What’s Happening?

Hot Topics in Equity Compensation

Emily Cervino, CEP

What’s Happening in 2013?

 Yikes! Potential Implications of 2013 Tax Changes  Pesky Parisians – Changes to French Qualified Awards  Performance Awards: Rewarding Performance or RSUs in Disguise?

 Participant Perceptions Perking Up?

 No Money Left on the Table  Back In Style: Employee Stock Purchase Plans Turning Heads Again  Revisiting Retirement  Tell It Like It Is: Plan Analytics for Management  Ownership Guidelines 2 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Yikes! 2013 Tax Changes

3  Effective January 1, 2013, changes in tax rates apply to income from stock option exercises, restricted stock and RSU vesting, non-qualified ESPP purchases, sales of stock, and dividends.  Top federal withholding rate on supplemental income rose to 39.6%.    Supplemental income is subject to one of two flat rates that are linked to income tax rates. For aggregate supplemental wage payments totaling up to $1 million during the year, the rate is 25% (the rate of the third income tax bracket). For aggregate supplemental wage payments that exceed the level of $1 million in a calendar year, the rate is now 39.6% (the new rate of the highest income tax bracket).   Social Security rate returned to 6.2% up to $113,700 in 2013. Increased Medicare on compensation income for high-income taxpayers from 1.45% to 2.35%  Single > $200,000; Married > $250,000  Indexed the annual AMT income exemption amounts permanently for inflation  New tax legislation did not extend the refundable AMT credit that was available for the tax years 2007 through 2012. FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Yikes! More 2013 Tax Changes

 New 3.8% Medicare surtax applies to investment income, such as capital gains from stock sales.  Capital gains tax rate that applies to the proceeds from a stock sale increased:  To 20% for single filers with income > $400,000 and for married filers with income > $450,000. (For taxpayers whose yearly income is below these thresholds, the top rate remains 15%.)  Tax rate on dividends increased:  To 20% for single filers with income > $400,000 and for married joint filers with income > $450,000. 4 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Looking Ahead - Potential Implications of 2013 Tax Changes

 Taxes are up  Taxes are up on all W-2 income  What are the options?

 Stock options offer the ability to time the year for recognizing income  Defer income into the future with RSUs and PSUs  Do ISOs help?

 For people in the highest tax bracket, the tax advantages of ISOs compared to NQSOs have been slightly reduced  Continue to offer benefits of lower capital gains vs. income tax rates for qualified dispositions 5 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

French Qualified Plans – Tax Withholding for French Non-Residents

 As of April 1, 2011, participants who are in France during part of the service period, but leave prior to exercise/vest are subject to tax withholding  Qualified awards – Sale  Nonqualified awards – exercise/vest  Managing the withholding  Qualified awards – administrator and payroll  Nonqualified awards – administrator and payroll  39% of companies operate a qualified French free share plan* 6 *Source: 2012 Global Equity Incentives Survey, PWC and NASPP .

FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Changes to French Qualified Awards

7  On the heels of the July 2012 increase in employer social taxes, French Constitutional Court issued a decision on December 29, 2012 on measures in the 2013 Finance Law:  Cancelled some controversial provisions, e.g., proposed increase of social contributions, which would have gone up from 10% to between 17.5% and 22.5%  Eliminated minimum four-year holding period requirement for “qualified” stock options granted on or after September 28, 2012 – No changes were made to tax and Social Security regime applicable to gains on stock options granted prior to September 28, 2012 – Does not impact holding period requirements for French-qualified RSUs  For “qualified” awards granted on or after September 28, 2012 – Gains realized at exercise or vesting are subject to progressive tax rates of up to 45% at the time of sale (no longer at flat rates) – Employer is liable for employee and employer social charges when it fails to report gains on annual declaration FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Changes to French Qualified Awards –

What do they really mean?

 French-qualified award income subject to a maximum combined tax rate of approximately 61% (plus existing 3% or 4% surtax for high earners).

