Executive Compensation without Notes

ATTEST & ASSURANCE | TAX COMPLIANCE & RESEARCH | SPECIALTY & CONSULTING

PRESENTATION TO:

Westchester County Bar AssociationDomestic Relations and Family Law SectionMarch 24, 2015

Handling Options, Restricted Stock, & Other Compensation in Divorce

Executive Compensation

Presented by:

- Gary Karlitz, CPA/ABV/CFF, CBA, ASA

- Mark DiMichael, CPA/ABV/CFF, CFE

Modern Elements of Incentive Pay

TYPICAL COMPENSATION ELEMENTS FOUND FOR:

CEO of a publicly traded company

President of reinsurance company or bank

Principal of a hedge fund

Portfolio manager of a hedge fund

Principal of private equity fund

CEO of a portfolio company

Financial Advisor

3

Three Fundamental Definitions

Security

Stock

Membership Interest

4

CEO of a Publicly Traded Company (1 of 7)

Base Salary- IRC § Section 162(m) precludes a public

company from deducting for any year compensation paid

in excess of $1 million to a "covered employee" .

5


Restricted Stock- Can be known as “letter stock” under rule 144 which is not fully transferable but it can be a form of equity compensation under IRC § 83.

- A substantial risk of forfeiture exists where rights in the stock are conditioned

- Vesting may be a “cliff” or a “scheduled over time.” But during the vesting period the stock can’t be transferred.

> Valued as a minority, non-marketable interest

> Taxable as ordinary income when risk of forfeiture lapses

> Alternatively taxed under IRC § 83(b).

6


Restricted Stock Units (RSU).

- RSUs involve a promise by the employer

- Gained popularity

- The biggest difference between RSUs and employee stock

options

7


Restricted Stock Units (RSU) - continued.

- Generally RSU’s are considered an incentive to stay with the company. Assuming the employee stays for the entire vesting period, and depending on how the company's stock performs, the employee may actually receive more or less than the value of the RSU’s at date of issuance.

- Example:> At Grant Date - 200 RSUs at $50 Per Share = $10,000

> Vests 3 Years from Grant Date

> At Vesting Date - 200 RSUs at $100 Per Share = $20,000

- Tax Treatment

- Where does the money come from?

- The closing price on the vesting date becomes the cost basis of the vested shares.

8


Geared RSUs (Performance Grants)- Units that can

convert into a greater (or lesser) than 1:1 ratio

depending on achieving performance targets i.e., share

price, earnings per share, return on equity, peer group

standing.

Stock Options – See discussion later in program.

9


Parachute Tax Gross Up- Parachute payments arise

when a corporation experiences a change in control.

Severance Rights Agreement - Specifies severance paid

on a termination of employment.

SERP - Non-Qualified Deferred Compensation

Arrangements - "Top Hat" Plan

Perquisites- For example, Jack Welch-General Electric

Company

10


"In addition, the Company shall provide Mr. Welch, for the

remainder of his life, continued access to Company

facilities and services comparable to those provided to

him prior to his retirement, including access to Company

aircraft, cars, office, apartments, and financial planning

services. The Company shall also reimburse Mr. Welch, upon

the receipt of appropriate documentation, for reasonable

travel and living expenses which he incurs in providing

services at the request of the Chief Executive Officer, or which

he incurs because of his position as a retired Chairman of the

Board and Chief Executive Officer of the Company." (J. Welch

Employment and Post-Retirement Consulting Agreement with

General Electric Company, dated December 20, 1996).

11

President of a Reinsurance Company or Bank

(1 of 2)

Base Salary

Cash bonuses

Equity Grant or Equity Participation Plans

Stock Options

Rabbi Trust - Trusts established by Employer to fund

deferred compensation obligations.

12

President of a Reinsurance Company or Bank

(2 of 2)

Secular Trust- An irrevocable trust, not subject to

employer's creditors.

Annuity Contracts- Alternative to Secular Trust the

"inside buildup" will not be currently taxable if the

executive is the owner of the contract.

