Up In The Air: How Boeing's 737 Max Problem Teaches Key Points About Preventing Insider Trading

At myStockOptions.com, we are always looking for new ways to make learning about stock compensation more fun. This includes our coverage of the ways in which employees and executives at public companies need to avoid insider trading in company stock.

A compelling hypothetical question recently came our way. You probably heard about the recent aviation emergency, widely reported in the news, in which a door panel blew off a Boeing 737 Max 9 in mid-flight. Fortunately, while everyone on board was understandably terrified, nobody was hurt. Perhaps this relatively good outcome to the potential disaster led to the high spirits behind the creative question below, posted last week to the Reddit discussion forum wallstreetbets:

While it seems unlikely that an airline passenger’s first thought in this situation would be stock trading, the question remains: Would it be illegal insider trading to trade Boeing securities (which includes buying puts or calls) while you’re on a damaged Boeing airliner before the news has been reported and thus made public?

After all, you know that the incident will drive down the company’s stock price. But at the time only you, the other passengers, and the crew know about the incident. It is easy to independently connect the dots that this accident will impact Boeing’s share price.

There are two very different outcomes of this hypothetical situation. They depend on your relationship with Boeing. Below we explain.

What Is Insider Trading?

Insider trading occurs when you trade a company’s stock or other securities (e.g. put and call options) while knowing what is termed material nonpublic information (MNPI) about the company. MNPI is confidential knowledge that will affect the company’s stock price either positively or negatively when it is publicly disclosed.

You can obtain MNPI about your company while you're on the job or not. Public companies have clear policies and procedures to try to prevent insider trading among their employees and executives. These include blackout and window periods for when these insiders can or cannot trade the company’s stock.

A related behavior known as insider tipping, i.e. sharing MNPI with others, is also illegal. It means telling someone MNPI about a public company which leads that person to trade the company’s securities. Many insider-trading charges have been brought against friends or family members of company insiders who, whether carelessly or deviously, tipped MNPI to them.

Pursuing insider-trading violations has long been a high priority of the US Securities and Exchange Commission (SEC), which can bring civil enforcement actions with big financial penalties against violators, and the US Department of Justice (DOJ), which can bring criminal charges.

Rules Apply To Everyone

The insider-trading laws apply to everyone, not just to executives and other company insiders. Moreover, the laws apply to MNPI not only about a company you work for but also about any company you may know through a professional or personal relationship, e.g. a vendor, client, or competitor of your employer, or from a family member or friend affiliated with that company.

Gray Areas Of Insider Trading

Insider-trading law has grown extensively out of the general antifraud provision of Rule 10b-5 in the famous Securities Exchange Act of 1934. It has evolved mostly from court interpretations as the SEC tests the edges of Rule 10b-5. The SEC and prosecutors continue to develop legal theories to reach anyone who trades on a company’s misused MNPI. These include the “misappropriation” and “temporary insider” theories.

One high-profile example is an insider-trading case in 2016 involving professional golfer Phil Mickelson and a corporate director (see the related SEC public statement). It shows that when the SEC finds insider trading somewhere in a chain of events, all who profited will be forced to pay back their gains, even if they did not know that the information in question was tainted. In the SEC’s action, Mr. Mickelson was named as a “relief defendant,” i.e. an individual who must turn over ill-gotten gains arising from schemes perpetrated by others.

Even the definition of confidential material information is expanding beyond just straightforward good news (e.g. mergers, financials better than expected, new products ahead of schedule) and bad news (e.g. poor earnings, dividend cuts, FDA denies drug approval). The SEC often brings cases of all sizes to probe the edges of the law’s reach. Sometimes it is successful; sometimes it is not.

Over the years, the SEC and the DOJ have also looked for insider trading as it has adapted in novel circumstances. See another article on this blog for examples of SEC and DOJ charges of insider trading stemming from the Covid-19 pandemic: How To Avoid Insider Trading: Cautionary Tales For Employees From The Pandemic.

Recently the SEC has yet again pushed the boundaries by bringing insider-trading enforcement actions for what it calls “shadow trading.” This is when you learn material nonpublic information about your company that you believe will also impact the stock price of another public company and then trade in the other company’s stock.

In 2021, the SEC filed a complaint (SEC v. Panuwat) in a California federal court that tests this legal theory. The SEC claims that the defendant misappropriated confidential information about his employer, Medivation, when he learned that the company was an acquisition target of Pfizer. Rather than buying his company’s stock, the defendant purchased options in a competitor company “whose value he anticipated would materially increase when the Medivation acquisition announcement became public,” the SEC alleges. The stock of that competitor did increase by 8% after the acquisition’s announcement.

As those examples show, the SEC is not shy in hunting for insider trading in novel circumstances. But what about potential insider trading in Boeing stock on a damaged Boeing airliner in mid-flight? That’s about as novel as circumstances can be.

Outcome #1: No Fiduciary Duty Or Relationship To Boeing

In our opinion, the hypothetical situation presented by the Reddit poster would probably not be insider trading, assuming the passenger is just an airline customer with no connection to Boeing or any supplier of the defective part—also assuming the passenger did not cause the fuselage blowout (in which case the insider-trading charges would be the least of their worries).

The reason for our opinion is that insider trading/tipping arises when the trader or tipper has a fiduciary duty or relationship to the company whose stock is traded. To commit insider trading: (1) the person would have to be an employee, contractor, vendor, executive, or director of the company with inside knowledge of the plane’s defect, or have a contractual agreement not to use what they learn as a customer for their personal benefit; or (2) a passenger without any Boeing connection would need to have been given (i.e. tipped) the information by, or have stolen it from, any of those types of individuals with a fiduciary relationship to the company.

An airline passenger without any of these connections would not be committing insider trading. While certainly a case of trading inside the plane, the act would not be insider trading of Boeing securities. The knowledge of the aircraft accident fell out of the clear blue sky, so to speak. This person can use the information gained in mid-flight as the reason to purchase Boeing put options or sell stock before the news goes public.

Outcome #2: Fiduciary Duty Or Relationship To Boeing

For all of the reasons discussed earlier in this article, the Reddit poster's hypothetical situation would be a potential case of insider trading if the person trading Boeing stock on the plane works for Boeing, whether as a employee, executive, director, or contractor; similarly works for a vendor or supplier of Boeing; or has some other fiduciary relationship with Boeing. The SEC would almost certainly at least investigate the trade to discover whether the person possessed MNPI, such as knowledge about an ongoing plane defect. Depending on the outcome of the investigation, the SEC might not only bring a civil action for liability but also make a criminal referral to the DOJ.

Employees, executives, and directors of a company must be extremely careful when they are tempted to trade company stock on the basis of information they learn about the company, whether on the job or not. Is it material nonpublic information not yet released to the public? If so, they must not trade until the information has been made public.

In the context of employee stock compensation, the concerns about insider trading may even extend to decisions about whether to exercise stock options (see the myStockOptions FAQ on that topic).

For company insiders who frequently know MNPI, a prearranged Rule 10b5-1 trading plan, created when you do not know MNPI and over which you exert no subsequent influence, can allow periodic stock trades while providing an affirmative defense against insider-trading charges. The SEC has recently tightened its rules about 10b5-1 plans.

Try To Avoid Being An SEC Test Case

The SEC likes to test the borders of insider-trading law. Even if you’re acquitted or not formally charged, being the focus of an SEC investigation is costly, embarrassing, and stressful. Therefore, even if you have no link to a company and its stock, it is best to seek legal counsel before trading its securities while knowing information you come across that has not yet been reported or released to the public.

Abundant resources on insider-trading law and prevention are available at myStockOptions.com (see the section SEC Law), including an interactive quiz to help you stay out of trouble.

AdvisorFind Directory
Find a financial, tax, or legal advisor with experience in stock compensation

Stock compensation raises many questions.

• How much should you contribute to your ESPP?
• When should you exercise stock options?
• Should you sell or hold restricted stock at vesting?
• How can you diversify your company stock holdings?
• How can you minimize your tax bill?
• How do you negotiate for stock compensation in your employment agreement?

While myStockOptions.com is a good place to learn about concepts, issues, and general strategies in equity compensation, at some point you may need an advisor to help with your unique situation. Yet finding a good advisor can be hard when you are busy and don't know where to start. The AdvisorFind Directory from myStockOptions.com is for you.

