The Advisors' Blog

– Jurgita Ashley, Thompson Hine LLP

At times companies face challenges of needing to grant equity awards that fall outside of their equity plan limits, particularly when new talent is coming onboard. Based on the premise that a company and new employees have an arm’s length relationship, NYSE, NYSE MKT and NASDAQ provide an exemption from shareholder approval requirements for inducement grants of equity awards to new hires.

Although most exchange-listed companies have shareholder approved equity incentive plans, the exemption comes in handy when insufficient shares for planned awards remain available under those plans or when grants are large enough to exceed the plan’s individual participant limits.

Resale Restrictions & Registration Considerations

Inducement grants are made outside of the plan and are not covered by the company’s existing registration statement on Form S-8 for the plan. A company may choose to file another Form S-8 for inducement grants or, as occurs more frequently, may be able to rely on an exemption from registration under Section 4(a)(2) of the Securities Act or Regulation D promulgated under that act. If a registration statement is not put into place, the awarded securities are “restricted” and are subject to a six-month holding period before they can be freely tradable. In the case of employee stock options, the holding period commences when the options are exercised and paid for at the time of the exercise.

Whether or not a registration statement is available, if the award recipient is hired as an executive officer or is otherwise an affiliate of the company, the recipient will be deemed to hold “control” securities and will have to comply with the other restrictions of Rule 144, including volume and broker transaction restrictions, before being able to dispose of the securities but the holding period only applies when shares are unregistered.

When its use is advantageous, a Form S-8 registration statement is simple, can be prepared quickly and inexpensively as long as the company is current in its filings with the Securities and Exchange Commission for the last twelve months, and can be filed at any time before stock is granted or inducement options are exercised, without regard to when the options were granted or became exercisable. The terms of the inducement grant are generally set forth in an award agreement or an employment agreement with all applicable change of control, termination and other provisions, which, in the case of the grants under the plan, are frequently incorporated from the plan. If a registration statement is filed, the new employee should also receive a short prospectus describing the terms of the award, tax consequences and any resale restrictions.

Public Announcement

Somewhat as a deterrent, stock exchanges require inducement grants to be publicly announced by promptly issuing a press release. The release has to name the recipient and the recipient’s title, list the number of shares subject to the award, and describe the material terms of the grant. It also usually states that the company is relying on an exemption for inducement grants from shareholder approval requirements.

When inducement grants are made to non-executive-level employees and are not specifically negotiated or approved, but instead are made pursuant to the company’s pre-existing program of routinely granting equity to new hires without individual negotiation, then in press releases, companies are permitted to aggregate information about grants to new hires made over two weeks and provide that information in a summary form listing the number of employees hired over those two weeks and the equity granted to them during that period, without identifying the specific employees. However, inducement grants to executive officers must be immediately announced in a press release, identifying the recipients. A Form 8-K, which may have to be filed with the SEC for certain officer appointments, is insufficient to replace the press release required by stock exchanges.

In addition, in connection with submitting an additional listing application to the exchange, exchanges require a company’s representation that the grant is an inducement material to the new hire entering into employment with the company. Although stock exchanges generally request an additional listing application two weeks prior to stock issuances, exchanges work with companies on applications for inducement grants within more realistic timeframes. For example, NASDAQ specifically provides that an additional listing application for an inducement grant should be submitted no later than five calendar days after entering into the agreement to issue the securities or the date of the press release announcing the grant, whichever occurs earlier. NASDAQ considers a press release for the inducement grant to be timely and “prompt” as long as it is issued within four business days of the grant.

Limitations

The exemption for inducement grants is of limited nature. It applies only to employees and does not extend to new consultants, newly appointed non-employee directors, or directors entering into employment arrangements with the company. It is also limited to grants made in connection with an offer of employment and does not extend to grants otherwise made shortly after an individual is hired. As another potential limitation, performance-based compensation that is not approved by shareholders does not qualify for an exemption from the Section 162(m) deduction limit. Section 162(m) of the Internal Revenue Code imposes a million dollar deduction limit on the compensation paid in a taxable year to each of the public corporation’s covered employees, which generally include all named executive officers included in the corporation’s proxy statement, with the exception of the chief financial officer for larger corporations. Section 162(m) includes an exemption from the deduction limit for performance-based compensation if, among other requirements, the terms, including the performance goals, are approved by shareholders. Since that is not the case for inducement grants, the company is not entitled to exclude these grants from the Section 162(m) deduction limit.

Disclosure Considerations

Other reporting and disclosure requirements for inducement grants are similar to the requirements applicable to equity grants made pursuant to shareholder approved plans. Inducement grants have to be approved by a compensation committee consisting of independent directors or a majority of the company’s independent directors. These grants may trigger a Form 8-K for the company for the new compensation-based material agreement that is not made pursuant to a previously disclosed plan or for the unregistered issuance of securities if no Form S-8 is filed to cover the grants. For higher-level employees, the awards may also trigger the requirement for the recipient to report the receipt of equity securities on a Form 4. As with other compensation, the company must report these awards in its proxy statement for the annual meeting of shareholders.

In the company’s proxy tables, inducement grants should appear as the plans that are not approved by shareholders. Any material amendments to inducement awards following their issuance would require shareholder approval under the stock exchange rules despite the fact that the initial grants were made pursuant to an exemption from shareholder approval requirements.

The use of inducement grants is a limited, but at times very effective tool. While granting equity under shareholder approved plans presents less limitations and is advisable when possible, inducement grants can be effectively utilized to attract necessary talent to the company.