Avoiding "Sloppy" Equity Grant Practices
Over the years I have seen a number of poor practices and procedures associated with granting equity to key employees of a public company. The purpose of this Post is to highlight some (not all) basic rules that public companies should consider when granting equity.
Authority to Effectuate Grants
Absent a valid delegation, only the board of directors has authority to grant equity. If no delegation exists, the compensation committee may only make recommendations to the board. The following assumes a valid delegation to the compensation committee exits.
Delegation from the Compensation Committee
Typically the compensation committee charter and the equity plan document that was approved by the company's shareholders will allow the compensation committee to delegate its granting authority to an inside director or a non-director officer of the company. I generally disfavor such delegations. My thought is that the administrative burdens associated with the compensation committee acting through written consent resolutions is not high enough to warrant additional delegations. However, I do recognize there are instances where delegations to an inside director or a non-director officer of the company may be appropriate (e.g., in connection with routinely granting equity to new hires who are not executive officers and where the equity is granted within a limited period of time from the date of hire). If a delegation from the compensation committee is appropriate, the following points should be considered:
- Delegations must comply with applicable state law.
- Delegations should be governed by a written equity grant policy (the "Policy") that was approved by the compensation committee and/or the board.
- The Policy should include a reporting mechanism to the compensation committee of all equity grants. To avoid "date of grant" issues discussed below, the Policy should clearly state that only a "reporting" to the compensation committee is required (i.e., no ratification or approval by the compensation committee is required).
- Attached as exhibits, the Policy should contain award agreements that were pre-approved by the board or the compensation committee. This will help to avoid successful arguments that delegated awards contained favorable definitions and terms not previously approved by the board or the compensation committee.
- The Policy should specify the total number of awards (individually and collectively) that may be made pursuant to the delegation.
- Delegations should exclude the ability to make grants to those who are Section 16 insiders as of the date of grant (i.e., compliance with Rule 16b-3 (Link) requires the full board of directors or a committee of two or more non-employee directors to approve in advance all grants to Section 16 insiders).
- Delegations should exclude grants to those who would be "covered employees" as of the exercise date (if a stock option) or vesting date (if a stock grant) (i.e., compliance with the performance-based exemption under Section 162(m) of the Internal Revenue Code requires such grants to be approved in advance solely by two or more outside directors).
Determining the Date of Grant
Another issue to consider is the date of grant. An accurate date of grant is important to support accurate accounting charges and to avoid adverse tax consequences under Section 409A of the Internal Revenue Code.
The date of grant is generally the date the board or the compensation committee "approves" a grant containing "definitive terms." If the board or the compensation committee acts prior to knowing the definitive terms, then the date of grant would typically be the date all definitive terms become known.
- For purposes of the above, a grant is "approved" on the date the board or the compensation committee acts pursuant to written minutes. If instead the board or the compensation committee acts pursuant to unanimous written consent resolutions, then the grant is approved on the date of the last signature.
- Generally, definitive terms include the identity of the recipient, the number of shares subject to the award, the vesting schedule and the exercise price (if applicable).
Again, this Post does not cover all of the instances in which sloppy equity grant practices arise, however, it does cover the issues I see on a more frequent basis.