Life Insurance- see Annuity Contracts.

13

Principal of Hedge Fund (1 of 2)

Base Salary - draw against annual compensation

Net profit from management company (if any)

"Points"- Annual Compensation based on a percentage

of Performance Fees or carry

14

Principal of Hedge Fund (2 of 2)

Performance Fee Allocation – if a “carry” exists then the

benefit can result in larger share of the fund without

current tax recognition

Voluntary Deferral -a percentage of Annual

Compensation is usually deferred into a master fund, on

or offshore.

Mandatory Deferral - a percentage of Annual

Compensation subject to vesting.

15

Portfolio Manager of Hedge Fund

(see Principal of Hedge Fund)

Trading P&L- for a specific investment or investments

during a specific applicable measurement period.

16

Principal of a Private Equity Fund (1 of 3)

“Private Equity Fund” – a fund that purchases equity investments, generally in non-public companies.

Base Salary

Net profit from management company (if any)

Convertible Preferred Stock

- Class A, B or C interests –

» A Founder (preferred voting);

» B Investor (preferred voting but less, management control).

» C Employee (non voting Common).

17


Options - a security that gives the holder the right to purchase a share of stock at a predetermined price.

Carried Interest - a share of the profits that the general partners of private equity and hedge funds receive as compensation despite not contributing any initial funds (also called Carry, Points, Promote, or Profit Interest).

Catch-up - clause in agreement between the General Partner and the Limited Partners. Once the Limited Partners receive a certain portion of the total return & initial investment, the General Partner participates significantly in the profits until an agreed upon split is reached.

18


Claw back - the right of the Limited Partners to reclaim

payments to the General Partner

High water mark

19

CEO of a Company in the Portfolio of a

Private Equity Company

Salary

Annual Bonus- Performance Award

Long Term Incentive Grants- RSU's, option, profit

interests

Accelerated Stock Options - Stock options that vest

on an accelerated schedule based on performance

20

Financial Advisor

Commissions

Draw against Commissions

Loans

- Forgivable loans

- Bonus paid so financial advisor can repay loan

21

Stock Options 101

Stock Option

- A contract that gives someone the option to buy or sell shares of

a particular stock for a set price, for a set amount of time.

> Call Option

> Put Option

22

Stock Options 101

Stock Option- A contract that gives someone the option to buy or sell shares of a

particular stock for a set price, for a set amount of time.

> “For a Set Price”

– Strike Price (Exercise Price) – The pre-specified price at which the holder of a call option can buy a stock.

» $50 - Fair Market Value of Stock» $45 Strike Price - In the Money» $55 Strike Price - Out of the Money

> “For a Set Amount of Time”

– Expiration Date (Exercise Date) » American Style Options» European Style Options

23

Stock Options 101

Example

- Grant Date = January 1st

- Expiration Date = December 31st, 2015

- Market Price as of January 1st, 2015 = $70

- Strike Price = $70

24

Stock Options 101

Types of Value

- Intrinsic Value

- Time Value

25

Option Pricing Model Theory

Two Most Commonly Used Methodologies

- Black Scholes Model

- Binomial (Trinomial, Etc.) Option Pricing Model

- Both methods rely on the concept of “Option Hedging” – the

ability to purchase offsetting options to eliminate risk.

26

Black Scholes Model Example

An employee is granted a stock option that vests

immediately.

- The option expires in 5 years.

- The Stock’s Market Value at Grant/Vesting Date is $10.

- The strike price is $10.

- Historical volatility is determined to be 50%.

- The stock pays no dividends.

- What is the option worth?

