Conglomerate

Tax Consequences of Facebook's IPO: Zuckerberg's Stock, Stock Optons and RSU's

2012-02-09T11:35:25-07:00

Yesterday I told my Corporate Tax class that we could teach a whole course on the tax implications of the Facebook IPO. I wasn't kidding. Here are a few of the interesting issues that highlight current debates in the taxation of corporations and their shareholders. (Gregg Polsky has also covered some of these on The Faculty Lounge.)

Mark Zuckerberg's stock: CEO Zuckerberg holds almost 414 million shares of stock. At the time of the IPO, he owes no taxes on that stock until a recognition event, such as sale. When and how did he acquire this stock? Most likely, much of it is "founder's stock." This is friend of the Glom Vic Fleischer's territory (See Taxing Founder's Stock). Zuckerberg probably contributed the algorithms and code for Facebook in return for stock as a nontaxable event either as a contribution to a corporation by a control group or (as Vic explains), making an election to have the stock distribution a taxable event, with the valuation of the stock as equal to the contribution. Even though the stock is more accurately described as consideration for Zuckerberg's labor, it will be taxed at some point as capital gains, which is now 15% and considerably less than the ordinary income rate. Gregg argues that this isn't that bad because the corporation doesn't get a deduction for it, so no deduction plus 15% is better than 35% deduction and 35% taxation, if you look at it from the point of view of the public fisc. I think Vic is looking at it from the point of view of regular folks who contribute labor for stock versus founders. Interesting debate.

Zuckerberg's and others stock options: From reports in the media, it seems that the stock options that Zuckerberg holds (and probably others) are nonqualifying stock options. The S-1 describes a 2005 stock option plan that issued incentive stock options, but stock options issued before then or under a different plan don't seem to be qualifying options. Should holders of nonqualifying stock options exercise those options at or after the IPO, they will encounter a taxable event regardless of whether they sell the stock. Zuckerberg has over 120 million stock options giving as compensation, which he plans to exercise. His exercise price is 6 cents. So, at something like $30/share,that's about $3.6 billion (say it like Mike Myers) of taxable ordinary income (the spread between exercise price and price at conversion). Zuckerberg's tax bill (federal and California) may well be one of the biggest tax bills ever. Apparently, he plans to sell enough shares to pay his taxes, which may reach $2 billion. Other holders will also face the same dilemma of having a tax bill even if they don't have any additional cash on hand. Those who exercise qualifying ISOs will not have a current tax liability if they do not sell. (I have now wandered away from things I know about, so I will stop.)

But, for each option that is exercised that is taxable as compensation, Facebook gets a deduction, even though no cash is (or has ever) gone out of the company for that expense. So, Facebook calculates that it will have tax refunds for awhile given the billions of dollars in compensation expense it will enjoy.

Restricted Stock Units: Starting in 2008, Facebook began granting service providers RSUs instead ot stock options, probably to avoid the 500 shareholder threshold for registration under 12(g) of the Securities Exchange Act. These RSUs are scheduled to vest six months after the IPO. The recipients will be taxed at ordinary rates for the difference between the FMV of the stock at the time and the price paid for the grant (if any). (Though, recipients could make an 83(b) election at the time of the grant when valuation is both less and less clear, but this may be a risky move.) Finally, Facebook has to withhold cash for that. Facebook has listed this as a risk factor in its S-1:

We anticipate that we will expend substantial funds in connection with the tax liabilities that arise upon the initial settlement of RSUs following our initial public offering and the manner in which we fund that expenditure may have an adverse effect.

Whew. That's enough.

The STOCK Bill's Sideline In Political Expert Networks

2012-02-09T02:21:00-07:00

It is interesting to see the House sweat over whether they have to act on a bill that passed the Senate 96-3. But part of the reason may be because the expert networks about which the SEC is so suspicious, at least if they are the political variants of the same, will have to register as lobbyists. Can't imagine the hedge fund industry expected that. Anyway, this Times piece is pretty interesting.

The Hiring News Is Coming In, And I Don't Believe In It

2012-02-08T14:15:25-07:00

Prawfsblawg's community spreadsheet thingy is here. You should contribute if you can. It's already looking quite interesting.

But it does illustrate one of the difficulties of trying to play moneyball in an area that isn't baseball, finance, or the weather. For those subjects, data has been collected every day for decades, and it has been systematized in a single place.

But we probably won't get perfect accuracy on who got hired by where from the Prawfs database, we won't get many variables on them, and law school hiring happens once a year, on different standards than law schools employed just ten years ago. Apples to apples comparisons are difficult. And if you want to know how those entry levels at top schools did it, you're talking about a tiny number of subjects. What's the added value (or disutility) of a Yale JD, a pre-law career as an equities analyst, or a Ph.D in sociology? I doubt you could tell anything other than an anecdotal story about whether these resume items are good or bad.

Which in turn makes moneyball stories in law schools not tales of zigging where others zagged, but rather a plausible story that that's what you did. That may be more an exercise in marketing, rather than number crunching.

Family Film Blogging: Big Miracle

2012-02-07T03:18:00-07:00

I loved Big Miracle! OK, I stole the ending, but I wanted to get that out of the way. The boys and I went to see Big Miracle on Friday, and I have to say I'm a big fan. The four year-old got a little fidgety (OK, so he kept climbing over the railing for the stadium seating), but he did remind me that he did not leave early like We Bought a Zoo. The ten year-old was pretty into it, and I was really into it.

The movie is based on a true story, Operation Breakthrough, that apparently was a media sensation when I was in college, but I don't remember it at all. Of course, the fall of 1988 was my second year in college, and I missed a lot of current events during that time. So, the movie is set during the Bush v. Dukakis presidential campaign and tries to be a "period piece." (I still don't understand why Drew Barrymore's hair is an ombre mess with 6 inches of highlights grown out. Is there a message that in the 80s people didn't pay attention to their hair color maintenance? Perhaps working for Greenpeace, her character is so passionate about her causes that she has let her hair go? That's sort of 70s, not 80s.) The story is that in Barrow, AK, three whales are trapped under the ice and cannot get to the ocean where they are supposed to swim to Baja, CA for the winter. Without human intervention, the whales will die. Enter reporter Adam (John Krasinski), who would love to move to "the lower 48," and the whales begin to get national attention. Various groups decide how much attention to turn to the whales, and for what purposes.

The movie could be a centerpiece of a government class, with student groups representing the different special interests with their agendas: Greenpeace, an Alaskan oil company CEO, President Reagan, the Inuits, the National Guard, the media, the local business owners, and even the Soviets. What I liked about the movie was that none of these folks seemed one-dimensional, and all of them were portrayed as flawed to various extents. No one has an entirely pure motive, even the heroes.

The end, of course, is happy. (There is a nonhuman death, for the parents out there.) I teared up a little. Why? Because, as the movie tells us, everybody loves whales. We seem to empathize with whales and project our hopes and fears onto them. But, if you're coming to the movie because you love movies and want to see a lot of whale footage, be prepared. There's not much. (It's a $40 million movie, not a $100 million movie.) Most of the whale scenes are whales sticking their snouts out of a hole in the ice, with only a couple of good underwater scenes.

Why Aren't There Women or Minorities on Facebook's Board?

2012-02-06T20:11:59-07:00

That's the question Huffington Post asks. Bloomberg observes the same. This though 58% of Facebook's users are women and its COO, Sheryl Sandberg, has commented on gender equity issues before (as Christine observed).

Just today I sat in on a discussion about the dearth of women on boards. Some thought maybe the issue was passe, already solved. We've come a ways, after all: according to Catalyst 15.7%. of board seats were held by women in 2010.

OK, that doesn't really sound so good, does it?

But by my calculations, 15.7% of 7 (the number of Facebook directors) is 1.099, and that's 1.099 more women directors than Facebook has.

Really? The blockbuster IPO of 2012 doesn't see fit to put anyone but 7 white guys on its board? Really?

I realize may sound angry, but I really don't mean to. I'm more incredulous. This is a the social media company, whose professed mission is "to make the world more open and connected." Mark Zuckerberg is already serving as both Chairman and CEO and using dual class common to keep control, both of which are corporate governance best practices no-nos. Basically they translate into 1) letting you as CEO head up the entity that's supposed to monitor you and 2) selling your company to the public without risking that your could ever be bought out, even if the market thinks you're doing a lousy job. I would have thought Zuckerberg would at least make a gesture towards boardroom diversity, so that Facebook's vision of the world has some semblance of input from the outside.

Nope.

Super (Bowl) Madonna!

2012-02-06T12:53:05-07:00

In case you live under a rock, there was a big football game last night, and both Madonna and the NY Giants won. It was a good game, a close game, with a great halftime show.

I am rarely interested in the Super Bowl halftime shows. The Who? Bruce Springsteen? Tom Petty? The Rolling Stones? Um, not so much. But Madonna is something entirely different. I am the Madonna generation. I remember seeing "Borderline" on MTV in 9th grade and thinking "I have got to have that haircut." Madonna's music is truly the soundtrack to my youth. The summer I was 16 my favorite song was "Into the Groove," and on Mondays, "Teen Night" at Midnight Rodeo, I would wait and wait for that song to play. I remember being in London in 1989 when "Express Yourself" was released. In 1991, I had the most argumentative car ride from Houston to Austin, but I was listening to The Immaculate Collection in the background.

So, I did look forward to halftime, and I was not disappointed. In fact, it was better than the pessimist in me had predicted. She did not dress like a 17 year-old (just because you can, doesn't mean you should). She sang mostly old favorites. She was great. I especially loved ending with "Like a Prayer." Interesting how a song that spawned protests and a Pepsi boycott was the finale of a Super Bowl halftime with hardly a mention. She must have loved that.

Unpaid Student Internships, Price Controls and Rationing

2012-02-06T10:34:00-07:00

The NYT is having a discussion forum today on unpaid student internships. For those of you who have not had this topic on your radar, here's a brief catchup: Internships have become increasingly prevalent for college students, business school students and law students. For law schools, internships and externships provide students with the practical experience that they need, supervised by folks who do this full-time. However, the Labor Department has issued guidance on these internships that some people pay attention to and others don't. I'll detail the guidance criteria below. The debate is whether these criteria (and their enforcement) are beneficial in that they protect students from exploitation or whether they hinder students from obtaining useful work experience and career contacts.

According to a January 2010 memo from the U.S. Department of Labor, an intern may be considered an "employee" for purposes of the Fair Labor Standards Act unless the worker is a bona fide "trainee." If the intern is an employee, then minimm wage and overtime provisions apply. The memo then lists six factors to consider, including these two: "training is for the the benefit of the trainees" and "the employer that provides the training derives no immediate advantage from the activities of the trainees, and on occasion the employer's operations may actually be impeded."

So, in the context of a law school internship, to meet the criteria, the school would not be able to recruit employers by emphasizing the benefit the employer would get from our smart, go-getter students and the employer would not be able to profit from the student's labor (i.e., bill out the work). According to the memo, "if the workers are engaged in the primary operations of the employer and are performing productive work (for example, filing, performing other clerical work, or assisting customers), then the fact that they may be receiving some benefits in the form of a new skill or improved work habits is unlikely to make them trainees given the benefits receied by the employer." In other words, if it's a good deal for the employer, then it probably will not qualify as an unpaid internship. Because of this, many law school internships are with nonprofits, who don't have to worry about this. But, there are only so many nonprofits and some students would like (ahem) transactional experience in a corporation or a law firm.

The discussion is mostly about undergraduates, but Above the Law's David Lat weighs in from the legal training side. His take is basically the same as mine. These internships are valuable. Everyone is making a rational choice. They probably do not shut out those seeking paid work, but even if they do, so does the minimum wage that would otherwise apply. If companies were not allowed to offer unpaid internships, then they would offer a much smaller number of paid internships (maybe zero).

Some critics complain that the explosion of unpaid internships hurts those who are not in a financial position to take them. This may be true. Students from poorer backgrounds may not be able to pad their resumes with activities and volunteering, may have to work during college instead of studying 24/7, and may find unpaid internships pose a financial hardship on them. No laws can change the myriad ways in which those with financial and social capital have advantages. But, I think we should also ask "compared to what?" I don't think there is a parallel world of thousands of paid internships that would instantly bloom if unpaid internships were outlawed. I think the choices would then be between a small number of paid internships in a student's desired field compared to finding wage-earning employment in retail, food, etc. For law students, paid internships and clerkships are at historical lows. Liberalizing unpaid internships is more likely to get more law students more experience than convert all of those choice gigs into unpaid slave labor.

The McCann FitzGerald Chair in Corporate Law

2012-02-06T01:26:35-07:00

Announcement:

The School of Law, Trinity College Dublin and McCann FitzGerald are delighted to announce the establishment of the McCann FitzGerald Chair in Corporate Law. This is a full-time permanent position in Ireland’s oldest and most prestigious Law School, and we are seeking applications from suitably qualified candidates in Corporate Law specialising in areas such as corporate governance or securities law.

Trinity College Dublin? Very cool.

Super Bowl Commercials

2012-02-05T00:51:24-07:00

No need to wait for the game. Here and here are nice collections. Matthew Broderick's update of Ferris Bueller's Day Off was nice, but my favorite was "The Bark Side":

Good Parenting

2012-02-04T11:49:00-07:00

The year after Jaws ensured that I would never feel comfortable swimming in an ocean,* I laughed at Grizzly, a copycat entry in the animal horror genre. I thought about Grizzly when I read the WSJ's article about Pamela Druckerman's new book Bringing Up Bebe, an ode to French parenting. Battle Hymn of the Tiger Mother this is not.

I am as much of a Francophile of the next guy -- some of my ancestry is French, which I assume accounts for my love of fine cheese, and I have spent a decent amount of time in France over the past two decades -- but I am not buying that the French have "parenting secrets." What Druckerman describes is not "French parenting," but simply "good parenting." As far as I can tell from the WSJ story and the promotional material on the book, here is the secret to French parenting: parents make sensible rules and enforce them. No fake threats. No bargaining. No cheating.

This sort of parenting requires courage and integrity ... and an abundance of love for the child. Even then, parenting isn't all sunshine and rainbows. Children come to the world with lots of software already installed, and most of the people I have met who think that they have found the secret to parenting success have not completed the raising of any children (young parents are particularly susceptible to the delusion of parenting certainty). Good parenting is improvisational, and that implies the inevitability of frequent failures. Adaptation and iteration are keys, just like creating a successful startup company.

At least that's my view as an unfinished parent of five wonderful children.

* I was in junior high school in Wisconsin in 1975, so I could not have been much further from an ocean, but that movie terrified me. And it's true, I still don't like going into the ocean.

Executive Compensation As An Increasingly European Preoccupation

2012-02-04T09:58:13-07:00

As the folks at Corp Counsel observe, the UK is making a big thing about reining in exeuctive pay:

As I've blogged before, the United Kingdom has been on a path to revise its executive compensation laws to rein in excessive pay. Yesterday, the UK announced a slew of proposals that would push the envelope in the executive pay area - here are the proposals (or the closest thing I could find to them), as well as British Business Secretary Vince Cable's oral statement, a summary of responses to the related discussion paper and a comparison with the High Pay Commission's report that came out a few months ago (note that the HPC is not an independent commission; it's a left wing charity). And here is a Towers Watson memo, ISS blog and NY Times article discussing these proposals.

The proposed major changes include:

- Say-on-pay votes would be binding
- Approval threshold increased to 75% from 50%
- At least two compensation committee members would have no prior board experience
- Clawbacks of bonuses if executives failed
- Enhanced disclosures

It's notable that Britain's opposition party is quoted in media reports as criticizing these proposals as not going far enough!

The Basel Committee is also worrying about executive pay in financial intermediaries. I think this stuff is evidence of a change in the driver of the debate of executive pay regulation. The American laissez faire perspective on pay was beginning to spread, to some consternation, to Europe and elsewhere. But if anything, I think that the post-crisis inclination of foreign countries to point to executive compensation as part of the problem may end up constraining the old American liberality ... through vehicles like Basel.

30-Day Challenges

2012-02-04T00:38:00-07:00

Tonight at a law school event, I fell into a discussion of parenting with several friends. We discussed various methods of behavior modification, and one person endorsed the 30-day challenge. Inspired by Matt Cutts, see the video below, I have been doing a series of 30-day challenges, including one that had me blogging every day for the month of January. (Did you notice?)

Next up: work on the next edition of my casebook every day for 30 days. That should enable me to finish off this next edition, which has been in the works for about two years.

Carlyle Abandons Arbitration Provision

2012-02-03T22:26:44-07:00

Everyone, including Christine, thought that Carlyle's plan to require arbitration for "any disputes arising out of or relating in any way to our partnership agreement or the common units, including those under the federal securities laws of the United States" would encounter resistance. Today, Carlyle removed the provision after the SEC told the company that it would not approve the IPO.

I stand with Harvey Pitt on this one: "If somebody tells you that you’re going to have a very different set of remedies if you make this investment, and you still want to invest, it seems to me government has done its job."

And Hal Scott: "What’s at stake is the competitiveness of our capital markets. If the SEC is going to take this position, we are all entitled to know why they think securities class actions are helpful."

This is a nice example of how the right rules could encourage companies to become laboratories of corporate governance. If investors don't like arbitration provisions, let them punish the unit price, but if investors are willing to buy the units, why should the SEC stand in the way? The investors are not vulnerable consumers who need the SEC to evaluate the merits of the deal. Disclose the terms and let the market set the price.

More on Law & Strategy

2012-02-03T16:27:16-07:00

Peter Klein, referring to my post from last week, is on the case: "The emerging field of non-market strategy (1, 2), led by people like David Baron, Vit Henisz, and the de Figueiredo brothers, studies how firms use not only law but also the regulatory system, bureaucracies, and other non-market features to achieve competitive advantage."

Looks like I have some weekend reading ...

Komen, Planned Parenthood and Branding

2012-02-03T10:12:19-07:00

The last few days have seen a firestorm of protest on social media outlets such as Facebook and Twitter due to the decision of the Susan G. Komen for the Cure foundation to eliminate grant funding to Planned Parenthood for breast cancer screening. I saw both sides of this controversy as branding problems.

Ten, fifteen years ago, Komen was building a very successful brand. Consumers generally thought of Komen as the charity started by the sister of a young woman who lost her fight with breast cancer and the charity that hosts the 5K Race for the Cure fun runs. (I myself placed 3rd in my age group in the 1995 Lubbock, Texas Race for the Cure.) In the past decade, Komen has become a wildly successful charity, licensing its "pink ribbon" logo to numerous types of consumer products, flooding the month of October in pink. (I myself have a Dyson pink ribbon vacuum.) But, Komen has been involved in several PR crises. First, consumer groups, crying "pinkwashing," criticized Komen for taking money from firms to put the pink ribbon on products that may be unhealthy (KFC) or even carcinogenic (perfume with known carcinogens, yogurt with hormones). Then, Komen was criticized for vigorously defending its "race for the cure" trademark against small charitable groups raising money for various cancers and other diseases. These controversies have spawned various anti-Komen websites and a new documentary on the politicization of breast cancer awareness, Pink Ribbon, Inc.

The decision to cut off funding to PP poses another branding threat to Komen. PP is a health care provider to millions of women, mostly women with lower incomes. Komen risks being seen as interested in breast cancer health of women who have their own gynecologist, have health insurance, eat Yoplait, do fun runs and have Dyson vacuum cleaners. Komen officials have couched the decision in terms of "new granting writing guidelines" and not giving grants to organizations "under investigation," but pretty much everyone agrees that the decision was made because of PP's abortion services, either out of donor pressure, political pressure or the preferences of senior officers there.

This leads to PP's branding problem. PP wants the world to know that this decision affects its efforts to provide breast cancer screenings, a major service it provides. Abortion procedures constitute 3% of its services. (Screening for STD's, birth control and cancer screenings are its big three services.) But, many equate the name "Planned Parenthood" with abortion, possibly because PP performs about 25% of abortions in the U.S. (330,000 out of 1.2 million, according to the census). But, PP provides many other critical health care services, mainly to those with lower incomes who don't have private doctors or private insurance. But, PP definitely doesn't downplay abortion on its websites and even seems to highlight it. Abortion is generally listed first in categories or lists of its services -- which are in alphabetical order. A commercial firm would highlight its big stuff. Now, politically, the folks at PP may want to keep it at the front, to make a point that it isn't hiding its abortion services, that abortion is legal and not a back-alley business, etc. But, if it wants to present itself as a full-service health care provider for women, then PP might want to highlight its bread-and-butter services and develop a more general health care brand.

Of course, Komen and private donors are free to direct their dollars however they choose and may prefer a zero-tolerance policy to abortion. However, as an organization dependent on donor dollars itself, Komen has a lot of thinking to do about its own brand.

UPDATE: Right after I posted this, I received a notification that Komen has reversed itself on the decision. Press release here. The Facebook is mightier than the sword.