Corporate governance and backdating of executive stock options
A recent high-profile spring-loading case involving Tyson Foods Inc.resulted in a Delaware court judge criticizing a company director's behavior as not "acting loyally and in good faith as a fiduciary."And a corollary practice, "bullet-dodging" -- delaying an options grant until just after the announcement of corporate bad news -- has also come under scrutiny, though no prominent legal cases involving it have yet arisen."There is no doubt in my mind that 'timed options' represent the next big wave in corporate-governance reform," Jay Eisenhofer, an attorney with Grant & Eisenhofer, a Wilmington, Del.-based law firm representing institutional investors, told the Reuters news agency recently."As a result, policyholders often must balance their need for insurance coverage with their strategies for defending themselves against backdating allegations."* Be clear about process.Spell out your definitions of process exactly and mechanically -- perhaps with a flow chart -- around how each transaction will work.They're not making decisions; they're just facilitating a process," Wolf says.
"If the backdating had been vetted by the compensation committee and then disclosed through various public filings, there would be no [legal] issue with it.""But if the CEO or CFO are saying, 'We really didn't know the details of this; these options just appeared in our package and we went forward,' and the guys below the HR executive are saying, 'Well, we just implemented the directives of the HR executive,' at that point, the HR executive has already been thrown under the bus," Rosenthal says.
If the market price falls below the exercise price, the option has no value.
Indeed, one motivation for backdating options has been to artificially create a lower exercise price to create value in an option contract when the market price of the stock has gone south or has simply languished, instead of rising.
And, as a practical matter, they add, HR executives probably cannot avoid getting caught in the legal cross fire -- if not taking a bullet directly -- should things go awry, even if they weren't intimately involved: Their superiors will probably blame them, and subordinates will disavow them.
Meanwhile, the scope of investigations into the potential abuse of stock-options grants is expanding from the garden-variety undisclosed backdating, to "spring-loading" grants -- timing them to precede upcoming corporate "good news" presently known only to insiders to maximize their value.