It has been close to a decade since the New York Stock Exchange (NYSE) last updated its set of frequently asked questions (FAQs) regarding equity compensation plans. On August 18, 2016, the NYSE released updated FAQs and, although the update primarily clarifies certain FAQs and eliminates certain stale FAQs, it does significantly revise an FAQ relating to shareholder approval of share recycling provisions in equity compensation plans. In particular, the updated FAQ permits NYSE-listed companies to amend their equity compensation plans without shareholder approval to reflect the new accounting rules relating to stock-for-tax withholding.
Share Withholding for Tax Obligations
Earlier this year, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-09 intended to simplify accounting for stock-based compensation under FASB Accounting Standards Codification Topic 718 (Topic 718). Both Topic 718 and ASU 2016-09 apply to public and private companies.1
Under Topic 718, stock-based compensation may be classified as either equity or liabilities. If an award is classified as equity, the fair value of the award is measured on the grant date of the award and the compensation cost is amortized over the life of the award. If an award is classified as a liability, however, the fair value of the award must be re-measured at each reporting date until the award is settled, with any changes in the fair value recognized as a compensation cost. A company will generally seek to avoid liability accounting classification as it can result in greater costs to the company’s earnings.
Prior to ASU 2016-09, Topic 718 provided that, if a company withheld shares to satisfy a grantee’s tax obligations for equity awards at a rate in excess of such grantee’s minimum statutory withholding tax rate, then the entire equity award would be classified as a liability. ASU 2016-09 amended Topic 718 to eliminate this rule and permit companies to withhold shares to satisfy a grantee’s tax obligations for equity awards up to such grantee’s maximum statutory tax rate for each applicable jurisdiction without adverse tax consequences. The maximum statutory rate is based on federal, state and local taxes and is determined on a jurisdiction-by-jurisdiction basis.
As many companies have the minimum statutory withholding tax requirement baked into their equity compensation plans, this change in accounting standards raises the question of whether companies should amend their plans to reflect this change and, if so, whether for public companies such an amendment would require shareholder approval under the company’s applicable listing rules.
NYSE Shareholder Approval Rules
Rule 303A.08 of the NYSE Listed Company Manual (Rule 303A.08) generally provides that shareholders of a listed company must be given the opportunity to vote on all equity compensation plans and material revisions to such plans.
An “equity compensation plan” is a plan or other arrangement that provides for the delivery of equity securities (either newly issued or treasury shares) of the listed company to any employee, director or other service provider as compensation for services. An equity compensation plan also includes a compensatory grant of stock options or other equity securities that is issued under a plan.
Rule 303A.08 sets forth a non-exhaustive list of material revisions to equity compensation plans that require shareholder approval. Included within the list is an example relating to equity compensation plans that contain a formula for automatic increases in the shares available for issuance under the plans (also referred to as an “evergreen formula”) or for automatic grants of equity awards pursuant to a formula (i.e., so-called formula plans). Under Rule 303A.08, unless the formula plan has a term of not more than 10 years, each such increase or grant is a material revision to the plan requiring shareholder approval.
In determining whether an equity compensation plan is a formula plan, the plan’s share recycling provisions – provisions that specify the circumstances under which shares may be added back to the share pool (e.g., shares withheld or surrendered to satisfy tax obligations) – must be considered. The NYSE FAQs provide guidance in this regard.
Revised NYSE FAQs for Formula Plans
Prior to the update, the NYSE FAQs provided that a provision in an equity compensation plan to add back shares to a share pool (a share recycling provision) would not be a formula so long as such shares were never in fact issued to the grantee.
While this concept remains unchanged in the update to the NYSE FAQs, in response to ASU 2016-09, the updated FAQs provide that an amendment to an equity compensation plan to permit withholding of shares based on a grantee’s maximum tax obligation (rather than the statutory minimum tax rate) is not a material revision requiring shareholder approval. However, this is only the case if the withheld shares are never issued to the grantee, even if the withheld shares are added back to the share pool under the equity compensation plan.