Dealing with Underwater Stock Options

October 27, 2008

Many companies originally granted stock options to provide an incentive to employees to remain with the company and to enable them to share in the stockholder value that they help create.  The recent prolonged and widespread stock market downturn has increased pressure on these companies to develop an effective strategy to provide stock compensation to employees and other service providers who feel as if all they have are worthless options and to use limited stock plan share reserves more effectively. 

The last broad market downturn in 2001 ushered in the first large-scale response to underwater options.  The legal environment and the degree of oversight of large institutional investors and their advisory services have both changed greatly since that time.  Gibson Dunn’s Executive Compensation and Employee Benefits group has extensive experience with the issues that companies should consider in developing solutions to underwater stock problems, including:

  • The extent to which shareholder approval is needed for option amendment, exchange and/or cancellation programs pursuant to the requirements of the NYSE and NASDAQ exchanges and/or proxy voting recommendations of shareholder advisory services such as RiskMetrics/ISS;
  • Whether the Securities and Exchange Commission’s tender offer or other disclosure rules are implicated;
  • Securities law disclosure requirements related to compensation arrangements involving “named executive officers” (including proxy statement and/or Form 8-K disclosure);
  • Reporting obligations for persons subject to Section 16 of the Securities Exchange Act;
  • Federal and state tax considerations of tendering options and receiving the company’s offered payment (including under Section 409A);
  • The accounting treatment under FAS 123(R) for repriced and/or exchanged awards; and
  • Securities, tax and other legal issues for underwater options held by employees and other service providers outside of the United States.

The problems that underwater options present to companies take time to work through due to the time required to consider, resolve and implement the various issues raised by SEC filings, interactions with institutional shareholders, program design, employee presentations, announcements, enrollment, etc.  Gibson Dunn has assembled a team of experts that can help clients timely and effectively consider their alternatives for addressing the problems raised by underwater options.

Gibson, Dunn & Crutcher LLP 

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or any of the following:

Stephen W. Fackler (650-849-5385, [email protected])
Charles F. Feldman (212-351-3908, [email protected])
Ronald O. Mueller (202-955-8671, [email protected])
David West (213-229-7654, [email protected])
David I. Schiller (214-698-3205, [email protected])
Michael J. Collins (202-887-3551, [email protected])
Sean Feller (213-229-7579, [email protected])
Amber Busuttil Mullen (213-229-7023, [email protected])
Jennifer Patel (202-887-3564, [email protected]
Chad Mead (214-698-3134, [email protected]
Meredith C. Shaughnessy (213-229-7857, [email protected]
Jonathan Rosenblatt
(650-849-5317, [email protected])
John C. Cook (202-887-3665, [email protected])

Please read more about the firm’s Executive Compensation and Employee Benefits Practice Group.

IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any matters addressed herein.

© 2008 Gibson, Dunn & Crutcher LLP

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.