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Exchange of Stock Options for Restricted Shares


Guest jhall

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I am wondering what others think about the potential 409A implications of the following situation.

Company has a number of in-the-money stock options in various stages of vesting that for share preservation and other purposes it desires to convert / exchange / swap for restricted stock which will be subject to further vesting.

I have seen companies do this in cases where the options are underwater but not with restricted shares. In addition to a concern that the swap of the options might essentially be considered an exercise or cancellation of the option and thus taxable to the optionees at the time of the swap based on the value of the (albeit unvested) restricted stock, I am concerned that the exchange might create an extension or modification of a stock right under 409A. Although restricted shares are generally exempt from regulation under 409A, it seems to me the exchange might nonetheless be considered an additional deferral feature or otherwise deemed to constitute an extension of the existing stock option thus raising 409A concerns. Anybody have any thoughts on these issues?

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The conversion or exchange of a stock right for a legally binding right to compensation in a future tax year is an extension that creates an additional deferral feature from the date of grant. Because the option would be "in the money" at the time of the extension, the option would be treated as noncompliant under 409A from the date of grant, with penalties and interest applying retroactively.

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Steelerfan,

Thanks. That is my concern as well if you are dealing with unvested restricted shares. However, what if the exchange was for restricted shares that were 100% vested. Since the shares would be immediately taxable, seems there should be no deferral of compensation to a future tax year and so the option should not be considered an extension in violation of 409A. On the other hand, would the fact that there was no longer an exercise price due on the option exercise constitute a "modification" for 409A purposes even if the number of shares received was basically reduced to net out or take into account the exercise price amount? Thanks

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Steelerfan,

Thanks. That is my concern as well if you are dealing with unvested restricted shares. However, what if the exchange was for restricted shares that were 100% vested. Since the shares would be immediately taxable, seems there should be no deferral of compensation to a future tax year and so the option should not be considered an extension in violation of 409A. On the other hand, would the fact that there was no longer an exercise price due on the option exercise constitute a "modification" for 409A purposes even if the number of shares received was basically reduced to net out or take into account the exercise price amount? Thanks

It would be a transfer subject to section 83. I think the option would be considered " otherwise disposed of" under reg 1.83-7. Thus there is no additional deferral feature that would violate 409A.

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