Articles

A friend reminded me the other day that every dark cloud still has a silver lining. His feel-good disposition provides hope, in spite of the economic crisis that is affecting us all in some form or another. His interpretation of the downturn was, however, somewhat different from the words of wisdom provided by economists on a daily basis. You see, for him, the downward spiralling economy simply meant less gridlock obstructing his commute to and from work, but more importantly…the positive spin is a direct result of shorter line-ups at his local McDonald’s!
Now, I’m not suggesting for a minute that we should make light of an economic slowdown that has probably affected every one who reads this article, but I am implying that this downturn is not (yet) equal to the great depression of 1929 that lasted for almost a decade in some countries.

John D. Rockefeller said that "These are days when many are discouraged. In the 93 years of my life, depressions have come and gone. Prosperity has always returned and will again.”¹

These are days when many are discouraged. In the 93 years of my life, depressions have come and gone. Prosperity has always returned and will again

- John D. Rockefeller

One could argue that the current economic crisis has also successfully forced most of us, and most of the people who surround us, to confront and hopefully correct some of the bad habits we had developed over the past few decades. Longer term success in this regard will benefit everyone for decades to come, because we’d be translating our short-term pain into real long term gain.

The National Center for Employee Ownership estimates that 9 million employees have stock options as part of their compensation. So, what should be done with all those incentive awards that may be viewed as ‘not much of an incentive’ today?

The answer to the question above is almost as complex as the underlying problem, but we do have a few choices:

• If your underlying business fundamentals are sound, and you are effectively and efficiently able to share this information with your employees who had previously been granted awards, the awardees may adopt a more long-term, positive view to their awards and your corporation’s proposed future performance. In this scenario, your corporation’s employees “will keep doing the right thing,” and soon enough your stock performance will represent an attractive investment, bringing back the buyers, driving the price ever higher!
• Your corporation could grant new awards at the current lower stock prices although your shareholders would likely – especially at this time – frown upon this.
• Your corporation could, alternatively, decide to re-price the existing awards. In the U.S. specifically, this is a little tricky because under stock exchange requirements, you’d require shareholder approval. In essence, that means you’d be asking the shareholders to approve a benefit for your employees that they (the shareholders) themselves will not enjoy. ²
• Your corporation could repurchase underwater options: This generally involves a cash outlay by the company; the amount will vary based on the extent that the shares are underwater and to the extent that such repurchase is limited to fully-vested options. A repurchase would reduce the number of options outstanding as a percentage of the total number of common shares outstanding (referred to as the “overhang”), which is generally beneficial to a company’s capital structure. ³

Many employees view the current market situation in a positive light and see it as an opportunity to further invest in the future of their company, at a discounted price! This is evident by the high volume of calls received by the Solium Call Centre from ESPP participants trying to purchase additional company stock, in addition to their regular contributions. If your corporation still does not offer an Employee Stock Purchase (ESP) program, now may be the perfect time to launch one…what a wonderful opportunity for your employees to become owners in the corporation at a greatly reduced, ongoing cost of entry! The fees for administering an ESP program are generally also quite low (especially if the rules of the program aren’t too complex!).

All said, even if things look bleak now, you never know when a market recovery could suddenly get your employees’ option holdings back in the black. Viewed optimistically, we’ve probably hit the bottom and as such, there’s only one way to go from here, and that’s up!

For a more detailed look at potential courses of actions with underwater options, please have a look at a recently published white paper written by the Managing Principal of Solium Equity Consulting, Jim McBride, available for download by clicking here.

Rudi Bester
Executive Vice President
Sales & Marketing
rudi.bester@solium.com

1 Schultz, Stanley K. (1999). "Crashing Hopes: The Great Depression".

2 NYSE, Inc. Listed Company Manual, Section 303A(8); NASDAQ Rule 4350(i) and NASDAQ Interpretive Manual IM-4350-5. See the American Stock Exchange. Company Guide Section 711 and related commentary.

3 White & Case Client Update - October 2008

On November 7, 2008, President-Elect Barack Obama met with his Transition Economic Advisory Board to establish and implement a strong set of guidelines, in response to the current economic crisis in the United States. As a result, there has been a lot of buzz surrounding the Obama camp regarding the personnel appointments that will make up his administration.

With the choice of the top financial titles of the new administration having been announced in November (see article below in Financially Stated), it wasn’t until December 18th that President-Elect Obama announced who would replace the current SEC chairman, Christopher Cox. The appointment of all five commissioner positions of the SEC is left to the President’s discretion, one of which takes on the top executive role as SEC chairman. With no more than three of the appointments permitted to come from one political party, and after the monumental win on November 4th for the Democratic community, President-Elect Obama had a major decision to make.

I will ensure our regulatory agencies are led by people who are ready and willing to enforce the law,

- said Obama.

