Key Questions and Answers for U.S. Issuers Offering an ESPP Outside the U.S.

Key Questions and Answers for U.S. Issuers Offering an ESPP Outside the U.S. May 1, 2009 (Revised from August 1, 2006) Compliments of Valerie Diamond Baker & McKenzie LLP

This publication includes a series of informal questions and answers by Valerie H. Diamond, a partner in Baker & McKenzie s Global Equity Services ( GES ) group in the San Francisco office. Ms. Diamond assists U.S. multinationals in designing and implementing equity programs that will be offered to employees on a worldwide basis. The GES group works primarily with U.S. multinational employers to design, implement and maintain equity-based compensation programs, including stock option, stock purchase, restricted stock/unit and SAR plans for their employees, consultants and directors. They provide advice regarding the U.S. and non-u.s. tax, securities, labor, exchange control, data privacy and other legal requirements. They design equity-based compensation programs to take into account the new corporate governance and accounting environment as well as a company s international tax structure. The GES group also offers sophisticated and experienced perspectives to achieve equity plan share pool and plan design efficiencies, minimation of account expense and preservation of the equity incentives in transactions such as spinoffs, mergers, and acquisitions. In addition to legal services, they provide project management and employee communication services. To complement their equity-based compensation services, they provide guidance in connection with global and domestic benefit plans to rationalize fiduciary decisions, compare benefit programs, and attain compliance. Table of Contents 1. Are there any countries where a typical U.S. ESPP (Code Section 423 Plan) cannot be offered?...1 2. What are the securities law requirements which must be complied with to offer a U.S. ESPP outside the U.S.? Are there any filings that U.S. issuers should avoid?...1 3. Are there countries where employees will not be able to participate in the ESPP by means of payroll deductions or where a bank account is required to hold employee contributions?...4 4. Do local financial intermediaries or investment advisors need to be involved in an ESPP offering?...4 5. Are there any tax-favored programs or other tax issues that should be considered before rolling out an ESPP outside the U.S.?...5 6. Can a U.S. issuer offer its ESPP to employees outside the U.S. without plan changes or special enrollment forms?...5

1. Are there any countries where a typical U.S. ESPP (Code Section 423 Plan) cannot be offered? Yes. The two countries that come readily to mind are China and Vietnam. China is a problem due to both securities laws and exchange control restrictions. Under the securities laws, an issuer is required to obtain approval from the China Securities Regulatory Commission (the CSRC ) prior to any public offering of securities to individuals in China. Unfortunately, the CSRC has not provided guidance as to how a U.S. issuer should obtain such approval. To the extent an ESPP offering is a public offering of securities (which may be debatable), there is currently no mechanism for a U.S. issuer to obtain CSRC approval for the offering. Some issuers have received informal oral confirmation from officials at the CSRC that the ESPP offering is not a public offering, but no official guidance has been issued to date. This issue is complicated by the recent liberalization of the exchange control restrictions in China which would allow issuers to obtain approval from the State Administration of Foreign Exchange ( SAFE ). So although the risk of enforcement on securities law compliance is low, it is not risk free to offer an ESPP in China even with SAFE approval. Vietnam is another problem country due to exchange control restrictions. The State Bank of Vietnam ( SBV ) has issued exchange control approvals for the operation of a U.S. issuer s equity plans where options are restricted to a cashless sell-all exercise and restricted stock units are granted. To the best of my knowledge, no U.S. issuer has obtained an approval from the SBV to operate an ESPP in Vietnam. 2. What are the securities law requirements which must be complied with to offer a U.S. ESPP outside the U.S.? Are there any filings that U.S. issuers should avoid? One of the good things about a U.S. ESPP is that, typically, the plan is designed to allow the issuer to decide which subsidiaries may participate and which may not. This feature can be particularly helpful when it comes to securities law compliance in offering the ESPP to employees of subsidiaries residing outside the U.S. In many countries, the public offering of securities requires a securities registration and a prospectus - similar to the requirements for securities offerings in the U.S. With regard to ESPP offerings by U.S.-based multinationals, the issuer must look at the requirements on a country-by-country basis to see what is necessary. 1

