Securities Exchange Act of 1934 — Section 16

April 20, 1992

Response of the Office of Chief Counsel
Division of Corporation Finance

You have asked the Division to concur with your view as to when options that entitle their holders to purchase issuer shares to the extent specified conditions are met (the "Instruments") become derivative securities under Rule 16a-1(c) under Section 16 of the Securities Exchange Act of 1934.

The Instruments may be granted to employees under an issuer's plan. The issuer's board of directors or a committee it appoints chooses grantees, the number of underlying shares, the exercisability period and the exercise price of the Instruments. The exercise price is fixed at the time of grant. If the grantee's employment terminates, the grantee's Instruments terminate as well.

The Instruments become exercisable in installments. The number of shares for which the Instruments become exercisable at the time of each installment is one of the following three amounts: (1) a fixed number specified at grant if the issuer's earnings for the prior fiscal year meet a threshold specified at grant (the "Target"); (2) a fixed number specified at grant adjusted downward to the extent the issuer's earnings for the prior fiscal year do not meet the Target; or (3) a number determined pursuant to a formula established at grant based on the issuer's earnings in the prior fiscal year.

Based on the facts presented, the Division is of the view that the Instruments are not derivative securities under Rule 16a-1(c) until and to the extent that the number of shares for which they are exercisable is determined, regardless which of the three methods described is used to determine the number of shares for which the Instruments become exercisable at the time of each installment. In reaching this conclusion, the Division notes in particular that the Instruments cannot be settled to any extent unless the issuer's earnings reach a specified threshold. Accordingly, because the exercisability of the Instruments is subject to conditions (other than the passage of time and continued employment) that are not tied to the market price of an equity security of the issuer, the value of the Instruments is not tied to the market price of such an equity security. Participants will, however, be subject to Section 16 with respect to the Instruments once they become derivative securities, i.e., once the number of shares for which they are exercisable is determined.

The Division's conclusion would be the same as to the Instruments' derivative security status after April 30, 1991, regardless of whether they were granted on or before that date or under a plan complying with former or new Rule 16b-3 or neither, because the term "derivative securities" is defined in Rule 16a-1(c) rather than former or new Rule 16b-3. Similarly, the conclusion would remain the same if the term of the Instruments commences with the date of the report of the issuer's accountants with respect to the subject fiscal year instead of the date of grant.

Because these positions are based on the representations made to the Division in your letter, it should be noted that any different facts or conditions might require a different conclusion.

Incoming Letter:

The Incoming Letter is in Acrobat format.

http://www.sec.gov/divisions/corpfin/cf-noaction/cbah042092-sec16.htm