The coronavirus (COVID-19) pandemic has been adversely impacting companies and their employees in numerous ways. Public companies have been experiencing reductions in their available cash resources and the value of their shares. In addition to the impact on the value of the shareholdings of key service providers, the reduction in value of a company’s equity can deprive a company of an important resource for executive and director compensation.
Decreases in stock prices of many public companies as a result of the COVID-19 pandemic have required them to issue more shares in order to provide the same intended value of equity compensation that they would have granted in the absence of such price declines. As a result, many public companies face a potential shortfall in the number of shares that will be available under their equity compensation plans.
Public companies whose shares are listed on national stock exchanges are required to obtain shareholder approval prior to adopting equity compensation plans or increasing the number of shares available under equity plans. As a result, listed companies facing potential shortfalls in the number of available shares are considering various alternatives. Such alternatives include:
- Increasing the amount of cash compensation to offset the reduced availability of equity
- Granting equity awards that are payable in cash (although this alternative results in “mark to market” financial accounting)
- Delaying annual equity awards until a later time in the hope that stock prices will have rebounded
- Setting the number of shares subject to equity grants based on a trailing average stock price that includes a prior trading period when prices were higher
- Granting equity awards outside the shareholder-approved equity compensation plan as “inducement grants” for newly hired employees
This LawFlash addresses the NYSE, NYSE American, and NASDAQ rules for “inducement grants.” While each of the other alternatives listed above requires various tradeoffs for the company or the employee, such as the expenditure of limited cash resources, delays in providing compensation, adverse financial accounting consequences, or reductions in compensation, “inducement grants” permit the issuance of shares without depleting the company’s shares available for grants under the equity compensation plan.
What are Inducement Grants?
Inducement grants are a type of equity award to newly hired personnel. Although the NYSE, NYSE American, and NASDAQ require shareholder approval of all equity compensation plans and any material revisions, which include a material increase in the number of shares available under the plan, a company may make inducement grants without shareholder approval if the requirements described below are met.
Inducement grants may only be made to newly hired employees and must be disclosed in a press release.
What are the Benefits to Making Inducement Grants?
Inducement grants can be made to new hires without using shares reserved under equity compensation plans. Inducement grants need not be subject to individual share limits in an equity plan.
What are the Disadvantages to Making Inducement Grants?
Inducement grants are dilutive and subject to scrutiny by proxy advisory firms. For example, proxy advisory firms consider inducement grants when assessing plan cost, share usage, burn rate, overhang, and future equity plan proposals. Shareholders and shareholder advisory firms will take inducement grants into account as outstanding awards when determining the number of shares to be available for future equity plan proposals.
Inducement grants can result in additional administrative burdens. For example, the company must administer separate share pools, file a separate Form S-8 and listing application or notice for the shares covered by inducement grants, memorialize the inducement grant as part of the hiring process through employment agreements or offer letters and communications with the newly hired employees, and provide disclosure through a required press release as more fully described below.
The exemption for inducement grants is limited to the initial inducement for employment. As a result, shareholder approval of a material amendment to an inducement grant is required, even if the initial grant did not require approval.
What are the Requirements for Inducement Grants?
Inducement grants must be:
- Options or other equity-based compensation awards;
- Granted as a material inducement to new employees (which may include new employees in a corporate transaction or a person being rehired following a bona fide period of interruption of employment);
- Granted by the listed company or any of its subsidiaries; and
- Approved by the company’s independent compensation committee or a majority of the company’s independent directors.
Is any Disclosure or Notice Required for Inducement Grants?
Yes. Promptly following an award of an inducement grant, the company must issue a press release disclosing the material terms of the inducement grant, including the recipient and the number of shares.
Companies must provide their applicable listing exchanges with notice of the use of the inducement grant exemption to the shareholder approval requirements.
The company must also register the issuance of the shares under the Securities Act and obtain the listing of the shares on the applicable exchange, as described below.
Is an Immediate Press Release Required for Each Individual Grant Made?
Yes. An immediate press release is required for individually negotiated inducement grants or inducement grants made to executive officers.
However, routine inducement grants to new hires under a program in which equity grants are made to new hires without individual negotiation can be aggregated in a press release no less frequently than every two weeks. Each of NASDAQ, NYSE, and NYSE American permits aggregated disclosure when inducement grants are made to employees of a target company in connection with a merger or acquisition, other than grants made to executive officers of the post-merger company.
For individually negotiated inducement grants and inducement grants made to executive officers, aggregated disclosure of multiple grants is not permitted. Otherwise, aggregation is permitted: (i) over a period up to two weeks for a company that typically awards inducement grants to new employees, and (ii) when a company makes inducement grants to employees of a target company in connection with a merger or acquisition. Aggregated disclosure must include the material terms of the inducement grants, including the number of employees and the number of shares involved. Such aggregated disclosure does not need to identify specific employees.
How do Companies Make Inducement Grants?
Companies have the following alternatives for making inducement grants:
- Designate special share pool under an existing equity plan;
- Establish a separate equity plan for inducement grants only; or
- Award an inducement grant outside of an equity plan.
Companies should follow a process for making inducement grants to new employees. To demonstrate that the grant is an inducement to hiring, there should be written communication of the inducement grant prior to the new employee’s acceptance of the job offer and commencement of employment (or prior to closing if in connection with a merger/acquisition). The specific terms of the inducement grant should be in the new employee’s offer letter or employment agreement.
The company must also register the issuance of the shares under the Securities Act and obtain the listing of the shares on the applicable exchange. Issuances of shares outside of existing equity compensation plans will not be covered by the registration statement on Form S-8 already filed with the US Securities and Exchange Commission (SEC) and will require filing of a new registration statement on Form S-8. Although a registration statement on Form S-8 is a very simple document that incorporates most of the substantive information from prior SEC filings and is effective immediately upon filing, the company will need to pay the filing fee and obtain the consent of the company’s auditors for the incorporation of their most recent audit report and an opinion of legal counsel with respect to the due authorization of the shares.
The listing of the shares on the NYSE or NYSE American requires the submission of a listing application no later than the public announcement and prior to the issuance of the shares. The listing of the shares on NASDAQ requires the submission of a notice of listing of additional shares by the earlier of five days after entry into the agreement to issue the shares or the date of public announcement.