The Obama administration already employs one seasoned former SEC chairman, William Donaldson (who was previously appointed by President Bush in 2003), as a member of his Economic Advisory Board, and as such, speculation was circulating regarding whether or not President-Elect Obama would have been enticed to re-appoint Mr.Donaldson as SEC Chairman. However, on December 18th, President-Elect Obama announced his appointment of brokerage regulator Mary Schapiro, 53, to the position instead of Mr. Donaldson.

Ms.Schapiro is taking on an enormous challenge by accepting the position with the SEC, not only due to our current economic crisis, but also because she is doing so in the wake of Bernard Madoff’s alleged Ponzi scheme. With a lot of fingers pointed at the SEC for missing the red flags of this $35-$50 billion fraud case and for not doing anything to halt the collapse of two of the nation’s largest investment banks, Ms.Schapiro will be stepping into a role that is already under intense scrutiny. In addition, she is doing so with a pay cut. Her former position at NASD earned her $2.1 million in deferred compensation in 2005, whereby her role with the SEC pays a mere $158 500 per annum. She will also be giving up her board positions with Duke Energy and Kraft Foods.

Ms.Schapiro is no stranger to challenges having been CEO and Chairman of the NASD and led the consolidation of that organization with the NYSE Member Regulation in 2007 to form the Financial Industry Regulatory Authority (FINRA), where she then acted as its CEO. She has also been an SEC Commissioner in the past and also served as Chairman of the Commodity Futures Trading Commission. There is confidence in Wall Street that she will perform well in this new role.

Securities defense attorney, Jerry Isenberg stated, "Mary knows the industry, she knows the commission, she knows the Hill and I think she'd be an excellent choice."

“(Ms. Schapiro's) vast and broad experience (as a regulator) will be invaluable as the regulatory restructuring process goes forward." said Robert Glauber, former chief executive of the NASD.

Since appointing Ms.Schapiro, nothing has been reported in regards to IFRS implementation but one can assume that the move will still be subject to continued scrutiny under the Obama administration, and by Ms.Schapiro herself.

As for the other four commissioners, the current chief accountant, Conrad Hewitt, has already announced his resignation from the SEC in January and feels it is likely that the existing commissioners will finish out their existing terms and stated that will “provide a lot of continuity.”

As the end of the year rapidly approaches, there are many year end duties that administrators of stock plans need to consider. The checklist below is not exhaustive by any means but may include many duties that need attention depending on your professional role, the country of the Issuer and the employee incentive plan(s) offered by your company.

Reconciliation of Data

• Reconcile stock plan administration data with payroll/HR (new hires/participants and terminations)
• Determine last payroll cut-off for stock income and tax withholding amount
• Audit tax withholding amounts
• Reconcile employee demographic information to ensure current address, business group, etc.
• Verify any changes in tax rates for participants
• Verify plan reserves and capitalization table and reconcile with Transfer Agent numbers
• Balance amounts received from employees (via broker) with each payroll location and tax authority
• Audit plan share usage with those from transfer agent
• Ensure all 2008 exercises are processed and reset YTD amounts for stock plans prior to new exercises in 2009

Coordination with other Corporate Departments

• Prepare Executive Compensation Disclosures
• (US) 10-K or Q -Compensation data for 10-K for Dec.31st year end or for 10-Q if only quarter end
• Prepare 409A –(new for 2008) deferred compensation plans plan and grant documentation
• Section 16 Insiders -ensure filings are current
• Data Requests -requests from other departments (Legal, Tax, Accounting, Finance HR, etc)
• Prepare annual report on 10K and distribute to plan participants
• Coordinate year-end close with Payroll including NQ and ISO reporting
• Coordinate distribution of W-2s with Finance (ensure newest version is used-updated March 8, 2008 – PDF available by clicking here  and for information on filing, click here).
• Prepare for annual report publication and distribution
• Prepare for stockholders meeting and proxy voting process

Grant based plans

• Prepare for distribution of new grants in 2009
• Income Tax Communications - Communications to participants (Section 6039) for exercise of incentive stock options.
• Collect ISO cash exercise Disqualifying Disposition Surveys (due Dec. 21st)
• Report ISO dispositions to Payroll
• Provide audit data for all NQSO and Restricted Stock

Contribution based plans

• Collect ESPP Disqualifying Disposition Surveys (due Dec. 21st)
• Income Tax Communications - Communications to participants (Section 6039) for transfer of ESPP shares
• Report ESPP dispositions to Payroll

Employee Communications

• Run report and inform any participants with expiring options in 2009

• Set-up any Blackout periods necessary for year-end reporting and inform participants

• Inform employeed of stock market holiday hours and last date for trading/settlement in 2008

• Inform employees of tax slip mailing dates

Regular Features

Obama's New Advisors

Highlights of the expectations and plans from the team

• Craft plan to create 2.5 million jobs within two years including tax credit for businesses that create new US jobs
• 95% of workers to get a tax cut
• Increase food stamp payments
• Direct federal aid to states and cities
• Health care reform (will be Barnes’ focus)
• Likely new budget reforms that call on Americans to make certain sacrifices
• Investment in infrastructure (roads, bridges, schools and alternative-energy)
• Multi-year stimulus program estimated to cost $500-700 billion

There is a sense of urgency to implementing and building on Obama’s financial plan as he stated “That work starts today because the truth is, we don’t have a minute to waste.” January 20th marks the first day Obama takes office and this economic dream-team officially assume control, however, they are already working on recommendations to Congress and change is already in motion. Obama plans for his administration to “hit the ground running”.

