3

RSA/RSU Share Issuance & Deferral

Deferrals for RSUs that vest in less than one year after grant

Answer 3

the deferral election must be made before the end of the calendar year preceding the year in which the units are granted.

Question 4

RSA/RSU Share Issuance & Deferral

Differal Event for Restricted Stock

Answer 4

If a deferral does take place, you are deferring the release of the shares, which also defers the income tax for that event. That deferral, however, would only defer federal and state taxes. The payment of FICA taxes (Social Security and Medicare) are still required on the vest date.

Question 5

RSA/RSU Share Issuance & Deferral

Administrative Convenience

Answer 5

Is when the payment of FICA taxes can be deferred until the end of the calendar year. From a Social Security perspective, this could mean that the person caps out between the vest date and the end of the year, resulting in the Social Security taxes being maxed out and would then no longer have to be collected from the vesting event of the shares. At that point only Medicare taxes would need to be collected.

Question 6

RSA/RSU Share Issuance & Deferral

DEU

Answer 6

Some RSUs may be entitled to a Dividend Equivalent Unit instead of the actual dividend. That means that the cash value of what the potential dividend would have been is converted into additional units/cash which are accumulated and added to the grant with the same vesting schedule of the underlying grant.

Question 7

RSA/RSU & Retirement

RSU Tax Treatment if the plan has RETIREMENT provisions

Answer 7

FICA tax on RSUs would be due on the earlier of the vest date or the retirement eligibility date.

For income tax it would be due at the later of the vest date or the release date.

Question 8

RSA/RSU & Retirement

RSU Tax Treatment if the plan has RETIREMENT provisions

Answer 8

Both income tax and FICA tax are due at the retirement eligibility date for RSAs

Question 9

Stock Appreciation Right

Accounting treatment when it is at the discretion of the company to decide if it is stock settled versus cash settled

Answer 9

Your accounting requirement would be based upon the historical behavior of the company’s decision

Question 10

Stock Appreciation Right

Accounting treatment when it is at the discretion of the employee to decide if it is stock settled versus cash settled

Answer 10

Have to consider the worst-case scenario, which would be cash settled. You would apply that method until the employee actually makes a decision. Cash settled would mean liability and mark to market accounting until the employee decides what settlement type they prefer.

Question 11

IRC 409A Exempt SARs

Service Recipient Stock

Answer 11

common stock that is issued by the entity benefitting from the employee’s service, or the parent of such an entity with ownership restrictions.

Question 12

IRC 409A Exempt SARs

How fair market value is used in 409A exempt SARs:

Answer 12

• The payout of the SAR may not be greater than the difference between the fair market value of the underlying stock on the date of exercise and the date of grant.
• The exercise price cannot be less than the fair market value of the common stock on the date of grant
• Dividend equivalents cannot be accumulated in a manner that decreases the exercise price of the SAR
• The number of shares covered by the grant must be set at or before the date of grant.
• The SAR cannot provide for a deferral of income beyond the date the SAR is exercised.

Question 13

IRC 409A Compliant SARs

In order for a stock appreciation right to be compliant with IRC 409A:

Answer 13

Grant must specify applicable payment events
* A specific payment date, and/or
* Separation from service, and/or
* Death/Disability, and/or
* A change in control (as defined in 409A)
Exercise price is not tied to FMV of underlying stock
* based on an objective formula or
* good-faith determination by the board

Question 14

External Considerations – Plan Features

Shareholder approval is required by US Stock Exchanges when:

Answer 14

• SCOPE/ Material revisions
• Repricing
• Corporate Transactions
• Exclusions

Question 15

External Considerations – Plan Features

What is ISS ?

Answer 15

Institutional Shareholder Services- is a proxy advisory service and makes recommendations to shareholders on how to vote on corporate initiatives that are put to a shareholder vote. In your assigned reading you’ll learn that ISS is well-known for its negative recommendations on stock pool increases, especially evergreen provisions, but also that an evergreen provision on an ESPP is more acceptable than one on an option plan

Question 16

Fair Labor Standards Act (FLSA)

What is the Fair Labor Standards Act (FLSA)?

