Today, the Division of Corporation Finance delivered its report to the SEC on shareholder access – and should be commended for making its report public. The 33 page report is well-written and organized, with a series of pros and cons for the 5 alternatives presented – and a series of questions for the Commission to consider when it puts together an official proposal. See the staff report at http://www.sec.gov/news/studies/proxyreport.pdf. There is also a 55 page summary of comments at http://www.sec.gov/news/studies/proxycomsum.pdf.
I have yet to fully digest the report – but at first glance, it appears clear that the staff has considered the state law issues involved in what could be a complicated rulemaking project. Obviously, the Commission has the authority to require enhanced disclosure – and has some room to maneuver under the proxy rules regarding the nomination process.
However, state law dictates most of the nominating process – and the tension between those state laws and the staff’s alternatives that would allow major, long-term shareholders to nominate directors that will come under close scrutiny.
Here is an interesting observation from Sue Morgan, a partner at Perkins Coie: She thinks it is very interesting that Microsoft apparently is actually going to grant restricted stock units, not “stock awards” in the usual sense. While the references in the conference call and articles are to “stock awards,” the Microsoft press release makes this one reference:
“While many companies provide stock awards, commonly know as restricted stock units, to executives, Microsoft is one of the first major corporations in which every employee will be eligible to become a direct owner of the company through Stock Awards.”
Sue confirmed this with someone at Microsoft, who said that “we are doing units, but they will be referred to as stock awards.” According to Sue, while restricted stock is actually outstanding stock, restricted stock units are units of stock that are recorded in an account and paid out in shares as the units vest. As with other companies that have granted restricted stock units rather than restricted stock, one of the reasons is most likely to avoid the Section 83(b) election morass that comes with actual awards of restricted stock.
In anger over comments made about classification of non-audit services at HealthSouth, the SEC has sent a letter to E&Y. The letter states that not all attestation services can be treated as “audit-related” for purposes of the audit/non-audit fee table in the proxy statement. See the letter at http://www.sec.gov/info/accountants/staffletters/e-y070803.htm.
Thanks to John Jenkins at Calfee, Halter & Griswold for the following insightful analysis regarding the questions I posed on Wednesday regarding Microsoft’s underwater option arrangement with JP Morgan:
It’s hard to predict what Microsoft is going to do, but I’ll bet that from a 1933 Act standpoint, they’ll do something similar to what they did for their directors and executive committee members’ stock options back in December 1997, which is use the discretion provided under the plans to allow them to transfer the options, and then register the primary shares underlying them on an S-3 – http://www.sec.gov/Archives/edgar/data/789019/0001047469-97-009148.txt.
By doing it this way – instead of through the the re-offer prospectus approach contemplated by General Instruction C to Form S-8 – I guess Microsoft concluded that it could avoid having to name the transferors or transferees of the options as selling shareholders. I don’t think that works with whatever they’re doing here. If the transferees are JP Morgan or other identified investment banks and they’re purchasing the securities, I would imagine that the S-3 would have to identify the relevant investment banks in the plan of distribution section or in a prospectus supplement and that those folks would likely be subject to Section 11 liability.
The issue of shareholder approval came up when the SEC eliminated the restrictions on transferability back in the mid-1990s. I know that back then, the staff took an interpretive position that eliminating the transferability restrictions wasn’t a material modification requiring shareholder approval. It looks like Microsoft acted on that advice, like I think most people did. In the 1997 S-3, there’s language indicating that the option plans generally prohibit transfers by plan participants, but as with many of the plans put in place after transferability was first permitted, they allow the Board to “extend such transferability rules, on a general or specific basis, in its sole discretion.” I think most post-1995 plans have similar language, so even if Microsoft is dealing with newer plans than the ones covered here, my guess is that the ability of the board to allow transfer won’t be an issue under the plans or the agreements.
The transcript of Steve Ballmer’s press conference sheds some light on the accounting treatment Microsoft expects (the bottom line is that they’re going to expense all of their outstanding options and reflect that treatment in prior periods as well):
“Given that we are going to account for this under FAS 123, which is also the rule under which stock options must be expensed, it means we will also be expensing stock options that have been granted previously. For best comparability of our results going back and forward, we will reflect FAS 123 in our basic results for prior years in addition to our go forward results.”
Ballmer’s comments provide a few more details on how this is going to work (I’ve got no idea how they’re going to implement this, but it sort of sounds like a combination of a standby underwriting arrangement and some of the restricted stock hedging strategies that brokerages have been peddling for quite some time). It also looks like they’re trying to get some interpretative advice from the Commission (perhaps on the tender offer issue):
“The other thing which we are announcing to our employees today is the work that we are doing to implement a program that will allow them or give them the option, I should say, the choice, to sell their options that are, let’s say, quite a bit underwater, to a third party or a set of third parties. We are working through the details of that now, both with the Securities and Exchange Commission, who needs to review this kind of an offer, as well as with third parties. The goal here would be to allow the employees to make a sale of their underwater options, and to receive the proceeds from a third party on that sale on some schedule which vests into the future.”
As to the tender offer issue, Microsoft probably is arguing this isn’t like a repricing exchange offer, in that it involves the facilitation of the exercise of an option, which is best regarded as a compensation decision, and not an investment decision. Ballmer’s comment that the optionees are going to be paid “on some schedule which vests into the future” undercuts that argument, and also suggests to me that in addition to any Williams Act issues are associated with the deal, there may also be some 1933 Act issues associated with what the employees are receiving from JP Morgan (or whomever).
I got some great feedback to yesterday’s questions posed about Microsoft’s novel underwater option arrangement with JP Morgan from several community members.
Art Meyers of Palmer Dodge notes that the existence of the JP Morgan program raises the possibility that any stock options issued in the future by Microsoft might be taxable at grant under the Section 83 IRS regulations. The analysis is if JP Morgan’s valuation program can be viewed as causing the company’s stock options to be considered “actively traded on an established market” within the meaning of IRS Reg. 1.83-7(a) and (b)(1), then future options (whether immediately exercisable or not) might be taxable upon grant, not exercise.
Furthermore, even if this trading criteria is not met, a future option that is fully vested when issued (or perhaps even an early exercise option) and is freely transferable could be taxable upon grant under IRS Reg. 1.83-7(b)(2). That subsection generally only requires such an option to have a fair market value which can be “measured with reasonable accuracy.”
Let me know if you have anything to add to Art’s reasoning. I will post additional community member thoughts tommorrow.
By the way, Mike O’Sullivan of Munger Tolles provides some detailed background about Microsoft’s plans in his excellent “Corp Law Blog” at http://www.corplawblog.com.
Today’s problem for the day (as sent by a community member): Does anyone understands how the proposed Microsoft plan to have employees sell underwater options to JP Morgan works? It would seem options registered on an S-8 are generally not transferable (See General Instruction A to Form S-8) but perhaps an S-3 could be filed or something. Is this a tender offer by Morgan? Also, if the option agreement provides for nontransferability, or if the plan documents provide for nontransferability, can those provisions be waived without shareholder approval as a material amendment? What are the accounting issues associated with an amendment? We will post answers soon – but if you have any thoughts, send them to email@example.com.
As reported by Alan Dye on Section16.net, last week the SEC sent over 600 letters of rejection to companies that tried to file Section 16 reports on paper.
Even more troublesome is that we hear that companies might believe they have successfully filed a report through the SEC’s new system – because they did not receive a rejection email – yet the filing was not successful. It is critically important to go to the SEC’s Edgar database each time you believe you have made a filing to confirm the filing was made!
Please share any similar horror stories with us by sending me an email at firstname.lastname@example.org.
Back in the saddle after a trip to Yellowstone (most beautiful place on the mainland) and the annual conference of the American Society of Corporate Secretaries (always one of the best). At the ASCS conference, there was much discussion about drafting reporting-up policies before the August 5th implementation date.
Many companies and law firms have waited to see how the SEC would proceed after its January reproposal of “reporting out.” But now that it appears that the SEC might not act before August 5th, they are hastily putting a policy together. For TheCorporateCounsel.net subscribers, we have put together an “Attorney Responsibility Portal,” complete with a sample reporting up policy and an interview with Kris Sharpe on issues to consider regarding QLCCs (among other items). The Attorney Responsibility Portal is at http://www.thecorporatecounsel.net/member/FAQ/attnyresponsibility/index.htm.
Well, I hope my ability to interact with Broc’s blogging software has improved since Tuesday.
