Summary
President Clinton has signed into law the Worker Economic Opportunity Act (the "Act") which amends the Fair Labor Standards Act (the "FLSA") to clarify that an employer must exclude compensation attributable to a stock option, stock appreciation right or stock purchase under a "bona fide employee stock purchase program" (an "ESPP") from the calculation of overtime pay and also the calculation of whether the federal minimum wage has been paid for a non-exempt employee (i.e., an hourly employee). State laws regarding calculation of overtime compensation and the minimum wage are not covered in this Alert.
A stock option, stock appreciation right or purchase right under an ESPP granted prior to August 16, 2000, does not require any changes for the employer to obtain the benefit of the Act.
After August 15, 2000, certain restrictions are imposed on stock options, stock appreciation rights and ESPPs in order for the employer to obtain the benefit of the Act. If these restrictions are not imposed, then an employer is required to recalculate an hourly employee's overtime pay for up to the two years preceding each time a non-conforming stock option or stock appreciation right is exercised or stock is purchased under a non-conforming ESPP. Failure to recalculate and pay overtime on this basis exposes an employer to class action suits, fines and other penalties prescribed under the FLSA.
While regulations have not yet been issued explaining the full nature and scope of these restrictions, at this time it appears that options that provide for vesting in the first six months from the date of grant and options that may be exercised immediately, but remain subject to the employer's repurchase right (for example, on termination of employment on the case of so-called "early exercise options") present problems. More information is provided in this Alert.
Restrictions Imposed on Stock Options and Stock Appreciation Rights Granted After August 15, 2000
- Terms and conditions of the particular plan must be communicated to participating employees either at the beginning of the employee's participation in the plan or at the time of the grant of the option or right. A copy of the plan and option agreement will suffice for this purpose, and the legislative history of the Act indicates that the information need not be provided at one time as long as it is provided prior to an exercise.
- Exercise of the option or right is voluntary, which is typically the case for stock options but not always for stock appreciation rights.
- The option or right cannot be exercisable for a period of at least six months after the time of grant (unless because of death, disability, retirement, or a change in corporate ownership, or other circumstances as permitted by future regulation).
- The exercise price must be at least 85% of the fair market value of the stock at the time of grant.
- Any determinations regarding the award of, and the amount of, employer-provided grants or rights that are based on performance must be made based upon:
- meeting previously established performance criteria (which may include hours of work, efficiency, or productivity) of any business unit consisting of at least ten employees or of a facility, except that any determination may be based on length of service or minimum schedule of hours or days of work; or
- past performance (which may include any criteria) of one or more employees in a given period so long as the determination is in the sole discretion of the employer and not pursuant to any prior contract.
Warning: For employers that typically grant options to hourly employees that vest on a monthly basis starting with the date of grant or that permit exercise ("early exercise") prior to vesting, it is important to note that under the Act such options must not be exercisable for six months from their respective dates of grant to permit their exclusion from the calculation of overtime wage rates. This is an area in which we would expect the U.S. Department of Labor to issue exempting regulations, but none have been issued to date. Furthermore, since employee classification is extremely fact specific, unless/until exempting regulations are issued, employers should consider limiting to executive level employees grants of stock options that are immediately exercisable or that begin to vest within six months following the date of grant, unless the optionee's classification is certain.
Action Items for Employers
Employers should undertake a review of their documents and procedures relating to stock options and stock appreciation rights granted to hourly employees to ensure that the above procedures and conditions will be met for grants after August 15, 2000. In particular, employers that grant options to hourly employees that vest and permit exercise of some or all shares less than six months from their respective dates of grant or allow early exercise prior to vesting will need to reconsider continuing such a program (the legislative history clarifies that only the portion exercisable within six months of the date of grant need be included in the calculation of overtime). For example, an employer might permit vesting during this period, but delay exercisability for the vested option shares until the six month period has passed or until regulations are issued that clarify when the option may be exercised earlier.
Restrictions Imposed on ESPP Offerings Commenced After August 15, 2000
The Act does not define the term "bona fide employee stock purchase program." The Congressional report that accompanies the Act, however, clarifies that an ESPP that meets the requirements of Section 423 of the Internal Revenue Code of 1986, as amended (a "Section 423 ESPP") is one type of "bona fide employee stock purchase program." An ESPP that is not a Section 423 ESPP can still be a "bona fide employee stock purchase program" if contributions are voluntary, stock is purchased at no less than 85% of the fair market value of the stock on either the date the purchase right is granted or exercised, and the ESPP does not permit an hourly employee to accrue the right to purchase stock at a rate which exceeds $25,000 of the fair market value of such stock (determined either at the time the option is granted or the time the option is exercised) for each calendar year. The following additional requirements are imposed to qualify purchases under a "bona fide employee stock purchase program":
- Terms and conditions of the ESPP must be communicated to participating employees either at the beginning of the employee's participation in the program or at the time of the grant of the purchase right (a copy of the plan and offering will suffice and the legislative history indicates that information need not be provided at one time, but all information should be provided prior to a purchase to exempt that purchase).
- Exercise of the purchase right is voluntary (given the purpose of the legislation, "voluntary" should include an automatic purchase caused by an employee's voluntary enrollment in an ESPP, particularly if the ESPP also permits voluntary withdrawal prior to the date of the automatic purchase).
Action Items for Employers
Employers should make sure that information is being timely delivered and that if the ESPP provides for automatic exercise, there is also an opportunity for voluntary withdrawal prior to each purchase date.
Additional Exemptions
An equity compensation program that does not meet the above requirements, but was established under a collectively bargained agreement that was in effect on August 16, 2000, is exempted. Similarly, if an equity compensation program was in effect on May 18, 2000 (the date of the Act's enactment) and will require shareholder approval to modify the program to conform to the applicable requirements imposed by the Act, then grants or rights under such a program that are made from August 16, 2000 to August 15, 2001 are also exempt, even if they do not meet the above applicable requirements.