 Alternative? The combined tax rate for non-qualified award income is 59%.

   What companies are doing now: Reviewing and re-thinking French equity programs Updating French sub-plan and option agreement to remove any references to holding period restrictions   Updating restrictions regarding holding periods Updating any employee communications, e.g., tax supplements, to address new legislation 8 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Performance Awards: Rewarding Performance or RSUs in Disguise?

9 

Fidelity performance award data

 89 clients    Average participant size: 178 (Ranging from 2–2,439) Payouts over 5 years (’08–’12) 1-year to 3-year plans

Number of Employees Market Capitalization % of Employees Receiving Performance Award Vesting Years Performance Period Years <2.5K

13 <$1B 15 <1% 47 1 year 18% 1 year 32%

Source: Fidelity Stock Plan Services Performance Plan Study, March 2012 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

 

Compared payouts to a company’s performance

 Benchmarked performance against S&P 500 – focused on TSR & EPS

Payout classification:

  Payout above target considered high pay Payout below target low pay

2.5K

–10K 10K –25K 25K –100K >100K 29 $1B –$5B 28 1% –5% 32 21 $5B –$10B 18 5% –10% 6 20 $10B –$25B 15 10% –15% 3 6 >$25B 10 >15% 1 2 years 3 years 4 years 5 years 23% 2 years 14% 51% 3 years 44% 7% 4 years 10% <1%

Performance Awards: Rewarding Performance or RSUs in Disguise?

Max

TSR Performance Versus S&P 500 (n=106) Payouts aligned

with

TSR

Performance

72%

of the time Low Performance High Pay (n= 19) High Performance High Pay (n= 50) R² = 0.1596

Target Low Performance Low Pay (n= 26) High Performance Low Pay (n= 11) 0% 25% 50% 75%

TSR Percentile Rank Relative to the S&P 500

Performance Plans Align Pay with TSR Performance

Source: Fidelity Stock Plan Services Performance Plan Study, March 2012 10 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

100%

Key Conclusions:

 Payouts are in directional alignment with Total Shareholder Return (TSR) relative to S&P 500 companies  Outliers are mainly due to companies measuring performance on metrics other than TSR

Performance Awards: Rewarding Performance or RSUs in Disguise?

Max

EPS Growth Performance Versus S&P 500 (n=87)

Low Performance High Pay (n= 14) High Performance High Pay (n= 41) R² = 0.2596

Payouts aligned

with

EPS

Performance

70%

of the time Target Low Performance Low Pay (n= 20) High Performance Low Pay (n= 12) 0% 25% 50% 75%

EPS Growth Percentile Rank Relative to the S&P 500

Performance Plans Align Pay with EPS Growth

Source: Fidelity Stock Plan Services Performance Plan Study, March 2012 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

11 100%

Key Conclusions:

 Payouts are in directional alignment with Earnings Per Share (EPS) growth relative to S&P 500 companies  EPS has a stronger statistical correlation to performance compared to TSR, with fewer significant outliers

Performance Measurement Period: Implications of Short vs. Longer Term

Max

EPS Growth Performance Versus S&P 500 - 3 Year Plans (n=41)

High Performance High Pay (n= 18) Low Performance High Pay (n= 5) Target Low Performance Low Pay (n= 11) R² = 0.3559

High Performance Low Pay (n= 7) 0% 25% 50% 75%

EPS Growth Percentile Rank Relative to the S&P 500

Source: Fidelity Stock Plan Services Performance Plan Study, March 2012 100%

High Pay

rewarded for

High Performance

72% of the time 3-year plans have the strongest correlation between pay and performance

Key Conclusions:

 Although there are challenges with setting longer-term goals, 3-year plans have a stronger pay and performance relationship  Bucked expectation that 1-year performance periods would be better aligned due to goal setting 12 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Participant Perceptions Perking Up?