27

Black Scholes Option Pricing Model

28

Black-Scholes Call/Put Option Pricing Model

Assumptions

Variables & Values Description

C 4.89$ Call Option Price ($)

P 2.87$ Value of Put Option ($)

S 10.00$ Current Value of the Underlying Stock ($)

K 10.00$ Strike Price of the Option ($)

t 5.00 Time to Expiration of the Option (Yrs.)

r 4.50% Risk-Free Rate (%) (match horizon to Expiration)

v 50.00% Annual Volatility (%) (standard deviation)

d 0.00% Dividend Yield (%)

e 2.71828 2.71828

N(d1) 0.7765 Value of normal distribution at (d1)

N(d2) 0.3603 Value of normal distribution at (d2)

C = S e^-dt N(d1) - K e^-rt N(d2) = 4.89

d1 = (ln(S/K) + (r - d + v^2/2)t)/vt^.5 = 0.7603

d2 = d1 - vt^.5 = -0.3578

Taxation of Employee Stock Options

Two Types of Employee Stock Options – Both Taxed Differently:

1 Non-Qualified Stock Options> When options are exercised, the difference between the market price

and the strike price is taxed as ordinary earned income, subject to payroll taxes.

> After stock purchase, if stock is held for a period of time, any future gains/losses compared to the market value at the exercise date is taxed as capital gains/losses.

2 Incentive Stock Options (ISOs)> Numerous requirements for stock to qualify as an ISO under Internal

Revenue Code Section 422.

> Qualify for favorable tax treatment for the employee’s. Several different taxation issues discussed on next two slides.

29


ISOs – Income Taxes on Premature Dispositions

- A Premature Disposition of an ISO is when an individual sells the

stock less than 1 year from the exercise date or less than two

years from the grant date. Taxed as follows:

> Individual pays ordinary income tax on compensation – valued at

the spread between the strike price and the market price at the

grant date.

> Any profit above compensation income is capital gain.

> If employee sell the shares at a loss, the entire amount is a capital

loss, and there is no compensation income to report.

30


ISOs - Income Taxes on Qualifying Dispositions

- Qualifying Disposition - means that the ISO stock, was disposed

more than two years from the grant date and more than one year

after the exercise date.

> No tax at the time of exercise (potential AMT exception).

> Taxed as a long term capital gain/loss on the difference between the

selling price and the exercise price of the stock.

> The difference between the strike price and the market price at the

grant date (the spread) becomes an Alternative Minimum Tax (AMT)

preference item, which may increase the employee’s tax liability in

the year the grant is exercised.

31

DeJesus vs. DeJesus

The parties were married in October of 1979.

In November 1993, Astoria Financial Corporation

granted Wilfred DeJesus two stock option plans:

- Incentive Stock Option Plan (ISO)

- Recognition & Retention Plan (RRP)

32

DeJesus Stock Option Plans

Both plans (ISO & RRP) granted in 1993.

Couple filed for divorce in July 1994.

ISO gave Husband an option to purchase company stock at $25 per share, exercisable in three annual installments in January of 1997, 1998, and 1999.

RRP gave Husband a right to receive shares of company stock (with no payment necessary), in three annual installments in January of 1997, 1998, and 1999.

Both stock option plans were contingent on Husband’s continued employment with the company and both were described by the employer as "incentives.“

33

DeJesus v. DeJesus

Trial court found that although the rights to the stock

plans did not vest during the marriage and may never

vest, the were “tangible benefits which were bestowed

on [Husband] during the marriage”.

The court referenced a Colorado Decision In re Marriage

of Miller and adopted a methodology for determining the

percentage of a stock option or bonus that is marital

property.

34

Takeaways from DeJesus

Sometimes a spouse is awarded a form of executive compensation for efforts that were expended during the marriage as well as for efforts that are expected to be expended outside of the marriage (before or after).

The first step is to determine the time period during which the compensation is earned.

- Concept of a Bonus vs. an Incentive

This could result in a determination that the efforts were

- Marital

- Separate

- A combination of the two

35

The “DeJesus Formula”

If the compensation is determined to be a combination of

marital and separate property, the next step is to determine

the marital portion of the bonus or incentive:

In the case of a stock incentive, the fraction would be:

Time from date of the grant to the date of commencement

Time from date of the grant to the date of exercisability

Bonuses can also be apportioned by the same fraction, but

with different descriptions for the numerator & denominator.

