Form 4 and Form 5 Model Form 133: Grant of Performance Rights (or Performance Shares)
ILLUSTRATIVE FACTS: Timothy T. Temple, an executive vice president of TUV Corporation, is a participant in the TUV long-term incentive plan. The plan authorizes the compensation committee of TUV’s board of directors (consisting of two “non-employee directors”) to award “performance rights” (sometimes called “performance shares” or “performance units”) to selected employees, to determine the vesting date or dates of awards, and to establish the performance criteria which must be met as a condition to vesting. Awards that vest are payable in cash or shares of TUV common stock, at the election of the committee, and awards that do not vest on the specified vesting date expire automatically. On January 5, 2009, the committee granted to Temple three awards of performance rights, with each right having a value equal to one share of TUV common stock. The first award was for 5,000 performance rights and vests if the price of TUV’s common stock increases from $26 (its market price on the date of grant) to a target of $30 per share before December 31, 2009. The second award was for 10,000 performance rights and vests to the extent that TUV’s earnings per share and return on equity for the year ending December 31, 2009 exceed 2008’s levels by specified amounts. The third award was for 15,000 performance rights and vests on December 31, 2010 if (i) the market price of TUV’s common stock increases from $26 on the date of grant to at least $33 per share (weighted at 75%) and (ii) Temple meets certain individual performance objectives, i.e., attainment of specified production quotas and product acceptance levels (weighted at 25%). The terms of the third award provide that the plan administrators may adjust the performance criteria or periods at any time prior to the vesting date. Temple was notified of the committee’s actions by memorandum the following day.
REPORTING PRINCIPLES: (1) Performance Rights Reportable Where Vesting Based On Market Price Of Issuer Securities. A performance right whose value is tied to the market price of issuer securities is a reportable derivative security, whether the right is payable in cash, in stock, or in a combination of the two. Where the sole performance criterion is an increase in the market price of an equity security of the issuer, performance rights are derivative securities, reportable as of the date of grant, without regard for whether the rights will vest, if at all, some time in the future and only if the insider remains employed by the issuer. See General Mills, Inc. (recon. January 31, 1992); Kansas Power and Light Co. (March 25, 1992); Equifax, Inc. (January 5, 1993); Compliance and Disclosure Interpretations, Exchange Act Section 16 and Related Rules and Forms, Interp. 209.03 (May 23, 2007)). Accordingly, Temple’s 5,000-share award of performance rights constituted a reportable award as of January 5, 2009. Performance rights that do not vest on the basis of the market price of equity securities of the issuer are not derivative securities, even where the rights are denominated in shares of issuer common stock (see Equifax, Inc. (January 5, 1993)), may be paid in cash upon a change of control (id.; Kansas Power and Light Co. (March 25, 1992)), or provide for the payment of cash equal to the amount of dividends paid on stock issued in settlement of the right. (Id.) (2 Performance Rights Not Reportable Where Vesting Based On “Components” Of An Equity Security. Performance rights that vest based on components of an equity security do not have a value “tied to the market price of issuer securities” and therefore are not derivative securities for purposes of Section 16. The vesting of Temple’s 10,000-share award of performance rights is based on TUV’s earnings per share and return on equity, neither of which is the equivalent of the market price of issuer securities for purposes of Section 16 (even though they may affect the market price). Despite the SEC staff’s initial conclusion to the contrary (see General Mills, Inc. (May 7, 1991)), the staff now takes the position that performance rights based on such criteria are not derivative securities. See General Mills, Inc. (recon. January 31, 1992); Kansas Power and Light Co. (March 25, 1992). Accordingly, the grant of Temple’s 10,000-share award is not reportable. The SEC staff also takes the position that performance rights that vest based on increases in the issuer’s book value over a specified period of time are not derivative securities. See Lincoln National Corp. (March 20, 1992) (Q. 4). The Commission has indicated that the staff will continue to analyze the vesting provisions of other forms of performance share awards to determine whether such awards should be deemed to be derivative securities. See Release No. 34-37260, § III.D. (1996). (3) Performance Rights Not Reportable Where Vesting Based In Part On Market Price Of Issuer Securities And In Part On Other Factors. The staff has taken the position that performance rights are not reportable derivative securities where vesting is based in part on the market price of issuer securities and in part on other factors, such as individual performance factors, achievement of production objectives, etc. See Ford Motor Co. (July 18, 1991). In the Ford Motor Co. letter, the staff suggested that performance rights based 