SEC releases IFRS roadmap

The initial roadmap outlined in August by the IFRS has finally been published in its more refined version on November 14th. After delays due to the worldwide financial crisis the document outlines a plan where most large U.S. firms would begin to file their financial statements using IFRS instead of GAAP as early as 2014. There is a 90-day comment period for the 165-page document, placing its date of approval in the first few months of the job for the new SEC Chairman, still to be announced by the Obama administration.

There are at least 110 eligible companies earmarked by the SEC as optional earlier adopters but some are hesitant to make the move, especially considering the current economic situation. As a result, these companies are focusing on more pressing issues for the time being. The conversion also has significant cost increases associated with it including system changes, training existing staff; external consultants/auditors, higher cost to bring in the high-demand accounting personnel that are familiar with IFRS implications and procedures and the possibility of maintaining two sets of books for a period of time. These costs may be offset, however, by the need for fewer resources as both a parent company and its foreign subsidiaries would be utilizing the same set of standards and, similarly, they would also enjoy the benefit of decreased audit fees, making U.S. issuers more attractive to foreign investors.

With that being said, CPAs around the US are increasing their preparation for IFRS with only 45% of respondents of an American Institute of Certified Public Accountants survey in early October stating they were not preparing for IFRS. This is down from 59% from a similar survey six months earlier. With the recent release of the IFRS roadmap, that number is sure to decline further and more drastically in the near future.

The SEC’s decision regarding whether the US will move forward with IFRS reporting will come in 2011 after early adaptors begin initial filings in 2010 and hinges upon several milestones that must be met.

 The published Roadmap can be viewed at http://www.sec.gov/rules/proposed/2008/33-8982.pdf .

The SEC Hit List

New Reporting Requirement for Canadian Executive Compensation

The Changing Face of HR in 2009

To put it mildly, this is a challenging time for Human Resource professionals. With many employee incentive options being significantly underwater, corporations instituting hiring freezes, reports of massive layoffs as well as an older workforce now unable to retire due to the loss of value in their portfolios, the economic instability in the last year creates a lot of questions for how HR should respond. 2009 brings a new year, a new US president and new areas of focus for HR professionals. Here is a look at what 2009 could have in store:

Job Market – The current financial crisis will be the initial focus of the new administration as they look to jump-start the economy. This includes a promise to create of 2.5 million jobs, largely through infrastructure development. This is currently being overpowered with the highest unemployment rates in the US in 15 years at 6.7% and 533,000 jobs being slashed in November, the highest amount in a single month in 34 years.

Considering many upper level employees have a high percentage of their total compensation derived in stock option and other LTIs and with estimates that 90% of Fortune 500 chief executive currently have under water options, there may be some movement at executive levels but this may end up being a case of getting out of the frying pan and into the fire.

Healthcare – One of Obama’s main priorities was, and still is, health care reform. Look for the newly appointed Director of Domestic Policy Council, Melody Barnes to be the driving force. While other recommendations are coming in for topics such as universal coverage, insurance-market reform and cost management,  Sen. Max Baucus’ (D-Mont. And Chair of the Senate Finance Committee) 100 page Call to Action for Health Reform in 2009 is the most comprehensive.

Large Corporations will look for the Senate to clarify the Play or Pay health care reform statement of what a “meaningful contribution” is or will end up contributing to fund national insurance program. The impact of this will have to be conducted on a per company basis by HR professionals.

It is also likely see a shift back to employer-based health insurance as opposed to the health-savings accounts preferred by the Bush Administration.

Tax Policy Changes – Under Obama’s comprehensive tax policy plan, 95% of workers can expect to receive tax cuts of around $500 with additional cuts for such things as paying a mortgage, sending a child to college or incurring childcare expenses. 

Compensation – In light of the economic situation, merit and variable pay budget revamps are anticipated by approximately two out of five companies but the anticipated decline in salary increases is, actually, quite moderate. According to studies, the average salary is likely to increase around 3.7 – 3.9% from 2008 rates, although the rate varies dependant on a number of factors, including industry.

Retirement - Penalty-free access to funds in defined-contribution plans and changes to the distribution rule requirement at age 70 ½ are likely as proposed to Treasury (D-Cong. George Miller (CA), D-Cong. Rob Andrews (NJ)).

What's in Store for 2009 Salaries

With a new year comes the typical season for annual pay increases and the review of annual incentive plans. What action companies will take in the New Year with long-term incentives is still to be determined. As stated in Tapping Resources above, the average forecasted salary increase will be in the 3.7 – 3.9% range with anticipated inflation rate of 2.0% for 2009. However, an employee’s performance will still have a significant impact on the percentage of salary increase they can expect.