Restricted Stock

Restricted stock, also known as letter stock or restricted securities, refers to stock of a company that is not fully transferable until certain conditions have been met. Upon satisfaction of those conditions, the stock becomes transferable by the person holding the award.

One type of restricted stock is a form of compensation granted by a company. Typically, the conditions that allow the shares to be transferred are continued employment during a period of time, upon which they vest. However, those restrictions can also be some sort of performance condition, such as the company reaching earnings per share goals or financial targets. Restricted stock is becoming a more prominent form of employee compensation, particularly to executives. It has come to prominence as stock options have fallen out of favor after the perceived excesses of the stock market in the early 21st century, particularly the imposition of accounting rules which make granting of options no longer "free" on the balance sheet.

Restricted stock awards are also coming into favor for executives because the income tax consequences can be more favorable to employees than stock options. For example, in the United States the consequences of a restricted stock award may be managed by the election under section 83(b) of the Internal Revenue Code, and in some cases the award can be structured to allow for the deferral of all tax until the time of the sale of the stock, and for all appreciation to be taxed at capital gains rates, even if the stock appreciated prior to vesting. In contrast, stock options can result in ordinary income to the recipient when exercised (under AMT rules), especially when the stock has appreciated prior to vesting, with only the post-exercise appreciation deferred to the time of sale at capital gains rates.

Executive compensation practices came under increased congressional scrutiny when abuses at corporations such as Enron became public. The American Jobs Creation Act of 2004, P.L. 108-357, added Sec. 409A, which accelerates income to employees who participate in certain nonqualified deferred compensation plans (including stock option plans). Later in 2004, FASB issued Statement no. 123(R), Share-Based Payment, which requires expense treatment for stock options for annual periods beginning in 2005. (Statement no. 123(R) is now incorporated in FASB Accounting Standards Codification Topic 718, Compensation—Stock Compensation.) The median number of stock options (per company) granted by Fortune 1000 firms declined by 40% between 2003 and 2005, and the median number of restricted stock awards increased by nearly 41% over the same period (“Expensing Rule Drives Stock Awards,” Compliance Week, March 27, 2007). From 2004 through 2010, the number of restricted stock holdings of all reporting executives in the S&P 500 increased by 88%. Accepting restricted stocks without enough warranties is not encouraged. Similarly, some small firms take advantage of workers by bullying in which the collaborator or partner is threatened about diluting the value of his stock. Usually, the wronged worker does not realize about bullying before it is too late and most of his career and family has been affected as for instance in Applied Silver Inc.