In many countries, the fact that the ESPP is offered only to employees means that the issuer can rely on an employee share exemption. In other countries, private placement exemptions exist (some are self-executing and some require a filing) based on the fact that the securities are offered to a limited number of individuals and the value of the securities offered is low. The availability of a private placement exemption is usually based on the total number of employees offered the right to participate, not the number who actually participate. In Australia, for example, class order exemptions are available which allow a U.S. issuer to offer an ESPP to Australian employees without filing a registration statement or prospectus if certain requirements are met. Generally speaking, the issuer must have its shares quoted on an approved foreign market (including NYSE and NASDAQ) throughout the 12-month period immediately preceding the offer to rely on a class order exemption. The exemptions generally require a sub-plan to the U.S. issuer s ESPP document and an offer document for employees. Copies of the grant materials must also be lodged with the Australian Securities and Investments Commission. The costs to comply with the class order exemption is usually not particularly high, so most U.S. issuers tend to take the necessary steps. Japan is a country that can be particularly troublesome if the ESPP is offered to more than 50 Japanese employees and the Japanese company employing the individuals is not a wholly and directly owned subsidiary of the U.S. issuer. The issuer may need to file a Form 7 registration statement and a prospectus if the value of the offering is 100 million or more and deliver it to all Japanese employees before making the ESPP offering. This can be a time-consuming and costly filing which a U.S. issuer may want to avoid. Further, once a Form 7 filing is completed, the issuer becomes subject to onerous semi-annual and annual securities filings, as well. Lastly, there are limits on offerings to employees in the EU. Each EU member state was required to implement the EU Prospectus Directive No. 2003/71/EC (the Directive ) into local law by July 1, 2005. The Directive requires the filing of a prospectus in the issuer s EU home member state if there is a public offer of securities and a passporting of the prospectus into any other countries where the offering is made. The prospectus must be made available to those receiving the securities offering. There has been informal guidance from the Committee of European Securities Regulators ( CESR ) that employee stock options (which are non-transferable) and restricted stock units granted for no cash consideration may not be subject to the Directive. To date, however, the CESR and the EU securities regulators generally have not taken the same view with regard to an offering under an ESPP. This is true notwithstanding the fact that U.S. issuers have attempted to explain to the regulators that rights granted under the typical U.S. ESPP plan are non-transferable options. 2

To determine if a prospectus is required for an ESPP offering under the Directive, a U.S. issuer should first consider whether the offering might fall within an exclusion to the Directive. The most relevant exclusion for ESPP offerings is an offer of securities with a total consideration of less than 2.5 million calculated over a 12-month period. There is one problem we have seen for some issuers who want to rely on this exclusion. If an issuer has employees in Germany, the law implementing the Directive has restricted the application of this exclusion solely to banks or issuers whose securities are admitted to trading on EU regulated exchange. This limitation has made the exclusion unavailable to many U.S. issuers. Assuming an exclusion is not available, the issuer should consider whether it has securities admitted to trading on an EU regulated market. If so, there is an employee share exemption that is available provided certain disclosure is made to employees. The problem with relying on this employee share exemption is that most U.S. issuers do not list their securities on an EU regulated market, so the exemption is usually not available to them. We understand that there is a proposal to make this exemption available to issuers whose shares are listed on a recognized non-eu regulated exchange (e.g., NYSE), but the earliest this proposal would take effect would be to 2011. If a U.S. issuer does not have securities admitted to trading in the EU, then it may still be able to avoid an EU ESPP prospectus filing if another exemption applies. The most useful exemption is the exemption for offerings addressed to fewer than 100 persons per EU member state. However, issuers should be careful in relying on any exemption without the advice of counsel as there are some unexpected interpretations among the EU member states as to the 100-person threshold. If there is no exclusion/exemption available, then the U.S. issuer will have to file a prospectus in the home member state and passport it into the EU member states where ESPP is offered. The prospectus generally needs to be reviewed by the issuer s auditors, and the prospectus and passporting process can be a rather costly one, depending upon the circumstances. The prospectus also needs to be updated on at least an annual basis. Most U.S. issuers which have filed EU ESPP prospectuses have recognized France or Belgium as their home member state and have filed in those countries. A few U.S. issuers have filed in Germany, Luxembourg, Netherlands and the U.K. 3

3. Are there countries where employees will not be able to participate in the ESPP by means of payroll deductions or where a bank account is required to hold employee contributions? Yes. For example, in Argentina and Hong Kong, employees are not technically permitted to participate in the ESPP by means of payroll deductions. In Argentina, contributing to an employee stock purchase plan through payroll deduction may be permitted within certain limits, but not if the plan is sponsored by a foreign parent company, as would be the case with a U.S. issuer s ESPP. In Australia, Austria and New Zealand, for example, payroll deductions should be separated out of a local company s general funds and held in a bank account. In Australia, the payroll deduction feature is seen by the securities authorities as constituting a managed investment scheme for which a specific exemption must be sought and the employee payroll deduction contributions must be held in a separate non-interest bearing bank account. In Austria, to avoid a violation of banking laws, payroll deductions should be held in a separate interest-bearing trust or escrow account. In Singapore, Ministry of Manpower approval is required for the ESPP if payroll deductions will be taken from non-managerial employees pay. In Japan, an agreement between an employee representative and the local entity must be signed to permit employees to participate in an ESPP by means of payroll deductions. 4. Do local financial intermediaries or investment advisors need to be involved in an ESPP offering? Yes, in some countries. The CONSOB (Italian securities authority) has said that any placement of securities with individuals in Italy, including ESPP offerings to employees of an Italian subsidiary of the U.S. issuer, must be made through a licensed financial intermediary. Not all U.S. brokers are licensed financial intermediaries, so U.S. issuers may need to work with their U.S. broker to set up a special process involving an Italian broker or bank. In Australia, the issuer is required to hold an Australian Financial Services License when offering securities in Australia; however, generally U.S. issuers are eligible for an exemption from this license requirement provided certain requirements are met and specific disclosure language is provided to employees. 4

