Modifications to Equity Awards

(addressed below: Performance Awards; then Accelerated Vesting)

Performance Awards

  • 2020.05.01  Adjusting Performance Goals - Wrestling One Impediment. What if a company has established performance goals for annual bonuses or longer-term awards, and the underlying plan does not authorize a change in those goals? That is a question that is arising with some frequency.
    • Response:​ This question is a tricky one. Assuming directors are disinterested (because they seldom receive performance awards), their plan-related decisions are generally accorded high deference under the business judgement rule.
    • The starting point for analysis is the plan itself. Many plans provide indirect (if not direct) authority for changing performance goals.  The key plan provisions to examine involve those that relate: (1) to the setting of performance goals, (2) to modifying the plan and awards, and (3) to determining the scope of administrative authority as it relates to awards. In many cases, some combination of the foregoing are broad enough to allow a modification of performance goals without the need for seeking shareholder approval for a plan amendment (on the ground that the associated plan change is merely clarifying and not material).
    • If a plan needs an amendment in order to provide a reasonable basis for an exercise of discretion to change performance goals, the plan’s provision for shareholder approval of amendments becomes key to consider. Attention should also be given to exchange listing requirements because the NYSE’s FAQs from 2016 provide in B-2 that “If  [a plan] revision  would  have  the  effect  of  materially  increasing  the  potential  dilution  of  shareholders over  the  lifetime  of  the  plan,  it  is  considered  material.”
    • In theory, the ability to revise performance goals could lower the bar for earning shares, and thereby increase dilution, making it safest to seek shareholder approval (subject to considering what the plan’s amendment provision says about shareholder approval requirements).
    • Here is one last point: if a plan does not provide a reasonable basis on which to justify a change in performance goals, such action by a board (or committee) could trigger shareholder derivative litigation alleging the action was invalid because outside the authorizations provided under the plan. There is precedent for success of such litigation - notably where awards exceed a plan’s max limit on awards/individual. More info here
    • Overall, this issue needs individualized attention based on a company’s plan documents and awards, as well as its past proxy statement proposal describing the plan for shareholders when they were asked to approve it.

Acceleration of Vesting

Listed below are some of the primary issues that employers should consider before amending  outstanding equity awards to provide for accelerated vesting due to retirement. Here are some of the key issues that warrant consideration: 

(1)  Securities Law Considerations: no issues should arise if the employer exercises its authority (if reserved in a plan or award) to unilaterally authorize accelerated vesting of equity awards

  • Announcement of the change should occur through a prospectus supplement or updated plan prospectus (for public companies).
  • SEC tender offer issues may arise if the employer provides more than a few award holders with an election of some kind, because that technically would involve an investment decision for an equity security.  The SEC published that position about 15 years ago, for stock option re-pricings.
  • An SEC Form 8-K may be required to announce the program, if it is considered material (e.g. due to materially impacting executive officers).

(2)   Code §162(m): stock options and performance-based restricted stock or RSU awards will lose their exemption from Code §162(m)’s  $1 million dollar deduction limit if vesting accelerates due to retirement.  Revenue Ruling 2008-13 establishes that rule.
(3)   Code §409A: no issues for stock options, because 409A expressly exempts modifications that neither reduce the exercise price nor extend the initial term of the grant. For restricted stock and RSUs, an employer’s discretionary acceleration of vesting upon retirement does not violate 409A (absent tax manipulation through substitution of other deferred compensation), but it could cause 409A’s six-month delay rule to apply due to loss of the short-term deferral exemption from 409A. Loss of that 409A exemption could also create complex issues if retirement involves a period of consulting services.
(4)  Code §422: no issues for incentive stock options (aka ISOs) because Treas. Reg. 1.424-1(e)(4)(ii) provides that an amendment to accelerate vesting is not a material modification that would disqualify an option from tax-favored ISO treatment.
(5)  FICA-Medicare:  these employment taxes become payable on upon vesting (not necessarily bad but important to address in the planning).
(6)  Financial Accounting: the modification of equity awards to provide for accelerated vesting would trigger a new “measurement date” for financial accounting purposes, based on my understanding of ASC 718 The modification could trigger unexpected expense. The Company’s accountants are best to consult in this regard.