August 11, 2005

More on the FASB’s Option Expensing Position on Grant Dates

A phenomenal number of members asked questions in the wake of Mike Melbinger’s blog two days ago on the FASB’s position on option grant dates. To clarify, the FASB’s position only applies under FAS 123(R), so it will not become relevant until a company makes its first grants after it adopts 123(R) and there should be no direct tax impact from the FASB’s actions. This article from the WSJ yesterday explains how the FASB’s grant date position emanates from overlooked language in 123(R).

I asked NASPP Executive Director Barbara Baksa for her views on what companies might do now – here is Barbara’s insight on the two alternatives posed in Mike’s blog (and two new alternatives):

“I believe alternative #2 could be problematic under 409A, but we don’t know for certain yet as the IRS and Treasury are still developing their interpretations. The grant date for tax purposes most likely will still be the date the board approved the grant. Thus, if the market value declines before the option price is set, you’ll have a discounted stock option under 409A. I think a discounted option under 409A is probably a much worse result than the differential in fair value. Also, this alternative creates a lot of administrative work without really accomplishing much. For these reasons (and more in this NASPP alert), I don’t expect #2 to be popular.

There is a third alternative, which is to simply try to minimize the amount of time between when the board approves the grant and when the terms are communicated to employees. Unless the market value moves dramatically during this time period, this isn’t likely to have a significant impact on the option fair value. For these reasons – and more in this NASPP alert – I expect that this third alternative is the approach most companies will take. With the emergence of online grant communication, many companies have already begun tightening up their practices in this area and this will probably just further that trend.

And there is a fourth alternative, which is to communicate the material terms (except for the option price) of the grant to employees in advance. For example, in a new hire situation, I would expect that it isn’t completely uncommon for the material terms of the grant to be included in the employee’s offer letter (the company would probably still have to follow-up with employees to let them know that the grant was approved, but this could be a relatively short and simple communication). For annual grants, the company might communicate the terms in advance or have managers review with employees the grants that will be recommended for them, then just send out a global communication that grants were approved at X price on the date the board approved them.”

More on this is available in the NASPP’s “Option Expensing Portal,” including a number of firm memos and the NASPP alert on this topic.

Office Depot Amends Corporate Governance Guidelines Ala Pfizer

Last week, Office Depot amended their corporate governance guidelines so that any director who receives a majority withheld vote is required to tender their resignation, just like Pfizer did a few weeks ago. Here is an excerpt from the latest ISS Friday Report: “Heeding a 52 percent shareholder vote, Office Depot Inc. announced this week that it had adopted a modified majority standard for director elections. The company joins Pfizer Inc. and more than 20 other U.S. companies that have some form of majority voting.

While Office Depot’s new policy is not, strictly speaking, a majority election standard, the company’s move adds to the growing shift from the plurality system that most U.S. companies use to elect directors. So far this year, a majority of investors in at least 14 U.S. companies, including Dell Inc. and Supervalu Inc., have supported shareholder proposals on the issue.

In another recent development, the American Federation of State, County and Municipal Employees (AFSCME) has submitted the first binding resolutions seeking majority elections. Those proposals were filed at Sysco Corp. and Paychex Inc.

Office Depot’s policy change is also noteworthy because company CEO and Chairman Steve Odland also chairs the Business Roundtable’s corporate governance task force. The BRT is an influential trade association that has urged “careful consideration of the complications any new standard would present.”

Another Blow to SEC’s Mutual Fund Governance Rules

Late yesterday, the US Court of Appeals in DC unanimously granted an emergency motion for a stay pending court review of the latest lawsuit filed by the Chamber of Commerce. This stay puts on hold the SEC’s new mutual fund governance rules that require mutual fund boards to be comprised of 75% independent directors and have independent chairs. As you might recall, the SEC re-adopted these rules on June 29th, just before former SEC Chair Donaldson left office.

These new rules were to take effect January 16, 2006. The Court directed the parties to provide briefs on the issue of whether the SEC had the authority to adopt the rules, in light of the fact that the Court had not yet issued its mandate sending the case back to the SEC. The Chamber of Commerce is asking the Court to order the SEC to put the modified rule out for public comment, which could force the SEC to hold yet a third vote.