NSO
iso

Uber lawsuit alleges employees were misled on equity compensation

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An Uber employee has filed a lawsuit accusing the company of misleading employees about their equity compensation. Uber “devised a fraudulent scheme to recruit highly sought software engineers,” according to the case.  

The lawsuit claims that Uber promised a more tax favorable type of options at the time employees were hired and then later changed the plan. The case alleges that at least 100 others on the Uber staff may have been impacted and that these stock options can potentially be worth “hundreds of millions of dollars” to employees and also save Uber “millions of dollars of tax deductions.”

The plaintiff, Lenza McElrath, who was previously a lawyer and is now an engineer at Uber, says that he was under the impression that all his shares could be treated as ISOs, which do not require an upfront tax bill. He said he was later given a notice about a change to the exercisability schedule, that effectively turned most of his shares into NSOs, which are taxed at the time they are exercised.

While many startups allow their shares to become exercisable over the course of a four-year vesting agreement, Uber has share agreements that become exercisable after just six months. In other words, Uber employees can buy the stock they are entitled to shortly after they gain employment.

Exercising options sooner can potentially result in long-term tax savings, so Uber can make the case that they did this to benefit employees.  But by designating them as “exercisable” at this point in time, regardless of whether they are actually exercised, it triggers the law that no employee is entitled to more than $100,000 of exercisable ISOs in a given year. The rest are automatically treated as NSOs.

According to the legal claim, “this tax is many times the strike price and can total hundreds of thousands of dollars, meaning that NSOs – unlike ISOs — can impede an employee’s ability to exercise the option depending on whether he or she has the financial resources to pay the tax.”

Uber has given us the following statement.  “We want our employees to have a real stake in Uber’s success, and we’re proud to offer equity compensation in service of that goal. Whereas our stock incentive plans are designed to work for all employees, we believe Mr. McElrath has misinterpreted his stock option agreement to benefit himself and his particular tax situation.”

The Uber team will likely point to McElrath’s legal background and claim that he is a litigious individual. After attending Stanford Law School, he worked at O’Melveny & Myers and later worked with the legal team at Yelp, while he was also an engineer there. He previously sued AT&T for poor service, which was sent into arbitration.

They may also argue that the employment agreement states that the ISOs could be subject to tax restrictions. “The Option will be incentive stock option to the maximum extent allowed by the tax code.”

The stock option agreement, which was presented after the employee joined the company, specifically warns that the options could be treated as NSOs. They explicitly lay out the scenario where anything in excess of $100,000 triggers the NSOs.

Others are even arguing that the whole notion behind the case is faulty because it assumes that ISOs are better than NSOs. It’s “all premised on this notion that an ISO is clearly superior from a tax perspective, which is not necessarily a true statement,” said Christine McCarthy, a partner in the technology companies group at Orrick. Because an ISO could potentially trigger other taxes, known as AMT, “whether or not there is significant harm is a substantial question,” she said.

But even if McElrath’s financial burden is exaggerated, the court may still want to evaluate what was verbally promised to him in the course of job interviews or other communication with the company. It has yet to be determined if they’ve fallen short on commitments to him or other employees.

If the court ultimately concludes that McElrath was misled, then this suit may have precedent. This case could not only pose significance for the other similarly situated Uber employees, but also the staff at other startups.

One of the most compelling reasons to join a company like Uber is the equity compensation package. At the time McElrath joined the company in 2014, Uber was said to be valued at just $18 billion. Today, it is estimated to be worth $68 billion.

Early employees at places like Google and Facebook were handsomely rewarded after the companies went public and their share values went up. Uber is rumored to go public within the next two years.

A similar lawsuit was previously filed in a California state court, where the judge dismissed most of the allegations against Uber, but allowed the misrepresentation claims to move forward. The suit was refiled in the U.S. District Court on Monday and he is represented by Phillips, Erlewine, Given & Carlin, a firm which has been involved in a class-action suit against the Honest Company.

We’ve included both the lawsuit and the employment agreement documents provided by Uber.

Lawsuit

Employment agreement

Options agreement

Featured Image: STR/AFP/Getty Images