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  1. Barbara Baksa, NASPP June Anne Burke, Baker & McKenzie LLP Denise Glagau, Baker & McKenzie LLP May 13, 2014 The Hottest Issues in Stock Compensation Today National Association of Stock Plan Professionals Austin Chapter Baker & McKenzie LLP is a member firm of Baker & McKenzie International, a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a "partner" means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an "office" means an office of any such law firm.

  2. Presenters Barbara Baksa | NASPP (510) 493-7599 June Anne Burke | Baker & McKenzie LLP (212) 626-4371 Denise Glagau | Baker & McKenzie LLP (415) 576-3067

  3. Agenda • Performance Awards • Tax Developments • Mobile Employee Taxation • Tax Reform in the US • Increase in Tax Reporting Obligations • Clawbacks / Forfeitures • Data Privacy • Grant Acceptance • CEO Pay Ratio Disclosure

  4. Performance Awards

  5. The Rise of Performance Awards • Performance award usage began increasing in the mid 2000s as a result of market volatility and changes in accounting practices, and has accelerated in prevalence as a result of ISS, say on pay, and shareholder expectations for pay and performance Source: NASPP Stock Plan Design Survey (2004 – 2013, co-sponsored by Deloitte Consulting LLP)

  6. Performance Awards – Here to Stay Summary of Key Findings on Performance Plans (units, cash and shares)* • Prevalence: usage of performance awards outpaces stock options and rivals time-based awards for senior management and above • Eligibility: median minimum salary for eligibility for performance awards is $139,200 (up from $120,000 in 2010) • Grant frequency: annual grants used by majority of companies • Vesting schedule: 69% of companies who grant performance awards paid out in stock and 72% of companies who grant performance awards paid out in cash have a three-year performance period • Dividends: For performance awards paid out in stock, 62% pay dividends on the awards. The majority (80%) pay out the dividends only when the underlying award is paid out (half of these respondents pay the dividends in cash and half reinvest them in additional shares) Source: NASPP 2013 Domestic Stock Plan Design Survey (co-sponsored by Deloitte Consulting LLP)

  7. Types of Metrics Performance Awards – Here to Stay Number of Metrics Used Prevalence of Specified Metrics Source: NASPP 2013 Domestic Stock Plan Design Survey (co-sponsored by Deloitte Consulting LLP)

  8. Why is This Such an Important Trend? • Performance plans have been rising each year, and are now passing the tipping point of 50% of a CEO’s LTI • As performance plans take up more of the pay program, it is increasingly important to design them carefully

  9. Tax Developments

  10. Mobile Employee Taxation

  11. Mobile Employee Dilemma • Employee typically taxed on worldwide income in state and country of “tax residence” • e.g., entire gain at RSU vesting • Also taxed on “source” basis where income was earned • e.g., all states/countries of employment during RSU vesting period • Extra complexity for US transferees – citizens and greencard-holders subject to US federal tax on worldwide income • Tax residency in most countries based on time spent in country, intent to reside indefinitely, ownership of real estate, etc. • Social insurance rules often do not mirror tax rules • May depend upon recharges, role of local employer, whether employee remains on home country social system, etc.

  12. Mobile Employee Dilemma Transfer Transfer Country A Grant Country B Vesting Period Country C Vest Date RSU Gain • 100% Resident Tax? • Any tax withholding or reporting? • Any double withholding relief? • US citizen or green card? • Social taxes? • Source Taxation? • 100% as grant location? • Any tax withholding or reporting? • Source Taxation? • Any Exemptions –how long in Country B? • Any tax withholding or reporting?

  13. Mobile Employee Dilemma • Income taxes and social insurance may be due in multiple countries on different amounts and at different times • Double taxation of same income may occur • Tax treaties/totalization agreements/foreign tax credits may apply to avoid or reduce double taxation – but can be tricky to apply • Special exemptions should be considered to potentially avoid tax • Timing of employee movement or grant of award may increase or decrease tax amounts due • Employee movement can be difficult to control and track ** Heightened attention to mobile employees from tax authorities around the world as countries looking for tax revenue **

  14. Recent Developments in Mobile Employee Taxation -- Ireland • Ireland taxes RSUs on an “all in/all out” basis • If resident in Ireland at vesting, all gain is taxed without apportionment • If not resident in Ireland at vesting, no gain is taxed in Ireland • Tax credit available if a double tax treaty is in effect • For tax years beginning January 1, 2013 and after, “real time” tax credit where credit for foreign tax paid through PAYE • The employer must satisfy certain reporting requirements

  15. Recent Developments in Mobile Employee Taxation -- Switzerland • The Swiss Social Security Administration issued guidance in November 2013 on new rules regarding Swiss social security taxation in mobile employee situations • The new rules align Swiss social security with Swiss income tax in mobile employee situations • Effective for taxable events occurring on or after January 1, 2013 • Because guidance was late and not well publicized, the authorities may be willing to permit companies to implement for 2014 forward 19

