BeUb iq, Inc. Risky ESPP Business: Avoiding and Mitigating Risk in 423-ESPPs Sarah Roberts, CEP, Stock & Option Solutions, Inc. Bernice Toy, Visionary/Founder, BeUbiq.com Alison Wright, Baker & McKenzie LLP
Disclaimer The following discussion and examples do not necessarily represent the official views of Stock & Option Solutions, Inc., Baker & McKenzie LLP, or BeUbiq.com, with respect to any of the issues addressed. Moreover, this presentation and the views expressed by the individual presenters should not be relied on as legal, accounting, auditing, or tax advice. The outcome of any individual situation depends on the specific facts and circumstances in which the issue arises and on the interpretation of the relevant literature in effect at the time. Anyone viewing this presentation should not act upon this information without seeking professional counsel and/or input from their advisors. BeUbiq, Inc. 2
Agenda Disqualify Whole Plan Disqualify Individual s Purchase Disqualify Some Shares Other Consequences Just use your best judgment. We trust you. - Joel s parents before they leave town. BeUbiq, Inc. 3
Notes on ESPP Risks None of us has EVER heard of an IRS audit of a 423-qualified ESPP None of us are aware of ANY enforcement action re: 423-qualfied ESPP violations That said, better to avoid the situation than test the boundaries BeUbiq, Inc. 4
ESPP Trends Does your company have an employee stock purchase plan (ESPP)? (n=581) 48% 52% Yes No NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey BeUbiq, Inc. 5
ESPP Business Objectives Indicate the objectives of this plan. (Check all that apply.) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 93% 64% 59% 47% 36% 32% 30% 13% NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey BeUbiq, Inc. 6
Length of Offering Period 70% 60% 50% 60% 53% 40% 30% 20% 10% 0% 13% 10% 11% 9% 1% 2% 15% 9% 8% 2% All Companies High-Tech Companies NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey BeUbiq, Inc. 7
It seems to me that if there were any logic to our language, trust would be a four letter word. DISQUALIFY ENTIRE PLAN
Refresher on Inclusion / Exclusion of Employees Covered Employees Revised 423 regulations clarify that employers may exclude: Employees who have been employed less than 2 years Employees whose customary employment is 20 hours or less per week or not more than 5 months in a calendar year Highly-Compensated Employees (HCE) Compensation above a certain level (for 2012, $115K) or Section 16 officers Foreign employees, if prohibited under laws of jurisdiction or if compliance with the laws of the jurisdiction would violate 423 Exclusions must be applied in an identical manner to all employees eligible to participate in that particular offering BeUbiq, Inc. 9
Missing an Enrollment Form Why does it disqualify entire plan? Requirement that all eligible employees be allowed to participate How do you avoid? ESPP Online Enrollment Records should be retained at least 3 years Confirm enrollment by logging into system / receipt of email confirmation Confirmations of enrollment via email Even if they have not enrolled, email you have not enrolled (even if you use online enrollment?) Require them to respond/correct within X days or enrollment stands BEFORE enrollment closes? If paper forms, stamp date/time, initial and give employee a copy BeUbiq, Inc. 10
Data on ESPP Online Enrollment 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Which of the following actions are employees able to perform electronically with respect to your ESPP? 88% 77% 71% 69% 62% 59% 17% 4% NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey BeUbiq, Inc. 11
Solves Other Problems Too Missing Enrollment Form Terminated and rehired, not included in purchase Missed changes to contribution rates BeUbiq, Inc. 12
Determination of Grant Date Establishing grant date is important for Determining compliance with requirements under section 423 Is discount > 15%? Lookback only works if grant date is first day of offering Determination of whether 2 year holding period is met $25K limitation is based on grant date Date of grant is first day of offering if: Designate max # of shares that may be purchased by each participant or Establish a formula that on first day of offering, max number of shares that may be purchased by each participant If maximum number of shares is not fixed or determinable on the first date of offering, purchase date = grant date Lookbacks not feasible Holding periods will not start until purchase date BeUbiq, Inc. 13
