A SINKING STOCK MARKET has left many employees holding underwater stock options -- options that cost more to exercise than the cost of purchasing the stock at market value. As a result, companies are revising employee stock option plans, says Robert Kimball, a partner in the law firm of Vinson and Elkins, in Dallas. "Management believes they won't be able to maintain and motivate existing employees who are holding underwater options," Kimball says. Repricing, particularly the cancellation of existing underwater options and the subsequent reissue of new options, can pose financial, tax, and career problems for employees.

Get the repricing basics

"Repricing occurs when an existing option's exercise price is lowered, or when higher-priced options are replaced with new options with a lower exercise price," Kimball says. The goal of repricing, says Ed Speidel in the Boston office of Unifi Network, a PricewaterhouseCoopers subsidiary, is to make options more valuable to the employees. An example, says Speidel, is if a company cancels 1,000 underwater options with a strike price of $1,000 and replaces them with 1,000 new options with an exercise price that equals the fair market value of $20.

But repricing is not such a simple process. Companies consider accounting standards, SEC regulations, and tax consequences, which can be uncontrollable when repricing occurs on the same day or within a short-term time frame. As a result, "most companies are not doing an outright repricing," Speidel says. "Those that are doing that are often the most desperate and are losing monies."

For tax advantages, Speidel says, many companies are taking a delayed repricing route. The company cancels employees' currently held options and then reissues new options later -- more than six months later. But this delayed issuance can put employees at risk: They aren't holding any options in the period between cancellation and reissuance, Kimball says.

Evaluate repricing offers and risks

The company can't force option repricing on employees. Each employee must consent to the repricing or cancellation and subsequent issuance. "Unless there is a specific statement in the original option grant, an employee always has a right to turn this offer down. This is a contractual arrangement," Speidel says.

Employees presented with a repricing or delayed option exchange offer have many issues to consider: tax consequences, option terms, option and share valuation, vesting schedules, how to finance options, and the health and long-term outlook of their company, the company's industry, and the stock market.

"Companies usually set the reissue price at the stock's market price or right above the market price. One problem in evaluating an option repricing offer is that you won't know the price of the new options until the day they're reissued," Kimball says. If the stock's market value increased before the reissue date, employees might be issued new options with exercise prices that are higher than the prices of the previously canceled options. Speidel offers some advice: "Be careful about [exchanging options] that are within 20 to 25 percent of [the stock's] fair market value, given the volatility of the market and how quickly business can turn around."

Consider your personal risk when evaluating repricing offers

Evaluating the option repricing offer and trying to predict future market conditions are difficult in themselves, but they are not the only factors to consider. Employees must also consider their own personal and professional future. "An employee could leave, be fired, or be laid off in the period between cancellation and reissuance, or before reissued options are vested," Speidel says. Moreover, an employee approaching retirement may not want to exchange underwater options for new options -- and a new option vesting schedule that extends beyond his or her expected retirement date.

Employees should also consider tax consequences with certain stock options. "With incentive stock options that are already in the grant period, an employee who holds his shares for two years gets favorable capital gains tax treatment. If an employee accepts a repricing, this starts the capital gains tolling period over again," Speidel says.

Educate yourself about different offers

Both Speidel and Kimball strongly suggest that employees carefully review repricing offers, which must be held open 20 business days, to get the information they need. Companies are required to give employees documentation that resembles lengthy and complex tender offer documents. This information is often difficult to decipher. "Demand of the employer a communication around the offer in layman's terms," Speidel says.

When Speidel handles client repricing matters, he provides a copy of the stock option plan, repricing FAQs, the employee's actual offer, vesting schedule, current and outstanding option grants, and current option strike prices and vesting dates. He also suggests that management hold educational meetings with employees.

What employees really want, Kimball says, "is an understanding of how the options being surrendered compare in value to what's being offered. Usually a study is done that gives a 'best guess' as to where the market will be. Companies are hesitant to predict valuation and give this information to employees, but may give an outline of the document's findings."

Learn about new options for options

To deal with market volatility Speidel says some companies are turning to performance extended term options. Speidel gives an example: A company may grant options with an exercise price of $10 and a two-year term that vests in 18 months. If at the end of the two-year term the stock price hasn't reached $10, the option will terminate automatically. In that case, companies usually will issue new options. If the share price has reached $10, the option term will be extended, usually five to ten years. "Employees won't be holding underwater options," Speidel says.

» posted by ITworld staff

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