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Staff Grants Relief for Tender Offer to Address Backdated Options

The SEC's Office of Mergers and Acquisitions has granted relief to CNET Networks, Inc. in connection with a tender offer, to be followed by a cash payment, to existing employees who hold options that are subject to potential adverse tax consequences under Internal Revenue Code section 409A. The proposed delay in the cash payment until January 2008 is required by the provisions of IRC section 409A. CNET was one of the companies identified in a study by the Center for Financial Research and Analysis whose exercise prices matched or were close to a 40-day low for its stock price between 1998 and 2001.

Shortly after the Center's analysis was issued, CNET conducted an internal investigation of its past option grants and the related accounting matters. The company identified instances where the grant date used as the measurement date for accounting purposes differed from the measurement date as defined in Accounting Principles Board Opinion No. 25. CNET corrected the accounting treatment for approximately 40.8 million options and restated its financial statements for the affected periods.

CNET's proposed tender offer will be made to all eligible employees to amend options granted under four of its equity incentive plans that have an exercise price per share that is less than the fair market value of the underlying common shares on the measurement date under APB No. 25. The offer is for options that were unvested as of December 31, 2004 and are outstanding on the last date the offer is open for acceptance. The offer will only be made to individuals who are subject to U.S. federal income taxes. It will not be extended to former employees who hold the options. CNET explained that it is excluding foreign employees and former employees in reliance on the exemptive relief granted by the Commission in connection with repricings (Repricings, Exemptive Order issued May 25, 2001).

Eligible employees who participate in the offer will be given the right to receive a cash payment equal to the difference between the exercise price of the discount option and the amended option, multiplied by the number of shares subject to each discount option, less any applicable withholding tax. The cash payment will be made on the first payroll date after January 1, 2008, which is expected to be January 10. CNET explained that the timing was established to comply with the section 409A prohibition against paying cash compensation during the same calendar year that an option is amended to increase its exercise price.

CNET cited the guidance issued by the IRS and the Department of Treasury on amending stock options subject to section 409A so that holders will not be subject to the adverse tax consequences. If it were not prohibited by section 409A, CNET explained that it would promptly pay the cash amount at the expiration of the offer. Instead, the right to receive the cash will be evidenced by a nontransferable written agreement delivered to each eligible employee who participates in the offer. CNET plans to conduct the offer in compliance with rule 13e-4, subject to the relief granted for issuer exchange offers conducted for compensatory purposes (Issuer Exchange Offers Conducted for Compensatory Purposes, Exemptive Order issued March 21, 2001).

CNET said it is conducting the offer for compensatory purposes in order to provide employees with the economic benefit of the discount options without the adverse tax consequences of section 409A. It plans to pay cash rather than to grant additional equity compensation awards in order to avoid the dilutive effect on nonparticipating shareholders. CNET added that its employees supported the plan to receive cash rather than additional equity awards. If the company granted new stock options instead of cash, it estimates that it would need to grant options to purchase approximately 500,000 shares, which not only would increase shareholder dilution, but would also use a significant portion of CNET's unused equity award pool.

The cash element is essential to the offer, according to CNET. Otherwise, the eligible employees who participate in the offer would have to forfeit the intrinsic value of their discount options, which would have a negative impact on morale. CNET said it does not want to delay the offer until closer to 2008 because that would diminish the value of the discount options. The company cited a number of instances in which the staff has granted relief from provisions of rule 13e-4 to issuers engaging in tender offers where requiring otherwise would defeat the valid compensatory purpose of the offers.

In granting the no-action relief, the staff noted that the offer will be made for compensatory purposes in order to minimize or avoid the potentially adverse personal tax consequences to employees. Further, the delay in the cash payment is requirement by IRC section 409A. The staff also observed that the offer is not being extended to former or current executive officers and directors. Other than the prompt payment issue, the staff noted CNET's reliance on the relief that was granted on March 21, 2001.

Jacquelyn Lumb