Should a Company Consider Stock-Price Forfeitures of Stock Options?


The purpose of this post is to consider whether implementation of a stock-price forfeiture within a stock option award agreement could be used to increase the life expectancy of the equity plan's share reserve.

Explanation of the Problem

The problem arises whenever a company has, or expects to have due to volatile stock prices, outstanding stock options that are underwater (i.e., a stock option where the exercise price is greater than the fair market value of the underlying common stock).  If the company desires to reprice such underwater stock options, then the Schedule TO rules would have to be followed unless:

  • The repricing is conducted on an individually negotiated basis and limited to a small number of key executives (see March 21, 2001 Exemptive Order); or
  • The repricing is conducted on a unilateral basis (i.e., without optionee consent), the goal being to negate the Schedule TO rules because there would be no "offer" under applicable securities rules (i.e.., absent an offer, the optionee would not make an investment decision, and absent an investment decision, no Schedule TO should be triggered).

Noteworthy is that incremental compensation cost will likely be incurred in the unilateral repricing situation because, with a unilateral repricing, a value-for-value exchange is not possible.

Possible Solution to Consider

One solution is to draft the stock option award agreement to provide that the stock option will be automatically and immediately forfeited if the fair market value of the underlying stock falls below the exercise price by a certain dollar threshold.  For example, a stock option with an exercise price of $2.25 could provide in the award agreement that it will be automatically forfeited if the fair market value of the underlying stock is ever at or below $1.95.  The benefits of a stock-price forfeiture provision could include:  

  • The forfeited shares could return to and replenish the share reserve of the equity plan;
  • Avoidance of the time and expense associated with repricing underwater stock options and complying with the SEC's tender offer rules; and
  • Possibly avoiding shareholder issues that are typically associated with repricings and tender offers of underwater stock options.

Risks to Consider

For companies considering whether to implement a stock price forfeiture, the following issues should be considered (not an exhaustive list):

  • Whether the trigger of a stock price forfeiture, even if implemented at a time when the stock option is granted at the money, would be deemed a "cancellation" under NYSE and NASDAQ listing rules, thus being deemed a "repricing" subject to shareholder approval under such rules;
  • Depending upon the above answer, whether the terms of the equity plan would require shareholder approval to implement a stock price forfeiture;
  • Whether the terms of the equity plan would allow the forfeited shares to return to and replenish the share reserve under the equity plan; and
  • Whether the implementation of a stock price forfeiture at the date of grant would cause beneficial or adverse accounting consequences for the company.

Just another idea to consider that could increase the life expectancy of an equity plan's share reserve!


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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