The Advisors' Blog

With the stock market’s nose dive this year, many options that were granted in 2021 are now underwater. This 5-page Holland & Knight memo provides 4 alternatives to address out-of-the-money options – and highlights the major issues that should be vetted when considering a repricing. Here’s an excerpt that lays out those considerations (also see this blog I shared a few months ago):

Accounting. Under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 718 – Stock Compensation, an accounting charge may be incurred based on the approach taken.

Section 409A. New options must be structured so that they are either exempt from or compliant with Section 409A of the Internal Revenue Code of 1986, as amended (Section 409A).

Recognition of Ordinary Income. Depending on the approach taken, option holders may lose their ability to control the timing of a taxable event.

Incentive Stock Options. Option repricings involving incentive stock options (ISOs) raise certain tax issues. First, if an option is repriced, the adjustment will be considered a new option and will give rise to a new grant date for purposes of the ISO holding periods set forth in Section 422 of the Internal Revenue Code. Second, Section 422(d) of the Code provides that ISOs will be treated as non-qualified stock options (NQSOs) to the extent that the aggregate fair market value of the stock with respect to which ISOs are exercisable for the first time during any calendar year exceeds $100,000. In a repricing, if the exercisability of the prior option is carried over to the new option, the new option may cause the aggregate ISOs vesting in that year to exceed the $100,000 limitation.

Shareholder Approval. Whether shareholder approval is required depends on the approach taken and the terms of the equity plan document. See also the below regarding shareholder considerations.

Tender Offer. The SEC has taken the position that a stock option repricing in the form of an exchange program that allows employees to surrender existing, out-of-the-money options for new, lower-priced options involves individual investment decisions and, therefore, constitutes an issuer tender offer. As a result, these exchange programs are subject to Rule 13e-4, the issuer tender offer rule, which, among other things, requires the filing of a Schedule TO with the SEC and the dissemination to option holders of the disclosure documents specified by the rule. In addition, the issuer must also comply with Regulation 14E, which places restrictions on the conduct of tender offers and requires all tender offers to remain open for at least 20 business days. These requirements will add significant costs and time delays to the process of conducting these exchange programs.

However, the SEC issued an exemptive order for issuer exchange offers that are conducted for compensatory purposes, which generally eliminates the following tender offer requirements:

– the “all holders” rule, which requires that the tender offer is open to all holders of the share class subject to the offer, and

– the “best price” rule, which requires that all holders in a tender offer be paid the same price.

In order to qualify for this exemption, the exchange offer must meet the following four conditions:

– the issuer is eligible to use Form S-8, the options subject to the exchange offer were issued under an employee benefit plan, and the new options offered in the exchange will be issued under such a plan

– the exchange offer is conducted for compensatory purposes

– the issuer discloses in the offer to purchase the essential features and significance of the exchange offer

– except as exempted by the order, the issuer complies with all requirements of Rule 13e-4

If the repricing is only offered to a small number of executives, however, the repricing is unlikely to be considered a tender offer.

The memo goes on to summarize proxy disclosure issues and the shareholder backlash that repricings usually create. Proceed with caution!

– Liz Dunshee