• Identify and contact an expert who can provide specialized professional guidance on equity compensation.
• Search for advisors by geographical area, type of advisor, years of experience, minimum portfolio size, and other key criteria.
• Look up resources for performing background checks on advisors.

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Instacart IPO: Long-Awaited Liquidity For Employee RSUs And Stock Options

After hinting at an initial public offering (IPO) last year, delivery service Instacart has finally gone public with a listing on Nasdaq. It is the highest-profile venture-backed company to go public since the end of 2021. The IPO has been heralded as a sign of a potential resurgence in initial public offerings after a dearth in 2022 and the first half of 2023.

As with many later-stage startup companies, Instacart’s initial public offering (IPO) is as much about its human capital as its financial capital. Grants of restricted stock units (RSUs) and stock options are important forms of compensation for Instacart employees—but to cash in, they needed a liquidity event for the company’s stock.

That is why, in an interview with CNBC on IPO day, Instacart CEO Fidji Simo proclaimed: “This IPO is not about raising money for us. It’s really about making sure that our employees can have liquidity on stock that they worked very hard for.”

Filed under its formal corporate name Maplebear Inc., the company’s S-1 registration statement with the Securities and Exchange Commission (SEC) discloses details about Instacart’s equity programs for employees.

RSUs With Double-Trigger Vesting

Larger, later-stage pre-IPO companies often grant RSUs instead of stock options for many reasons, including concerns about shareholder dilution and high valuations leading to exercise prices that go underwater. Instacart is no exception. In its later stages before going public, the company moved in a big way from grants of stock options to grants of RSUs. No stock options were granted at Instacart in 2020, 2022, or the first six months of 2023.

The equity capitalization table from its S-1 shows the following total outstanding grants as of June 30, 2023, for its non-voting common stock:

Stock Options	29,910,133
RSUs	63,467,028

In a now common practice for later-stage pre-IPO companies, Instacart structured its RSU grants (and some of its stock options) with both the usual service-based vesting plus a second vesting condition that requires a liquidity event for the grant to fully vest:

1. With service-based vesting, you must work at the company for a specified period after grant. The service-based vesting period for these awards at Instacart typically runs four years, with a cliff vesting for part of the grant at one year of service followed by continued vesting monthly or quarterly.
2. With vesting based on a liquidity event, vesting conditions are met upon the earlier of (1) a change of control (e.g. a merger or acquisition) or (2) the effective date of a registration statement for an initial public offering of the company’s common stock.

Instacart also has some grants that vest only upon the satisfaction of both service-based vesting conditions and market-based vesting conditions (e.g. the achievement of specified future valuation or capitalization amounts). To make it even more of a puzzle to grasp all their different equity grants, the company made others that vest only upon the satisfaction of service-based, liquidity-event-based, and market-based vesting conditions.

Tax Hits For Employees

Many of Instacart’s employees have grants that met their vesting conditions immediately after the IPO. This will result in a big tax bill for employees when the shares are delivered. In fact, the value of the shares they receive will probably push most employees into the top tax bracket for all of their income in 2023—the one potential downside to the liquidity and wealth the IPO creates for them.

The S-1 registration statement explains that the company assumes a 47% tax-withholding rate for holders of its RSUs and shares of non-voting restricted stock that will vest and settle in connection with this offering. The company will automatically withhold shares from the RSU grants to pay the taxes owed, a practice referred to as “net settlement.” Instacart assumes a 43% tax-withholding rate for holders of its stock options, mostly via net option exercises.

$2.6 Billion Financial Impact

The use of stock compensation and the immediate non-cash accounting expense for the way the grants are designed to vest is so large that Instacart states the following in its registration statement (our bolding for emphasis):

“In the quarter in which this offering is completed, we will recognize approximately $2.6 billion of stock-based compensation expense associated with the satisfaction of the liquidity event-based vesting condition for outstanding RSUs and shares of outstanding restricted stock, for which the service-based and/or market-based vesting conditions have been fully or partially satisfied on or before August 15, 2023. As such, we expect to incur a net loss for the quarter and year in which this offering is completed, primarily as a result of recognition of this stock-based compensation amount.”

Amid dilution concerns, the company’s growing cash position enabled it to offer cash alternatives to employees. For example, the registration statement disclosed that in April 2023 it offered employees the choice to elect cash in lieu of a portion of certain equity awards.

Lockup Of Employee Shares With Potential For Earlier Sales

The liquidity for employees that Instacart’s CEO mentioned is not immediate. Instacart did separately register on SEC Form S-8, for employees’ public resale, all of the shares of common stock issuable under its previously granted equity incentive awards, along with those the company will grant in the future under its new equity incentive plan and separate employee stock purchase plan (ESPP).

Employees still will need to wait 180 days to sell their shares under the standard post-IPO lockup provisions. The S-1 registration statement reveals an exception that allows earlier sales during an open trading window should the stock trade at more than 120% of its IPO price for at least five of ten consecutive trading days. One of those days must occur after the company’s first quarterly earnings announcement.

Further Resources

Equity compensation is a key benefit for many employees at private companies, from startup to IPO or M&A stages. myStockOptions has articles, FAQs, videos, and quizzes that explain all aspects of private company stock compensation, from the basics to tax and financial planning.

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WEBINAR: 10b5-1 Trading Plans And Other SEC Rules Advisors Must Know

Thursday, October 12, 2023
2pm to 3:40pm ET (11am to 12:40pm PT)

Get crucial insights on the SEC's new rules for 10b5-1 plans and their impact, along with a solid grounding in other key SEC requirements, including Rule 144, Section 16, and insider trading.

Join us on Oct. 12 (2pm–3:40pm ET, 11am–12:40pm PT) for a webinar on the fundamentals and mechanics of Rule 10b5-1 trading plans, new SEC rules, evolving best practices, and most effective designs for executives, employees, and anyone else who wants to regularly sell stock to meet financial goals but knows material nonpublic information about the company.

Discover how to use these plans to maximize your clients' wealth in company shares, stock options, and restricted stock/RSUs while protecting them from insider-trading charges. The webinar's panel of experts will provide real-world case studies:

• Michael Andresino (JD), Partner, ArentFox Schiff LLP
• Rich Baker (MBA), Exec. Dir., Morgan Stanley Executive Financial Services
• Megan Gorman (JD), Founder, Chequers Financial Management
• moderator: Bruce Brumberg (JD), Editor-in-Chief and Co-Founder, myStockOptions

2.0 CE credits for CFP, CPWA, CIMA, CEP/ECA, EA (live webinar only), and CPE for CPAs (live webinar only); 1.5 potential self-determined CE credits for CFAs

Register now. Time/date conflict? No problem! All registrants get access to the webinar recording, which offers 2.0 CE credits for CFP, CPWA/CIMA, and CEP professionals, plus the webinar slide deck and handouts.

RSU Grants At Amazon, Apple, Google Adapt To Help Retain Top Talent

Hiring competition, the Great Resignation, and stock-price volatility are prompting changes in longstanding stock compensation practices for key performers at big, established tech companies such as Amazon, Apple, and Google. Although grants at these tech giants are still more likely to be restricted stock units (RSUs) than the stock options that can be wealth-builders at tech startups, features of their new grants are evolving in an effort to retain top employee talent.

The changes that these industry leaders are making in their stock grant designs will be widely observed and may be emulated by other companies.

Amazon

One example is Amazon, discussed in an article from Bloomberg (Burnt Out Amazon Employees Are Embracing The Great Resignation) and other sources, including financial advisors who work with Amazon employees. The company is facing challenges with employee retention, for numerous reasons including a decline in its stock price since its high last July.

Amazon caps salaries for white-collar workers at a specified amount and then adds in stock grants that gradually vest in “steadily increasing chunks” over four years. In response to the tight labor market, the company just announced that it plans to more than double its cap on base salary, from $160,000 to $350,000 per year. According to an article from GeekWire, Amazon also stated that it will start making stock grants to employees when they are promoted, instead of waiting until the next annual grant cycle. Amazon’s announcement says the purpose is “to better align newly promoted employees with the compensation range of their new level.”

Further changes may also be coming in Amazon’s stock grant practices. Amazon’s RSUs currently vest 5% after the first year, 15% after the second, and then 20% every six months for the remaining two years. This is a backend-loaded vesting schedule. An article from Business Insider reveals that Amazon Web Services is considering a shift to a monthly vesting schedule for employees at Level 7 (principal) or higher and for approximately 15% of employees with a “top tier” annual performance review rating (see Amazon Considers Changing How It Distributes Employee Stock Options To Stem Exodus Of Top Talent).

