162(m) Qualification for Discounted Option Grants

[Alf]

Can stock options that do not quaify for the special stock option rule in the 162(m) regulations (because they were issed at a discount or have performance vesting, for example) qualify as performance based compensation under the general rule as a practical matter.

Do the shareholders just have to approve the stock option plan and not the individual agreements?

[Kirk Maldonado]

Alf:

Why do you believe that performance vesting would not be acceptable under Section 162(m)?

[E as in ERISA]

Under Reg. Sec. 1.162-27(e)(2)(vi) stock options are automatically deemed to satisfy 162(m) if, among other requirements, the amount of compensation is based SOLELY on increases in the value of stock. If you have performance vesting, then you don't meet the exception. The performance goals would be something that have to be disclosed to shareholders so that they could take their impact into consideration before deciding whether or not to give approval.

[Guest Harry O]

I don't think performance vesting violates the regulation section you cited. The amount of compensation payable to the employee is still based solely on the increase in the value of the stock. The performance vesting condition only determines if the employee can exercise the option, it doesn't impact the amount of compensation he gets.

There is arguably a problem with indexed options under section 162(m) but not options with performance vesting.

Discount options might be able to qualify under the general performance based rules if the right to exercise the option is conditioned on satisfying pre-established objective performance criteria (rather than just the passage of time) and you meet the other section 162(m) rules (e.g., get compensation committee certfication prior to exercise; shareholder disclosure and approval, etc.).

[Kirk Maldonado]

Harry O:

I agree with your reasoning.

But I have another question for you. Do you think that it would work in your scenario if the same conditions had been imposed upon the grant rather than the exercise of the stock option?