Two Step's Private Company Equity Management Blog

I'd like to share with our Corporate Focus and Equity Focus users three great resources that I recommend for equity planning, equity transactions, and understanding equity instruments. Our customers have used all of these, and I want to make sure the Two Step community is aware of them. This is Part 3 of a three-part series.

If you're an employee receiving stock options or a manager awarding stock options, it seems you never can know enough. Equity compensation is a constantly changing field, and there's always something new on the horizon, whether it relates to understanding the vast array of equity instruments (options, restricted stock, ESPPs, RSUs, SARs) or navigating the complex accounting and tax issues.

When seeking answers, sometimes you need just a little more information in order to ask the right questions of your attorneys, accountants, and advisors. That's why so many Two Step users have turned to myStockOptions.com. It's an unbiased source of expert advice that you can start using for free. Then, you can upgrade to their Premium version for more in-depth information (which is well worth the small additional fee). myStockOptions.com recently celebrated its 10th anniversary and published a great article: Five Major Developments in Equity Compensation of the Past Decade.

The myStockOptions website says:

"Equity compensation can be complex and confusing. By educating you, or your advisor, we help you make smart financial decisions. With our independent and unbiased expertise, we encourage you to make the most of stock options, restricted stock, restricted stock units, stock appreciation rights, employee stock purchase plans, or performance shares.

"Our excellence is attested by our awards, our US patent, our contracts with major stock plan providers, and the praise of people who use the site. The award-winning educational content and tools of myStockOptions.com were developed by experts in financial planning, taxation, securities law, stock plan administration, and human resources."

If you need a reliable equity compensation resource, take a look at myStockOptions.com. I promise it will be time well spent. And when you're ready to simplify your ownership administration or equity compensation reporting, contact us at Two Step Software to see our system or find other great resources.

I'd like to share with our Corporate Focus and Equity Focus users three great resources that I recommend for equity planning, equity transactions, and understanding equity instruments. Our customers have used all of these, and I want to make sure the Two Step community is aware of them. This is Part 1 of a three-part series.

Want to know how much equity compensation to award a founder or senior executive? Look no further than "the startup executive compensation resource": www.compstudy.com. Now in its 10th year, the CompStudy survey is put out by J. Robert Scott, Ernst & Young, and academics from the Harvard Business School. It covers China, India, Israel, the UK and the U.S. According to the CompStudy website:

"CompStudy is the longest-running, most comprehensive survey of equity and cash compensation for top management positions and boards of directors at private companies in the technology and life sciences industries. The study results provide essential information for businesses and investors who want to stay abreast of current trends in senior executive compensation and organizational structures."

CompStudy offers an irresistible deal: if you complete the 2010 survey and send along your information (which will be kept anonymous), you'll get a free copy of the survey - much better than paying $999! If you need this type of information as you're planning your equity compensation awards, take the survey and get your free copy of the 2010 results when they come out. Or if you can't wait, you can purchase the 2009 survey today.

I was impressed with last year's survey and consider CompStudy to be a great resource for our law firm users, who have clients that need knowledgeable advice on what to award key employees. It's also helpful for our CFO customers, who need to ensure that their total compensation packages compare favorably to the market.

If you have questions or remarks regarding CompStudy, feel free to add them to the Comments section. And when you're ready to simplify your ownership administration or equity compensation reporting, contact us at Two Step Software to check out our system.

In my previous blog post, I answered the question, "Should You Add New Web Tools to Your Stock Plan Administration Toolkit?" with a resounding "yes!".

So right about now you're probably asking, "Well, Jeremy, what are these web tools, exactly?" Luckily, I've got some great answers for you. Listed below are just a few of the powerful tools you can leverage to streamline your stock plan administration work.

1. Tools for Communicating with Your Employees
   I bet that most people reading this are still using regular old email to send out notices to their employees. With the latest web tools, you can create engaging, interactive newsletters that your employees are more likely to read. Here are two of my top picks:
1. Vertical Response - This is an email creation tool that allows you to create stylish templates from which to send emails to your employees. Not only that, but you can set it up to tell you precisely how many of your employees are actually reading your emails.
2. Vizu - When you want to know what your employees think about a change to their stock plan, create a short poll for them. Vizu is a free tool that allows you to do this easily. You can then embed the poll on your portal page or include it in an email.
2. Tools for Training Your Employees
   Every new employee needs to be trained on how your stock plan works, and every existing employee needs to be educated on changes to your stock plan. This is typically done by having either one-on-one trainings or a group meeting to go over the changes. These types of physical meetings are useful, but what do you do for people who miss them - or for those who work remotely? These two tools offer great solutions:
1. GoToMeeting - This application allows you to set up an online or "virtual" meeting with an employee in a remote location. You can share your computer screen with that person to go over the details of the stock plan. An alternative to this tool is Skype, which also works very well.
2. Jing - This free tool is made by Camtasia and allows you to record video and audio from your computer screen, which can then be shared with your employees via your portal or email. If you need advanced video editing, you can always pay for their Camtasia tool.
3. Networking Tools
   These web tools allow you to network on the web. I know one stock plan administrator who used these tools to land his current job - and he couldn't have done it without them.
1. LinkedIn - If you haven't already done so, I strongly recommend joining LinkedIn. On LinkedIn, you can post an electronic resume and connect with other LinkedIn members in the industry. After you have your LinkedIn account, take some time to explore the LinkedIn groups that interest you. You can use these to read through questions that others post, as well as post your own questions for the community at large. After you join, feel free to connect with me.
2. Equity Compensation Experts - This site was created by Dan Walter of Performensation and grew out of a LinkedIn Group. There are currently 1,000 members, and it's a great resource for any stock plan administrator.

The above is only a sampling of the cutting-edge web tools that can make a stock plan administrator's life easier. For more examples, you can check out the slides from our recent GEO presentation on our Web Tools in Stock Plans page. If you have any tools to add, please leave them in the comments.

Of course, if you need a web-based tool to track your stock and option records, check out the 4-minute demo of Equity Focus.

Most of us already incorporate the new generation of Web tools into our daily lives. I'm talking about everything from Linking In to Facebooking to Tweeting to watching videos on YouTube to replying to poll questions. In fact, you're using a front line tool right now - by reading this blog.

Recently, I participated on a seminar panel at the Global Equity Organization along with Elizabeth Dodge from SOS and Dan Walter from Performensation. We presented on the topic of leveraging Web-based tools like social media in stock plans. The three of us heartily agreed that stock administrators should be using these tools as part of their stock plan administration toolkits, and here are the four reasons why:

1. Employees Are Already Using Them - The "twenty-somethings" entering the workplace today are already using interactive Web tools - and expect that companies they work for will use them as well. Dan shared a story about Starbucks as an example. Starbucks was implementing a new equity plan and its employees were creating their own blogs to talk to each other about it.
   
   The point is that if you don't use these tools to announce changes to your stock plan, your employees will.
2. They Help You Stay Informed - The world of equity compensation is always changing. One day, stock options are the hot topic. The next day, it's restricted stock... the next day, it's LLCs. Not to mention the numerous backdating stories that have been disclosed over the last year. How is a stock administrator (who is already overworked) supposed to stay on top of it all?
   
   The answer is to let the information come to you. By subscribing to RSS feeds, reading blogs, and even following experts on Twitter, you'll get the important information of the day delivered straight to your computer desktop, without having to look for it.
3. They Allow You to Inform Others - In any field, the experts are really the ones in the trenches, and stock administration is no different. When there are more experts out there blogging, Tweeting, and commenting, the entire community benefits. Why? Well, the chances are that if one stock administrator has a question on how to handle a 1:200 reverse stock split, another one has already gone through it and has the answer.
4. They Promote Networking - If you're a stock administrator, using Web tools to build a network through LinkedIn, blogs, and discussion groups opens you up to a wealth of new opportunities. Imagine going in for a job interview and being able to (a) point to the Web tools you used to better communicate with employees and (b) reference the additional information you posted to the Web to benefit others. It will definitely give you a leg up on the competition. Not to mention, you never know when that connection you made knows a person who knows a person who has that next great job opening at that next great company (know what I mean?).

