Extension of Option Expiration Dates Under 409A

[Guest jhall]

I have some questions, a couple specific ones and another, more general question, in light of 409A's regulation of extensions of option exercise periods that I would welcome others' thoughts on:

1. Is it fair to read 1.409A-1(b)(5)(v)©(2) providing that extensions of a stock right before April 10, 2007 solely in order to provide the holder of such stock right an additional time beyond the time originally prescribed within which to exercise such stock right are disregarded for 409A extension purposes as broadly as it seems to be drafted? That is to say, if we had a case where the option term (actual term, not just a post-separation exercise period) expired at the end of 2006 but the parties basically permitted the optionee to exercise the option in early 2007 before April 10, 2007 there should be no 409A concern.

2. What if similar situation as in 1 above with option expiring on December 31, 2006 and parties permitted optionee to exercise expired option in 2007 any way but after April 10, 2007. Option was in-the-money at time of exercise. I am assuming there is basically no way to rescind the actual exercise. (Assume that you could rescind the amendment / extension of option term prior to end of 2007 provided the option hadn't been exercised but here the option was basically extended / exercised at the same time.) Option was not drafted to be 409A compliant so am assuming we have 409A violation dating back to original grant. If option was all vested prior to 2005, could you argue it is grandfathered? Assume not since it has been materially modified by the extension. Does that mean optionee would have been treated as receiving non-409A compliant deferred comp on option spread amount as option vested and would owe 409A excise taxes and late filing penalties and interest?

3. Curious what people are doing with in-the-money options with original terms that are about to expire. Have seen many 6-7 year option terms of small start-ups that are about to expire. The options are in-the-money but there has been no change in control and none are on the immediate horizon for the companies so optionees are faced with exercising, paying taxes and having to hold illiquid stock. (Obviously, usual risks for private company options but 7 years ago everybody assumed company would have undergone some liquidity event and so wasn't a real issue.) I don't see any way to really extend the original option term under 409A. I suppose you could let the old options expire and grant new, discounted options with 409A-compliant terms but that's not really very desirable. If you grant restricted stock, that results in immediate taxes to optionees without any liquid market. (Query whether those approaches might result in some form of illegal substitution.) Granting new replacement options that aren't discounted obviously causes optionees to forfeit appreciation to date. Anybody come up with creative ways to hold on to the optionees' appreciation and not require exercise or taxes?