It’s been a busy week absorbing the new NYSE and Nasdaq equity compensation plan shareholder approval rules. At this point, it seems that practitioners have more questions than answers. Those of us on the west coast technology world are of course focusing primarily on the Nasdaq side of things, and our questions on those new rules include:
What is a bona fide period of unemployment?
When Nasdaq says that it “recommends” that plans meant to permit repricing use explicit terminology to make this clear, what does it mean in practical terms? It stops short of saying that the plans “must” include explicit terminology. We anticipate that Nasdaq will get many questions on this issue.
Does the exception from the shareholder approval requirement in a merger context (where the acquiror “acquires” shares under a target shareholder-approved plan and may issue such shares under awards to certain employees of the combined entity post-deal) apply where the target was private before the transaction? We think it should, but need Nasdaq to weigh in on this.
If an acquiror “acquires” target plan shares in a merger in the above manner, can it use the shares so acquired under any plan (e.g., use target ESPP shares to issue regular stock options post-deal)? There is language in the release to support this conclusion.
If an acquiror acquires a target plan that includes a shareholder-approved evergreen, can the evergreen continue to add shares to the plan after the deal and if so how would this work in terms of calculating the number of shares to be added each period (maybe the fixed number in most evergreens would apply by default)?
What is meant by the statement that a company “would not be permitted to use repurchased shares to fund options without prior shareholder approval”? We think this sentence is just meant to underscore that there is no free pass (as there never has been for Nasdaq companies) to use treasury shares unless you have shareholder approval of the maximum number to be so used. But the wording is causing some consternation.
Is the exception from shareholder approval for tax-qualified plans absolute? So, for example, if a company had a 20-year ESPP with an evergreen, would the tax-qualified plan exception mean that the company would not have to obtain new shareholder approval of the plan after ten years (as it would apparently be required to do if the plan were an option or other non-tax-qualified plan)?
Is it permissible to grant an award under a plan that has not yet received shareholder approval, where the grant is made contingent upon later shareholder approval?
And I’d guess there are many questions arising with respect to the grandfathering of old plans.
On another note, while the Disney and Abbott Labs cases have garnered a lot of attention recently about where the courts are on director duties and liability, I’ve just had a chance to read the Delaware Chancery Court opinion in the Oracle Corp. Derivative Litigation (June 17, 2003). The Court conludes that an Oracle Special Litigation Committee was not independent (and therefore won’t accept its findings) because of various ties between both the SLC members and the company insiders involved in the litigation to Stanford University. The opinion seems to underscore how different the Delaware courts’ attitudes on these issues are from a couple of years ago — it shows the court looking under every rock to identify potential conflicts. This seems like it will be a controversial case — it will be interesting to see where it goes from here. I’d recommend the opinion for your holiday weekend reading list (2003 Del. Ch. LEXIS 55).
While Broc is enjoying the wild west (Yellowstone) with his family this week, a lot has already happened on the SEC front.
Section 16. First, yesterday, June 30th, was the effective date for mandatory electronic filing and website posting of Section 16(a) reports. Not only did the SEC make this requirement effective one month earlier than required by Sarbanes-Oxley, but in doing so they also created a new online filing service that is intended to simplify the filing process for Section 16 reporting persons. There are still some kinks being worked out in the new online system (the SEC is planning an upgrade to the system at the end of July), but this system is streamlining the filing process and hopefully making the insider transaction information reported more accessible to the general public.
SEC Staff indicated that on each of Friday and Monday they received about 500 electronically filed Forms 4. The Staff also indicated that the Commission rejected paper Section 16 filings it received on Monday (about 250 in total).
NYSE/Nasdaq Rules. In addition, and after much anticipation, yesterday the SEC approved new rules proposed by NYSE and Nasdaq that expand the shareholder approval requirements for equity compensation plans for NYSE- and Nasdaq-listed issuers. As expected, these new rules became effective yesterday, June 30th (on an accelerated basis). In the same release, the SEC also approved a change in the NYSE Rule 452, eliminating the ability of brokers to vote shares held in “street name” on equity compensation matters (at least those below the 5% dilution threshold level, deemed to be “routine” matters under the prior rule) unless the beneficial owner of the shares has given the broker specific voting instructions with respect to the plan proposal. This broker voting rule has a 90-day transition period prior to becoming effective, meaning that it will be effective for shareholder meetings that occur on and after September 28, 2003. The SEC release on these shareholder approval and broker voting matters is located at http://www.sec.gov/rules/sro/34-48108.htm.