Piliero Mazza &
Pargament, PLLC

Vol. V, Issue 9
December 1999

An Update for Federal Contractors and Commercial Businesses


The Use of Digital
Signatures and
Electronic Documents
to Transact Business
on the Internet

Court Decisions and
EEOC Guidance
Underscore the Need
for Effective
Anti-Harassment Policies

Incentive Stock Options:
The Benefits and Risks



The Use of Digital Signatures and Electronic Documents
to Transact Business on the Internet

As a variety of users increasingly rely upon the Internet to transmit information, many businesses are discovering the advantages of transmitting electronic messages to conduct commercial transactions "on-line." These advantages include, among other things, the speed with which electronic messages can be transmitted, and the reduction in costs associated with the transmission of such messages. For example, the costs of sending and storing electronic messages are significantly less than the costs associated with paper documents. Similarly, gaining access to electronically stored documents is faster and easier than accessing paper documents, as electronically stored documents can be retrieved according to topic or content. Many businesses, therefore, are turning to electronic contracts and other documents in order to facilitate their commercial transactions. In so doing, they are utilizing and relying upon "digital signatures" in order to authenticate electronic documents and provide for safeguards against forgery.

A digital signature is an identifier used to verify the identity of the author or sender of an electronic document. Like a manually signed signature, a digital signature is unique to the sender of the document. An encryption process is utilized to allow both the sender to input his own identifying "signature," or identifier, and the recipient of the document to read the identifier. This encryption process protects the integrity of the sender's signature, as the signature cannot be tampered with or altered by any third party. Therefore, the encryption process provides for an added level of security not usually associated with paper documents, which may be susceptible to forgery.

Despite the advantages associated with digital signatures, their use presents several novel legal issues. For example, the common law notion known as the "Statute of Frauds" generally requires a written signature to enforce a contract for the sale of goods, the transfer of real property, and the disposition of testamentary property. Similarly, the Uniform Commercial Code requires a written signature for transactions involving the sale of goods valued at more than $500. Thus, it is questionable whether the use of digital signatures and electronic documents fulfills such requirements. This issue has only recently been addressed by lawmaking authorities.

On November 9, 1999, the United States House of Representatives passed H.R. 1714, the "Electronic Signatures in Global and National Commerce (E-Sign) Act," which establishes national standards for digital signatures and electronic records and affords them the same legal validity as written contracts and documents. The Senate has not yet considered this legislation. Pursuant to this legislation, so long as such electronic records remain accessible for "later reference, transmission and printing," they will be afforded a presumption of legal validity. As a result, states cannot enact laws denying the legality of documents that are electronically signed.

Moreover, pursuant to the legislation, companies may provide warranties, notices, recalls and other required disclosures in electronic form, so long as consumers affirmatively assent to the receipt of such notices through electronic means.

The Clinton Administration has indicated, however, that the President may veto the legislation due to the legislation's alleged failure to adequately take into account consumer rights. Specifically, the Administration and certain consumer groups have suggested that, notwithstanding the requirement that consumers assent to the receipt of such electronic information, the legislation impermissibly trumps state consumer protection laws by allowing for the delivery of documents and notices through the use of a medium to which many consumers do not yet have access. Accordingly, it is questionable whether federal legislation recognizing the legal validity of electronic documents and signatures will be passed in the near future.

In the absence of such federal legislation, existing state laws will continue to apply. However, only a few states have addressed the issue of whether digital signatures and electronic documents are legally binding and enforceable. While the New York legislature has recognized the legal validity of digital signatures in the context of "qualified financial contracts" and the Utah legislature has explicitly recognized the binding legal effect of digital signatures, most states have not yet addressed this issue.

Therefore, until such time as federal or state lawmaking authorities address this issue in greater detail, the widespread use of digital signatures and electronic documents may be impeded. However, when such laws are passed, we expect that there will be increasing use of electronic signatures and documents as a means of conducting business.


Court Decisions and EEOC Guidance Underscore the Need
for Effective Anti-Harassment Policies
Recent decisions by the U.S. Supreme Court and Enforcement Guidance from the Equal Employment Opportunity Commission (“EEOC”) have underscored the importance of establishing and enforcing an effective anti-harassment policy in the workplace.  All employers should ensure that they promulgate and distribute an effective anti-harassment policy to all employees.  Based on recent court decisions and EEOC Guidance, an anti-harassment policy should cover not only sex-based harassment, but harassment based on race, age, national origin, disability, religion and any other protected categories.
In 1998, the Supreme Court issued a pair of decisions addressing the circumstances in which an employer will be held liable for harassment by supervisors. Faragher v. Boca Raton, Florida; Burlington Indus. v. Ellerth.  The Court held that an employer can avoid liability for such harassment if: (1) the employer exercised reasonable care to prevent and promptly correct the sexual harassment; and (2) the employee-plaintiff unreasonably failed to take advantage of any preventive or corrective opportunities provided by the employer.  In cases of harassment by persons other than supervisors, such as co-workers, customers and independent contractors, the standard for liability is whether the employer “knew or should have known” of the harassment and failed to take prompt and effective corrective action.
The Court noted that it would be “difficult” for an employer to satisfy the first element of this test if it did not have an effective sexual harassment policy and grievance mechanisms. 
In June 1999, the Supreme Court issued a significant decision regarding the availability of punitive damages against employers in employment discrimination cases brought under Title VII of the Civil Rights Act of 1964.  Kolstad v. American Dental Association.  In Kolstad, the court held that an employer may be liable for punitive damages in employment discrimination cases even if its conduct was not “egregious,” if its violation of Title VII was malicious or reckless. 
The Court also held that punitive damages may not be awarded against an employer which made “good faith” efforts to comply with Title VII by adopting anti-discrimination policies and educating personnel on Title VII's prohibitions.  The Court suggested that the dissemination of a written sexual harassment policy, for example, would “go a long way” toward showing that an employer did not act recklessly or maliciously in a sexual harassment case. 
Also in June 1999, in response to the Supreme Court’s decisions in Faragher and Ellerth, the EEOC issued Enforcement Guidance on the issue of sexual harassment by supervisors.  In its Guidance, the EEOC reiterated the principle that “it is generally necessary” for employers to establish, publicize and enforce anti-harassment policies and complaint procedures.  The EEOC stated that employers should provide every employee with a copy of such a policy, which should be written in a manner understandable to all employees, and redistributed periodically.  The EEOC suggested that the policy should be posted in central locations and incorporated into employee handbooks.  In addition, the EEOC suggested that employers should provide training on harassment to all employees.