50% on the value of issuer securities and 50% on other criteria do not have a value tied to the market price of issuer securities and therefore are not derivative securities. Subsequently, the staff suggested that performance rights will be deemed derivative securities only if their value is tied solely to the market price of issuer securities. See Equifax, Inc. (January 5, 1993). Accordingly, Temple’s 15,000-share grant (which is based 75% on the market price of TUV’s common stock) is not reportable. (4) Total Shareholder Return As A Performance Condition May Be Equivalent Of Stock Price. The staff has expressed the view that an award that vests only if the issuer achieves a specified level of “total shareholder return” (defined as stock price appreciation and dividends) may be reportable at the time of grant as an award whose vesting is tied solely to the price of the issuer’s stock, depending on the significance of dividends as a component of the issuer’s total shareholder return. If, for example, the issuer pays no dividends or only a de minimis dividend, conditioning vesting of an award on total shareholder return would be the equivalent of conditioning vesting on the issuer’s stock price, and therefore the condition would not prevent the award from being reportable at the time of grant. See the September 2008 issue of Section 16 Updates at p. 9. (5) Performance Rights Not Reportable Where Plan Administrators May Modify Performance Criteria Prior To Vesting. Where the vesting of performance rights is based on criteria that may be altered by the plan administrators prior to vesting, the value of the rights is based on the action of the administrators, not the market price of issuer securities, and therefore the rights are deemed not to be derivative securities for purposes of Section 16. See Merrill Lynch & Co. (August 28, 1992) (Q. 4); Boston Edison Co. (March 19, 1992). Accordingly, in view of the discretion of TUV’s compensation committee to adjust the performance criteria and periods applicable to Temple’s 15,000-share award, the award did not constitute the grant of derivative securities and therefore need not be reported for that additional reason. (6) Grant Of Performance Rights Exempt Under Rule 16b-3 If Approved By Committee Of Two Or More Non-Employee Directors. Rule 16b-3(d) exempts grants and awards of equity securities that are specifically approved in advance by the board of directors or a committee “composed solely of two or more non-employee directors,” or are approved in advance or ratified by the issuer’s shareholders no later than the date of the issuer’s next annual meeting, or are held for at least six months. Temple’s awards of performance rights were approved by TUV’s compensation committee, which is composed of two non-employee directors, and therefore the grant of Temple’s 5,000-share award was exempt from Section 16(b) by virtue of Rule 16b-3(d)(1). (7) Exempt Grant Of Performance Rights Reportable On Form 4. A grant of performance rights is reportable on Form 4, whether or not the grant is exempt from Section 16(b) under Rule 16b-3(d). See Rule 16a-3(f)(1)(i)(A) and Rule 16a-3(g)(1). The deadline for reporting the exempt grant of performance rights is, therefore, the end of the second business day following the date of grant. (8) Date Of Grant Of Performance Right Is Date On Which Rights And Obligations Of Parties Become Fixed. The date of grant of a performance right is the date on which the rights and obligations of the issuer and the insider become fixed. For most issuers, that date will be the date on which the board of directors or an authorized board committee adopts resolutions approving the grant of the performance right. Issuers that notify grantees of their receipt of performance rights by sending a memorandum summarizing the terms of the award might instead take the position that the date of grant is the date of the insider’s receipt of the memorandum, based on an argument that the award is not enforceable by the insider until he or she receives notice. Similarly, issuers that enter into agreements with grantees evidencing grants of performance rights might take the position that the rights and obligations of the parties do not become fixed until both the issuer and the insider have executed an agreement. While each of the latter two positions is supportable, issuers may find it difficult to track individual grant dates if either position is utilized to determine the grant date. Accordingly, most issuers treat the date of board or committee approval as the grant date for purposes of Section 16. This position is consistent with the FASB staff’s position that, for purposes of FAS 123(R), an issuer may treat the date of committee approval of an award as the date of grant, provided that (i) the award is a “unilateral” grant, meaning that the grantee does not have the ability to negotiate the key terms and conditions of the award, and (ii) the issuer expects to communicate the key terms and conditions of the award to the grantee within a relatively short period of time after committee approval. See FASB Staff Position No. FAS 123(R)-2 (October 18, 2005). The grant date is the applicable date for purposes of completing Box 3 of Form 4 and Column 3 of Table II of Form 4 or Form 5, and also is the date from which the Form 4 filing deadline is calculated. Temple has treated the date of committee