I believe that all stock plan administrators need to start exploring these Web tools to determine which ones work best as part of their stock plan administration toolkit. This will not only benefit their current company and employees; it will be a boon to their professional development.

In my next post, I'll go over some specific tools and how they can be used. If you don't want to wait, you can check out the slides from our presentation on our Web Tools in Stock Planspage.

If you would like to see how Equity Focus fits into your stock plan administration toolkit, check out our demo.

Recent research conducted by faculty at the University of Illinois and Michigan State University finds that, on average, executives value their stock option holdings at 40% of the opportunity cost to the company. More important, however, is their finding that this “cost-value” gap can be closed by employing a short but effective personalized equity education program.

Net Worth Strategies, Inc. has repeatedly conducted studies at the National Association of Stock Plan Professionals Conferences and discovered that experts in equity compensation also underestimate the value of equity compensation holdings even though they understand valuation models and the leverage inherent in stock options. (Net Worth Strategies offers corporate education programs, a family of equity compensation planning software and advisor support services.)

Bill Dillhoefer, Vice President of Net Worth Strategies, addresses the cost-value gap in a white paper aimed at helping CFOs and CEOs maximize the effectiveness of their equity compensation programs. Dillhoefer believes that companies have a responsibility to take action to close this cost-value gap and should invest in a brief education program to bring the value more in line with the cost.

According to Dilhoefer, the payoff from personalized equity compensation education comes from the following three areas:

• Improved retention of key personnel. As all corporate officers know, the cost and pain of losing even one of your best and brightest can be staggering. If key people have embraced the full value of their holdings, outside recruitment discussions are likely to be short lived.
• Increasedmotivation of key personnel and alignment with corporate objectives. Executives who understand and have embraced the upside potential of their holdings, and the importance to their financial goals, are more likely to dedicate themselves to driving earnings and avoiding actions that might jeopardize the stock price.
• Responsibilityto owners for the full value from their investment in equity compensation. As a result of accounting scandals and new regulations, shareholders and groups that represent them have placed a spotlight on the dilution and income statement impact of equity compensation programs. To date, the focus has been on the cost side of the equation. As shareholders come to understand the cost-value gap, however, they are likely to focus on the value side as well -- particularly since the cost to close the gap is relatively small.

Because companies must book and expense options based on Black-Scholes or another approved valuation method, the existence of a “cost-value gap” raises important questions regarding the viability and effectiveness of stock option programs in fulfilling their stated purpose of motivating and retaining key employees.

In light of mandatory option expensing and increased shareholder scrutiny, a little more education will go a long way to ensuring that your employees realize the full value of their equity compensation. Read the white paper here.

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) recently announced the release of its discussion document: Guidance on Monitoring Internal Control Systems. The guidance which is extensive and goes into great depth applies to the internal control objectives over financial reporting, as well as the objectives related to effective operations and compliance.

According to COSO Chairman Larry Rittenberg, Ph.D., "This guidance more fully develops the monitoring component of COSO’s Internal Control - Integrated Framework,” and is appropriate for organizations of any size or structure to improve the quality of their internal controls systems for multiple business purposes, but especially those dealing with the reporting requirements under the U.S. Sarbanes-Oxley Act of 2002, Section 404.”

Of the two documents, the second, Internal Control – Integrated Framework Executive Summary, is an excellent summary of the five interrelated components of effective internal control (of which monitoring is the 5th component.) The five are: control environment; risk assessment; control activities; information and communication; and monitoring. COSO makes the point that while entities of different sizes may implement them in different ways, they are applicable to business of all sizes, large and small. The framework set out by COSO is worth reviewing at least annually by any organization and then choosing how to apply the framework, particularly for those where internal controls are not mandated by SOX.

COSO seeks feedback on the concepts in this discussion document until Oct. 31, 2007; they want to know if they are clearly articulated and if you agree with the conclusions reached. They also want to receive examples of innovative approaches you have taken in monitoring the effectiveness of internal control. They will consider these observations in the development of their final guidance. Accompanying the release of the discussion document is access to a Web-based feedback portal on the COSO Web site at www.coso.org/publications.htm.

