Companies want employees to make premature exercises of ESOs and so do the Wealth Managers.
John Olagues Truth In Options 504-305-4449 www.optionsforemployees.com/articles email@example.com .
Below are links to the Google Stock Plan document and to the Cisco Incentive Stock Plan document: Google http://www.secinfo.com/d14D5a.r3mD3.d.htm#1stPage Cisco http://www.secinfo.com/d14D5a.v5RKa.d.htm Although both of the Stock Plan documents prohibit transferring or pledging the employee stock options (Google allows a limited form of selling to selected banks and under some circumstances the Cisco options can be transferred to family members), n either of these documents have a prohibition against hedging with exchange traded calls and puts. Nor is there any prohibition against hedging in the Options Award Agreements.
The Stock Plan and Award Agreements are the documents that constitute the contract between the company and the grantee regarding the granted equity compensation. Since there is no prohibition against hedging in the contract documents, why do many companies discourage the strategy? Some even tell their employees that hedging is prohibited by the plan. If holders of employee stock options are prohibited from hedging ESOs, then why is it not written in the documents?
The answer is that the company officials know that there is generally no prohibition in the company documents but they know that premature exercises benefits the company in three ways as below. 1. The employee forfeits the remaining "time premium", which the company recaptures. 2. The employee pays an early tax, and the company gets an early deduction from income tax, equal to the difference between what the grantee buys the stock for and what the stock could be sold for in the market. 3.The employee pays the exercise price early and that adds to the cash flow to the company. Therefore, the company encourages premature exercises by ESO holders .
But when most of the plans were established, there was no prohibition against hedging. And the plans require that if there is a change to the plan which may be adverse to the grantee, the company needs the approval of the grantee. So the companies can not just insert a prohibition against hedging into their present plans, because that diminishes the value of the ESOs to the existing grantees and those who relied on there being no prohibition.
So the companies try to make employees think that there is a prohibition when there is none. But there is a drawback to that strategy and that is if the company adviser tells the employee he can not hedge and the stock goes down after he is told that he can not hedge, the company would be liable for damages. Also, in my opinion, the advisers who tell their clients that they can not hedge when the documents clearly allow hedging, open themselves up to a liability similar to the company's liability. The difference in after tax value that the grantee will receive is on average about 50% more from hedging compared with a premature exercise strategy with the stock 90% above the exercise price. So the liability is not incidental.
In this part of the presentation, I will refer to the specific parts of the plans and discuss the fact that in both the Google and Cisco Stock and Options plans, there is very limited transferability and no pledgeability but no prohibition from hedging. I will also discuss the fact that both plans mention that the plans can not be amended without the approval of the optionee.This prevents the company from adding a prohibition from hedging when none was there prior. In the Google plan, Paragraph 4b(v) discusses the duties and abilities of the Administrator but he does not have the discretion to prohibit hedging. Paragraph 14 discusses the ESOs non-transferability. There is no prohibition against hedging there. Paragraph 18 c) discusses the fact that the plan can be amended only with the participant's approval. See the link http://www.secinfo.com/d14D5a.r3mD3.d.htm#1stPage
In the Cisco plan, we find that the plan does not prohibit hedging but does prohibit transfers or pledging. Article 1, Paragraph D, under Administration of the Plan , illustrates the limitations of the Administrator. Article 2, Paragraph G under Options Terms describes the prohibition against transferring, selling and pledging but hedging is not mentioned. Article 5, a paragraph which is titled Amendment to the Plan does not allow an amendment which may effect the rights and obligations of optionees in the plan unless with the is approval from the optionees. http://www.secinfo.com/d14D5a.v5RKa.d.htm
In summary, Google and Cisco have no prohibitions against hedging. Holders of ESOs are free to manage their equity compensation as they see fit as long as it is consistent with the Plan Documents and Options Agreements, without further approval from anyone. Those who tell grantees that they are not allowed by the company to hedge when the documents permit hedging are subjecting themselves to liability.