Another article from Business Insider discloses an internal company memo stating that Amazon will allow employees to take longer leaves of absence before pausing their RSU vesting (Amazon Changes Employee Stock Distribution Policies After Exodus Of Top Talent And Complaints Of Slow Vesting Period). Previously, Amazon paused vesting for leaves of longer than two weeks for any reason, which is not a common practice. The Bloomberg article cited above adds that the company will now let vesting continue during parental leave and for up to 26 weeks of medical leave. Amazon will now also give employees the choice to trade fractional shares, and when an employee dies it will accelerate the vesting schedules for beneficiaries.

Apple

Apple has informed certain high-performing engineers (10%–20% in some divisions) that they will receive out-of-cycle RSU grants that vest over four years, according to a short news article from Fortune (Apple Is Doling Out Bonuses Up To $180,000 To Retain Top Employees). These grants are seen as a retention incentive to prevent defections to tech rivals. The grant values range from $50,000 to $180,000, with both the size and timing being atypical and surprising, the article claims.

The article also touches on the downside of these out-of-cycle types of grants, which are different than regular annual grants. They “irked” some engineers who didn’t get them and saw the selection process as arbitrary. Some grants equaled the annual stock grant normally given only to engineering managers.

Separately, Apple’s CEO received a new performance-based vesting RSU grant (performance stock units, or PSUs) on the 10th anniversary of his promotion to that position. See pages 44 and 50–52 of Apple’s definitive proxy statement filed with the SEC for his grant and others to executives, and also an article from MarketWatch (Apple CEO Tim Cook’s Compensation Rises To Nearly $100 Million Thanks To New Stock Award). These pay out stock based on the relative performance of Apple’s total shareholder return compared to companies in the S&P 500. For example, if Apple ranks in the 85th percentile of companies in the S&P 500 for the performance period, 200% of the target number of RSUs vest. For an explanation of the difference between time-based vesting RSUs, which were also granted at the same time to these Apple executives, and PSUs, see an FAQ at myStockOptions.com.

Alphabet/Google

Alphabet, the parent company of Google, is similarly finding the need to make larger grants to retain its top talent—see, for example, an article from CNBC, Alphabet Grants Tens Of Millions Of Dollars In Stock Awards To Top Execs. As detailed in Alphabet’s 8-K filing with the SEC on new compensation packages for four senior executives, including the CFO and the chief legal officer, each executive received stock awards valued between $23 million and $35 million, split between performance-based and time-based vesting RSUs.

The performance-based RSUs will vest from 2022 to 2024 according to total shareholder return (TSR) relative to companies in the S&P 100. The number of PSUs that vest will range from 0% to 200% of the target grant size. The time-based RSUs will vest quarterly in 12 installments, assuming continued employment at the company.

Business Insider reports that for all of its employees globally, Google has shifted to more front-loaded vesting for its RSU grants. Its RSUs used to vest evenly over four years (25% yearly). Now they vest 33% per year for the first two years, 22% in the third year, and 12% in the fourth. In comparison, most startup and pre-IPO companies tend to use a four-year vesting design in which 25% of the grant vests at the one-year mark, then monthly for the remaining term of continued employment (36 monthly vests after one-year cliff vest). I predict that more public companies will be tweaking their vesting schedules in various ways, including moving away from annual vesting to quarterly or monthly.

At Forbes.com, senior contributor Jack Kelly has a few insights on the RSU grants at Google for principal engineers. The author, a respected recruiter at one of the largest global search firms, emphasizes the importance of stock grants “that could potentially change your life” (Google Engineer Shares How They Made Over $1 Million In Total Annual Compensation: The Advice Applies To Everyone).

Underwater Stock Options

With stock markets in decline at the start of 2022 and IPOs underperforming, concerns about underwater stock options have resurfaced. Martin Peers, New York bureau chief and columnist at The Information, bluntly expresses both good news and bad news about the volatility in a recent article (Tech Stock Slump Hits 2021 Stock Comp). The good news? Grants made early this year will have “lots of upside.” The bad news? Last year’s grants. Even with RSU grants that do not technically go underwater (unless the stock price falls to $0), the value of grants at some companies has been substantially sliced.

In the author’s view, the big decline in tech stocks will have a widespread impact on employee compensation, and companies will need to address that in the upcoming months. He also wonders whether companies will take steps to make up for what employees lost by “beefing up” new grants to increase employee retention.

More Resources

See the extensive articles and FAQs at myStockOptions for more about restricted stock/RSUs and performance shares/PSUs, including their tax treatment.

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AdvisorFind Directory

Stock compensation raises many questions.

• How much should you contribute to your ESPP?
• When should you exercise stock options?
• Should you sell or hold restricted stock at vesting?
• How can you diversify your company stock holdings?
• How can you minimize your tax bill?
• How do you negotiate for stock compensation in your employment agreement?

While myStockOptions.com is a good place to learn about concepts, issues, and general strategies in equity compensation, at some point you may need an advisor to help with your unique situation. Yet finding a good advisor can be hard when you are busy and don't know where to start. The AdvisorFind Directory from myStockOptions.com is for you.

• Identify and contact an expert who can provide specialized professional guidance on equity compensation.
• Search for advisors by geographical area, type of advisor, years of experience, minimum portfolio size, and other key criteria.
• Look up resources for performing background checks on advisors.

Searching AdvisorFind is free and does not require registration at myStockOptions.com.

Wealth Tax Debate: The Movie

As the 2020 presidential election year approaches, Democratic candidates, most notably Senator Elizabeth Warren, have proposed a 2%–3% wealth tax on the assets of the super-rich to help ensure that they pay their fair share along with other taxpayers.

Upon first hearing about a wealth tax, we at myStockOptions.com thought it could apply to any company founder that built a successful company, executives with substantial grants of stock options or restricted stock units, or employees who joined an early-stage startup and now have significant wealth after an IPO or acquisition. However, the proposed tax is really for the super-wealthy: billionaires and mega-millionaires. Under Senator Warren’s proposal, for example, the wealth tax would be triggered only if your household net worth, including stock holdings, is over $50 million. It would apply to individuals such as Jeff Bezos, Michael Bloomberg, Bill Gates, Larry Ellison, Larry Page, Mark Zuckerberg, and others whose enormous wealth comes from stock in the companies they founded.

To find out more, we watched the live internet-streamed seminar The Wealth Tax Debate, recently held by the Penn Wharton Budget Model (PWBM). It’s a nonpartisan research-based initiative at the Wharton School, the business school at the University of Pennsylvania. Three scholars discussed the feasibility and tradeoffs of the wealth tax proposed by Senator Warren and other Democratic presidential candidates. Below I present a few highlights from each speaker’s talk.

While this streaming video is perhaps not as exciting as Amazon Prime or Netflix, for anyone interested in tax and public policy issues it’s an absorbing drama and short enough to watch in one sitting. It runs about 90 minutes (presentations 50 minutes and Q&A for remainder), shot with a single camera and no editing, with the speakers’ slide decks on screen during their talks.

After watching the full 90-minute running time of the seminar, you’ll come away with a better understanding of the complex issues involved with the wealth tax. Those who oppose the wealth tax will give this movie a thumbs up, while supporters of the wealth tax may find parts of it tough viewing.

Wealth Tax In Brief

Many of the wealthiest US citizens have vast assets but little income, so traditional income taxes struggle to reach them. In the view of some of the Democratic presidential candidates, a wealth tax would ensure that these very richest Americans pay their fair share.

Another underlying purpose for the wealth tax concerns democracy. By reducing income inequality, the wealth-tax proposals seek to protect democracy itself by limiting political oligarchy: the amount of wealth and related political influence that the rich can accumulate. The aim is to control the potential for one tiny plutocracy to dominate election campaigns.

The Wealth Tax Debate

In the Penn Wharton seminar, Senator Warren’s proposed wealth tax is the primary focus of the three speakers. Her proposal’s research, rationale, and estimates of revenue potential were developed by Emmanuel Saez and Gabriel Zucman, two economists at the University of California, Berkeley.

Part One: Economic Growth

Richard Prisinzano, Director of Policy Analysis at Penn Wharton Budget Model (PWBM), presented his research team’s initial projection of the impact Senator Warren’s proposed wealth tax would have on revenue and the US economy. The researchers found that if the tax raises as much new revenue as intended and the revenue is used to cut the federal debt, annual economic growth in the United States would slow from the current average of 1.5% to an average of just over 1.3% over a decade.

