New Stock Options Law Reduces Overtime Costs.

Stock options have become a powerful tool for recruiting employees. In fact, the National Center for Employee Ownership has estimated that 7-10 million workers are now receiving some form of stock options. The use of stock options is no longer reserved for top executives. A recent study by the Federal Reserve Board concluded that in the past two years, 37 percent of companies that offer stock options have broadened the categories of employees eligible to participate to include many non-exempt employees.

A new federal law will allow employers to use stock options as a cost-effective way to motivate non-exempt employees without the risk of "overtime penalties" under the federal wage and hour laws. The new Worker Opportunity Act, which was signed into law by President Clinton in May, amends outdated wage and hour provisions of the Fair Labor Standards Act of 1938 ("FLSA"). Prior to this amendment, the FLSA required stock option profits to be considered in calculating an employee's overtime pay, creating the potential for huge, unexpected overtime bills.

The FLSA requires employers to pay overtime rates to "non-exempt employees" who work more than 40 hours in a particular workweek. [1] With a few exceptions, the overtime rate is generally one and one-half times the employee's "regular rate of pay." Typically, the regular rate of pay is calculated by dividing the employee's total compensation by the employee's non-overtime hours worked. Compensation includes the employee's base hourly pay plus commissions, some bonuses, on-call pay and certain non-cash payments.

In an opinion letter dated February 12, 1999, the Department of Labor (the federal agency charged with enforcement of the FLSA) concluded that the provisions of the FLSA then in effect required consideration of an employee's profit from exercising stock option when calculating the employee's regular rate of pay. The letter advised that the profit needed to be allocated over the lesser of the prior two years or the period from the vesting date until the date that the employee exercised the option.

Not unexpectedly, employers balked at this opinion letter. Several employer groups called for rescission of the letter and for legislation to amend the outdated provision of the FLSA that calls for this result. On March 29, 2000, the Worker Economic Opportunity Act was introduced in both the Senate and the House of Representatives. Labor Secretary Alexis M. Herman applauded the introduction of these bills, stating in a press release "In today's tight labor market, many employers find that using stock options is an important tool to attract and retain good workers." With the full support of both Congress and the White House, the bill sailed through the legislative process and was signed into law by President Clinton on May 18, 2000. The amendment will become effective 90 days after this enactment date.

The Worker Opportunity Act amends Section 7(e) of the FLSA to exempt from the regular rate of pay "any value or income derived from employer-provided grants or rights provided pursuant to a stock option, stock appreciation right, or bona fide employee stock purchase program" if certain requirements are met. First, the employee's participation must be voluntary. Second, the terms of the plan must be disclosed to the employee. Third, in the case of stock options and stock appreciation rights, there generally must be a minimum six-month period before the grant or right can be exercised, and, if offered at a discount, the exercise price must be at least 85 percent of the fair market value at the time of the grant. In addition to these general requirements, the amendment sets forth criteria for performance-based, employer-provided grants or rights.

Fortunately, the amendment has a safe harbor provision that precludes liability being retroactively imposed on employers for past infractions of the FLSA based on stock option grants to non-exempt employees. In addition, employers who must obtain shareholder approval to modify their stock programs will have one year following the effective date of the new law to bring their programs into compliance. Employee stock programs that are provided under collective bargaining agreements are also shielded from liability.

Employers who allow non-exempt employees to participate in stock option or stock purchase programs should ensure that these programs comply with this new federal law. An ounce of prevention now should prevent unexpected federal overtime penalties later.

(1.) Under federal law, "exempt employees" are typically those who qualify as executives. administrators and professionals. Improper classification of employees as exempt may have substantial financial consequences. For assistance in determining whether your employees should be classified as "non-exempt" or "exempt," please contact one of our attorneys in the Gray Cary Ware & Freidenrich LLP Employment Practices Services Group.