According to the EEOC, an anti-harassment policy should contain the following elements:
  • A clear explanation of prohibited conduct

  • Assurance that complaining employees or employees providing information relating to complaints will be protected against retaliation

  • A complaint process which provides accessible avenues of complaint and a prompt, thorough and impartial investigation

Based on recent court decisions and EEOC Guidance, such policies should address not only sexual harassment, but harassment based on other protected characteristics.  Employers should also consider conducting training sessions for all personnel, including supervisors and upper management, on unlawful harassment and established complaint procedures.


Incentive Stock Options: The Benefits and Risks

The competitive labor market which currently exists has prompted many high technology companies to offer incentive stock options (“ISO”) to top management and key employees. ISOs are being used to reward company employees and lure skilled and professional employees from competitors.  ISOs provide a corporation with the means to pay executives without offering high salaries. For high-tech start-up corporations which require substantial cash flow in the first years of operation, ISOs can be an attractive recruiting tool.  While ISOs offer benefits to employers and their employees, they also can pose risks and have unintended tax consequences. Accordingly, before offering stock options to employees and new hires, consideration should be given to the risks and benefits of ISO plans.

ISOs are rights to purchase a company’s stock in the future at present day prices.  If the company is successful, and its stock value increases, the shares of the company may be purchased by an employee in the future at a price significantly below the fair market value of the shares. By creating the potential to make this profit, an ISO motivates the company’s employees to work hard to make the company successful.

There are two basic types of options that may be offered to employees --  non-qualified stock options (“NSO”) and incentive stock options. Each has different rules and is treated differently under the federal tax laws. For example, NSOs can provide a company with a tax deduction when the option is exercised.  To obtain the deduction, the company must withhold the proper amount from the employee’s income. 

No tax deduction, however, is available with an ISO.  Rather, the deduction is only available if the employee engages in a “disqualifying disposition,” i.e., the employee disposes of ISO stock before the requisite holding period, subjecting part of the proceeds to ordinary income tax. Because of the tax deduction offered by NSOs, most corporations view them as more beneficial than ISOs.  However, ISOs remain very popular because they are often viewed more favorably by employees or prospective employees and do not require tax withholding by the company.

From an employee’s perspective, an ISO is more beneficial than an NSO because there is no federal tax obligation when an ISO is exercised.  In contrast, when an NSO is exercised the employee realizes income at ordinary income tax rates. This can create an onerous financial burden on the employee at the time the NSO is exercised. In contrast, ISOs do not impose federal tax obligations upon shareholders when the option is issued or exercised. Rather, the employee is taxed when the stock is sold at a profit. The gain is taxed at capital gains rates, which are lower than ordinary income tax rates.

Although ISOs are more costly to a company than NSOs, some corporations are willing to forego the deductions available through NSOs to lure valuable employees. Employers wishing to benefit from ISOs need to make certain they follow specific requirements to qualify for the benefits such plans offer. For example, the option plan must be approved by the shareholders and the options must be granted within ten years of the date of adoption of the plan.  Unless other technical requirements are followed as well, the anticipated benefits of the plan may not be available.

Also, if an employer does not follow any adopted stock option plan (whether ISO or NSO), it risks liability on a number of fronts. In recent cases, former employees have successfully argued that they were terminated without cause to prevent them from exercising their options. Employees with valuable ISOs have also used them to make high severance demands upon employers.  Moreover, unless proper care is taken, independent contractors and temporary employees may argue that company-wide stock option plans were intended for their benefit. 

In short, careful thought should be given to the pros and cons of stock option plans. Although corporations often offer ISOs to retain and attract highly qualified employees, tax consequences should be fully understood.  Therefore, corporations need to carefully develop their stock option plans in accordance with regulatory requirements. Failure to do so may not only have adverse tax consequences but also give employees unintended expectations (and perhaps certain rights) in the company’s stock.


888 17th Street, NW
Suite 1100
Washington DC 20006
202.857.0200 Fax

Legal Notice