  16. Recent Developments in Mobile Employee Taxation -- Switzerland Some exceptions apply: • If employee subject to social taxes in home country under a social security treaty, e.g., social security totalization agreement, Swiss social security will not apply • If employee subject to tax in another country that imposes social taxes without proration, Swiss social security will be determined on a case-by-case basis RECOMMENDED ACTION: • Review method used for transfer situations involving Switzerland 20

  17. Recent Developments in Mobile Employee Taxation -- United Kingdom • Finance Act 2014 harmonizes tax rules for mobile employees • Options and RSUs taxed in the same way, generally based on portion of vesting period worked in UK • Eliminates exception to UK tax for options granted outside UK without link to UK employment • Effective for grants from September 1, 2014 • New statutory residence test • Considers number of days spent physically in the UK and "connecting factors". • If less than 16 days in the UK in the tax year, not resident, and one who spends 183 days or more in the UK in a tax year will always be resident • Sliding scale for presence more than 16 days and less than 183 days

  18. Tax Reform in the US 22

  19. Proposed Tax Reform in the US • Proposal for broad tax reform released by Chairman of the House Ways and Means Committee Dave Camp • Income tax brackets reduced from seven to three • What would happen to the supplemental flat rate? • Preferential tax rates for long-term capital gains and qualified dividends would be replaced with 40% income deduction • AMT eliminated • Likelihood of full enactment seems remote, but parts of the legislation may become law Listen to the NASPP’s podcast interview with Bill Dunn. Search for “NASPP” in iTunes and download episode 5.

  20. Proposed Tax Reform in the US • Proposals related to equity compensation • No more deferred comp, everything would be taxed when no longer subject to substantial risk of forfeiture • Could apply to stock options as well as full value awards • Would accelerated/continued vesting upon retirement become a thing of the past? • Currently approximately 50% of companies provide some sort of automatic payout to retirees • Or would this further push companies towards performance-based awards? • Overhaul of Section 162(m) • CFO once again a covered employee • No exemption for performance-based compensation • Would IRS take this opportunity to align treatment of equity awards with the proposed requirements for health insurance providers?

  21. Increase in Tax Reporting Obligations 25

  22. Increased Tax Reporting Obligations • Many countries have implemented foreign asset / foreign account tax reporting requirements • Belgium • Canada • France • India • Japan • Korea • Spain • U.S. • Varying thresholds apply • May impact awards, shares and/or sale proceeds

  23. Clawbacks / Forfeitures 27

  24. Clawbacks • A clawback requires an award recipient to re-pay benefits received pursuant to an award (e.g., shares or sale proceeds) • The purpose of clawbacks include: • Promoting good behavior • Punishing bad behavior • Protecting the company’s business and trade secrets • Complying with applicable laws • U.S. Sarbanes-Oxley Act of 2002 (“SOX”) • U.S. Dodd–Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) - July 2010 • Outside the U.S., most statutory clawbacks apply only to financial institutions (e.g., EU Capital Requirements Directive or CRD-IV, Hong Kong Guidelines on Sound Remuneration System, Singapore FSB Principles for Sound Compensation Practices)

  25. Forfeitures • A forfeiture requires an award recipient to forfeit an award, vested and/or unvested, that has not yet been paid • Serves similar purpose as a clawback, but there may be differences in enforceability

  26. Clawbacks on the Rise Employees that are most frequently subject to clawback provisions: Top three most common triggers: • 60% of companies indicate their grants are subject to a clawback provision (an 88% increase since 2010) Source: NASPP 2013 Domestic Stock Plan Design Survey (co-sponsored by Deloitte Consulting LLP)

  27. Effective Clawback / Forfeiture Provisions • Clearly define scope • Distinguish between vested and unvested awards • Provide for ability to waive or modify discretionary clawback / forfeiture if necessary to comply with local laws • Even if unenforceable, may decide to leave clawback / forfeiture provision in award agreement as deterrent (generally fine, but some exceptions, e.g., California in the case of a clawback based on a non-compete) • Select US law as governing law, if possible • Require employees to affirmatively accept terms; consider translations • Include appropriate labor law disclaimers in award agreements

  28. Final Word on Clawbacks / Forfeitures • Obtain legal advice prior to any enforcement attempt • Civil and/or criminal penalties may apply for such attempt, e.g., France • Clawback applied to current employees may provide basis for constructive termination claim • Consult with auditors before implementing forfeiture/clawback provisions • Consider a separate, designated brokerage account for holding shares subject to forfeiture/clawback provisions • Designing clawback/forfeiture provisions should not be a stand-alone exercise • Evaluate what your peer group companies are doing/considering and incorporate the clawback/forfeiture provisions in the overall executive compensation program design

  29. Data Privacy

  30. Australia –New Data Privacy Legislation • New data privacy law, Australian Privacy Principles (“APP”), took effect on March 12, 2014 • APP regulate the handling of personal information by both businesses and Australian government agencies • Replaces existing data protection principles to strengthen compliance • Penalties of up to $A1.7 million for corporations  RECOMMENDED ACTION: • Stay tuned for further developments

  31. Malaysia – New Data Privacy Legislation • New data privacy legislation into force on November, 15, 2013 • Participant consent required for use and transfer of data • Notification must comply with certain minimum disclosure requirements • The notice must be provided in both the national language of Malaysia and in English RECOMMENDED ACTION: • Obtain separate consent • Modify country addendum language and include consent award agreement language in addendum

  32. South Africa– New Data Privacy Legislation • The Protection of Personal Information Bill ("POPI") signed into law November 26, 2013 • The Act sets out requirements for processing of personal data, including eight "core information-processing" principles and the founding of an independent information-protection Regulator • Will significantly impact the way in which organizations collect, store, process and disseminate information • Impact on incentive awards is not yet clear RECOMMENDED ACTION: • Stay tuned!

