A History Of 409A Valuations
Enron was an energy, commodities, and services company whose shocking malpractices shook the foundations of corporate America. The outcry of this scandal was so immense that it spawned various laws for raising the accounting standards for US companies, including the American Jobs Creation Act that introduced 409A regulations.
These regulations govern the taxation and administration of deferred compensation plans in the US. If your private company issues stock-based compensation, understanding the 409A valuation history and the intricate connection between the Enron scandal and 409A valuations is crucial.

The Enron Scandal: A Catalyst for Change
Some of the key players in the Enron scandal and 409A regulation’s origins were Jeffrey Skilling, Andrew Fastow, Kenneth Lay, and Arthur Andersen LLP.
It all started in 1990 with Kenneth Lay, the then-Enron CEO, appointing Jeffrey Skilling as the CEO of Enron Finance. Under Skilling, in 1992, Enron replaced its traditional historical cost accounting method with a mark-to-market (MTM) method. This allowed Enron to claim their asset’s projected profits on their books even if they had negative returns.
In 1998, Andrew Fastow became Enron’s CFO and started transferring loss-making and underperforming assets to special purpose vehicles (SPVs) not on Enron’s books.
To summarize, the earnings of assets were inflated, and the assets that still could not show profits were moved off the books. As a result, the company appeared way more profitable than it was.
Why was Enron able to get away with such malpractices? In 2002, Arthur Andersen LLP, Enron’s external auditor, admitted that it instructed its employees to destroy documents related to Enron. As a result, the accounting firm was found guilty of obstructing justice and subsequently went out of business, turning the Big Five into the Big Four.
The Origin of IRC Section 409A
The amount of tax Enron was able to deduct from its tax returns because of employees exercising non-qualified stock options increased 10-fold from 1998 to 2000.
Weeks before Enron’s bankruptcy filing, 127 executives received early distributions of more than $53 million in nonqualified deferred compensation arrangements. In this same period, Enron also implemented two special bonus programs which cost $105 million.
So, as Enron was falling, its executives were rewarding themselves.
Naturally, investors, creditors, and regulators had a negative reaction to the Enron scandal, and 409A regulations were introduced through the American Jobs Creation Act. This marked a pivotal moment in the 409A valuation history.
Some of the key provisions of Section 409A were:
- No acceleration of payments – Non-qualified deferred compensation payments cannot be accelerated except under very limited circumstances.
- Specified events for payments – The payments can be made only when a specified event like retirement, death, or disability occurs, or as per the approved schedule.
- Election timing – The decision to defer compensation must be made before the year in which the related services are performed except in the case of new participants and certain performance-based compensation.
- Restrictions on securing payments – If such compensation is transferred to a trust by the employer, any related increase in value or earnings will be treated as an additional transfer of property. So, trust arrangements could not be used to reduce tax liabilities on such compensations.
The then US President George Bush signed this act on 22nd October 2004 and it came into force on 1st January 2005. Since these rules applied to any deferred compensation that was vested after 31st December 2004 or significantly modified after 3rd October 2004, companies rushed to make sure their compensation plans were tax compliant.
Evolution of 409A Valuations
On 10th April 2007, the Internal Revenue Service (IRS) issued the final regulations on Section 409A, introducing safe harbor provisions—a key milestone in the 409A valuation history—under which valuations would be considered reflective of a company’s fair market value if they were based on:
- An independent appraisal
- A repurchase formula that applies to compensatory and non-compensatory purposes (Binding formula presumption)
- Valuations by a qualified individual(s) when the company did not anticipate a change in control event or public offering (Illiquid startup presumption)
If a company secures safe harbor status, the onus will be on the IRS to show that the valuation is grossly unreasonable.
In these regulations, the IRS also made it easier for companies to manage their stock options and stock appreciation rights (SARs) while avoiding severe tax consequences, and relaxed the criteria for stock options and SARs to be exempt from Section 409A.
Startups were expected to prefer the illiquid startup presumption route to safe harbor, but its several requirements meant that independent appraisal became the most preferred type of 409A valuation.
Importance of 409A Compliance Today
Today, 409A valuations, i.e. valuations complying with Section 409A, are crucial for any startup or established company if they issue nonqualified deferred compensation.
If a company does not comply with the requirements of Section 409A, their employees, independent contractors, and even directors will face serious consequences like:
- The entire vested deferred compensation becomes immediately taxable
- Higher than normal interest on pending taxes
- Tax penalty of 20% of the entire vested deferred compensation
As a leading independent appraiser, Eqvista has helped thousands of companies stay tax-compliant and avoid such expensive consequences.
Optimize Your Equity Strategy with a Comprehensive 409A Valuation
The 409A valuation history is fundamentally tied to the gross accounting malpractices exposed during the Enron scandal. The links between the Enron scandal and 409A valuations are undeniable. Their executives did not stop at misreporting losses but also gave themselves huge bonuses as the company was headed for bankruptcy.
In response, the US government came up with Section 409A to prevent such abuses in the future.
Given the serious consequences of non-compliance, it is clear that obtaining a 409A valuation is critical for any company issuing deferred stock-based compensation. That’s where Eqvista’s affordable and reliable 409A valuations come in. Get in touch with our team to know more!