Phantom Stock/SAR under 409A

[Scott]

An executive was granted phantom stock in 2001. Under the arrangement, on the "payment date", he will receive in cash the excess of the stock's fair market value over the "initial value" of the award, which was the fair market value of the stock at the time the award was granted. The payment date is the earliest to occur of (i) 10 years after the date of grant, (ii) a change of control, or (iii) termination of employment (provided that if he is fired for cause or resigns other than for good reason, he will forfeit the award.

The employer is about to be purchased, which will trigger a payment date. The executive, who will continue employment after the change of control, doesn't want to receive the payment yet, and the company wants to accomodate him if possible. The proposal is to amend the arrangement to remove change of control as a payment date so that he will be paid at the earlier of (i) 10 years after the grant, or (ii) termination of employment.

Will such an amendment cause any problems under 409A?

As it now stands, it appears that the phantom stock award meets the SAR exemption from nonqualified deferred comp under Q&A-4(d)(iv) of Notice 2005-1 because it was granted under a program in effect before October 3, 2004, the initial value ("exercise price") is not less than the fair market value at the date of grant, and the award does not include a feature for the deferral of compensation other than the deferral of recognition of income until the exercise of the award.

I can see an argument that the proposed amendment might cause the award to be subject to 409A. In light of the fact that a payment date (the change of control) is pending, the amendment could be viewed as adding a "feature for the deferral of compensation" that would blow the SAR exemption above.

Under that scenario, the award would become nonqualified deferred comp, and since it was not earned and vested as of 12/31/04, it would be subject to 409A. Under 409A, it seems that the amendment would constitute an election to delay a payment, and since the change of control will occur within the next couple of months, I'm not sure that the election would satisfy the requirements of 409A(a)(4)©.

Does anyone have any thoughts on this? Am I totally off base, or do you think the proposed amendment could pose a problem?