Broadly, the PWBM finds that wealthy Americans would simply consume more, save less, and invest less to reduce taxable wealth. The resulting drop in investment would, in its modeling, reduce economic growth. “The wealth tax shrinks the economy because saving is more expensive,” Mr. Prisinzano summarized. “The results also suggest that the negative effect of the tax increases as the tax rate increases.”

For commentaries that critically review at least parts of this PWBN analysis for not fully considering the potential economic growth generated from government programs that spend the new tax revenue, see articles in Business Insider, The Week, and New York Magazine’s Intelligencer.

Part Two: Questions Of Revenue, Constitutionality, And Alternatives

Natasha Sarin, Assistant Professor of Law at the University of Pennsylvania Carey Law School, dissected the revenue estimates of Senator Warren’s wealth tax that were calculated by Emmanuel Saez and Gabriel Zucman at UC Berkeley. In short, she finds their assessment flawed and unrealistic. When she dynamically corrects what she considers “sloppy math” and unfounded assumptions about actual wealth holdings and tax compliance among the rich, she projects that the proposed wealth tax would generate $1.1 trillion, far lower than the Warren team’s estimate of $2.75 trillion.

Additionally, the task of annually assessing the net worth of the wealthy for a wealth raises difficult practical issues. Given that over 50% of wealthy assets are illiquid, how would they be valued?

Furthermore, shifting from economics to law, Professor Sarin noted that a wealth tax would almost certainly be challenged as unconstitutional and probably nixed from the start. Under the US Constitution, direct taxes must be evenly apportioned across the states. However, the roughly 75,000 super-wealthy households impacted by a wealth tax are not evenly distributed across states. Given two centuries of legal precedent against a wealth tax, she believes that the current US Supreme Court, for better or worse, would inevitably rule that a wealth tax is unconstitutional.

Professor Sarin shows in her slide deck that, instead of attempting a wealth tax that may be problematic, there are more efficient ways to raise federal revenue:

• crack down on IRS tax compliance among the wealthy (she recently wrote a paper on this with economist Lawrence Summers)
• close corporate and individual tax shelters
• eliminate the stepped-up basis of assets at death
• cap taxable deductions for the wealthy
• end pass-through deductions
• broaden the estate-tax base
• increase the corporate tax rate

She estimates that these measures would increase revenue by $2.83 trillion, slightly beating the revenue estimate of $2.75 trillion put forward by Senator Warren’s team—and hugely exceeding Professor Sarin’s $1.1 trillion estimate of the wealth tax’s actual revenue potential.

Part Three: Tax Tradeoffs

Greg Leiserson, Director of Tax Policy and Chief Economist at the Washington Center for Equitable Growth, discussed the approaches and tradeoffs of taxing wealth. He explained the issues in the different approaches of taxing wealth itself compared to taxing the income generated from wealth, and the difference between taxation based on valuation compared to when the gains are realized.

He summarized the advantage of the income approach:

• More seamless integration with existing income tax
• Greater risk sharing between taxpayer and government
• Reduced constitutional risk

He summarized the advantages of the wealth approach:

• Taxes assets that generate consumption flows
• Less volatile revenues
• Easier to explain

He concludes that any approach needs to look at who the tax is burdening, which we assume impacts compliance, and how much revenue is going to be realistically raised. (For the challenges involved in raising more tax revenue from the super-wealthy, see what financial advisors have to say in an article from The New York Times.)

Wealth Planning: Not Just For The Super-Rich

Whatever the size of your wealth from stock compensation and company stock holdings, you and your advisors will find useful planning ideas and insights in the section Financial Planning at myStockOptions.com.

Capital Gains Indexing: Tax Cut By Presidential Executive Order?

Capital gains tax affects everyone with employee stock compensation. Anyone who sells shares acquired from equity comp is subject to the tax rules of capital gains and losses.

Now capital gains tax is back in the news in a big way. According to media reports, the Trump White House is seriously considering a presidential executive order which would require the United States Treasury to issue new regulations that index the capital gains cost basis for inflation. That would effectively result in a tax cut—but without the approval of Congress.

While this has been a "sleeper" issue so far, not getting much coverage in the news media or in publications used by many tax professionals, it's a big deal. A tax change by executive order, bypassing the power of the purse in Congress, would be constitutionally controversial. It would have a major impact on the federal budget (see an analysis by the Wharton School at the University of Pennsylvania). The legal challenges against it would be prolonged, complicating its implementation.

How Capital Gains Indexing Would Work

The concept of capital gains indexing has been around for a while. As long ago as 1990, when investors did not have the current preferential long-term capital gains tax rates of 0%, 15%, and 20%, it was mentioned in a report issued by the Congressional Budget Office.

How would indexing work? In brief, the cost basis of an investment is the number you subtract from your sale proceeds to determine the size of your gain (or loss). Capital gains indexing would increase the cost basis of investments, such as stock, for inflation. With indexing, the cost basis would be floating and no longer a fixed number.

Currently, the income trigger points for long-term capital gains tax rates are indexed. If the basis itself were indexed, you would reduce the size of your taxable proceeds at sale, as only the inflation-adjusted capital gain would be taxed.

Example: Your restricted stock unit (RSU) grant vested at $20 per share. Under current tax treatment, that will be the cost basis of those shares whenever you sell them. With capital gains indexing, assuming 2% inflation per year for five years before you then sell the stock, with a sale price of $30 per share your basis would instead be approximately $22 at sale. You would then have $8 in long-term capital gain, compared with a $10 gain under the current tax treatment.

Controversy Over Indexing

The big issue is whether the definition of "cost" in Internal Revenue Code Section 1012 is vague enough to allow for interpretation through new Treasury rules without approval by Congress. Should the Treasury decide it has the authority to make this happen through executive order, it will require detailed regulations on actually how and when the indexing occurs, potentially disrupting many financial-planning and charitable-donation strategies based on its application to different assets. The policy of inflation-indexing capital gains has both its supporters (see Tax Foundation and Americans for Tax Reform) and its critics (see Institute on Taxation and Economic Policy and the Tax Policy Center).

From our experience at myStockOptions.com in developing and updating tax-return-reporting guides for brokerage firms, indexing the cost basis will strain their administrative, reporting, and IT systems. They report to the IRS and brokerage customers the cost basis and other purchase/sale information on Form 1099-B, which is hard enough to get right even when the basis is fixed. The inevitable and lengthy legal challenges to the executive order would also create uncertainty about the actual size of the after-tax gains from any asset sale.

See the Tax Center at myStockOptions.com for detailed information about recent tax changes and their impact on stock compensation.

Amazon Ends RSU Grants To Hourly Employees, But The Benefits Of Broad-Based Employee Stock Grants Live On Elsewhere

When Amazon announced a pay increase for warehouse workers and other hourly employees to at least $15 per hour, we were surprised to hear that Amazon also eliminated bonuses and restricted stock units (RSUs) for those same workers. Amazon's move was widely reported by news outlets, such as Bloomberg. (We note, however, that some of the articles, along with Senator Bernie Sanders, mistakenly referred to these RSU grants as stock options.)

Amazon apparently cut bonuses and RSUs to redirect expenses for the increase in hourly wages and calculates that these workers will still see an overall pay rise. It also stated that as the pay these workers receive is "no longer incentive-based, the compensation will be more immediate and predictable."

Benefits Of Broad-Based Stock Grants

So what should we make of Amazon's decision? In past blog commentaries, we have reported favorably on stock grants made by various prominent companies, including Apple and Starbucks, to their broad employee populations. An article on similar topics in The Wall Street Journal rightly observes that broad-based equity can be a "powerful recipe for an engaged workforce," mentioning that modest restricted stock grants at this employee level "is good for the bottom line because it generates loyalty."

We are, therefore, very curious about the internal calculation, evaluation, and (hopefully) debate that Amazon went through before its decision to eliminate the RSU grants and cash incentive bonuses. When your company's stock price has skyrocketed and is expected to remain strong, as at Amazon, that is often when employees want equity the most. That is when stock compensation can play its most powerful role in recruitment, retention, and motivation, whether in the executive suite or in the warehouses. Plus, it is often the lower-level employees who most appreciate how equity pay increases their wealth and helps them with financial planning and funding for important life events.