 2012 Participant Research  1,800+ participants; 100+ companies  SOP, ESPP, and RS participants = aggressive savers  18% of household income saved  What do participants plan to do with stock plan assets?

 57% earmarked for eventual investment or retirement savings  13% targeted to pay off bills or debt in the future  Increased awareness  Restricted stock value - 82% (vs. 67% in 2011)  Option value – 86% (vs. 79% in 2011)  Vesting schedule - 88% (vs. 78% in 2011) 13 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

No Money Left on the Table – Auto Exercise at Expiration

 In-the-money options left unexercised at expiration represent  Money left on the table  Compensation expense incurred; no compensation delivered  Demoralizing to employees  Considerations  In the money – Percentage – Dollar amount  Authorization – Net exercise vs. sell to cover  Plan provisions  Terminated employees 14 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Back In Style: Employee Stock Purchase Plans Turning Heads Again

 Despite the challenges imposed by FAS 123R/ASC 718, ESPPs are still an important component of many equity compensation plans.  ESPPs can help promote an ownership mentality across a broad base of employees at a relatively low cost.  Plan design changes, particularly those related to discount rates and look-back periods, often have a big impact on participation rates. 15 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Back In Style: Employee Stock Purchase Plans Turning Heads Again

16  Lots to Love  Broad based  Guaranteed appreciation  Right combination of offering period, discount and lookback  Improve employee motivation/loyalty  45% of ESPP-only "work harder"; 80% want future employers to offer plan*  Non-excessive  Expense efficient  Cash inflow  Engaged employees – ESPP-only participants are only slightly less aware of the current stock price than RS/options participants (81% vs. 93%); nearly as likely to check after each purchase period - 70% vs. 80%*  Minimal share usage  Corporate tax deduction   Section 423 – upon disqualifying disposition Non Section 423 – upon purchase * Fidelity Stock Plan Services Participant Research, 2012 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Revisiting Retirement U.S. Tax: Retirement Eligibility

17  If plan/agreement contains provisions to accelerate (or continue) vesting at retirement  Participant “earns” the shares when they become retirement eligible – Accelerates accrual of expense  Grant date to retirement eligible date – Taxation event!

   Retirement eligible date,

OR

 Grant date (if retirement eligible at the time of grant) Some companies have tried to avoid this tax treatment by inserting a clause in the agreement – – – Acceleration / Continuation of vesting at discretion of board Therefore receipt not “guaranteed” Therefore no taxation event at time participant becomes retirement eligible IRS representatives have asserted (off the record) that they would look at “facts & circumstances” – – Has anyone ever forfeited?

Is it just a “rubber stamp”?

FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Revisiting Retirement U.S. Tax: Retirement Eligibility FICA due at Retirement Eligible Date

1

Income Tax due at Retirement Eligible Date

RSA

Yes

RSU

Yes Yes No

1 Rule of administrative convenience allows FICA to be collected at any date (after vesting) during the year. Many companies “deem” FICA collected on 12/31 when often Social Security limit has already been met.

18 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Revisiting Retirement

19

Options

Normal Retirement (n=465) Cos. % Early Retirement (n=445) Cos. % All (vested and unvested) forfeited Unvested forfeited Some unvested forfeited (vesting accelerates for the remaining unvested) None forfeited (continue to vest normally) Pro rata at end of performance Pro rata at time of termination Full payout at time of termination Full payout at end of performance Other 5 214 37 80

– – – –

17 * 2010 NASPP Stock Plan Design Survey 1% 46% 8% 17%

– – – –

4% 208 57 61 81

– – – –

17 47% 13% 14% 18%

– – – –

4% FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Restricted Normal Retirement (n=443) Cos. % Early Retirement (n=465) Cos. %

– – – –

208 47% 263 62% 57 61

– – – –

24 13% 14%

– – – –

5% 47 43

– – – –

21 11% 10%

– – – –

5% Performance

Normal Retirement (n=318) Cos. % Early Retirement (n=298) Cos. %

– – – –

101 32% 145 49%

– –

109 25 9 42 13

– –

34% 8% 3% 13% 4%

– –

85 12 1 22 11

– –

29% 4% 0% 7% 4%

Tell It Like It Is: Plan Analytics for Management

Reporting vs Analytics -

What’s the Difference?