  33. Grant Acceptance 37

  34. Grant Acceptance —Particular Relevance for RSUs For options, acceptance of award can be built into the exercise process; participants must take affirmative action to exercise options No participant action is required when RSUs vest Therefore, there is no built-in mechanism in an RSU award that forces the participant to accept the award prior to the vesting date This same issue also impacts restricted stock awards and performance units/shares

  35. Grant Acceptance -- Why is it Important? • Award agreement contains terms and conditions that protect the company in case of disputes • e.g., tax withholding consent, vested rights disclaimer, data privacy consent, governing law/venue provision • Award Agreement may also include other provisions that are beneficial to the company • e.g., restrictive covenants such as non-competes and non-solicits • Important that plan participants affirmatively agree to those terms and conditions so they are more likely to be enforceable

  36. Possible Solution #1 Cancel the award if not accepted by first vesting date Accounting Issues Expense and share counts would be disclosed from grant date through the first vest date until the award is forfeited Non-US tax issues If tax due at grant, may not be able to recoup despite cancellation (e.g., France) Consider communications/employee relations issues

  37. Possible Solution #2 No new grants to participant if he/she fails to accept award within timeframe or at all • Hybrid of Solution #1 • Does not rectify the original grant issues • Accounting Issues? • No tax issues • Communications/employee relations issues

  38. Possible Solution #3 Don’t issue shares until plan participant accepts the award US tax issues / Code Section 409A Code Section 409A requires document and operational compliance; failure to comply results in excise tax imposed on service providers/employees Short-term deferral exception – RSU award must be paid within 2 ½ months following the end of the year in which the award vests Late payment exception – later of the last day of the calendar year in which the payment is scheduled or 2 ½ months following the originally scheduled payment date Other exceptions; no legally binding right FICA due on vesting even if shares not issued

  39. Possible Solution #3 (cont’d) No accounting issues Non-US tax issues In several countries, tax due at vesting even if shares not issued (e.g., Australia) Problem: how to cover tax if shares not issued? Issue sufficient number of shares to cover tax Withhold from salary Administratively cumbersome

  40. Possible Solution #4 Include award in income at vesting but delay release of shares until acceptance No accounting issues US tax issues Code Section 409A requires compliance with the short-term deferral rule or payment date must be determined at time of grant – to avoid Code Section 409A violation, withhold and report income (and social insurance tax) on vesting date Global tax issues How to cover tax if shares not issued? May not be acceptable to accelerate taxable event without issuing shares

  41. Possible Solution #5 Issue shares at vesting but restrict sale/transfer of shares until acceptance Accounting issues No issues (if communicated in Plan or Grant Agreement) – share & sale restrictions for other reasons typically result in a discounted fair value Non-US tax issues Tax only due when restrictions lapse (e.g., Australia) Reduced taxable amount to reflect restrictions (e.g., Switzerland) Dual tax events: tax at vesting/issuance and upon lapse of restrictions (e.g., United Kingdom)

  42. Possible Solution #6 Try to obtain acceptance but issue shares on the vesting date even if not obtained Administratively cumbersome to chase employees No accounting issues Enforceability of award provisions may be limited For example, restrictive covenants and entitlement provisions Less protection in case of disputes Authority to withhold shares (or sell to cover) for income and social insurance tax withholding may be questionable No authority to transfer employee personal data from certain countries, unless consent obtained separately (e.g., in equity side/offer letter)

  43. Possible Solution #7 Implied or negative acceptance No accounting issues Enforceability of award provisions may be limited For example, restrictive covenants and entitlement provisions Less protection in case of disputes Authority to withhold shares (or sell to cover) for income and social insurance tax withholding may be questionable No authority to transfer employee personal data from certain countries, unless consent obtained separately (e.g., in equity side/offer letter)

  44. Possible Solution #8 Require acceptance of standard terms prior to making grant • No accounting issues • Administratively cumbersome (especially if broad-based grants) • Non-US issue: • May lead to entitlement issues if grant not made

  45. Recap One-size fits all approach may not be the best option Consider using different solutions in different jurisdictions or for different groups of participants When considering any solution consider: tax, accounting, labor law and data privacy issues – as well as company profile

  46. Common Practices If yes, what action do you take if awards aren’t accepted before vesting? Do you require employees to accept awards? Source: May 2011 NASPP Quick Survey on Restricted Stock and Units