5. Are there any tax-favored programs or other tax issues that should be considered before rolling out an ESPP outside the U.S.? Yes, although, in general, there are fewer tax-favored programs for ESPP offerings than there are for options. In the U.K., it is possible to shift to the U.K. employees the obligation of the U.K. employer to pay national insurance contributions ( NICs ) on the discount at purchase. This shifting of employer NICs generally is accomplished through special language in the enrollment form and a joint election form which is executed by the employer and employee and submitted to Her Majesty s Revenue and Customs. In Belgium, preferred tax treatment is available for employees participating in an ESPP if they agree to hold the shares for two years from the date of purchase. This agreement may be made through an undertaking signed by the employee which is usually incorporated into the enrollment form or procedures. Another tax issue sometimes overlooked by U.S. issuers is the fact that many countries have different methods for valuing shares in order to calculate the taxable amount due. In most countries, tax is due on the discount between the purchase price and the fair market value of the shares on the date of the purchase. The issue is that fair market value may be viewed differently than is typical in the U.S. For example, in Italy, the fair market value of the shares is based on an average of the share price over the month preceding the share purchase. Similarly, in Australia, the fair market value of the shares is typically based on a seven-day weighted average. U.S. issuers are not always aware of these valuation issues and do not properly calculate the taxable amount and/or do not provide employees with the correct share valuation for tax purposes. Lastly, there is both SEC Telephonic Guidance from July 1997 and Q&As from ABA - Joint Committee of Employee Benefits / SEC (Q&A No. 6 1999) which indicate that as part of a U.S. issuer s S-8 plan prospectus, the company should provide country supplements describing the applicable tax consequences to employees eligible to participate in the ESPP. Many U.S. issuers provide only a short statement that non-u.s. tax consequences differ and recommend employees check with their personal tax advisor for guidance. While the SEC s guidance to date is non-binding, the best practice is to provide non-u.s. employees with the tax consequences of participating in the ESPP. 6. Can a U.S. issuer offer its ESPP to employees outside the U.S. without plan changes or special enrollment forms? Generally, it is possible for a U.S. issuer to offer its ESPP outside the U.S. without making any changes to the plan design. As discussed above, there are certain countries where an issuer cannot offer or may not want to offer the 5

ESPP because it will require significant securities filings. In most cases, the employees working for subsidiaries in the problem countries are excluded from participating in the ESPP. There are certain features that are common in U.S. ESPP designs that are not very helpful when offering an ESPP outside the U.S. Among these are features that restrict contributions solely to payroll deductions, exclude part-time workers, prevent companies from paying interest or setting up bank accounts, or require beneficiary designation. It is generally possible to modify the ESPP to allow the issuer to obtain the flexibility to offer the program outside the U.S. and often the changes that are necessary are not material and do not require shareholder approval, but this must be reviewed on a case-by-case basis. We generally recommend that U.S. issuers design the ESPP to be an omnibus plan under which the issuer has the flexibility to make grants to employees in the U.S. under a Code Section 423 plan and grants to employees outside the U.S. outside of the 423 plan context. This design is similar to an equity incentive plan which gives the issuer the right to grant incentive stock options and non-statutory stock options and other rights. However, there are proposed Code Section 423 regulations that would need to be considered when drafting an omnibus plan to ensure compliance. We always recommend that additional tax withholding/reporting provisions, data privacy waivers and labor law acknowledgments be added to an ESPP enrollment form which will be used outside the U.S. The tax withholding/ reporting language is meant to give the company flexibility in ensuring tax withholding/reporting will be made in a timely manner. Generally speaking, an issuer will need the employee s permission to withhold taxes (and social insurance contributions) on the taxable amount from the ESPP, and it is best to make this part of the terms the employee agrees to in the enrollment process. The data privacy language is included in the enrollment form to obtain the employee s consent to transfer data in connection with the ESPP to jurisdictions outside of his or her local country where different data protections apply. The labor law provisions are added to the enrollment form to, among other things, reduce a company s exposure to claims that the ESPP is an entitlement of employment which cannot be unilaterally modified or discontinued by the company. If you have questions or would like additional information about any of the topics covered, please contact: Valerie H. Diamond Attorney at Law, Global Equity Services Baker & McKenzie LLP Two Embarcadero Center, 11th Floor San Francisco, California 94111-3909, USA Tel: +1 415 576 3086 Fax: +1 415 576 3099 vdiamond@bakernet.com 6

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