Reporting

translates data into information to show what is happening: 1.

2.

3.

What happened? When did it happen?

How many? How often? Where?

Where exactly is the problem? How do I find the answers?



Analytics

transforms data into insights to show why something is happening and what you can do about it: 1.

Why is it happening? What opportunities am I missing?

2.

3.

4.

What if these trends continue? How much is needed? When will it be needed?

What will happen next? How will it affect my business?

How do we do things better? What is the best decision for a complex problem?

20 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Tell It Like It Is: Plan Analytics for Management

Business Objectives

Visual reporting and analytics about plan trends and performance.

What’s Interesting?

 Account Certification %  Plan Value  Product Mix  Exercise Activity  ESPP Participation and Behaviors  Performance Plans 21 Screenshots are for illustrative purposes only.

FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Tell it Like it Is: Plan Analytics for Management

Business Objective

Provides a snapshot of the key highlights relating to equity compensation plans. Focuses on metrics that are foundational pieces of information for strategic discussion around effectiveness of equity plans.

What’s Interesting

 Participant counts by product  Award and exercise trends  ESPP purchase trends  ESPP plan design and participation benchmarking  Customer and client service levels  Participant interaction activity 22 Screenshots are for illustrative purposes only.

FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Ownership Guidelines

 Ownership Guidelines  2011 NASPP Stock Plan Administration Survey* indicates that ownership guidelines are hot, hot, hot!

– 73% of respondents have ownership guidelines, up from 54% in 2007  25% of companies that don’t currently have guidelines are considering implementing them 23 * NASPP 2011 Domestic Stock Plan Administration Survey (co-sponsored by Deloitte).

FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

Ownership Guidelines

 Ownership Guidelines  Most frequently apply to CEO, CFO, and other named executive officers – Rarely apply below executive level  Usually based on a multiple or perceantage of base salary – Typically 5-6 times salary for CEO, 2-4 times salary for CFO and other NEOs – Challenges with fluctuating stock price 24 * NASPP 2011 Domestic Stock Plan Administration Survey (co-sponsored by Deloitte).

FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION.

10b5-1 Plans: Making Headlines Again

 Recent

Wall Street Journal

articles allege improper trading in company shares by executives due to shortcomings of Rule 10b5-1  Most of trades in question occurred during the five trading days before the companies released material information AND  Were made under executive trading plans established pursuant to Rule 10b5-1  Federal prosecutors and securities regulators are taking a closer look into these allegations  Alleged shortcomings of 10b5-1 plans  Executives don authority ’t have to file trading plans with any regulatory  Companies aren ’t required to disclose the plan’s existence 25 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION .

10b5-1 Plans: Making Headlines Again

 Alleged shortcomings of 10b5-1 plans  Executives free to cancel or change plans without disclosure  No rule about how long plans must be in place before trading under plans can begin  How to minimize exposure and maximize compliance?

 Periodically reevaluate policies regarding the use of Rule 10b5-1 trading plans to ensure they are up to date and in compliance with best practices, e.g., require that plans have a minimum duration of at least one year  Focus on compliance with the spirit of the law rather than on strict literal compliance with the letter of the law 26 FOR PLAN SPONSOR USE ONLY. NOT FOR PLAN PARTICIPANT DISTRIBUTION .

Questions and Contact

Emily Cervino, CEP [email protected]

408 832 9080

27 Fidelity does not provide legal or tax advice and the information provided above is general in nature and should not be considered legal or tax advice. Consult with an attorney or tax professional regarding your specific legal or tax situation.

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