Answer 16

Sets forth what types of compensation must be included when an employer calculates benefits according to overtime calculations. The statute allows the employer to exclude equity compensation granted to non-exempt employees.

Question 17

Fair Labor Standards Act (FLSA)

Fair Labor Standards Act (FLSA) exemption requirments for employers to exclude equity compensation granted to non-exempt employers

Answer 17

Contingent on the awards vesting and pricing, stating that “exempt rights may not be exercisable for at least six months after grant and may not be priced at less than 85% of the fair market value of the stock or stock equivalent at the time of grant.”

Question 18

Fair Labor Standards Act (FLSA)

There are two situations that are specifically called out in the textbook that would disqualify the awards from exemption:

Answer 18

• An employee stock purchase plan with an exercise period of less than six months – so, for example, if the company had quarterly offering periods
• Options with vesting schedules of less than six months, so like those grants you see with 4 year monthly or quarterly vesting.

Question 19

XYZ Equity Incentive Plan

XYZ Equity Incentive Plan Share Reserve

Answer 19

The share reserve has a 1.5 to 1 ratio for all full value awards and a simple one to one ratio for options and SARs.

5,000,000

Question 20

XYZ Equity Incentive Plan

XYZ Equity Incentive Plan outside driector grant limit

Answer 20

Section 13.4

the XYZ Plan sets a limit of $500,000 value on a director’s aggregate grants in the first year of service as director and then a limit of $250,000 in aggregate value for subsequent years of service.

Question 21

XYZ Equity Incentive Plan- Change in Control

For Options, if outstanding awards are not assumed or substituted by a surviving or acquiring entity, the board has the discretion to:

Answer 21

• Pay cash to the participants in order to cancel the awards. The cash amount in this case would be the current fair market value minus the exercise price times the number of options held.
• The board can also simply continue the awards, leaving them in full force, or
• They can notify award holders that they have to exercise their awards before the change in control is completed
• The board in this circumstance is not required to treat all grants in the same way.

Question 22

XYZ Equity Incentive Plan- Change in Control

For Options, if outstanding awards are not assumed or substituted by a surviving or
acquiring entity and company is dissolved:

Answer 22

Then all the awards are cancelled.

Question 23

XYZ Equity Incentive Plan- Change in Control

For Options, if outstanding awards are not assumed or substituted by a surviving or
acquiring entity and company is dissolved:

Answer 23

Then all the awards are cancelled.

Question 24

XYZ Corporation Stock Option Agreement- Change In Control

The termination provisions are triggered if an employee is terminated by the company:

Answer 24

If an employee is terminated beginning one month before and ending 12 months after the change in control, and:
* 100% of unvested options vest immediately in exchange for optionee’s release of all claims.
* Termination must be involuntary but not for cause or be voluntary but within three months of an event that constitutes “good reason.”

Question 25

# XYZ Corporation Stock Option Agreement- Change In Control Good reason

Answer 25

Defined in the plan documents as: Significant reduction in duties or authority, reduction in base salary (unless it’s a one-time reduction of everyone’s pay by 10% or less), involuntary relocation of more than 25 miles, or breach of contract not cured within 10 days of receiving written notice from participant. Terminations because of death or disability do not trigger this provision.

Question 26

# XYZ Corporation Stock Option Agreement- Change In Control double-trigger acceleration

Answer 26

Requires two seperate events to trigger acceleration such as Change in Control AND termination.

Question 27

# XYZ Employee Stock Purchase Plan Documents How to calculate the number of shares a participant may purchase when an offering period extends beyond one year or straddles the calendar year?

