NEW YORK -- Given up for dead earlier this year, a proposal by Travelers Group Inc. to contribute stock options to its $2.3 billion 401(k) plan apparently is still breathing.
Sources say Travelers executives are trying to reconfigure parts of the proposal in hopes of winning approval from the Internal Revenue Service and the Department of Labor. Among the issues, they say, are:
Vesting and potential loss of value by participants who leave the company before being allowed to fully exercise the options.
According to a benefits consultant with connections to Travelers, "the deal killer" in the original proposal centered around vesting issues. "If they provide a plan in which all participants are fully vested after five years and the options are fully exercisable whether you are an employee or not, I believe it could move closer to approval," the consultant said.
The timing of tax deductions for stock option contributions.
Travelers executives apparently are flexible on vesting and how deductions are handled.
Sources said the vesting issue could be addressed if the IRS reconsiders the original proposal, which would allow a deduction when the options are exercised. It was the IRS, they said, that insisted on the up-front valuation approach.
The IRS initially had ruled Travelers could deduct from its corporate taxes the value of the options as of the date the contribution is made to the plan.
But industry experts complained the options would be withdrawn from participants who left the company before they could exercise them, even though treated as vested, because the options would only be exercisable while an employee.
Both government and Travelers officials emphasized the company's request to contribute stock options to its 401(k) plan, on a non-matching basis, is still alive. But none would confirm the proposal is being modified.
A Labor Department official would say only that Travelers' application for a prohibited transaction exemption ruling is on hold pending action by the IRS.
Travelers lawyers on the speaker circuit, however, are talking about the proposal and how it could be modified.
Travelers lawyers Richard Green and Stuart Lewis made one such presentation at an American Bar Association seminar in New York earlier this month. According to one lawyer present, the Travelers' attorneys said the company is willing to defer its deduction for contributing the options to the plan until they are exercised, rather than taking the full deduction up front.
"The sense I have is that they wouldn't be out talking about it if they weren't optimistic" of winning government approval, said the lawyer who attended the seminar.
"It sounded like they are talking with the IRS in an effort to iron out the obstacles . . .," the attorney said.
Mr. Green, Travelers' internal counsel, declined to comment, but sent word through a spokesman that his remarks before the ABA "were made before a private forum and not designed for public consumption."
The innovative concept developed by Travelers to contribute stock options to its 401(k) plan was thought to be headed for swift approval earlier this year following the IRS' determination letter on the qualification of the plan and its private-letter ruling on various tax issues.
Labor Department approval also seemed likely, until the proposal came crashing down amid questions about vesting, deductibility and how the options would be exercised.
The IRS subsequently announced it was reconsidering its approval. The DOL promptly put the Travelers application on hold. That's how the matter has stayed.
A Labor Department spokesman said the Travelers application "is still active until it is withdrawn."
"We are still waiting on the (Internal Revenue) Service. We need to see what the service is going to do; it is still quiet."
Travelers proposed to contribute options worth 10% of each employee's pay, up to $40,000. The options would be exercisable in 20% increments over the first five years after they were contributed and would expire after 10 years. In general, a participant only would be able to exercise the options while still an employee of the Travelers Group.
The Travelers proposal has generated substantial interest. Several plan sponsors are said to be ready to follow Travelers' lead.
Said Michael P. Barry, managing director at Bankers Trust Co., New York: "Someone will figure a way to get through the regulatory gamut. Having done so, it will open things up for everyone. But I think the big issue is the vesting issue."
Such a program can be advantageous to the plan sponsor. Travelers, for example, gets a tax deduction and can conserve cash while achieving its corporate goal of expanding stock ownership by its employees.
One benefit is how stock option contributions to the plan would be reflected on corporate financial statements. Usually, companies only can deduct, as an expense, the cost of stock options when they are exercised by employees.
Accounting practices do not require option grants to be reflected on corporate books at the time they are granted, even though a tax deduction is taken. When the option is exercised, the difference between the value of the stock and the exercise price is accounted for as a dilution of common equity and the option is not reflected on the company's profit and loss statement.