Subsidiary Rights

A new IRS rule makes it easier to give stock options to lower-level employees. Whether any companies will do so remains to be seen.

When the IRS’s long-awaited 409A regulations were finally released in
April, they generally clarified the tax rules regarding nonqualified deferred-compensation plans, which recipients now must include in their gross income. The biggest and most pleasant surprise within the 400 pages of text, however, was the loosening of the restrictions on stock options and stock appreciation rights offered to employees in divisions and subsidiaries.

Early versions of 409A set various restrictions on such stock options — including the requirement
that they be exercised on a fixed,
predetermined date — unless they were
granted in the stock that had the greatest
aggregate fair value. That generally
meant that only options in a parent
company escaped the restrictions.

With 409A pending, and the rules
for stock options in flux, companies
have hesitated to issue options at the
divisional or subsidiary level. Yet compliance
and ethics experts continue to
argue that stock options are the best
form of compensation for a company; at
unit levels they offer the added benefit
of tying individual effort to performance.

In their final form, the 409A regulations
exclude stock options in all
divisions and subsidiaries from restrictions.
The new rules “permit you to drill
down and give incentives at the level
that makes sense to the business unit
and to the employee,” says Tom White,
partner and head of the benefits practice
of Chicago law firm Chapman and
Cutler.

Whether companies will again
offer such options remains to be seen.
White, for one, believes they will. “You
give an employee a carrot, he works
harder and smarter, and you share the
gain,” he says. But Richard V. Smith, senior
vice president of Sibson Consulting,
points out that the expensing of options
has lessened their appeal. And even
though 409A has opened the door to
offering options at the unit level, he says,
“I wouldn’t jump on it.”

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