An Alternative International Incentive Plan – The Internal Stock Market
Corporate & Finance Alert
July 7, 2009
In difficult economic times, companies are faced with some tough decisions as they try to balance cost savings, employee retention, and company morale and public image. While there may be strong desire to provide employees with additional compensation (as much for employee retention purposes as a reward for hard work) many firms are finding it difficult to gather the funds to make that a reality.
At the same time, many employees are facing difficult investment decisions as faith in the market has not yet been restored and fear of volatility keeps mattresses and savings accounts fatter than brokerage accounts.
A clever potential solution to both of these issues is the implementation by a company of an internal stock market, making available its capital stock for purchase and sale by its employees. Current depressed company fair market values make the timing for such a compensation scheme ideal. Employees are given an opportunity to invest in their company with a high prospect of future growth, which promotes and maintains employee ownership of the company with a goal of providing limited resale liquidity. This keeps employees who elect to invest well incentivized at a low cost to the employer.
Typically, an internal market would permit eligible employees to offer to sell or buy securities from the company during one or more transaction period(s) established by the company from time to time. Limitations will often be set as to how many shares an employee would be eligible to purchase or sell during each transaction period. The price for the purchase and sale of the shares will be periodically set based on formulas to arrive at fair market value, often including an outside appraiser.
Depending upon demand and supply, the company may choose to buy securities into the company’s treasury or newly issue its securities. Alternatively, once the market is well established, the company may elect to only accept employee offers to sell securities to the company to the extent offset by employee offers to buy securities from the company.
An internal market is especially suited to large, international corporations because of the large number of employees which helps create a more efficient and self-reliant market. The creation of such a program, however, is not without its potential legal pitfalls, and it is absolutely essential that the terms of the internal market be reviewed carefully by counsel in each of the jurisdictions in which the company wishes to allow employee participation. Although covering all of the potential issues across various jurisdictions goes beyond the scope of this alert, some of the major categories warranting legal review are set forth below:
Securities Law Issues.
The operation of an internal stock market will involve both offers to purchase and offers to sell securities of the company to the employees. For each jurisdiction in which the company intends to allow participation in the internal market, the company will need to comply with applicable securities laws relating to the purchase and sale offers to its employees.
In the United States, for example, in the absence of an available exemption, offers and sales of securities are required to be made pursuant to an effective registration statement with the Securities and Exchange Commission as to the security. One such exemption allows the offer and sale of securities under a written compensatory benefit plan (or compensation contract) established by the company for the participation of its employees, directors, officers, consultants and advisors. In contrast, the rules in Australia are not quite as clear cut, and care must be taken to ensure that the company is not required to hold an Australian financial services license under section 911A(1) of the Corporations Act 2001 as buying and selling activities of the internal market could arguably be construed as falling within the definition of “market making” in section 766D thereof.
Care must also be taken with respect to the number of employees in each jurisdiction which will be eligible to participate in the market. Some jurisdictions, such as members of the European Union, have exemptions from securities law requirements that rely on the number of persons which are offered securities within such jurisdiction. In the United States, depending on the aggregate value of its assets, a company could run up against the public filing requirements of the Securities Exchange Act of 1934 once a class of its equity securities is held by 500 or more persons.
Employment Law Issues.
It is likely that any well-structured internal market will, at a minimum, have transfer restrictions and buyback provisions to prevent securities from being held by non-employees. Depending on the needs of the company, it may also be desirable to include in the plan documents: call provisions, penalty repurchasing provisions (for instance for violating policies of the company), and other company protections such as the waiver or release of employment claims. As a further means to compensate and attract talented employees, it is also possible that a company may wish to afford certain higher level employees benefits and rights under the plan that may not be offered to lower level employees.
While the foregoing desires to give the company broad leeway in exercising its rights and remedies under the plan documents, insulate the company from liability, and attract and maintain valuable employees are perfectly understandable from a business sense, such protective provisions need to be carefully reviewed for legal issues in each participatory jurisdiction. At a minimum, some of the plan provisions may be unenforceable under local laws. At the other end of the spectrum, certain provisions may inadvertently subject the company to discrimination or other employment-related claims.
When the company finally implements its internal market program, it is only natural that it would encourage employee participation. Any incentive (and certainly any obligation) to participate in the internal market must be carefully analyzed, however, as several jurisdictions have laws restricting companies from implementing requirements on how or where an employee should spend his or her salary.
Data Protection Issues.
The processing of purchase and sale orders and administration of the internal market will likely take place in one centralized location for the international company. Such processing will often involve the transmission of certain personal data concerning employees in a foreign jurisdiction. A company should be aware that some countries have regulatory requirements in connection with the protection of such personal data and employee privacy.
For example, under the French law number 78-17 of January 6, 1978, all automatic processing of personal data carried out on behalf of private persons must be declared, by the controller of the file, to the French data protection authority (Commission Nationale de l’Informatique et des Libertés or “CNIL”) before any such processing is commenced, and as soon as the processing is carried out in the context of the activities of an establishment, or a representative, of the controller on the French territory.
The concept of “personal data” is broadly defined under French law to include data which permit in any form, directly or indirectly, the identification of the natural persons to which they relate, such as family names, first names, addresses, telephone numbers, credit card numbers, etc.
The declaration is a notification on a standard form which may include a cross-border data transmission agreement to the CNIL which in turn delivers an acknowledgement to the company. Data processing is precluded prior to the receipt by the company of this acknowledgement.
Choice of Law Issues.
For legal symmetry, the company will want to provide that the internal market plan documents will be governed by the laws of a single jurisdiction, most likely the jurisdiction of incorporation or administrative offices. Although choice of law provisions are often enforceable (i.e. the foreign court will apply the substantive law chosen in the plan documents), it is a common jurisdictional practice for courts to reject the chosen law on a given issue to the extent such law is contrary to a fundamental policy or mandatory provision of law within the court’s jurisdiction.
A jurisdiction’s propensity to apply its own law on critical issues underlies the importance of coordinated local counsel review in implementing a successful internal international market.
In addition to the above issues, companies should pay special attention to local banking and currency requirements, broker / dealer matters, specific jurisdictional language requirements and company and employee tax issues.