Not surprisingly, some hourly employees at Amazon were disappointed by the company's elimination of bonuses and RSU grants, as discussed by articles in The New York Times and the magazine Money. The NYT gives details on both the variable compensation plan, which provided for the monthly attendance and productivity cash bonuses, and on the RSU grants. The NYT article reports that some employees "were saddened to lose the sense of ownership that the stock compensation provided." That is a message which we at myStockOptions.com have always emphasized as a major reason for having stock compensation.

Sharing Financial Success With Front-Line Workers

After Gardner Denver Holdings granted $100 million in shares to 6,000 employees, including hourly workers and staff in customer service and sales, a Bloomberg news report quoted chairperson Pete Stavros about the reasons. He explained that employee ownership at manufacturers can be effective at improving operations in which the company needs to do a "a million things a little better." He observes that "it's the workers on the front lines that often know where the inefficiencies are to fix and they share in the success through their equity stake." His statement succinctly expresses why broad-based grants, particularly to those in front line and hourly positions, are often a smart compensation approach. 

For data from studies exploring the benefits of equity comp to companies (and employees) and the various reasons why they make them, see an FAQ at myStockOptions.com.

What To Know About Tax Reform And What To Expect From The 'Tax Reform 2.0' Proposals

"Tax Reform 2.0" has hit the headlines, a month after this blog predicted a major buzz about followup tax cuts in the wake of the Tax Cuts and Jobs Act (see our related commentary, Tax Reform Developments: Making Provisions For Individuals Permanent; Capital Gains Indexing). Many of our talking points are now being echoed in the national news media, e.g. in The New York Times this week.

One of the most significant proposed tax cuts, the indexing of capital gains for inflation, is a long-recurring idea that has yet again been reintroduced. As explained in the tax-developments session at the recent myStockOptions financial-planning conference, capital gains indexing would routinely increase the cost basis of investments, such as company stock, for inflation. That would reduce the size of your taxable proceeds at sale, as only the inflation-adjusted capital gain would be taxed.

It must be acknowledged that the proposed additional tax cuts, especially if made by executive order, are politically controversial. As the NYT article bluntly puts it, the White House "is considering bypassing Congress to grant a $100 billion tax cut mainly to the wealthy, a legally tenuous maneuver that would cut capital gains taxation and fulfill a long-held ambition of many investors and conservatives." Nevertheless, the indexing of capital gains for inflation would, in particular, also make stock compensation more attractive for employees by reducing the amount of tax paid on the gains when shares are sold. It would, however, complicate the related brokerage recordkeeping, cost-basis calculation, and tax-return reporting. 

Tax-Reform Guidance At myStockOptions.com

After the Tax Cuts and Jobs Act, which took effect at the start of 2018, and with the current focus on more tax changes, tax planning remains at the forefront of public attention in the United States. Taxpayers remain concerned about the most effective ways to minimize taxes and prevent tax mistakes. This year the new tax law added potential confusion to the already complex arena of taxation for stock options, restricted stock, restricted stock units, ESPPs, and other forms of equity compensation.

The Tax Cuts and Jobs Act has several provisions that directly and indirectly affect equity compensation, whether in personal financial planning or in company stock plan administration. While the core tax treatment of stock compensation has not been altered, the new law's changes in the income tax brackets have a big impact on taxpayers who receive additional income during the tax year from an equity award or cash bonus.

At myStockOptions.com, the impact of tax reform on individuals is clearly explained in a variety of easily understandable content:

• Interactive quiz: Tax Cuts & Jobs Act

• Podcast: How Tax Reform Affects Your Stock Compensation And Financial Planning

• myStockOptions Blog: Tax Reform Developments: Making Provisions For Individuals Permanent; Capital Gains Indexing

• Article: Six Ways Tax Reform Affects Your Stock Compensation And Financial Planning

• FAQ: How does tax reform affect stock compensation?

• FAQ: Has recent legislation changed the taxation of incentive stock options (ISOs)?

• FAQ: How does tax reform affect restricted stock and RSUs?

• Article: Private Company Stock Options And RSUs: 10 Facts To Know About The New Tax-Deferral Opportunity

• Our patented calculators and modeling tools

"Tax reform affects financial planning for everyone, even strategies for estate planning and charitable giving," says Bruce Brumberg, the Editor-in-Chief of myStockOptions.com. "When you have stock compensation and holdings of company stock, you layer on an additional set of complex tax rules. With our content and tools, we help our site members and licensing clients make sense of it all."

Pro Membership: Crucial Edge For Advisors With Clients Who Have Equity Compensation

Beyond the Basic and Premium Memberships at our website, myStockOptions.com Pro is a special membership level for financial advisors, CPAs, and other professionals who have clients with stock compensation. It gives full access to the whole website plus special features in the tools, where advisors can track and model stock grants for multiple clients. Access to the vast library of content at myStockOptions.com puts answers to tough client questions right at the fingertips of advisors, who can create PDFs of crucial content with their logo on it for distribution to clients.

Stock Comp In The News: Grants At Apple, Starbucks, And Tesla Show The Versatility Of Equity Compensation

At myStockOptions.com, we never tire of seeing our favorite subjects in the news. In fact, our daily routine here includes keeping up with stories about stock compensation that make their way into the popular news media. Three recent big developments at high-profile companies show the versatility of stock compensation, from broad-based grants for rank-and-file employees to carefully crafted long-term incentives for corporate CEOs.

The business news media widely reported Apple's decision in January to issue grants of restricted stock units worth $2,500 to each of its employees (see, for example, Apple Gives Employees $2,500 Bonuses After New Tax Law, Bloomberg). The Apple news blog 9to5Mac published the text of the email that CEO Tim Cook sent to Apple's employees about the grant and other increased or new benefits. His statement nicely expresses the importance of stock grants and the reasons why companies award them broadly to employees:

I'm excited to let you know that we're also increasing our investment in our most important resource—our people. You are the heart and soul of Apple and we want you to share in the success made possible through your efforts. Your dedication helps Apple make the best products in the world, surprise and delight our customers, and ultimately make the world a better place.

To show our support for our team and our confidence in Apple's future, we’ll be issuing a grant of $2,500 in restricted stock units to all individual contributors and management up to and including Senior Managers worldwide. Both full-time and part-time employees across all aspects of Apple’s business are eligible.

Meanwhile, Starbucks announced stock grants to all eligible full-time, part-time, hourly, and salaried employees at stores, support centers, and bean-roasting plants (see Starbucks Gives Workers Raises, Stock Grants Due To Tax Law in the Seattle Times). In April, for example, Starbucks granted $500 worth of its stock to every retail partner and $2,000 in stock to each store manager. These grants, which have a one-year vesting period, were awarded in addition to what those employees were already receiving this year. According to the Starbucks press release announcing the new program, the grants have a total value of more than $100 million.

Naturally, major equity awards for celebrity CEOs always attract prominent media attention. A good example occurred when Tesla recently granted stock options to nerd hero Elon Musk, the much-admired CEO of both Tesla and SpaceX, as reported by major media outlets (see, for example, Tesla Shareholders Approve Pay Plan For Elon Musk Worth Up To $55 Billion Over 10 Years in the Los Angeles Times).

The grant to Mr. Musk is 100% stock options—but this is not your typical stock option grant. In fact, Tesla's new award to its CEO has some of the most detailed performance-based vesting features that we have ever seen for stock options. According to Tesla's announcement of the award and its proxy statement for the related shareholder vote, the stock options (worth $2.6 billion) can vest in 12 tranches depending on whether Tesla achieves key marketplace and operational performance milestones over 10 years. Each tranche equals 1% of the company's outstanding shares.

Tesla needs to hit 12 market capitalization milestones and 16 revenue or EBITDA operational targets for the award to vest in full. It has to reach a market cap of $100 billion for the first tranche to vest, and then each of the remaining 11 tranches require an additional $50 billion in market value. (Whew. We told you the grant was detailed!)

For more examples, including extensive survey data, that reveal equity comp trends among major companies, see a detailed FAQ at myStockOptions.

