Stock options and transitional rules

[Locust]

I've got an in-the-money option that is about to expire. Would like to extend it but can't do it under regular 409A rules (for example, extension would go beyond 10 years). Question: any problem with changing the option during the transitional period (ending 12/31/2008) to allow exercise at a 409A date, such as change of control or separation from service? By taking out the employee's discretion as to the time of payment, the revised option would be compliant with 409A. We're changing the payment date, but that's allowed during the transition.

I think it works - but will call on the megabenefitsmind out there in cyberworld to see if it disagrees.

[Everett Moreland]

The change needs to comply with the transition rules in Notice 2007-86, section 3.01(B)(1).02. That might be a problem if the option will expire in 2007. See the following from the end of Notice 2007-86, section 3.01(B)(1).02:

"Similarly, except as provided below with respect to certain discounted stock rights, an outstanding stock right that provides for a deferral of compensation subject to section 409A may be amended to provide for fixed payment terms consistent with section 409A, or to permit holders of such rights to elect fixed payment terms consistent with section 409A, and such amendment or election will not be treated as a change in the time and form of payment under section 409A(a)(4) or an acceleration of a payment under section 409A(a)(3), provided that the option or right is so amended, and any elections are made, on or before December 31, 2008. For this purpose, a stock right will not be treated as payable in a year solely because the stock right is exercisable during that year, if the stock right is also reasonably expected to be exercisable in a subsequent year."

[Steelerfan]

Just because an in the money option is involved doesn't make the option a discounted stock right, does it? Assuming the option would otherwise be excluded from 409A, this amendment would cause an option that would expire to be extended, which would cause it to be subject to 409A but then made to comply with 409A at the same time. I don't know if this can be done, but I don't see why not, at least while we're in the transition phase. Why would the IRS argue?

I have a similar question with respect to restricted stock. Could you take restricted stock that could forfeit in 2007 or 2008 (but is exempt from 409A at this time as sec 83 property) and extend the forfeiture period and make it comply with 409A--like convert it to RSUs and set the payment date farther down the road? I think this is the same legal question.

[Guest jhall]

I have an issue very similar to Locust's situation. We have a 10-year old, in the money option that will expire in early 2008. The option will then be at the end of its maximum 10-year term under both the option agreement and the equity plan. Any problem or different concern is granting a new, replacement option upon expiration of the old option that contains the same exercise price as the old option provided the replacement option complies with 409A. In this case we are thinking the event would simply be a change in control of the company as defined in 409A as this is about the only reason the option shares would have any liquidity.

Also, interested in any thoughts as to old, pre-409A constructive receipt issues associated with granting discounted options at such a deep discount that they are essentially tantamount to giving the stock. (For example, in my case the original exercise price is $0.10 per share but the stock is currently worth just over $2.00 per share--in other words a very steep discount. Could any concerns on this front be covered by making the replacement option subject to both vesting and automatic exercise if and only if there is a change in control? Thanks.