Underwater Stock Options, A Problematic Marital Asset

[Sue K. Varon]

In today’s economy a new issue has arisen regarding stock options that once upon a time had value as a marital asset. With the economic downturn, a majority of stock options are now underwater. Approximately, two thirds of public companies report their stock options underwater. How should we treat this asset in a divorce settlement?

Companies that issue stock options have to report the outstanding options as an expense on their books, driving meager earnings down. As a result, new policies are being introduced by several companies where they are re-pricing the stock options or recalling the options and reissuing them at a lower price. This may result in a new vesting schedule. This issue may also arise when a spouse loses a job, is lucky enough to find a new job and receives stock options from his subsequent employer to compensate him/her for marital options left on the table during the job change. It is necessary to anticipate this issue and address the manner of treating and dividing recalled or re-priced options when negotiating a property settlement.

It is important to include in the settlement agreement appropriate language to preserve capital gains treatment for the ultimate exercise and sale of qualified stock options. The spouse in whose name the stock options are titled (Husband) would need to hold onto the options on behalf of the other spouse (Wife), and upon the ultimate sale of her share of the options, Husband would pay to Wife her net share of the option proceeds after taking into account taxes. Possible language to include in the settlement agreement follows.

“It is understood that the Husband shall hold said options on behalf of the Wife. Husband shall not unreasonably withhold Wife’s request to sell her share of the options. Wife recognizes Husband’s fiduciary relationship to the corporation, and Husband will not be required to impair that relationship by exercising the options. Wife acknowledges that upon exercise of the options there will be a tax consequence to Husband, and she will be entitled to receive only the net after tax proceeds from the exercise of the option (net defined as Husband’s net). Husband shall have an affirmative duty to advise Wife of the vesting of the options, as well as the expiration date of the options.”

[Lisa C. Decker]

Sue, wonderful article on this issue. I have been seeing more and more of this with my clients. Thank you for your insight. You are always a wealth of knowledge and a great lady to boot!