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Register For Our Financial-Planning Conference

We are preparing to hold our first-ever conference, a one-day event: Financial Planning for Public Company Executives & Directors (Monday, June 18, 2018). Taking place in the Boston area, this is a must-attend national conference for financial, tax, and legal advisors working with or wanting to counsel executives, directors, and high-net-worth employees. We have a wonderful group of expert speakers and a comprehensive agenda of sessions on various stock-related and financial-planning topics:

• trends of importance to advisors
• tax, estate, and SEC-related planning challenges
• methods for attracting and advising high-net-worth clients
• case studies and other examples of successful planning strategies

CE credits will be available! Register at the conference website or contact us for more information (617-734-1979, [email protected]).

Tax Reform: Proposed Legislation Contains Opportunities And Surprises For Stock Compensation

The Tax Cuts and Jobs Act, now under consideration by the Ways and Means Committee in the House of Representatives, is the first effort in Congress at providing tax-reform specifics. See a handy interactive guide to the legislation from the law firm Davis Polk.

Alert (Nov. 21): On Nov. 16, the House of Representatives passed the Tax Cuts & Jobs Act. Its future remains unclear in the Senate, which is preparing its own tax-reform bill. That bill has been approved by the Senate Finance Committee.

Parts of the draft legislation would have an indirect impact on stock compensation (nonqualified deferred comp too), while other sections would have a major impact. They are summarized in the following paragraphs.

1. Simplification of individual income-tax rates. The bill proposes to shift from the current seven tax brackets to new brackets with rates of 12%, 25%, 35%. Additionally, the current top tax rate of 39.6% would continue, though with a higher income threshold (over $1 million for married joint filers and $500,000 for unmarried individuals and married individuals filing separately). How changes in income-tax rates would tie into the flat supplemental rate of withholding on stock compensation is unclear and would need clarification, as the structure of the rate is based on the current seven brackets. Since the 39.6% bracket has survived, contrary to earlier GOP discussions, and the 25% rate still exists, perhaps the flat withholding rates on stock compensation would stay the same.

2. No change in the capital gains rates (15% and 20%). The draft legislation does not change the capital gains rates. However, it creates a new income threshold for the 20% rate that is slightly above the current threshold for the 36% income-tax bracket ($479,000 for married joint filers and $425,800 for single taxpayers).

3. The termination of the alternative minimum tax (AMT). Among those who receive grants of incentive stock options (ISOs), much rejoicing would occur if the AMT were repealed. Companies might then use incentive stock options more frequently. The proposed AMT repeal is part of the House's draft legislation, as are new rules on how AMT credit carryforwards could be refundable through 2022. Under the provision, you would be able to claim a refund of 50% of the remaining credits (to the extent the credits exceed regular tax for the year) for the tax years 2019, 2020, and 2021. In 2022, you would be able to claim a refund of any remaining credits.

What would pay for the end of the AMT is the elimination of the deduction for state and local income taxes and real-estate property taxes on tax returns. Given the odd way in which the AMT is calculated, those deductions can trigger the AMT. Strangely enough, if they are eliminated along with the AMT, taxpayers with ISOs may actually see less tax savings than they might otherwise expect to get from the AMT repeal.

Other Provisions With Potentially Big Impacts

1. Nonqualified deferred compensation would become taxable once there is no longer a substantial risk of forfeiture. This would be a major change. Currently, under IRC Section 409A, tax is deferred until the income, e.g. deferred salary or a deferred bonus, is distributed (see myNQDC.com, our sibling website on NQDC plans). Stock options and stock appreciation rights could get caught up in the definition of NQDC, at least in the House draft legislation. If so, that could lead to taxation at vesting! However, considering the way in which stock options and SARs were initially penalized in the early versions of the Section 409A regulations, we would expect that if this provision continues it will be amended to apply only to discounted grants. According to the Description Of HR 1, The "Tax Cuts And Jobs Act" (see page 209), prepared by the Joint Committee on Taxation, what the report refers to as statutory options (ISOs and tax-qualified ESPPs) would be exempt from the definition of nonqualified deferred compensation under the proposed tax-law change.

Alert: In its Tax Cuts & Jobs Act, the House dropped the provision (Section 3801) that would have imposed the changes described above for NQDC and equity compensation. The amendment making this change was issued on November 9. (See also an alert from FW Cook.) The Senate's tax-reform bill initially introduced a similar provision, but it too was dropped in alignment with the House version (see an alert from the law firm Fenwick & West).

2. The performance-based exception to the Section 162(m) limit on deductible compensation would be repealed. Publicly traded companies would no longer be able to deduct annual performance-based compensation (e.g. stock options, performance shares) in excess of $1 million for the CEO, CFO, and the top three highest-paid employees.

3. The Empowering Employees Through Stock Ownership Act, which passed in the House in 2016 but was not voted on in the Senate, could become part of the final legislation. That legislation sought to allow an employee in a privately held company to defer taxes at option exercise or RSU vesting for up to seven years as long as the company's equity awards met certain conditions. The current draft legislation in the House has a similar provision but reduces the deferral period to five years.

Further Reading

For a broader summary and analysis of the tax-reform legislation, including links to commentaries from law, accounting, and consulting firms, see the related FAQ at myStockOptions.com.

News And Views On RSUs: Broad-Based Grants, Bankruptcy Court Case, And Survey

Grants of restricted stock units (RSUs) continue to become commonplace, whether alongside or instead of stock options, as a way to reward valuable employees and foster a company culture of employee ownership. In this blog commentary, we present three interesting stories involving RSUs that have recently come to our attention.

Unusual Broad-Based RSU Grant In Heavy Industry

An attention-grabbing example of a broad-based RSU plan is presented by an article in Bloomberg Businessweek. When Gardner Denver Holdings went public, backed by private equity firm KKR, it granted $100 million in shares to 6,000 employees who were not already part of its equity program. These grant recipients included hourly workers and staff in customer service and sales, with meaningful grants of equity equal to about 40% of their annual salaries, according to the article. Employees, including managers, now own about 10% of the company.

This move toward broad employee ownership is unusual in the company's manufacturing sector (industrial equipment and related services). As the Businessweek article points out, broad-based equity is far more associated with the white-collar high-tech industry than with blue-collar manufacturing, an observation also made by a blog commentary from the National Association of Stock Plan Professionals. Pete Stavros, head of KKR's industrial team and the chairman of Gardner Denver, believes employee ownership at manufacturers can be very effective at improving operations when the company needs to do a "a million things a little better." As employees everywhere know all too well, it's often the workers on the front lines who best know where inefficiencies need to be fixed. Through their equity stake in Gardner Denver, the company's employees now derive a direct financial benefit from striving for operational efficiency.

RSUs In Lehman Bankruptcy Case

While restricted stock or RSUs still have value even when a company's stock price is lower than the grant price (stock options would be underwater), any type of equity grant can be worthless if a company goes bankrupt. That is one of the many lessons of litigation stemming from the bankruptcy of Lehman Brothers back in 2008.

In the case In Re: Lehman Brothers Holdings Inc. (2017), the 2nd Circuit Court of Appeals confirmed that in a corporate bankruptcy RSU-holders do not have any preference over general creditors in the distribution of remaining corporate cash. Previously, the original decision in the lawsuit, made by the United States Bankruptcy Court, was upheld by the US District Court for Southern New York in 2016. It reasoned that RSUs fit the legal definition of "equity securities" and that employees with RSUs should therefore be treated like other holders of equity in Lehman Brothers. The contention that employees with noncompete agreements resulting from a merger should have priority over general creditors was similarly rejected. This outcome follows the reasoning set forth in a 2006 decision involving employee stock options in the bankruptcy of Enron. Some additional information on the Lehman case and the court's reasoning are provided by Courthouse News Service and Bloomberg BNA.

Long-Running Survey Charts Rise Of RSUs, Decline Of Restricted Stock

An article in Ayco Company's Compensation & Benefits Digest presents results of an informal survey that Ayco made of its 325 client companies in the United States which grant restricted stock or RSUs (Restricted Stock And Restricted Stock Utilization Today, pages 1–5). Ayco's long-running series of surveys in this area has found a significant rise in the use of RSUs between 2007 and 2017, along with a drop in the use of restricted stock during the same period. In 2007, 41% of the surveyed companies granted restricted stock, while only 13% did so in 2017. By contrast, in 2017 nearly three quarters (72%) of the surveyed companies are granting RSUs, while only 37% did so in 2007. An FAQ on myStockOptions.com discusses why companies may prefer RSUs over restricted stock. Another FAQ at myStockOptions.com has a range of survey data on trends in restricted stock, RSUs, and other equity awards.

