Monday, July 10, 2006
SEC Commissioner Paul Atkins set off a bit of a controversy when he praised so-called "spingloaded" options granted to corporate executives in advance of the disclosure of good news and said that they cannot constitute insider trading. In his remarks to the International Corporate Governance Network (here), he stated:
A scenario that has drawn much attention is the colorfully named “springloading,” which has been defined as the practice by which a company purposefully schedules an option grant ahead of good news, or purposefully postpones an option grant until after bad news. I am not sure where the term springloading came from, but it certainly has an ominous ring to it.
Not only are there difficult factual issues that need to be proven, such as the nexus between the grant decision and the subsequent news event, but there are also substantive legal issues that need to be addressed. Specifically, we need to ask ourselves whether there has been a securities law violation even if a nexus can be identified between the grant and the news event. Isn’t the grant a product of the exercise of business judgment by the board? For example, a board may approve an options grant for senior management ahead of what is expected to be a positive quarterly earnings report. In approving the grant, the directors may determine that they can grant fewer options to get the same economic effect because they anticipate that the share price will rise. Who are we to second-guess that decision? Why isn’t that decision in the best interests of the shareholders? We also need to remember that predicting the stock price effect of an upcoming event is difficult, let alone predicting the trajectory of the stock price over the next twenty quarters until the options vest.
Also swirling about are accusations of insider trading by corporate boards in connection with options grants. Again, one has to ask whether there is a legitimate legal rationale for pursuing any theory of insider trading in connection with option grants. Boards, in the exercise of their business judgment, should use all the information that they have at hand to make option grant decisions. An insider trading theory falls flat in this context where there is no counterparty who could be harmed by an options grant. The counterparty here is the corporation — and thus the shareholders! They are intended to benefit from the decision.
The issue of options-timing has come into focus recently as companies have revealed that documents related to the awards may have been backdated to ensure that the options priced at the low point to enhance their value. Some companies, such as Microsoft, disclosed their practice was to date the option at a low point for the stock, but it stopped that in 1999. Backdating documents does not mean the option grant was itself improper.
It's an interesting question whether an executive who accepts stock options from a company that "knows" of undisclosed good news and times the issuance of the options to enhance their value can even be termed insider trading, as Commissioner Atkins notes. Aside from his argument that there is no counterparty defrauded by the transaction, there is a question whether the transaction is even a "purchase or sale," an element of any fraud claim under Section 10(b) and Rule 10b-5, the basic insider trading provisions. Similarly, if the option is not exercised immediately but instead only down the road, can it be said the executive traded while in possession of material nonpublic information when that information may have been disclosed months or even years earlier? An interesting article by Professor Iman Anabtawi, Secret Compensation, 82 North Carolina L. Rev. 835 (2004), thoroughly reviews many of the issues related to using options and timing their issuance as a means to compensate management.
Compensation of senior executives is certainly generous, especially when compared with lowly law professors, and there is an almost natural reaction to view any transaction in stock related to undisclosed corporate information as potentially insider trading. A Wall Street Journal article (here) on the issue quotes the reaction of one person to Commissioner Atkins' statement as "[t]his is just not fair." There is a visceral reaction when well-paid executives appear to game the system to reap even more benefits, but that does not necessarily mean the federal securities laws have been contravened. Pigs at the trough maybe, but securities violators is a much more difficult conclusion to reach. (ph)