February 15, 2007
Delaware Chancery Court on BackDated and Spring Loaded Stock Options
The Delaware Chancery Court, in two opinions, In re Tyson Foods and Ryan v Gifford, ruled against motions to dismiss in derivative actions based on improperly granted compensatory stock options. In Tyson Foods the claims was based on spring-loaded options (options granted on the eve of known good news); in Ryan v Gifford the claim was based on back-dated stock options (options back-dated to an earlier grant date so as to fix a lower exercise price equal to a lower stock market price). In both the Court held the a demand on the board excused and in both the Court noted that the claims stated an allegation of board "bad faith" and breaches of the duty of loyalty. The decision on the spring-loaded options is particularly notable because the SEC, although uncomfortable with the practice, has apparently decided that the options are not a version of illegal insider trading under Rule 10b-5. The use of "bad faith" as the defining doctrine is notable as well; the Court may be giving life and shape to the Disney ruling that identified the lack of bad faith as a separate duty of the board of directors (although the Court did freely use duty of loyalty language as well). The Chancery Court held that spring loading was potentially deceptive to shareholders and needed express shareholder approval. Both rulings should encourage shareholders to bring derivative actions against the 200 or so companies accursed of improperly granting compensatory options.
There are only twenty or so pending class action lawsuits in federal court arguing that back dating options is a violation of federal securities laws. The federal suits are limited by the need of shareholders to show damage to the value of their shares; when the illegal practice is disclosed the stock prices of many firms have not declined significantly. The state derivative actions are not so limited and may simply demand that executives cancel the options and otherwise pay damages suffered by the firm itself. These two rulings should stimulate a wave of private derivative litigation. Even litigants worried about statute of limitations issues (most of the practices happened form 1998 to 2002) should take solace in the Tyson ruling, which held the statute tolled by "fraudulent concealment."
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