HCE and Warrants

[ESOP Guy]

I have an ESOP where the families that used to own the stock sold 100% of it to the ESOP.

During the sale they took back enough warrants that if they exercised them they all would be >5% owners.

I have looked at the HCE definistion and as long as the warrants don't have voting rights it would seem like these people are not HCEs by ownership.

I am having a brain breakdown. Do people agree or disagree?

[ESOPMomma]

A stock warrant is simply the right to purchase shares of a stock at a certain price. Warrants are good for a fixed period of time, but they're worthless once they expire. You're not locked in when you buy a warrant. You're always free to decide that you don't want to buy the underlying security.

Per IRC Section 318(a)(4), If any person has an option to acquire stock, such stock shall be considered as owned by such person. For purposes of this paragraph, an option to acquire such an option, and each one of a series of such options, shall be considered as an option to acquire such stock.

In determining 5%, I'm curious what you are using as the denominator.  If the ESOP owns 100%, let's say 1,000,000 shares, and there are warrants totaling 175,000 (synthetic equity) shares, is your denominator 1,000,000 or 1,175,000?

[ESOP Guy]

58 minutes ago, ESOPMomma said:

A stock warrant is simply the right to purchase shares of a stock at a certain price. Warrants are good for a fixed period of time, but they're worthless once they expire. You're not locked in when you buy a warrant. You're always free to decide that you don't want to buy the underlying security.

Per IRC Section 318(a)(4), If any person has an option to acquire stock, such stock shall be considered as owned by such person. For purposes of this paragraph, an option to acquire such an option, and each one of a series of such options, shall be considered as an option to acquire such stock.

In determining 5%, I'm curious what you are using as the denominator.  If the ESOP owns 100%, let's say 1,000,000 shares, and there are warrants totaling 175,000 (synthetic equity) shares, is your denominator 1,000,000 or 1,175,000?

Wow that is a blast from the past.  Oddly, we decided I was wrong as stated above.  We decided the code you are quoting is says they own the shares.  That is to say we decided these people were HCEs.   In this case the denominator didn't matter.  The family collectively has enough warrants to be worth 30% of the ownership.  So 30k/130k or 30k/100k are both so far over 5% we didn't get into that much.  

I would think you have to use the larger denominator - of use fully diluted basis as the denominator.  However, I couldn't cite anything to you to say I had to be right.   I guess if I had a case where it make a difference I would make the plan attorney make the call.  The attorney gets paid more than me to make those calls.   ?

As an aside it turns out saying that family are HCEs helped the that plan a ton.  The plan document excludes the family by name from entering the plan and becasue of a 1042 election.  But they have so much turnover that they would never benefit 70% of the NHCEs and now they don't have to do so as over 50% of the HCEs don't benefit either.  

[ESOPMomma]

Actually, I learned something through all of this.  The denominator for HCEs when there are warrants is similar to determining DQP in the 409(p) test (you ignore the warrants held by other shareholders).  If there are 3 participants with warrants (each has 58,333.33 to total 175,000) and the ESOP has 1,000,000 shares, the denominator for each participant would be 1,058,333.33 (not 1,000,000 or 1,175,000 as I queried above).  So as it turns out, my 3 guys are all considered HCEs because they own more than 5% (58,333.333 / 1,058,333.33 = 5.51%).  SARS are not part of the 5% determination.   I think you are wise to lean on the attorney when it's questionable!  

When I first responded to your post, I forgot to acknowledge how old your OP was!  Thanks so much for sharing.

[ESOP Guy]

1 hour ago, ESOPMomma said:

Actually, I learned something through all of this.  The denominator for HCEs when there are warrants is similar to determining DQP in the 409(p) test (you ignore the warrants held by other shareholders).  If there are 3 participants with warrants (each has 58,333.33 to total 175,000) and the ESOP has 1,000,000 shares, the denominator for each participant would be 1,058,333.33 (not 1,000,000 or 1,175,000 as I queried above).  So as it turns out, my 3 guys are all considered HCEs because they own more than 5% (58,333.333 / 1,058,333.33 = 5.51%).  SARS are not part of the 5% determination.   I think you are wise to lean on the attorney when it's questionable!  

When I first responded to your post, I forgot to acknowledge how old your OP was!  Thanks so much for sharing.

That is interesting.  I wonder if that is how they came up with the DQP method.  They basically used the method for warrants.

It seems logical that the SARs don't count.  They really don't turn into ownership as warrants can.  Although I have seen warrants that can only be turned into cash.  

[Degrand]

What happens if the warrants are only payable in cash and stock ownership is unavailable to the hold?