Legislative Update: Empowering Employees Through Stock Ownership Act Resurfaces In The Senate

Alert: A version of this bill was enacted as part of the Tax Cuts & Job Act, though with a five-year deferral period. See our blog commentary on the adopted legislation.

While stock options continue to be popular at startups and other pre-IPO companies, employees cannot sell stock at exercise to pay the exercise price and the taxes on the income. Moreover, under current law those taxes cannot be delayed. Last year, an encouraging legislative proposal was introduced in the House of Representatives to address this issue. Approved by a House vote in September 2016, the Empowering Employees Through Stock Ownership Act (HR 5719) sought to give employees in pre-IPO companies extra time to pay federal income taxes on the spread at exercise with nonqualified stock options and on the income at vesting with restricted stock units. (See the myStockOptions blog commentaries in July 2016 and October 2016.)

Under the proposal, the permitted deferral of taxation would be considerable. The legislation would allow an employee to defer taxes for up to seven years as long as the company's equity awards met certain conditions (for example, "Qualified Equity Grants" would need to be made to at least 80% of employees). In the feedback we at myStockOptions.com receive from stock plan participants and financial advisors, we understand that the current tax treatment does deter employees from exercising options and becoming true company owners. Although the proposal appears to be good news for employees at private companies who have equity comp, some provisions in the law could hinder its effectiveness, as we explained in our commentary on HR 5719 last October.

After its House approval last year, the Empowering Employees Through Stock Ownership Act went to the Senate, which did not take it up. However, in late June 2017, it was reintroduced as a separate bill with the same title in the Senate (S.1444). The Senate legislation is very similar to the House bill of last year and has bipartisan support: Its sponsors are two members of the Senate Finance Committee, Mark Warner (D–VA) and Dean Heller (R–NV), and two members of the House Ways and Means Committee, Eric Paulsen (R–MN) and Joseph Crowley (D–NY). Details of the proposals are available in the press release on it that was issued by Senator Warner's staff.

Although more than 70 companies have expressed support for the legislation, the prospects for its enactment remain somewhat uncertain in the current Congress, which seems to be preparing for a major effort at comprehensive tax reform (see the myStockOptions FAQ on how that could affect stock compensation). One obstacle could be finding a way to offset the cost of the proposed tax provisions. Although the legislation would allow only the deferral of taxes, not their elimination, the delay in tax payment would impose a revenue cost on the federal government.

Lawsuits And Court Cases Of Interest That Involve Stock Compensation

Here at myStockOptions.com, we keep an eye on major court cases and rulings that involve stock compensation or stock holdings, as these developments can influence both stock plans and the actions of stock plan participants. A few recent lawsuits and court decisions have drawn our interest.

Class-Action Lawsuit Claims Uber Made Unfair Changes In Stock Grants

Uber is facing a lawsuit related to changes it made in its stock grants, according to the complaint in a class action recently filed against the company. The acquisition centers around the technical ISO rule that only grants with an aggregate value of $100,000 can be exercisable in any one calendar year. Any grants that vest in a year with a value over that automatically become NQSOs, and income, Social Security, and Medicare taxes are withheld at exercise. According to the complaint, Uber recruited software engineers with whom it had employment agreements to grant ISOs with a vesting schedule of 25% after the first 12 months and then monthly vesting thereafter (see Exhibit 1). However, the company changed the provision to allow all of the shares to become exercisable after six months, forcing some ISOs to become NQSOs (see Exhibit 2). This situation raises the issue of whether "exercisable" means "vested" in the related tax-code provision, which was adopted before a distinction between exercisability and vesting existed in certain pre-IPO stock options with early-exercise provisions.

Various news publications picked up on this lawsuit, including TechCrunch and Courthouse News Service. TechCrunch reports a statement issued by Uber, which explains that the company gives employees a "real stake" in its success and that it is "proud to offer equity compensation in service of that goal."

State Supreme Court Confirms Nonresidents Cannot Escape Taxation On Options Earned In The State

You cannot escape state taxation of vested stock options by moving to a state without an income tax. In Allen v. Commissioner of Revenue Services, the Connecticut Supreme Court confirmed that Connecticut can tax income from option exercises by a nonresident if the options were granted as compensation for performing services within the state. Connecticut, like many states, has a provision that authorizes the taxation of income "derived from or connected with sources within this state of each nonresident." The court rejected the plaintiff's creative positions, including the argument that it is "unconstitutional" to impose a tax on income derived from the exercise of nonqualified stock options by someone who at exercise is a nonresident. For more about this case, see an article about it at the website of Forbes. The taxation of mobile employees in the US and in other countries shows the eagerness of governments to find tax revenue in stock compensation.

Supreme Court Issues A Major Decision On Insider Trading

Everyone working for or advising a public company needs to know the insider-trading rules. Even if you unintentionally violate the laws of insider trading, you can face a serious punishment. (For details, see the FAQs on insider trading at myStockOptions.com and the Think Twice video series for insider-trading prevention.) It is not hard to imagine a situation in which you casually tell a relative or a friend about upcoming important company news, and that this person then uses that information to make a stock-trading profit. Although the tipoff would probably be a violation of your company's confidentially rules, you might not have miscreant intentions or expect anything in return from the tipped-off person, and therefore might (wrongly) not view this act as insider trading.

The US Supreme Court has issued a major decision on insider trading that involves just that type of situation. In its ruling on Salman v. United States, the Supreme Court makes it very clear that whenever a friend or relative is tipped, insider trading has occurred, regardless of whether the tipster receives a benefit. Prosecutors do not need to show something of value was received for providing the valuable information. In the court's view, "the tipper personally benefits because giving a gift of trading information to a trading relative is the same thing as trading by the tipper followed by a gift of the proceeds." The tipper does not need to receive something of a "pecuniary or similarly valuable nature" in exchange for this gift to a trading relative.

The ruling is seen as a victory for the US government, as it strengthens the position of federal prosecutors and their will to bring insider-trading cases. The case prompted several commentaries, including articles from the law firms Morgan Lewis & Bockius and Goodwin Procter and an analysis in the blog of the Supreme Court itself.

Stock Compensation And The Secretary Of State Nominee

President-Elect Trump has nominated many company executives, directors, and founders for cabinet positions. Not surprisingly, they have substantial experience with equity compensation and its wealth-building potential. As we mentioned in a blog commentary soon after the election, Trump himself has received stock options grants in the past, though they eventually became worthless.

Stock compensation has emerged most prominently in the news in relation to Rex Tillerson, Trump's nominee for Secretary of State. Tillerson is a 40-year employee at ExxonMobil and is its outgoing CEO. His substantial holdings of company stock and unvested stock grants have raised many issues for the company and for him, as discussed by a recent article in Fortune magazine. This is the type of situation that requires a company to tread carefully while balancing its stock compensation philosophy and its commitment to reward a successful executive. In addition, the company must consider the executive's need to avoid conflicts of interest and his or her desire to minimize taxes.

Special Feature Of ExxonMobil Stock Grants

Incentive compensation awards for senior executives at ExxonMobil are not paid out until 10 years after retirement and cannot be accelerated for any reason except death, a rare requirement that strongly encourages (or even forces) long-term alignment between shareholders and executives. (For more on stock retention guidelines, see the related FAQ at myStockOptions.com.) There is a tax-code provision, IRC Section 1043, that allows political appointees to sell stock and defer capital gains taxes on investments that they need to divest, assuming the money is reinvested within 60 days into diversified mutual funds or government securities. (For more details on that provision, see an article about it by three accounting professors in the publication Tax Notes.) However, for Tillerson, that would merely defer gains on company shares he owns, not the income from his unvested RSUs.

Grants Surrendered While Trust Created

According to the related 8-K filing by ExxonMobil, Tillerson will surrender about 2,026,000 restricted stock and RSUs. In exchange for the surrender and the cancellation of these grants, the company will make a cash payment into an irrevocable ethics-compliance trust equal to the value of the company stock under a market-based formula, discounted by about $3 million under guidance from federal ethics authorities. The trust will receive around $180 million. The payout under the trust follows the terms that would apply to the unvested grants if he were still at the company, while also adhering to conflict-of-interest requirements. For example, distributions to Tillerson will happen only in a way that is consistent with the 10-year payment schedule that would apply if he were keeping the stock grant. The trust also has an interesting type of clawback provision that will be triggered if Tillerson ever again works in the oil and gas industry while there are still undistributed funds in the trust. Any remaining funds in the trust would then be forfeited, and "the money would be distributed to one or more charities involved in fighting poverty or disease in the developing world" (see Section 2g of the cancellation and exchange agreement).