Lookback Plans The discount is applied to the fair market value at: 34% 2% 1% Lower of beginning/end of offering/purchase period End of offering period 62% Beginning of offering period Other NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey BeUbiq, Inc. 14
Purchase Limits How does the ESPP define the maximum amount of stock that can be purchased (excluding any statutory limits such as the $25,000 limitation required under Section 423)? (Check all that apply.) (Section 423 Plan) Number of shares 17% 0% 23% 60% Percent of salary per year Dollar amount Other 22% No limitations other than statutory requirements NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey BeUbiq, Inc. 15
Allowing Inconsistent Contributions Violates equal rights and privileges requirement Disqualifies entire offering Contribution rules must be applied consistently If bonuses are allowable income for one group of employees, must be allowed for all What about commissions? (Often only available to small subset of the employee population) Bonuses but not overtime? How to avoid Clearly define eligible pay in the plan Work with payroll to determine eligible pay codes Have payroll review source data from payroll system to ensure no ineligible pay types included BeUbiq, Inc. 16
Compensation Types Allowed What forms of compensation can be contributed to the plan? (Section 423 Plan) 100% 100% 80% 60% 58% 53% 47% 40% 20% 0% 5% NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey BeUbiq, Inc. 17
Failure to Obtain Necessary Approvals? Necessary Approvals Shareholder Approval Approve max number of shares issued under plan Approve corporations or class of corporations eligible to participate Within one year before or after time plan is approved by BOD Without proper approvals, plans is not qualified Don t forget to get approvals for new subsidiaries Via acquisition, etc. BeUbiq, Inc. 18
Individual Purchase Inconsistent with Plan Terms If eligible employee granted an option that is inconsistent with terms of the ESPP or offering, and does NOT receive another qualifying option: Can disqualify whole plan! Okay if option terms qualify, but option is administered in such a way that it violates terms Example 4 from regs (1.423-2(a)(5)): Option terms for eligible employees say price will be 90% of FMV, but purchase allowed at 85% for one employee. Only that option is disqualified. BeUbiq, Inc. 19
Multiple Offerings Allowed under Same Plan One or more offerings may be made under a single plan Useful for non-us subs Parent corporations may designate one or more subsidiaries that will participate in a particular offering Not all subs need be included Offerings may be consecutive or overlapping Terms need not be same as long as each offering and terms of plan satisfy rules Cannot use two offerings for a single corporation i.e. May have a separate offering for each corporate entity or for a group of corporate entities, but.. Cannot have some employees (e.g. US) of same corporate entity in one offering and other employees (e.g. foreign) in a different offering Take care regarding corporate versus branch status BeUbiq, Inc. 20
You've done a lot of solid work here, but it's just not Ivy League, now is it? - Interviewers discussing Joel s work DISQUALIFY INDIVIDUAL S PURCHASE
Allowing Ineligible Participants to Participate Entire individual s purchase disqualified Taxed at grant (Includes non-employees because of late termination notifications) How to Avoid Strive to exclude only a limited set of employees Clearly outline exclusion policy (and how to determine excluded employees via available data) and request confirmation/sign off Checklist for Payroll before they send contribution files Export from HR / Payroll database Compare to same export from last quarter Compare to attributes from payroll, other systems of record BeUbiq, Inc. 22 22
Allowing Ineligible Participants to Participate How to Avoid (continued) Recon Process for Termination (HR to?) send list of employees term ed / hired to each manager, ask for confirmation / missing employees Manager of terminating employee log on and enter termination Who is responsible? HR or People Manager? Prep work is key! Start prepping at least a quarter in advance! BeUbiq, Inc. 23 23