Answer 27

Unused limit from the first calendar year is carried over into the next calendar year. The limit for the second calendar year of the offering is set at $25,000 plus the unused portion from the previous year. If the limit remaining at the end of the offering is greater than $25,000, the limit would be reset to $25,000 upon re-enrollment in the new offering, and any remaining limit would be forfeited.

Question 28

# XYZ EIP Change in Control Section 2.6 XYZ EIP is the definition of Change in Control and there are five possible ways the company can experience a change in control:

Answer 28

1. if a person or group becomes the beneficial owner of more than 50% of the total voting power of the company’s voting stock; 2. via the disposition of all or substantially all of the company’s assets; 3. through a merger or consolidation; 4. through a dissolution or liquidation of the company; 5. a change in control can happen if the Board of directors' changes composition through which fewer than a majority of the directors are Incumbent Directors.

Question 28

# XYZ EIP Incumbent Directors

Answer 28

Directors who either (i) are Directors of the Company as of the date the Plan first becomes effective pursuant to Section 17 hereof or (ii) are elected, ornominated for election, to the Board with the affirmative votes of at least a majority of those Directorswhose election or nomination was not in connection with any transaction described in subsections (i),(ii), or (iii) of Section 2.6, or in connection with an actual or threatened proxy contest relating to theelection of Directors to the Company.

Question 29

# Plan Provisions – Performance Measures Threshold

Answer 29

The minimum performance level that must be met to receive at least a partial payout of the award. Threshold can also refer to the base number of shares in the award.

Question 30

# Plan Provisions – Performance Measures Target

Answer 30

Refers to reaching the goal at hand and when it is a multiplier style or variable style performance award, that is when you would achieve 100% of what was granted, at target.

Question 31

# Plan Provisions – Performance Measures Total shareholder return or TSR

Answer 31

A market-based performance trigger that a lot of companies will use for performance grant metrics. Basically, it’s comparing shareholder return on your stock to other metrics and other company goals.

Question 32

Stock Swaps

Answer 32

When previously owned shares are delivered for payment, very common for broker assisted transaction.

Question 33

# The Sarbanes-Oxley Act of 2002 Section 404

Answer 33

Mandates that all publicly traded companies must establish internal controls and procedures for financial reporting and must document, test, and maintain those controls and procedures to ensure their effectiveness.

Question 34

# Transfer Agent General Duties

Answer 34

* Tracks stock ownership and certificates * Solicits proxy, distributes dividends * Requires specific issuance instructions from company for all types of transactions (e.g. shares for tax withholding, acquisitions, dispositions, capital adjustments)

Question 35

# Transfer Agent Issuance Authority

Answer 35

It is the plan administrator’s responsibility to provide, a certificate from the company listing specifically who may give the TA those transactional instructions, including each person’s name, title, relationship to the company, scope of authority if there are multiple plans, and sample signatures

Question 36

# Transfer Agent DWAC, Deposit/Withdrawal at Custodian

Answer 36

the electronic deposit/withdrawal at custodian, isn’t specifically on the syllabus, but it is the most common way for the transfer agent to deliver shares to a brokerage account.

Question 37

# Transfer Agent Reserves

Answer 37

It’s the plan administrator’s responsibility to request and reconcile reserve information and make sure that the reserves are properly allocated between multiple plans, if your company has multiple plans.

Question 38

# Transactions – Stock Swaps To determine the tax impact of a stock swap, you have to consider 3 main factors:

Answer 38

1. First, the type and number of previously-owned shares that you are tendering or surrendering. The terminology for these shares is “swapped shares” or “swapped-in shares”. 2. Second, the type of option being exercised 3. Third, the character of the newly acquired stock, which will include two buckets with different tax results. One bucket will be equal in number to the shares that were surrendered. The second bucket will be the “additional shares,” which is the number of shares in excess of what you surrendered.

Question 39

# Transactions – Stock Swaps Carry-over cost basis

Answer 39

Original cost basis of swapped shares plus any amount included in income as a result of the swap