Marital time period during which the bonus was earned

Entire time period during which the bonus was earned

36

S.H. v. E.S. – Application of DeJesusCitation: S.H. v. E.S., xxxxxxx, NYLJ 1202676582939 at *1 (Sup., WE, Decided October 24, 2014)

Plaintiff / S.H. - Husband

Defendant / E.S. – Wife

Husband hired by Bank Capital on Sept 22, 2008

Date of Commencement – November 4, 2009

Husband was awarded several separate stock option

and bonus plans that were contested.

37

S.H. v. E.S. – Special Cash Award

Hire Date - Sept 22, 2008


$1,750,000 awarded on hire date, payable in 2 annual installments:- 1st anniversary (9/22/09) – Parties agreed this was marital

- 2nd anniversary (9/22/10) – Disputed by parties

Court decided that the award was entirely marital- Bank offer letter refers to it as a bonus

- Not based on Husband’s performance

- Husband merely needed to maintain employment.

It appears that tenure alone does not render the award as partially separate property.

38

S.H. v. E.S. – 2008 Equity Participation Plan

(EPP) Award



Equity Participation Plan- Basic Award - 423,923 shares

- 20% Bonus Award - 84,786 shares

- 10% Bonus Award - 42,393 shares

- Shares are “Provisionally Granted” and to be paid out over a period of 3 to 5 years at the discretion of the plan trustee

Court decided that the award was an incentive plan, not a bonus.- Plan document stated that the purpose of the plan was “to align key

employees interest with those of the bank group shareholders”.

- The DeJesus formula was applied.

39

S.H. v. E.S. – Incentive Share Plan



Plan was granted to plaintiff on April 3, 2009.- Plan would provide 54,799 shares and also accrued 633 accrued

dividend shares to plaintiff.

- The award letter stated that the shares were earmarked for the plaintiff, but that the plaintiff had no right to them or any interest to them until his third anniversary of the award date at the discretion of the trustee.

Court decided that the award was an incentive plan- The plan name is “Incentive Share Plan”.

- The DeJesus formula was applied.

40

S.H. v. E.S. – Cash Value Incentive Plan



Plan was granted to Husband in August 2010- This plan was a hybrid award to husband of cash and stock.

- Though granted to Husband in August 2010, the plan was “recommended” in 2009 (the precise date was unknown) for the 2009 through 2011 plan cycle.

- “Participants in the Plan are the most highly valued executives in the firm and membership is a reflection of my assessment of your past and potential future contribution to exceptional business performance”

Court decided that the award was an incentive plan that was earned at least partially for work occurring during 2009.

The DeJesus formula was applied to determine the percentage of the husband’s award that is marital, to be distributed as if and when it is paid to the Husband.

41

S.H. v. E.S. – The “One Off Payment”



Letter dated December 17, 2009 stating that Husband

would receive a one time payment of $45,955 net of

taxes in January 2010 in exchange for the Husband’s

agreement to give 3 months notice of termination.

The court determined that this was separate property of

the husband.

42

Questions???

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CONNECTICUT | NEW JERSEY | NEW YORK | PENNSYLVANIA CITRINCOOPERMAN.COM

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CITRIN COOPERMAN & COMPANY, LLP

Gary Karlitz CPA/ABV, CBA, ASAPartner in Charge, Valuation & Forensics Department

E-mail: [email protected]

Phone: 212.697.1000

NEW YORK OFFICE

CONNECTICUT | NEW JERSEY | NEW YORK | PENNSYLVANIA CITRINCOOPERMAN.COM

Image

CITRIN COOPERMAN & COMPANY, LLP

Mark DiMichael, CPA/ABV/CFF, CFEManager, Valuation & Forensics Department

E-mail: [email protected]

Phone: 212.697.1000

NEW YORK OFFICE

CAYMAN | CONNECTICUT | NEW JERSEY | NEW YORK | PENNSYLVANIA

CITRINCOOPERMAN.COM

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