CPE Final Exam Flashcards
Which of the following are NOT always considered “insiders” under Section 16 of the Exchange Act:
a. Officers.
b. Directors.
c. More-than-10% shareholders.
d. The company’s legal counsel.
The correct answer is d. Officers, directors and more than 10% shareholders are always considered insiders for Section 16 purposes. Unless corporate counsel is also a member of one of those groups, he or she will not be automatically considered a Section 16 insider.
A company makes a round of stock option grants to its employees on February 2. On June 28, it conducts an IPO. After that date, can the company still rely upon Rule 701 to provide stock to its employees upon exercise of the February option grants?
a. Yes, as long as the options were exercised under a stock plan
b. Yes, as long as the options were granted under a written contract or stock plan
c. Yes, as long as the sales in reliance of Rule 701 in the preceding 12 months didn’t exceed 20% of the company’s total assets
d. No, the company can no longer rely on Rule 701 after the IPO
The correct answer is b. Rule 701 provides a safe-harbor exemption from registration for pre-IPO issuers that grant restricted securities under a written compensatory contract or employee stock plan and the company can continue to rely on the safe-harbor after the IPO for the exercise of any options issued under the plan before the IPO. For a company to use Rule 701, the sum of the exercise price of outstanding options plus the aggregate dollar amount of sales made in reliance on the rule during the preceding 12 months cannot exceed the greater of $1 million, 15% of the company’s total assets at the end of its most recent fiscal year, or 15% of the outstanding securities of the same class of stock.
Your company makes unvested restricted stock awards that vest 1 year after the grant date. Which of the following describes the employee tax treatment of such a restricted stock award? (The term “spread” is the difference between the award purchase price, if any, and the event date fair market value. The term “appreciation” is the difference between the grant date fair market value and the vest date fair market value. The term “gain” is the difference between the stock basis and the sale price.)
a. Taxation on spread at grant as compensation income; taxation on pre-vest dividends as dividend income; taxation on gain at time of sale as capital gain.
b. Taxation on spread at grant as AMT income; taxation on pre-vest dividends as compensation income; taxation on gain at time of sale as capital gain.
c. Taxation on spread at vest as compensation income; taxation on pre-vest dividends as compensation income; taxation on gain at time of sale as capital gain.
d. Taxation on spread at vest as compensation income; taxation on pre-vest dividends as dividend income; taxation on gain at time of sale as capital gain.
Explanation: The correct answer is c. Even though restricted stock awards mean the stock is issued in the recipient’s name at the time of the award, the award is not subject to taxation until vesting restrictions lapse and the stock is no longer subject to a substantial risk of forfeiture. If dividends are paid on the stock before the award vests, those pre-vest dividends are taxed as compensation income, not as dividend income. Once the award vests, the spread, the difference between the amount paid for the stock, if any, and the fair market value on the vest date, will be taxed as compensation income. When the stock is later sold, the gain, the difference between the basis (what you paid for the stock, plus the compensation income recognized at vest) and the sale price, will be taxed as capital gain or loss.
