Subsidiary Rights

When the IRS's long-awaited 409A regulations were finally released in April, they generally clarified the tax rules regarding nonqualified deferred-compensation plans, which recipients now must include in their gross income. The biggest and most pleasant surprise within the 400 pages of text, however, was the loosening of the restrictions on stock options and stock appreciation rights offered to employees in divisions and subsidiaries.

Early versions of 409A set various restrictions on such stock options — including the requirement that they be exercised on a fixed, predetermined date — unless they were granted in the stock that had the greatest aggregate fair value. That generally meant that only options in a parent company escaped the restrictions.

With 409A pending, and the rules for stock options in flux, companies have hesitated to issue options at the divisional or subsidiary level. Yet compliance and ethics experts continue to argue that stock options are the best form of compensation for a company; at unit levels they offer the added benefit of tying individual effort to performance.

In their final form, the 409A regulations exclude stock options in all divisions and subsidiaries from restrictions. The new rules "permit you to drill down and give incentives at the level that makes sense to the business unit and to the employee," says Tom White, partner and head of the benefits practice of Chicago law firm Chapman and Cutler.

Whether companies will again offer such options remains to be seen. White, for one, believes they will. "You give an employee a carrot, he works harder and smarter, and you share the gain," he says. But Richard V. Smith, senior vice president of Sibson Consulting, points out that the expensing of options has lessened their appeal. And even though 409A has opened the door to offering options at the unit level, he says, "I wouldn't jump on it."