The Department of Labor recently issued an advisory opinion letter concluding that the gain from stock options must be retroactively added to the wage base of non-exempt salaried and hourly employees.
This recalculated wage base must then be used to determine overtime pay. The effect of this opinion, if allowed to stand, would be to significantly decrease participation, if not completely eliminate, non-exempt employees from inclusion in their companies’ broad-based stock option plans due to the added costs, complex administrative requirements and uncertainty in calculating actual wage costs.
About the letter
The DOL advisory letter applied to a company that granted a one-time discretionary grant of stock options to non-exempt employees.
The letter states that the extra pay realized by the employees through the exercise of the stock option must be retroactively applied to the period the employee worked from the time the option was granted to the time the option was exercised, up to a maximum of 104 weeks.
The corporate sponsor would then be obligated to pro-rate the added value to the employee’s base wage and, for the weeks during that period in which the employee earned overtime, the overtime pay would be recalculated at the higher rate.
How options work
To fully understand the issue and the implications for corporate sponsors, it's necessary to understand how stock options work.
An option is a contract right to purchase shares in a corporation for a fixed period of time at a fixed price. In most cases the price is the fair market value of the stock on the date the option is granted.
Assume an employee is given an option to purchase 100 shares of stock when the fair market value of the stock is $1 per share. Typically, the grant may be exercised anytime in the next ten years. Now assume that when the employee exercises or purchases the shares granted under the option the fair market value has risen to $5. The employee has to pay the $100 ($1 X 100 shares) to the employer but in return s/he receives $500 ($5 x 100 shares) worth of stock.
Lots of calculations
Tax considerations aside (different types of options are treated differently under the tax code) it's possible that the employer will have no idea when that sale takes place and at what price.
According to the advisory opinion, the $400 in the example is required to be spread over the employees' regular pay rate between the date of exercise and the date of grant, up to a maximum of two years.
Employees typically have several years, ten in our example, to exercise options and they frequently receive new option grants each year. Therefore, several calculations would have to be made for each stock option grant to the employee in order to comply with the advisory opinion. After the gain is spread to the hours worked, the overtime adjustment must be made and paid.
Can you imagine doing this for a company like Starbucks where every employee is a "partner?"
Presumably, in issuing this opinion someone at DOL thought they were increasing compensation and doing a good thing for non-exempt employees. But the effect is clearly going to be the opposite. It will curb the use of broad-based stock option plans at American companies who will be unwilling to accept the added costs and financial uncertainties associated with retroactive overtime costs associated with a stock-based compensation award.
If it ain't broke…
Over the years, we've encouraged and worked with hundreds of companies, large and small, to install broad-based ownership plans, including but not limited to stock option plans.
When coupled with good communications and participatory management we have seen these plans bring workers, exempt and non-exempt, together as a cohesive team with a common incentive to help grow the business.
The government should not be putting up roadblocks to compensation approaches that are demonstratively beneficial to workers and clearly result in increased productivity, efficiency and competitiveness.