The second phase of the monitoring project, scheduled for release after comments are received on this discussion document, will provide examples, case studies, and tools to assist all organizations in implementing effective and efficient monitoring. COSO’s intent is to release an exposure draft of the full implementation guidance later this year and to release the final guidance in the first quarter of 2008.

I encourage you to read both documents and consider how your equity compensation technology fits in with your overall internal controls and compliance objectives.

And what’s the difference between restricted stock and stock options?

Bill Gates of Microsoft Corp. once said in an MSNBC interview that he regretted ever offering stock options to employees as part of the software giant’s compensation package. 

He said “Although such universal stock options were credited with creating the incentive that fueled much of the technology revolution of the 1990s in Silicon Valley and elsewhere, they also were criticized because of the way they allowed companies to compensate employees without fully accounting for the expense.

“Amid growing criticism over the accounting rules, Microsoft switched to a program of offering stock grants to employees that vest over time and are accounted for as an expense.”

As with many things ‘Microsoft,’ the idea has trickled down to smaller companies.  Now, restricted stock is the hot new alternative for equity compensation.  But what are the key differences between restricted stock and stock options?  What are some of the trade-offs, tax alternatives, risks and accounting issues?

Bruce Brumberg, Editor-in-Chief of myStockOptions.com, delivers many of these answers in a presentation he has given to diverse audiences this year as FAS 123R accounting has refocused many companies on stock option alternatives.

If you're tracking stock options or restricted stock, you'll want to review this presentation.

One year ago today, the Wall Street Journal published its second article on stock options backdating entitled: Options Study Becomes Required Reading which discussed a research paper by University of Iowa Professor Eric Lie entitled "On the Timing of CEO Stock Option Awards." It was a follow up article to the original ground breaking Wall Street Journal story on March 18, 2006 which first opened the public’s eyes to the suspicious timing of CEO option grants entitled: The Perfect Payday: Some CEOs reap millions by landing stock options when they are most valuable. Luck -- or something else?

Now, a year later, the firestorm of backdating articles on the front page of the business press has died down, the SEC investigations of the most egregious cases are proceeding, and major public companies are paying more attention to how they grant stock options. But, what about the rest of "Corporate America" that doesn’t tend to make headlines? Did the accelerated two-day filing requirements for Forms 4 mandated under Sarbanes have the desired effect? Did CEO and CFO certifications of internal controls encourage more careful work by compensation committees? What has been the influence on companies that are non-public and therefore not required to file with the SEC or comply with the new requirements of Sarbanes?

At this point, we really don’t know. It may still be too early to tell. One study by two finance professors, M.P. Narayanan and H. Nejat Seyhun, at the University of Michigan’s Ross School of Management that sheds some light on early compliance trends concluded that "24 percent of the option grants reported to the SEC by insiders after SOX regulations went into effect August 29, 2002 were reported late, with 10 percent of the grants being reported more than one month late."

"Backdating of grant dates and camouflaged timing appear to be practiced even after SOX, especially by smaller firms," Narayanan said. "In order to further restrict this behavior, the Securities and Exchange Commission needs to enforce the SOX two-day reporting rule and, if possible, limit the use of unscheduled option grants to legitimate purposes only."

While that’s generally bad news, it primarily takes into account the initial period shortly after the new accelerated filing requirements came into effect. What is yet to be seen is whether most companies, both public and non-public, will adopt appropriate internal procedures and controls to better insure that stock option administration and accounting is accurate, transparent, and trustworthy. As a place to start, we recommend visiting the Certified Equity Professional Institute’s web site which has put out a research study on risks and controls for equity compensation practices. And, as an added incentive, there are the SEC’s new Executive Compensation and Related Person Disclosure rules in Release No. 33-8732A that will further raise the bar for reporting stock option granting practices and will hopefully have a positive trickle-down effect on all companies’ stock option granting practices.

As Sarbanes internal controls, FAS 123R expensing, and new executive compensation disclosures become a more entrenched part of our compliance framework and non-regulatory pressure is applied from investors, customers and auditors, we will see in the near future what types of best practices develop as the new standards for equity compensation and raise the bar a little higher for all companies.