Leave of Absence Mishandling Review: Leave of absence = employment terminates after 3 months Unless employee has guaranteed right to continued employment by statute or contract FMLA or USERRA Issue: Allow Employees on Extended Leave to Purchase when they should be excluded Disqualifies their purchase tax due at purchase How to Avoid: Export from HR database Recon Process for Termination (HR to?) send list of employees on leave this quarter to each manager, ask for confirmation/missing employees Prep work is key! Start prepping at least a quarter in advance! BeUbiq, Inc. 24
Exceeding the $25,000 limit If participant exceeds $25K limit, all shares are nonqualified Taxed at purchase How to avoid Using a system? Run a test purchase before EACH purchase and confirm calculation is correct Export to Excel and confirm using steps below Even if nothing has changed Using a spreadsheet? One row per participant $25K/Grant Date FMV = Share Limit Add unused portion of $25K limit from last year (if applicable) Subtract shares purchased earlier THIS year BeUbiq, Inc. 25
Exceeding the $25,000 limit How to avoid Stop contributions at $25K limit, if possible Even if plan says 1% to 10% (or whatever) Suspend contributions without withdrawing participant Many payroll systems can support this Avoids overlimit AND avoids refunds/ disgruntled employees Somewhat controversial Should stock / payroll take this much responsibility BeUbiq, Inc. 26
$25K Limit Monitoring/Notification 47% Do you monitor ESPP participants' progress towards the $25,000 limit or other plan limits and notify them when their contributions have reached an amount that is likely to cause them to exceed this limit? (n=265) 4% 35% Yes, via paper format for all ESPP participants Yes, electronically for all ESPP participants 14% NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey Yes, for a few participants (e.g., executives or other high-level employees) No, we do not provide this notification for any ESPP participants BeUbiq, Inc. 27
Reduce to 0%? Are participants permitted to reduce their contribution rate to 0% without withdrawing prior contributions? (Section 423 Plan) 2% Yes, under any circumstances 31% 8% NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey 59% Only if purchase likely to exceed statutory or plan limitation Not under any circumstances Other BeUbiq, Inc. 28
It was great the way her mind worked. No guilt, no doubts, no fear. None of my specialties. Just the shameless pursuit of immediate gratification. What a capitalist. DISQUALIFY SOME SHARES
Running out of ESPP Shares / Oversubscribed If you run out of ESPP Shares, you must prorate the number of shares purchased Only shares already approved by shareholders qualify for preferential tax treatment If you allow purchase of more shares than are approved, issues abound How to avoid? Project share usage for next 2 to 3 years Factor in new hires and forfeiture rate Ensure management has plans to request shareholder approval of ESPP shares WELL in advance (12 to 18 months?) Set reasonable share limits as well use max to calculate possible max (if all increase contributions?) BeUbiq, Inc. 30
ESPP Share Usage Projections BeUbiq, Inc. 31
Exceeding Plan-specific Limits If participant exceeds plan limit, shares over limit are non-qualified Taxed at purchase How to avoid Using a system? Run a test purchase before EACH purchase and confirm calculation is correct Export to Excel and confirm using steps below Even if nothing has changed Using a spreadsheet? One row per participant Apply your own share limit Strive for simplicity in the limit Example: 2,000 shares per purchase NOT 4,000 shares per year Easier to admin, less error-prone Easier to communicate BeUbiq, Inc. 32
OTHER ISSUES Sometimes you just gotta say What the Heck
No Offering Carryover Other than Fractional Shares Be careful about allowing carryover of withheld but unused amounts from one offering to another Have to allow other employees ability to make direct payments of an equal amount (less any amount they carried over) Carryover for fractional shares okay BeUbiq, Inc. 34
Failed Disposition Tracking and Reporting Tracking Dispositions Disqualifying 2 years from enrollment, 1 from purchase Qualifying forever Why? Don t report it on the W-2, not entitled to the corporate tax deduction One company decided that if employees did not complete the survey, they would assume disposition and report the income and take tax deduction = HUGE penalty from IRS Reasonable Approach Require participants to hold shares in designated broker account (at LEAST while employed, perhaps after) Track / survey former employees for 5 years after termination? Forego tax deduction (confirm with CFO!) BeUbiq, Inc. 35