approval of his 5,000-share performance award (i.e., January 5) as the date of grant. (9) Grant Of Performance Rights Reportable In Table II. Reportable performance rights are derivative securities (see Reporting Principle (1) above), and therefore the grant of performance rights should be reported in Table II of Form 4 (or Form 5), as Temple has done in reporting his 5,000-share grant. (10) Use Transaction Code “A” To Report Exempt Grant Of Performance Rights. Because the grant of Temple’s 5,000-share award of performance rights was exempt under Rule 16b-3(d), it is reportable using transaction code “A” (“Grant, award or other acquisition pursuant to Rule 16b-3(d)”). If the grant were not exempt, Temple would use transaction code “P” (“Open market or private purchase of non-derivative or derivative security”). See Release No. 34-26333, n. 101 (1998). (11) Description Of Nature Of Performance Rights Not Required. Although it is necessary to describe in Column I of Table II the nature of a stock option (i.e., whether the option represents a right or obligation to buy or sell the underlying securities), the same is not true of performance rights. It is sufficient merely to insert “performance rights” in Column I of Table II. It is not necessary to indicate whether the rights may be settled in cash, stock, or a combination of the two. (12) Number Of Derivative Securities In Column 5 Of Table II Is Same As Number Of Underlying Securities In Column 7. Since one performance share is equal to one share of the stock to which it relates, the numbers inserted in Columns 5 and 7 of Table II (which relate, respectively, to the number of derivative securities involved in the transaction and the number of underlying securities) should be the same (i.e., the number of shares). (13) Insert “$0” In The Price Column When Reporting Performance Shares. Insiders generally are not required to pay for performance shares awarded to them as compensation. Accordingly, insiders should insert “$0” in the price column (Column 8 of Table II) when reporting the grant of performance shares, as Temple has done. It is not necessary for the insider to include a footnote explaining that no consideration was paid for the performance shares, although an insider may do so if he or she wishes. Insiders may not simply leave the price column blank, however, because the electronic filing system will not accept a Form 4 or Form 5 that reports a transaction on a line that leaves blank any of the transaction-related columns on that line (including the price column). (14) Acquisition Of Issuer Stock Upon Settlement Of Performance Rights That Are Not Derivative Securities Is Reportable. Performance rights that do not constitute derivative securities are not reportable at any time. If, however, they ultimately are settled in shares of issuer stock, the acquisition of those shares must be reported as the acquisition of issuer stock in Table I of Form 4 or Form 5, as appropriate. See Model Form 134. (15) Cancellation Of Performance Rights Due To Failure to Meet Performance Conditions Not Reportable. A typical performance right expires or is canceled automatically if the performance objective is not met by a specified vesting date. If the expired performance right was a derivative security, the expiration or cancellation of the right constitutes “[t]he disposition or closing of a long derivative security position, as a result of cancellation or expiration,” for no value, and therefore is exempt from both Section 16(a) and Section 16(b). See Rule 16a-4(d). Accordingly, if Temple’s reportable performance right fails to vest on or before December 31, 2009, the expiration of the right will not be reportable. The expiration of a performance right that is not a derivative security would not be reportable under any circumstance. (16) Grant Of Performance-Based Restricted Stock May Be Reportable. Generally, awards of stock or derivative securities that vest only upon satisfaction of performance criteria (other than the price of the issuer’s stock) are not deemed acquired as of the date of the award, but instead are deemed acquired when the performance criteria have been satisfied. The staff once expressed the view, however, that an award of performance-based restricted stock should be considered acquired on the date of grant, even though subject to forfeiture if the performance criteria are not satisfied, if shares are issued in the insider’s name and carry voting and dividend rights. See GFC Financial Corp. (April 11, 1994). The staff’s letter arguably is inconsistent with the general principle that an award subject to performance vesting is not beneficially owned until the performance criteria have been satisfied. In addition, the distinction between stock actually issued and stock issuable in the future (as with, for example, performance-based restricted stock units) suggests that voting and dividend rights, rather than the right to the value of securities, should determine beneficial ownership. In any case, the staff’s position provides a basis for insiders to report grants of performance-based restricted stock within two business days of the date of grant. Based on general principles of beneficial ownership, however, the authors believe that insiders may instead report such awards within two business days of the date of vesting.
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