Regulations Affecting the Administration of Company-Sponsored Stock Option Plans

The following is a partial list of regulations by various bodies that govern company-sponsored option plans. Please consult your legal and tax advisors for full interpretations of each of these important regulations.

IRS Code Section 421 - The section of the IRS Code regarding stock options in general.

IRS Code Section 422 - The section of the IRS Code regarding Incentive Stock Options (ISO) which delineates the requirements for a company’s option plan to qualify as a statutory plan.

IRS Code Section 423 - The section of the IRS Code regarding Employee Stock Purchase Plans (ESPPs). IRS Code Section 83(b) - An 83(b) election by an individual holding stock options requires that the individual pay taxes based on the FMV when transferable or no longer subject to risk of substantial forfeiture, instead of deferring the tax calculation and payment to the first day the stock becomes freely tradable (all restrictions lapse). If this election is not made, the tax payment is required on the first day that the stock becomes freely tradable, based on that day’s FMV.

SEC Rule 16(b) - The SEC rule regarding trading restrictions for company affiliates, also known as insiders.

SEC Rule 144 - The SEC rule regarding trading restrictions on certain holders of a company’s stock, i.e. - holding period requirements, limits on the volume of stock that can be sold, company insider restrictions for officers, etc. Usually applies to private placement-type securities.

SEC Rule 144(k) - Similar to 144 above, except that if the stockholder is not an affiliate of the company and has owned the private placement securities for more than two years, the restrictions may be less stringent.

FASB Statement 123 - Accounting for Stock-Based Compensation rule that encourages companies to adopt a fair market value method to account for expense recognition associated with employee stock-based compensation plans. Adoption of this method is typically accomplished through financial statement footnote disclosure.

Sequential Exercise Rule - ISOs granted prior to January 1, 1987 must be exercised in the order in which they were granted. The Tax Reform Act of 1986 rescinded this rule.

$100,000 Rule - States that an optionee cannot receive an ISO grant that creates more than $100,000 in value (valued as of the grant date) vesting for the first time within a given year. Any shares granted which exceed this $100,000 limit are considered Non-qualified Stock Options (NQSOs)

Blue Sky Regulations - Once a company goes public or offers stock for sale in a state other than where it was incorporated, it must register the stock with that state.

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