Backdating and spring loading


28-Sep-2020 16:18

In his decision, Chancellor Chandler stated, “It is difficult to conceive of an instance, consistent with the concept of loyalty and good faith, in which a fiduciary may declare that an option is granted a “market rate” and simultaneously withhold that both the fiduciary and the recipient knew at the time that those options would quickly be worth much more”.

This puts a spotlight on compensation committees that determine executive compensation and their own compensation as directors.

In short, like the much-ballyhooed Disney parachute decision at the motion-to-dismiss stage, it may be that such complaints will survive motions to dismiss but not give rise to actual liability when litigated to conclusion. The SEC recently amended the compensation disclosure rules for public companies' proxy statements and other reports. The Tyson court concluded that, without explicit authorization from the stockholders, the granting of options at a time when the director is in possession of positive material, nonpublic information involved indirect deception by the director.

The new rules, among other things, require companies, in their compensation discussion and analysis ("CD&A"), to discuss practices regarding the timing and pricing of stock option grants, including practices of selecting option grant dates for executive officers in coordination with the release of material, nonpublic information; the timing of option grants to executive officers in relation to option grants to employees generally; the role of the compensation committee and the executive officers in determining the timing of option grants; and the formula used to set the exercise price of an option grant. The court's rationale for this conclusion was that it is inconsistent with a director's fiduciary duty to ask for stockholder approval of a stock option plan that requires granting of options at fair market value and then later grant options in such a way as to undermine the terms approved by stockholders.

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To us, recognizing that the terms of a particular plan may dictate a result, a determination of "fair market value" is not formulistic or susceptible of exact definition. The 20-day return on options granted to management averaged 243 percent (annualized) over a five-year period.Key Observations About the Decisions Spring-Loading and Backdating May Breach Duty of Loyalty.Depending on the particular facts at hand, the decisions indicate that a director may be deemed to have breached his or her duty of loyalty by acting deceptively and in bad faith (and therefore outside the protections of the business judgment rule and personal liability limitations in the charters of most public companies) by authorizing the granting of options priced at a time when the director knows those options will be quickly worth more upon the subsequent release of material, nonpublic information.Apple CEO, Steve Jobs, was recently cleared by an internal investigation, but the former CFO and General Counsel were not so lucky. It is the practice of issuing stock options or grants to employees and artificially picking a past date. When a company picks a date when the stock price is lowest, the option has more value.

Unfortunately, it circumvents the law and the original intent of the option.A recent ruling in the Delaware courts indicated that companies and their board directors would be liable if options were wrongly issued.



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