CEP Plan Administration & Communication 3 — Questions and Answers
Question 1: Under IRC Section 423, an employee stock purchase plan (ESPP) must offer shares at a maximum discount of:
- 10% of fair market value
- 15% of fair market value (Correct answer)
- 20% of fair market value
- 25% of fair market value
Correct answer: 15% of fair market value
Section 423 qualified ESPPs may offer shares at a maximum discount of 15% off the lower of the fair market value at the beginning or end of the offering period.
Question 2: What term describes the process by which a company repurchases shares on the open market to offset dilution from equity awards?
- Share buyback (Correct answer)
- Fungibility
- Overhang reduction
- Anti-dilution adjustment
Correct answer: Share buyback
A share buyback (or repurchase program) is when a company buys back its own shares on the open market, often used to offset the dilutive effect of shares issued through equity compensation plans.
Question 3: Which proxy advisory firm's voting guidelines are most commonly cited when companies design equity compensation plans?
- SEC Advisory Board
- Institutional Shareholder Services (ISS) and Glass Lewis (Correct answer)
- FINRA Investor Education Foundation
- FASB Equity Committee
Correct answer: Institutional Shareholder Services (ISS) and Glass Lewis
ISS and Glass Lewis are the two leading proxy advisory firms whose guidelines on equity compensation plans (burn rate, overhang, plan cost) heavily influence institutional shareholder voting decisions.
Question 4: A company grants PSUs where the payout depends on TSR relative to a peer group over 3 years. If the company ranks at the 75th percentile, what does a typical plan design pay out?
- 50% of target
- 100% of target
- 150% of target (Correct answer)
- 200% of target
Correct answer: 150% of target
Relative TSR plans typically pay 150% (or up to 200%) of target at the 75th percentile, as that level of outperformance versus peers warrants above-target payout.
Question 5: When a company undergoes a merger and an employee's unvested options are assumed by the acquirer, what typically happens to the vesting schedule?
- All unvested options immediately vest
- The vesting schedule continues unchanged (Correct answer)
- All options are cancelled and replaced with cash
- The options convert to restricted stock units
Correct answer: The vesting schedule continues unchanged
When options are assumed in a merger, the vesting schedule typically continues on its original terms unless the plan or award agreement specifically provides for acceleration upon a change in control.
Question 6: Which form must insiders file within two business days of a reportable transaction in company securities?
- Form 3
- Form 4 (Correct answer)
- Form 5
- Form 144
Correct answer: Form 4
SEC Form 4 must be filed within two business days of any change in beneficial ownership of company securities by officers, directors, or 10%+ shareholders.
Question 7: A stock option's 'spread' at exercise is best defined as:
- The difference between the grant price and the current stock price (Correct answer)
- The total value of shares acquired
- The number of shares multiplied by the exercise price
- The intrinsic value divided by the number of options
Correct answer: The difference between the grant price and the current stock price
The spread is the difference between the current fair market value of the stock and the exercise (grant) price, representing the economic gain to the optionee at the time of exercise.
CEP Plan Administration & Communication 3
Under IRC Section 423, an employee stock purchase plan (ESPP) must offer shares at a maximum discount of: