Securities Act of 1934
Treatment of Stock Option Transfer Program under Rules 14e-1(b), 14e-1(c) and 13e-4 of the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder
Mr. Brian Breheny
Chief, Office of Mergers and Acquisitions
Division of Corporate Finance
Securities and Exchange Commission
MAIL STOP 3-3
450 Fifth Street, N.W.
Washington, D.C. 20549
Dear Mr. Breheny:
Microsoft Corporation, a Washington corporation ("Microsoft"), proposes to establish a stock option transfer program (the "Program") for compensatory purposes to enable Microsoft employees to realize some value for their "out of the money" employee stock options. The Program is part of a broader restructuring of Microsoft's employee compensation programs. Upon consummation of the Program, (i) the Eligible Options (defined below) of employees who elect to participate in the Program will be transferred to JPMorgan Chase Bank or its affiliates ("JPMorgan"), (ii) Microsoft will amend and restate the Eligible Options at the time of transfer to JPMorgan to, among other things, shorten the expiration dates of most of the options, (iii) Microsoft will pay employees for their transferred Eligible Options, in part on a contingent basis, and (iv) JPMorgan will make payment to Microsoft in an amount equal to the total payments due to employees for their transferred Eligible Options.
The Program is part of a broader restructuring of Microsoft's employee compensation program and will enable Eligible Employees (defined below) to transfer all (but not less than all)1 of their Eligible Options for cash, thus enabling such employees to realize some value for their "out of the money" options. "Eligible Options" are options or share appreciation rights2 that were granted under certain Microsoft compensatory benefit plans for employees, have an exercise price per share equal to or greater than $33.00 and have an expiration date on or after February 29, 2004. Participation in the Program will be entirely voluntary. None of Microsoft, Microsoft's board of directors or JPMorgan will make any recommendation to employees as to whether to participate in the Program. Employees who do not elect to participate in the Program will continue to hold all of their options, which will remain outstanding on their current terms and conditions.
Microsoft currently expects to distribute information regarding the Program to Microsoft employees either electronically or by mail on October 15, 2003, the commencement of the period (the "Election Period") during which Eligible Employees may elect to participate in the Program. The Election Period will end 20 business days later, at midnight on November 12, 2003, unless extended. The Averaging Period (as defined below) will begin no later than the first available trading day immediately following the second calendar day after the Election Period ends3 and is currently expected to end 15 trading days later, on December 9, 2003. At the end of the Averaging Period, each Eligible Employee who elects to participate in the Program will be able to view the amount of his or her total payment on an internal online stock compensation web tool accessible to all Eligible Employees (the "Employee Election Tool")or, for Eligible Employees who are not able to access the web tool4 , the information can be received by telephone.
To be eligible to participate in the Program, an employee must hold Eligible Options, be an employee of Microsoft or one of its subsidiaries throughout the Election Period and not be employed in certain foreign jurisdictions,5 the laws of which impose adverse legal or regulatory impediments to the Program (an "Eligible Employee"). Eligible Employees would be able to elect to participate (or withdraw their election to participate) in the Program at any time during the Election Period.
The total cash payment to be received by a participating employee for each Eligible Option transferred under the Program would be determined by reference to the average closing price for Microsoft common stock during a period (the "Averaging Period") that is currently expected to consist of 15 available trading days beginning no later than the first available trading day immediately following the second calendar day after the end of the Election Period. A trading day will not be considered an "available trading day" if, on such day, a market disruption6 occurs or the Microsoft registration statement to be used by JPMorgan to sell shares of common stock in connection with the Program is not effective and available. Neither Microsoft nor JPMorgan anticipates the occurrence or existence of a market disruption during this period and Microsoft has agreed to maintain the availability of the Microsoft registration statement for use by JPMorgan in connection with the sale of Microsoft common stock for the duration of the Averaging Period. If, as a result of the occurrence of any of these events or for any other reason, there are fewer than 15 available trading days between the end of the Election Period and December 15, 2003, but at least a fixed minimum number of available trading days (currently expected to be six), the Averaging Period will consist of the available trading days that have occurred. If there are fewer than six available trading days between the end of the Election Period and December 15, 2003, the Program will be terminated and Eligible Employees will retain all of their Eligible Options, which will remain outstanding on their current terms and conditions. The absence of withdrawal rights after the Election Period, and the fact that consummation of the Program is subject to satisfaction of certain conditions after the end of the Election Period, will be prominently highlighted in the information regarding the Program distributed to Microsoft employees.7
Except as described in the next paragraph, Eligible Employees who elect to participate in the Program will be paid a minimum of one-third of the total payment for their Eligible Options on the earliest administratively feasible payroll date8 following the end of the Averaging Period which is expected to be no later than December 31, 2003. Eligible Employees will be paid the remainder of their total payment (the "Contingent Payment") after completion of a period of continued service, that, for most employees, will be approximately two years and, for senior management employees, will be approximately two years for approximately one-half of their Contingent Payment and three years for the remainder of their Contingent Payment. To receive the initial payment, a participant must remain employed by Microsoft until the end of the Election Period. In order to receive the Contingent Payment, a participant must remain a Microsoft employee for the requisite vesting period. The contingent payment structure is designed to serve Microsoft's compensatory purpose of providing incentives for continued employment by participants. The additional one year vesting period for senior management is designed to provide an incentive for senior management to remain with Microsoft until 2006, which coincides with the end of the period for measuring Microsoft's performance for purposes of Microsoft's new long-term incentive compensation program. The vesting dates, including the additional year of vesting, were chosen to coordinate the Contingent Payment payout dates for Microsoft's senior management employees with its current compensation program.
For administrative reasons and to improve employee reception to the program and to motivate employees participants will generally receive the greater of $20,000 (or their total payment if less) or one-third of their total payment. Participants who reside in certain foreign jurisdictions with laws that would impose adverse tax consequences on such participants will also generally be paid in one lump sum.9 In all circumstances, Microsoft reserves the right to accelerate the payment schedules in the event of adverse tax rulings or other regulatory action that would, in Microsoft's judgment taking into account the best interest of the affected employees, make it appropriate to accelerate the payment schedule.
The elements of the Program that generally determine the pricing of the Eligible Options were selected by Microsoft to satisfy its compensation objectives, with the goal of allowing Eligible Employees to realize some value for their Eligible Options without expenditure of Microsoft's funds. Among these elements are the term of the transferred options and the expiration dates thereof, which for most options will be shortened in the hands of JPMorgan in order to provide a participant with an opportunity to receive a range of value that Microsoft believes in its best judgment is an appropriate compensation amount to be paid for each Eligible Option transferred in the Program.
Among other aspects of its compensation strategy, Microsoft determined that the amounts payable per option for a certain class of options (the "Multi-year Grant Options") should be less than the cash payments for similar options because the recipients of the Multi-year Grant Options were granted a larger number of options than are typically granted to employees. Therefore, in order not to distort the compensatory purposes of the Program, Microsoft deemed it appropriate for recipients of these options to receive a smaller cash amount.
Any option transferred to JPMorgan will be amended and restated by Microsoft to, among other things, have an expiration date currently expected to be approximately 36 months from the end of the Averaging Period for most options, and 24 months from the end of the Averaging Period for the Multi-year Grant Options. Eligible Options that are transferred under the Program whose terms expire less than 36 months (or 24 months in the case of Multi-year Grant Options) from the last day of the Averaging Period will have the same expiration dates upon transfer to JPMorgan as they did before such transfer, extended by the number of calendar days from (and including) December 5, 2003 to (but excluding) the last day of the Averaging Period, which we currently expect to be December 9, 2003.
Upon transfer under the Program, options will be removed from, and will no longer be subject to, Microsoft compensatory benefit plans. The shares underlying transferred options will not be available for future grant under such plans and will be deregistered from Microsoft's registration statements on Form S-8. Options transferred to JPMorgan will not be eligible for registration on Form S-8.
By reference to various possible average prices, Eligible Employees will be able to determine the total payment they will receive for their options by referring to information that Microsoft will make available to them at the beginning of the Election Period, which will include a table that an employee may use to determine his or her total payment based on a range of possible average prices and a calculator for determining the total payment based on possible average prices that do not appear in the table. This and other relevant information will be available through the Employee Election Tool as well as by hard copy and telephone for Eligible Employees who are not able to access the Employee Election Tool. Although we do not request that the Staff express any position with respect to the role of JPMorgan in the Program, we would bring to your attention the fact that Microsoft has exercised complete autonomy, control and independence in making all decisions whether or not to implement the Program in this or any other form, the timing of the Program, the eligibility of Microsoft's employees to participate in the Program, and which employee options are eligible for the Program. JPMorgan will not solicit, encourage or recommend participation by employees in the Program and will not have any recourse or claim against employees if the transfer of options by employees pursuant to the Program is not valid. Microsoft, alone, will make all determinations relating to the eligibility and validity of elections to participate in the Program and the validity of options employees elect to enter in the Program. Moreover, such factors as the duration of the options upon transfer, the differential treatment of certain option grants held by certain senior employees, the length of the vesting periods for the deferred payments and the size of the initial payment are all purely compensatory decisions which will be made solely and exclusively by Microsoft. JPMorgan will not have any obligation to pay employees for options transferred under the Program and employees will look solely and exclusively to Microsoft for payments. We also note that, although, upon consummation of the Program, JPMorgan will have beneficial ownership of the common stock underlying the options, the decision to permit the transfer of the Eligible Options to JPMorgan under the Program and the actual transfer mechanics were made by Microsoft in order to implement its compensatory objectives and as part of Microsoft's determination as to the appropriate mechanism for Microsoft to fund the payments under the Program. Upon transfer of Eligible Options under the Program, if JPMorgan were to be the beneficial owner of more than five percent of a class of Microsoft' voting equity securities, JPMorgan will timely comply with all applicable provisions of Regulation 13D-G, including, as applicable, the filing of a statement on Schedule 13D or 13G.
The Program is being offered by Microsoft to Eligible Employees and Microsoft will pay participants for the Eligible Options transferred under the Program; thus, the Exchange Act rules principally relevant to the Program are those relating to issuer tender offers. Rule 13e-4 promulgated under the Exchange Act governs any "issuer tender offer", which is defined in paragraph (a)(2) thereof as "a tender offer for, or a request or invitation for tenders of, any class of equity security, made by the issuer of such class of equity security or by an affiliate of such issuer."
We hereby request that, in relation to the Program, the Staff grant Microsoft relief from compliance with specific provisions of Rule 13e-4 pursuant to Rule 13e-4(h)(9) thereof and confirm that the Staff will not recommend that the Commission take enforcement action pursuant to Rules 14e-1(b) and (c).
The regulatory characteristics of the Program are very similar to those previously addressed by the Staff and by the Commission in the context of recent employee stock option exchange offers ("Option Repricing Offers")10 and issuer share repurchase programs for employee-owned stock ("Issuer Stock Purchase Facilities").11 We refer to the cited programs and the related functional relief collectively as "Analogous Facilities."
We recognize that certain features of the Program may be seen to raise regulatory issues, all of which we believe are addressed by the precedent relief accorded to the Analogous Facilities. We summarize those issues and the related relief below.
Withdrawal Rights (Rule 13e-4(f)(2)(ii). The Program may present "withdrawal rights" issues, arising from the fact that employee elections to transfer Eligible Options under the Program may not be withdrawn after the end of the Election Period and the Eligible Options transferred by employees under the Program would be accepted at the end of the Election Period subject to consummation of the closing of the transactions contemplated by the Program, which is expected to occur three business days after the end of the Averaging Period, which may be more than 40 business days from the commencement of the issuer tender offer. Under the Program, an employee will have full withdrawal rights during the Election Period, which will be at least 20 business days, but will not be able to withdraw an election after that period has expired. We note that none of the Option Repricing Offers provided any withdrawal rights during the six month pricing period for such offers, which is considerably longer than the period of time (which is currently expected to be approximately 15 business days) between the end of the Election Period and the date that the amount of cash that Eligible Employees may receive for the Eligible Options transferred under the Program will be determined and Microsoft's initial and contingent obligations to its employees will be fixed. The six-month period for the Option Repricing Offers is also considerably longer than the period in the Program even if the period until disbursement of the initial cash payment is included.
We recognize that the Staff and Commission do not generally permit the existence of conditions to an offer after withdrawal rights have expired. However, the structure of the Program and in particular, the pricing features of the Program that require an Averaging Period to occur after the Election Period ends, necessitates the existence of such conditions. Consummation of the Program requires the satisfaction or waiver of certain conditions in order for it to successfully close as contemplated in order to achieve the compensatory purposes Microsoft aims to fulfill. As noted above, the limitations on withdrawal rights and the fact that the Program is subject to the satisfaction of certain conditions following the Election Period will be prominently highlighted in the information regarding the Program distributed to Microsoft employees.
All Holders (Rule 13e-4(f)(8)(i). The Program may present "all holders" issues, arising from the facts that the Program excludes (i) options issued under non-qualifying option plans, options that have exercise prices below $33.00 and options with expiration dates earlier than February 29, 2004, (ii) options held by certain employees who do not meet continued employment criteria, (iii) options held by persons other than employees, including directors, advisors and consultants of Microsoft and (iv) options held by employees who are employed in certain foreign jurisdictions.
Microsoft is committed to providing competitive compensation packages for its employees as a means by which to incentivize its employees to provide excellent service to the company and align the interests of its employees with its shareholders. Microsoft has used option grants to provide strong performance incentives to its employees, thereby encouraging its employees to remain in Microsoft's service and enhance long-term shareholder value. Due to recent shifts in the trading price of Microsoft common stock and in the perceived value of technology stocks in general, the options granted to employees with exercise prices of $33.00 and higher may no longer provide the intended incentive to employees since those options are currently out-of-the-money. Options with exercise prices below $33.00 are more reflective of current market prices and, in Microsoft's judgment, better provide performance and retention incentives. As a result, Microsoft does not believe it is consistent with its compensation goals to make the offer available to holders of such options. In this connection, we note that the Staff has not objected to the treatment of employee options with different terms as separate classes of securities for purposes of the "all holders" rule. See Digimarc Corporation (Mar. 16, 2001); Lante Corporation (Feb. 9, 2001).
Microsoft's Board of Directors concluded it to be in the best interest of its shareholders and employees to fund the Program by having the tendered options transferred to JPMorgan. JPMorgan intends to enter into market transactions to hedge its market exposure under the options transferred to it and upon consummation of the Program, will make payment to Microsoft in an amount equal to the total payments due to employees for their transferred Eligible Options. To achieve the appropriate level of compensation payable to Eligible Employees in Microsoft's judgment, the Board, among other things, determined to exclude options expiring prior to February 29, 2004 since the value of such options will not justify the administrative cost of including such options in the Program.
The Program is available only to employees who are employed at the end of the Election Period and any Contingent Payment will be paid only to those participants who remain employed by Microsoft on the scheduled dates of such payment. In a number of Option Repricing Offers and Issuer Stock Purchase Facilities, employees who were not employed through the offer period were excluded because including non-employees would not be consistent with the program's compensatory purposes and new options subject to future vesting. See Accenture Ltd (Jan. 10, 2003); LookSmart, Ltd. (Mar. 20, 2001); Amazon.com, Inc. (Feb. 28, 2001); Westamerica Bancorporation (June 20, 1996); see also SEC Exemptive Order For Issuer Exchange Offers that are Conducted for Compensatory Purposes (Mar. 21, 2001). Similarly, Microsoft believes it would be inappropriate, as a matter of employee relations and its compensation policies, to extend the offer to persons other than employees of Microsoft. For this reason, Microsoft's Board determined to exclude directors, advisors and consultants from the Program since such persons do not serve in the same capacity as employees.
Microsoft has been informed by external advisors that due to local tax, regulatory, or exchange controls, it would be impractical or unduly burdensome for option holders in Belgium, Italy and Pakistan to be included in the Program on a basis that would be consistent with making the Program available to employees in the U.S. and other jurisdictions reasonably promptly and in a manner that would permit Microsoft to pay, and employees to receive, initial payments this year or in the reasonably near future. For this reason, employees in these countries have been excluded from the Program. Microsoft will consider whether it is practicable, in the future, to make similar or comparable programs or benefits available to employees in these jurisdictions.
Best Price (Rule 13e-4(f)(8)(ii). The Program may present "best price" issues, arising from the facts that (i) holders of Multi-year Grant Options will be paid less than other holders of options with similar terms, (ii) senior management employees with total payments in excess of $60,000 will receive a portion of their payments under the Program one year later than other employees and senior management employees in certain foreign countries with adverse tax regimes will receive an amount calculated by reference to the relevant increased tax imposed and (iii) certain Eligible Employees will receive their total payment on or about December 31, 2003 while other Eligible Employees will be paid only one-third (or $20,000, if greater) of their total payment on or about such date.
The holders of Multi-year Grant Options will be paid less than other holders of options with similar terms because the recipients of such options were granted a larger number of options than are typically granted to employees. To reduce the dilutive risk associated with this large grant of Eligible Options and to provide such holders with compensatory benefits comparable to those given to other employees that did not receive such large grants, Microsoft's Board determined that such holders should be paid less. The additional one-year vesting period for senior management employees is similarly designed to fulfill a compensatory objective - specifically, to encourage senior management employees to remain with Microsoft for a period of time that coincides with the end of the period used to measure Microsoft's performance for purposes of Microsoft's new compensation program.
Microsoft structured the Program to provide that participants whose total payments do not exceed $20,000 will be paid 100% of their total payment because Microsoft believes that contingent payments less than a minimum amount do not provide significant retention value as compared to the ongoing administrative costs to Microsoft for such payments.
Microsoft has been advised by external tax advisors that an option holder in certain foreign jurisdictions potentially may be subject to foreign tax on the total payment for the transferred options that would exceed the initial payment such holder would be entitled to receive under the Program.12 Microsoft determined, as part of its compensation objectives, that imposing this up-front cost on an employee would conflict with Microsoft's goal of providing compensatory incentives to its employees and thus will pay 100% of the total payment (or for senior management employees in Australia, Canada, Denmark, India, Spain, and Venezuela, an amount calculated by reference to the relevant increased tax imposed) to such participating holders. Approximately 9.3 million options are held by employees in these jurisdictions, which is only approximately 1.5% of the total number of Eligible Options. Microsoft has applied for and expects to receive favorable rulings in other countries; however because favorable rulings may not be received and because other unanticipated issues may arise, Microsoft reserves the right to accelerate the payment schedules in the event of adverse tax rulings or other regulatory action that would, in Microsoft's judgment taking into account the best interest of the affected employees, make it appropriate to accelerate the payment schedule. We note that the Staff has previously recognized the differential treatment of employees based on the tax laws of their jurisdiction of residence due to the inconsistency of such laws with employee relations goals. See Amazon.com, Inc. (Feb. 28, 2001).
Microsoft estimates that if all Eligible Employees participate in the Program, at the current price of Microsoft common stock, approximately 76% of them will receive 100% of their total payment in one lump sum at the time such employee would have received his or her initial payment scheduled to be made in December 2003.
The Option Repricing Offers include examples in which differential treatment was applied to employee holders based on such factors as (a) their management/compensation status and/or (b) the exercise price and/or grant date of their options. More specifically, holders of certain special options were required to surrender such options without receiving additional consideration, so as not to conflict with the programs' compensatory objectives. See LookSmart, Ltd. (Mar. 20, 2001); Amazon.com, Inc. (Feb. 28, 2001).
Fixed/Variable Price (Rule 13e-4 and Rule 14e-1(b)). We believe that the pricing methodology of the Program is consistent with the positions taken by the Staff with respect to the Option Repricing Offers and the Issuer Stock Purchase Facilities, which we believe established that, in a compensatory context, absolute price certainty is not an essential requirement so long as a rational and objective pricing methodology is employed. See Accenture Ltd. (Jan. 10, 2003); Westamerica Bancorporation (June 20, 1996), cf. AB Volvo (May 16, 1997). Moreover, the proposed average price methodology presents to employees a better opportunity to know final pricing terms at an earlier time than in the case of the Option Repricing Offers, in which pricing terms were not known until six months and a day after irrevocable commitment from the employee. In addition, use of an averaging period will expose employees to less price volatility risk than in the case of the Option Repricing Offers, which established the terms of the repriced options on the basis of a single day's stock price. The Program also provides Eligible Employees the opportunity to estimate their total payments at the beginning of and throughout the Election Period, by reference to a table and a calculator that will be provided to them in the Employee Election Tool, as described above.
Prompt Payment (Rule 13e-4(f)(5), Rule 14e-1(c)). The Program may be seen to present "prompt payment" issues, arising from the facts that (i) the total payment for Eligible Options transferred under the Program would not be determined until the end of the Averaging Period, (ii) the initial payment will not be paid until the next administratively feasible payroll date after the Averaging Period has ended for the reasons specified in footnote 8 and (iii) the Contingent Payment, although promptly credited to the employee's account, will be subject to continued employment and will not be fully paid until approximately two years after the Averaging Period (approximately three years for senior management).
The "prompt payment" issues identified in (i) and (ii) are addressed under the headings "Withdrawal Rights" and "Fixed/Variable Price" above. With respect to the Contingent Payment, we note that a minimum of the greater of $20,000 (or their total payment if less) or one-third of the total payment would be paid promptly after the Averaging Period, free of any subsequent vesting or employment restrictions. In Option Repricing Offers, new options issued to employees were generally subject to revised and extended vesting schedules and there was no vesting prior to the end of the six-month pricing period. As was the case in the Option Repricing Offers, Contingent Payments under the Program are subject to a vesting schedule requiring continued employment.
As noted above, the fact that the Program is subject to the satisfaction of certain conditions following the Election Period will be prominently highlighted in the information regarding the Program distributed to Microsoft employees.
Summary. Based on the similarity of the functional compensatory objectives of the Program and the Option Repricing Offers and the close similarity of the mechanical features of the Program and the Analogous Facilities, we believe it is appropriate to afford to the Program the same established framework of functional relief that has been granted in the context of the Analogous Facilities precedents.
On the basis of the representations made above, we respectfully request that, in relation to the Program, the Staff grant Microsoft relief from compliance with specific provisions of Rule 13e-4 pursuant to Rule 13e-4(h)(9) thereof and confirm that the Staff will not recommend that the Commission take enforcement action pursuant to Rules 14e-1(b) and (c).
If you have any questions concerning the foregoing, or if you require any additional information, please do not hesitate to contact Peter R. Douglas at (212) 450?4336 or Leonard Kreynin at (212) 450?4937 of Davis Polk & Wardwell, counsel for JPMorgan, or Richard B. Dodd at (206) 370?5790 or William Gleeson at (206) 370?5933 of Preston Gates & Ellis LLP, counsel for Microsoft.
Very truly yours,
DAVIS POLK & WARDWELL
By: /s/ Peter R. Douglas
Peter R. Douglas
PRESTON GATES & ELLIS LLP
By: /s/Richard B. Dodd
Richard B. Dodd
Because of adverse tax laws in Australia, Canada, Denmark, India, Spain and Venezuela, most participants in these jurisdictions will be paid their total payment in one lump sum. Unlike in the Czech Republic, Finland, Poland and Trinidad &Tobago, there are a number of employees in Australia, Canada, Denmark, India, Spain and Venezuela at the senior management level. To achieve Microsoft's retention goals with respect to these employees, they will be paid an initial payment calculated by reference to the relevant increased tax imposed and will receive the remainder of their total payment on the same schedule as senior management employees in the U.S. Employees in these jurisdictions hold a total of 9,362,062 Eligible Options (or 1.5% of the Eligible Options).
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