DOL Ruling May Kill Stock Options For Rank And File

The Wage and Hour Division of the U.S. Department of Labor (DOL) recently issued an opinion letter concluding that employee stock option gains need to be counted as compensation for the purpose of calculating overtime pay. The DOL letter was originally written on February 12, 1999, although the DOL did not release the letter until December 23, 1999.

The DOL's ruling could have the effect of making stock option programs for non-exempt workers much more expensive and complex for employers. Many employers may choose not to offer stock options to non-exempt employees rather than face such complexities. The result: Possibly no more millionaire administrative assistants who benefited from being let into stock option plans at the ground floor of start-up companies.

The February 12 letter, like all such DOL advisory opinion letters, was limited to the specific facts and circumstances presented in the letter. Therefore, the letter does not have the force or broad mandate of statutes or final DOL regulations. However, DOL advisory letters are generally viewed as the DOL's interpretation of federal overtime laws, unless or until the DOL withdraws the ruling or supercedes it by regulation.

At this time, most employers are taking a wait-and-see approach to the February 12 letter. It is possible that the DOL will withdraw the letter in response to mounting controversy, just as the DOL's Occupational Safety and Health Administration Division withdrew a recent advisory letter stating that employers are responsible for the workplace safety of telecommuters working at home after a flurry of protests.

Based on the information Davis Wright Tremaine LLP has compiled to date, the Employment Law and Employee Benefits attorneys recommend that employers take no drastic steps in response to the letter until the DOL further confirms the letter as an appropriate advisory publication. Remember, however, that even if the DOL changes its position, this will not preclude a private lawsuit seeking overtime by a non-exempt employee. If you have a need for immediate assistance or would like help answering employee questions about this matter, we recommend that you contact your employment or employee benefits attorney.

Under the DOL letter, a "non-exempt" employee's base pay should be increased by the spread on that employee's option, and any overtime pay due to that employee would have to be paid based on this larger sum. "Non-exempt" employees are those who are not exempt from the minimum wage and overtime provisions of the Fair Labor Standards Act (FLSA). Under the FLSA, hourly and other non- exempt employees must be paid overtime calculated as 150%, or "time and a half" of their "regular rate" of pay. The DOL's interpretation would force employers to use the recalculated regular rate of pay (including the profit from exercised stock options) to recompute the overtime owed for any hours which were worked over 40 in one workweek.

The DOL letter states that when an employee exercises an option, the spread would have to be retroactively attributed to the previous weeks the employee worked from the time the option was granted to the time the option was exercised, but only for a period of up to 104 weeks. This means the entire option spread would be attributed to the previous two years of work (or less if the option was exercised less then two years from the date of grant).

Assume the following: An employee making $10 per hour for a 40 hour week is granted an option to purchase 1000 shares of employer stock at fair market value, subject to a four-year vesting schedule. The fair market value on the grant date is $1 per share and the fair market value after four years is $11 per share. If the employee exercises all of her options after four years, she will realize a spread of $10 per share, totaling $10,000.

The DOL letter states that the $10,000 may not be allocated over more than the previous 104 weeks. This means that the employee's regular rate must be recalculated by including an extra $96.15 per week for each of the previous 104 weeks. For those weeks that the employee exceeded 40 hours per week over the past two years, and was due 1.5 times the regular rate for those overtime hours, the employee would have to be paid additional compensation. For example, if in one workweek the non-exempt employee worked 46 hours, the employee would be owed an additional $162.41 in overtime pay. (46 hours at $12.09/hour, plus 6 hours at $6.04 = $592.41, less the $430 already paid.) Of course, if the non- exempt employee's hourly rate has increased since the date the options were granted, the rate used would be the hourly rate in effect during the previous 104-week period.

Note: Some state overtime laws may require a different calculation.

The key legal issue is what the FLSA requires to be included in the "regular rate" of pay. In the specific facts of the February 12 ruling, the options were granted as a one-time discretionary grant to all employees. The company contended this qualified as a discretionary bonus exempt from the FLSA, but the DOL disagreed. The FLSA has a number of exemptions from the regular rate of pay for such things as holiday bonuses, life insurance, profit sharing and health plans, but the DOL letter states that stock options do not qualify for any of these exemptions.

One problem with this area is that the legal analysis requires the application of an old law to modern circumstances. The FLSA, which was written in 1938, did not anticipate that employers would grant employees stock options. While Congress has amended the FLSA to exempt holiday bonuses and certain specified employee benefit plans from the definition of the "regular rate of pay," stock options have not been specifically exempted.

Nonetheless, many legal professionals and business leaders believe that stock options should be exempted under the terms of the FLSA, and hope that further review by the DOL will lead the DOL to the same conclusion.

Several concerned businesses and individuals have voiced their dissents to the DOL letter. By letter to Secretary of Labor Alexis Herman dated January 11, 2000, Jeffrey C. McGuiness, president of employer group LPA Inc., requested that the DOL withdraw the February 12 letter. In addition, John Boehner (R-Ohio), Chairman of the Subcommittee on Employer-Employee Relations, issued a statement January 12, 2000, which criticized the DOL's opinion. The Association of Private Pension and Welfare Plans (APPWP), another employer group, has been conversing with the DOL and is also considering asking for withdrawal.

To date, the DOL has stood behind the February 12 letter notwithstanding the mounting criticism. However, the DOL's response to LPA hints that stock option plans might qualify for an exemption on other facts, but doesn't say how. Concerned employers may consider accessing the APPWP web site (below), or other employer-oriented sources, for information about how to effectively comment about the February 12 ruling.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.