Tillerson will also give up $3.9 million in an unpaid deferred cash bonus, and he will divest his ExxonMobil shares within 90 days of his confirmation. For additional details on the arrangement for his stock and executive compensation and his company stock holdings, see the letter that Tillerson sent to the Office of the Legal Advisor for the Department of State on various ethics undertakings.

What A Trump Presidency And Tax Changes Could Mean For Stock Compensation

Objectively, we know that stock compensation is not one of the biggest issues on people's minds as the United States slithers toward the unexpected reality of a Trump presidency. Naturally, however, it is our role to consider how stock compensation and employee ownership will be affected.

How Do Trump And His Supporters View Stock Compensation?

To get a sense of Donald Trump's views on stock comp, the myStockOptions staff did some in-depth research into SEC filings made by him and his companies. In 1995, the board of Trump Hotels & Casino Resorts adopted what it called its 1995 Stock Incentive Plan, which it amended in 1996 to increase the number of authorized shares it could issue (see pages 20–22 of the company's 1996 proxy statement). Trump himself received 500,000 stock options per year between 2000 and 2002 (see the tables, text, and footnotes on pages 16–18 of the company's 2003 proxy statement). Later, when Trump was chairman of the board at Trump Entertainment Resorts, the company adopted a stock plan at its 2005 annual meeting as part of its reorganization, and it canceled its prior plan and all of the grants made under it (see Proposal 3 on page 35–41 and Annex A of the company's 2005 proxy statement). Like other senior executives, Trump had to file Form 4 with the SEC to report his grants under the rules of Section 16 (see, for example, the reporting of his 2002 grant). Therefore, we can assume that Trump is familiar with stock options and restricted stock, though his company's subsequent bankruptcy eliminated the value of its grants.

It doesn't take a degree from Trump University to know that equity awards made broadly to a company's employees, along with employee stock purchase plans and other forms of employee ownership (e.g. ESOPs), are forms of egalitarian capitalism that can spread a company's wealth and reduce income inequality (see our recent blog commentary on this topic). Trump's supporters seem likely to approve of such a populist approach to employee compensation. However, the recent narrowing of stock grant eligibility and the huge equity comp gains made by senior executives have perhaps given stock compensation an elitist image that Trump's blue-collar supporters can be expected to find deplorable.

Republican Tax Reform May Increase The Value Of Stock Compensation

Tax changes are widely expected under Trump's presidency and the incoming Republican-dominated Congress (see a commentary from CCH). The House GOP Tax Reform Blueprint calls for the simplification of individual income tax rates to 12%, 25%, and 33%. How changes in income-tax rates would tie into the flat supplemental rate of withholding on stock compensation is unclear and would need clarification, as the structure of the rate is based on the current seven tax brackets.

Trump's tax plan does not propose to change the capital gains rates (15% and 20%). However, a reduction in the difference between ordinary income rates and the capital gains rates might affect tax-planning decisions, e.g. whether to hold shares at exercise, vesting, or purchase.

Changes may also include the elimination of the alternative minimum tax (AMT). That would be welcome news for anyone receiving grants of incentive stock options (ISOs), as currently the income spread at ISO exercise can trigger the AMT and complicate tax planning.

In addition, Trump vehemently asserted throughout his campaign that he wants to "repeal and replace" Obamacare. Presumably, that would eliminate the additional Medicare taxes used to fund Obamacare under the Affordable Care Act. Those additional taxes are:

• The 3.8% surtax on net investment income, such as capital gains and dividends, for single filers with yearly modified adjusted gross income of over $200,000 ($250,000 for married couples filing jointly). The removal of the surtax would increase the appeal of holding shares.
• The extra 0.9% Medicare tax owed by the same taxpayers through the withholding on compensation income, such as income from the exercise of nonqualified stock options or the vesting of RSUs.

Given the enormous federal budget deficit, the likely need for 60 votes in the Senate to defeat a filibuster and pass a major tax overhaul, and Trump's inexperience in the art of political compromise, there are no guarantees that these proposals will become law. One possible way to fund them to reduce the impact on the national debt would be to eliminate provisions that are favorable to stock compensation, such as the performance-based exception for limiting the corporate tax deduction under IRC Section 162(m).

Outlook For The Future

In the short term, with little risk of tax increases in 2017, there is no pressing tax-law reason to accelerate income into 2016. Even if you do predict that your tax rates are likely to drop or rise in the future, taxes should never be the only planning consideration for stock options and company stock at year-end. Instead, you may want to let investment objectives and personal financial needs, not tax considerations, drive your year-end planning.

In the long term, your company's stock price, not tax legislation, is likely to be the most crucial factor for your equity compensation. When a stock price falls after grant or becomes excessively volatile, equity grants tend to lose their perceived value (even if stock options do not actually go underwater). Therefore, if stock prices continue to perform well and we avoid the falling prices of a bear market, we can perhaps reasonably expect that stock compensation, ESPPs, and employee ownership will continue to thrive, especially when these opportunities are granted broadly to most or all employees in an egalitarian way. Additionally, the success of stock compensation depends not only on a company's share price but also on the efficacy with which it both communicates its stock plan to employees and provides them with educational resources on their grants. 

Legislative Update: Senate Considering Tax Change For Options And RSUs In Pre-IPO Companies

Alert: A version of this bill was enacted as part of the Tax Cuts & Job Act, though with a five-year deferral period. See our blog commentary on the adopted legislation.

We wrote a blog commentary in July about the Empowering Employees Through Stock Ownership Act (HR 5719), which was subsequently approved by the House of Representatives, through a vote of 287 to 124. The bill is now in the Senate for consideration. In short, HR 5719 seeks to give employees in privately held companies extra time to pay taxes on the income they recognize at option exercise or RSU vesting. Instead of paying taxes at the exercise of nonqualified options or at the vesting of stock-settled RSUs, employees would be allowed to elect to defer the resulting income, and thus the taxes on that income, for up to seven years.

A staff member for Congressman Erik Paulsen (R–MN), the bill's leading sponsor in the House, told myStockOptions that "Rep. Paulsen is hopeful that the Senate will pass the legislation soon and that it will make its way to the President's desk sometime in the lame-duck session, either as a standalone bill or as part of a larger package." He added that Rep. Paulsen is not aware of any timetable for Senate consideration. When we checked with the office of Senator Mark Warner (D–VA), a leading sponsor of the bill in the Senate, his staff confirmed that the legislation had just been introduced. With Congress now in recess ahead of the general election on Nov. 8, it is very unlikely that anything will happen with the legislation until after the election. There is a chance that the bill will be adopted during the lame-duck session, a busy time when many laws with populist intentions tend to be hastily enacted while the outgoing president is still in office. At Congress.gov, you can follow the progress of the legislation in the House and the Senate.

Details Of The Proposed Law Could Unintentionally Discourage Its Effectiveness

In general, we support a beneficial tax-law change for equity awards at pre-IPO companies and favor broad-based stock plans. However, in the report on the bill from the House Ways & Means Committee (see pages 10–14, "Explanation of Provision"), we do see some aspects of the legislation that might somewhat dampen enthusiasm for the proposed tax-qualified grants. The tax deferral would not apply to Medicare, Social Security, or state taxes. It would not apply to early-exercise options. As we interpret it, the deferral election apparently would turn ISOs into NQSOs. Furthermore, clarifications are needed on various aspects of the proposed law. For example, the House report states that an "inclusion deferral election" would be required within 30 days of vesting but does not mention that for options the election would need to be 30 days from exercise (not vesting). Also, the numerous rules that companies would have to follow to grant what the bill calls "qualified stock" might make these awards appealing only to large pre-IPO companies and not to true early-stage startups.

Moreover, companies currently already have a way to structure pre-IPO RSU grants so they do not trigger taxes until there is a liquidity event. Without liquidity and the ability to trade their stock, employees who exercise options in pre-IPO companies face the risk of tying up their money in stock that could be worthless. The proposed tax-deferral feature includes a seven-year period before taxes are owed, but for some employees this may not be long enough to encourage them to exercise options and create the widespread employee ownership that the bill wants to promote.

For additional analysis on the bill and the issues it raises, see a commentary from the consulting firm Compensia and an article by columnist Kathleen Pender in the San Francisco Chronicle.