The Riskmetrics voting policies regarding whether a “for” or “against” vote will be recommended for a stock option exchange or repricing note that while Riskmetrics will vote on a case-by-case basis on any proposal regarding this issue, they will take the following items into consideration: 

• The historic trading patterns at the company; the stock price shouldn’t be so volatile that the stock options are likely to be back in the money in the near future.
• The rationale for the repricing; was the stock price decline beyond the company management’s control? Presumably a drop that correlates with the fall of the overall markets would be beyond management’s control.
• Will the program be a value-for-value exchange? An exchange involving the stock option holder receiving one new stock option for each individual underwater stock option would be considered by Riskmetrics on a case-to-case basis to determine whether it could provide support for the program; however, a program that provides one new stock option for two or more underwater stock options would more likely be considered a value-for-value exchange.
• Are surrendered stock options added back into the applicable plan’s share reserve? If so, Riskmetrics will also consider the total cost of the company’s equity plans, the average three year burn rate, and the company’s historic annual award granting rate. If the numbers are deemed excessively high, it can be difficult to achieve Riskmetrics’ approval of the proposal; however, these items are determined on a case-by-case basis, and Riskmetrics will analyze these numbers in light of other more favorable aspects of the repricing or exchange program, the plan itself, or the company’s equity-based compensation policies in general.
• If the stock options are exchanged, will the new stock options have a black-out period or will they vest immediately?
• The term of any new stock options should remain the same as that of the replaced stock option. Riskmetrics will evaluate the grant date, the exercise price, the vesting schedule, and other similar terms individually. 
• The exercise price of the newly granted or repriced stock options should be set at fair market value or a premium to market.
• Executive officers and directors should be excluded from participating in the program.

Additionally, Riskmetrics will evaluate the intent, rationale, and timing of all repricing or exchange proposals. Hence, the proposal presented to the company’s stockholders should clearly articulate why the company’s board of directors is choosing to conduct the repricing or exchange program at that particular time (repricing underwater stock options after a recent precipitous drop in the company’s stock price demonstrates poor timing, and the drop should have not occurred within the one year period immediately prior to the date of the exchange or repricing). Repricing stock options following a recent decline in stock price triggers additional scrutiny and a potential “against” vote on the proposal. The grant date of any surrendered stock options should also be far enough in the past (two to three years is recommended) so as not to suggest the repricing is an attempt to take advantage of a short-term downward price movement. Finally, the exercise price of the stock options to be surrendered or exchanged should be above the 52-week high for the company’s stock price, counted back from the date of the exchange or repricing. Since the most significant drops in the stock market, namely those losses incurred in September 2008 and March 2009 should be a year in advance of the next stockholders’ meeting, most companies should not find significant difficulties in abiding by these timing and pricing guidelines.

A stock option exchange program or a repricing provides a significant benefit to a company over simply issuing new stock options to the holders of underwater stock options in that the company no longer needs to worry about the then-underwater stock options coming back into the money and providing an unintended twofold benefit to the stock option holders. In light of the uncertainty of the market and future stock prices, companies that initiate stock option exchange programs or repricings rather than simply granting additional stock options can be assured that employees will not be gratuitously compensated.

Lastly, stock options are largely intended to provide incentives to stimulate and retain the employees who are expected to contribute to the success of the company. Unlike other types of equity-based awards, stock options are unique in that they align employee’s interests directly with those of the company’s stockholders; when the company’s stock price improves, stock option holders and stockholders receive a similar benefit. When the exercise price of a stock option is significantly higher than the value of the company’s stock, the incentivizing and motivating element of the stock option is lost. Even in a weak economy, a company’s key employees often have other employment opportunities, and the lack of effective equity-based incentives may make the departure of important employees to competitors — where the employees may receive new stock option awards with exercise prices reflecting current market conditions — more likely. As a result, a stock option repricing or exchange program can be a vital element of retaining talented individuals who are instrumental to the company’s future success.

If you are considering a stock option exchange program or a repricing in order to revitalize the business incentive portion of your underwater stock options, you will be required to make several decisions pertaining to tax, securities, stock market exchange, and accounting rules in order to tailor a program to your company’s needs.

For more information, please contact Vinson & Elkins lawyers David D'Alessandro, Shane Tucker, or Melissa Jester. Visit our website to learn more about V&E's Employee Benefits and Executive Compensation practice, or e-mail one of the V&E Employee Benefits and Executive Compensation practice contacts.