Stock Options

A hot one. Stock options are the right to purchase (or sell, but companies don’t pay in "put" options) a defined number of shares of stock in a corporation at a certain value (called the "strike" price) at a certain date. There is always a period prior to expiration of the option, and always an expiration date. These have become a fairly common mode of employee compensation, particularly for executives within a corporation.

So, for example, an option might be that the holder has the right to purchase 1,000 shares of Vishay Electronics at 20 dollars a share, as of today and continuing for the next two years, with the right to purchase expiring at that time. If Vishay is selling today for $ 24 per share, the present value of the option is $ 4,000 less fees and taxes. Pretty simple, and this is the calculation suggested in Everett v. Everett, 195 Mich App 50, 54 (1992). The court also holds that "the actual date on which to determine the market price for valuation purposes is within the discretion of the trial court." Id at 54.

There are three problems. First, what about options that have not yet "matured", that is, those options that may not yet be negotiated? As the Everett court points out these may be tough to value since (a) there may be conditions attached to these options that do not accrue (continued employment) and (b) the price of the stock may decline (or increase) by the time of maturing, making valuation problematic. Ordinarily one would think about assigning or transferring a certain number of the shares, but this is (often) not an option under the plan that created the asset. The Everett court suggests no answer to this and merely turfs the problem back to the trial court with the note that the non-matured options must be divided "in a manner that protects" the parties equitable shares. Id at 55.

My suggestion is that valuation of the unmatured options take place at the time of the sale or termination of the option date. The transfer would then be the total asset, less any costs of sale, less the tax on the gain times a percentage to be awarded to the non-holding spouse.

A second issue, also mentioned in Everett, is the problem of options with no present value (share price below strike price) but possible future value due to the period of the option. The Everett court dodges this one as hypothetical to the facts before it, but I would suggest the answer is no different than options that have not yet matured. If "negative" options later become "positive", the post tax/cost of the asset should be divided by a defined percentage.

Third, a matter not confronted by Everett, is the issue of unvested options, that is, options that will accrue at some time in the future if an employee fulfills certain conditions, usually continued employment. Barb Kelly, the senior referee in Washtenaw County, has written that these options are "likely to be considered marital property just as the unvested portion of a pension plan." I agree with this, with the caveat that some portion of the non-holder’s share (percentage) might be decreased due to the post-JOD conditions. Note that Everett is the only Michigan precedent to this date to discuss the division of stock options.

Stock options as an income item (for child support or alimony) is a trickier issue, since the holder may have some ability to exercise the options at a date that avoids any family obligation. It also seems conceivable that there could be "amortization" issues---that the option gains should be spread over a period of years. Barbara Kelly has written on this point, though the writing does not confront the amortization issue---

If the options are granted after the (JOD) or in a case where the parties are not married they are income to be addressed in the support determination. They are a benefit of employment, often granted in lieu of a larger salary…

The real issue is the determination of when they should be included…One obvious answer is that it will be included when the income from the option is realized…The problem with this approach is in many stock plans…the employee could effectively keep the option income out of the support consideration for a number of years, or until the support obligation has ended.

A second answer is to include the income on the date it can first be realized or the date the holder is first told they will pay support out of the value, whichever is later. This allows the holder to make reasonable choices about what to do with the stock…. Of course, if the options are exercised and the stock sold during a period support is being considered but prior to the date the Court determines, they will be included in income. The actual income realized should be used.

There are many factors to consider in any decision to exercise the options and sell or hold the stock. Most of these factors should not be considered if the Court is setting the value. Tax consequences should be considered. In certain qualified stock option plans the gain from the options is not included in the holder’s income until the stock is sold. If the options are exercised and the stock held for one year, the gains will be eligible for a capital gains tax rate, currently 20%. If the options are exercised (in less than one year, a significant tax differential will accrue). The Court should consider allowing the employee to hold the stock for the one year period and value it on the first date the gain on the stock would be eligible for capital gains tax treatment. If the holder sells the stock prior to that date, the actual net gain should be considered income…

Internal FOC Memorandum. I don’t have much issue with this, save for the potential, nagging matter of amortization.

In 2002 Ann Arbor attorney, Sherry Chin, wrote an impressive and comprehensive paper on stock options. The paper was presented to the ABA and contains a bibliography of sources. See www.sherrychinlaw.com for the article. Craig Ross is also willing to e-mail the article, at the kind permission of Ms. Chin.