Broker Usage Are ESPP participants (other than executives) required or encouraged to use selected brokerage firms? (Section 423 Plan) Participants are required 11% to use specified broker(s) 10% NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey 79% Participants are encouraged, but not required to use specified broker(s) No brokerage arrangements have been made for participants BeUbiq, Inc. 36
Tracking DDs For your company's Section 423 plan, how are disqualifying dispositions tracked? (Check all that apply.) 60% 51% 49% 50% 40% 34% 30% 20% 10% 1% 0% 0% Third-party admin Broker report to Co. Participants surveyed Code certs / TA Tracks Other NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey BeUbiq, Inc. 37
Restricting Transfers? For your company's Section 423 plan, if dispositions are reported to your company by brokers, are participants restricted from transferring shares acquired under the plan to a brokerage firm where your company does not have this reporting arrangement? 31% Yes No 69% NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey BeUbiq, Inc. 38
Modification Accounting for ESPP Triggered by: Increases to contributions Automatic reset/rollover provisions Most systems don t support Spreadsheet calculations complicated / error-prone How to avoid Elimination reset provision Limit ability to increase contributions Change plan to a 6-month offering BeUbiq, Inc. 39
Automatic Resets/Rollovers Does the ESPP have an automatic reset provision? (n=284) 2% 13% Yes, the price is reset for the remainder of the current offering only Yes, a new offering begins when the price is reset No 85% NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey BeUbiq, Inc. 40
Increases Allowed Participants permitted to increase contributions during offering periods? (Section 423 Plan) Only at the beginning of each purchase period At any point and unlimited number 23% Only at specified times (other than beg of each period) 49% At any point and multiple not unlimited) 11% At any point, but only once during purchase period 5% At any point, but only once 5% 3% 3% 3% during the offering Other NASPP / Deloitte 2011 Domestic Stock Plan Administration Survey Increases are not allowed BeUbiq, Inc. 41
Diluted EPS for ESPP Many popular systems do not calculate Many stock plan professionals/accounting personnel overlook Often immaterial, but even one share can flip Diluted EPS by a penny = material How to avoid Use a spreadsheet Based on accounting report Weight shares Assumed Proceeds: Avg Unamortized Expense Exercise Proceeds (price * wtd shares) No Tax Benefit! BeUbiq, Inc. 42
Tax Accounting for ESPP Many systems do not support No DTA booked for tax-qualified plans ISOs/ESPPs No tax deduction may be assumed At Disqualifying Disposition Compare Actual Tax Benefit (Gain * Corporate Tax Rate) to Estimated Tax Benefit (Fair Value * Corporate Tax Rate) if Actual > Estimated then Increase to APIC and reduction to Tax Expense If Actual < Estimated then no How to Avoid Spreadsheet based on DD Report Custom reports also possible BeUbiq, Inc. 43
Failure to Comply with Section 6039 Requirements Participant statements by 1/31 IRS reporting By 2/28 if paper (only for < 250 transactions) By 3/31 if electronic (available to all, required if > 249 transactions) Transactions that trigger reporting - First Transfer Usually purchase = transfer, if deposited into brokerage account Penalties increased by Small Business Jobs Act of 2010 (H.R. 5297) Failure to file with IRS Late by 30 days or less: $30 per form; $250,000 max Late by >30 days but filed by August 1: $60 per form; $500,000 max Filed after August 1 or not at all: $100 per form; $1,500,000 max Penalty for intentional disregard starts at $250 per form, no maximum BeUbiq, Inc. 44
Closing Thoughts BeUbiq, Inc.
Contact Information Sara Roberts, CEP Equity Consultant 910 Campisi Way, Ste 2E Campbell, CA 95008 USA Bus: (408) 979-8700 E-mail: sroberts@sos-team.com Alison Wright, CEP Partner 2 Embarcadero Ctr Fl 11 San Francisco, CA 94111 USA Bus: (415) 576-3046 E-mail: Alison.Wright@bakermckenzie.com BeUbiq, Inc. Bernice Toy Visionary/Founder 1568 Alisal Ave San Jose, CA 95125 USA Bus: (408) 506-3348 E-mail: Bernice.Toy@BeUbiq.com BeUbiq, Inc. 46