stock options

[jpod]

Non-pubic company has employee stock options outstanding, all expire at 10-year anniversary very soon. The options are all exempt from 409A under the take-out provisions for stock options. Options are all well in-the-money, and will likely remain so through the end of the exercise period. For good reasons (which I won't bother to mention here), employer wants to offer the employees an incentive NOT TO EXERCISE. Essentially, if they allow the options to lapse at the 10-year point, they would receive restricted shares having a value equal to the in-the-money value (or perhaps as a further incentive shares worth something more than the in-the-money value). Those shares will be transferred to the employees subject to a 2-year vesting requirement, subject to accelerated vesting if terminated without cause, change in control or death. Thus, viewed in isolation, the transfer of those resricted shares would be a transfer of property subject to Section 83 and not a deferral of compensation subject to Section 409A. Nonetheless, if this offer is made, will it be an "extension" that causes the option to be treated as deferred compensation from the original grant date (resulting in a 409A violation)?

[Guest RetirementPlanCorrections]

Regulation 1.409A-1(b)(5)(i)(D) specifically excludes the receipt of restricted stock upon the exercise of a stock right as a feature for the deferral of compensation. Although not directly on point with your facts, it is something to hang your hat on if this was ever challenged.

[jpod]

No, by it's terms that provision only applies to early-exercise options; i.e., those which can be exercised prior to vesting. In my case the options are all fully vested and upon excercise the shares would be fully vested, so in a way what we are kind of talking about is subjecting the option to a new vesting condition. Granted, 1.409A-1(b)(6) read literally appears to apply a blanket exemption for the transfer of restricted stock, but I'm not so sure that provision is not trumped by the rules limiting the kind of things you can do to/with stock options in order to avail yourself of the (b)(5) exemption for stock options.

[401 Chaos]

I have not faced that particular situation but agree with jpod that caution is warranted. I asked a panel at an ABA conference some years ago about potential alternatives for private companies who had in-the-money options expiring and wanted to try and extend the life of the awards without forcing exercise, etc. in light of 409A. Nobody specifically asked about the proposal jpod has suggested here but everyone on the panel seemed to be void of ideas on how you could really extend the life / value of the options without running afoul of 409A. If this would work, it would be one possible alternative I suppose but I'd be concerned about possible risks with this if the optionees are required to exchange their current in-the-money options for these awards. (Seems they could always add on these new / additional awards with 2 year vesting if the current options went unexercised but directly requiring them to exchange those existing options for the new stock awards seems very close to an extension to me.)

Not sure what is on the horizon for the company. If it is sold or there is other liquidity event within 2 years, I suppose that short delay would be helpful to keep people around but seems otherwise they are very soon going to have former optionees getting large amounts of illiquid taxable stock without a ready way to cover taxes due on those amounts. If the company is going to have to help with that via bonuses, etc. they might want to just do that with exercise of the options now but, of course, that doesn't help them with additional incentive / retention for the next two years but I'm not sure there is a perfect solution to address all oft those issues.