This has been an interesting month for stock option decisions. As mentioned in my prior post, a few weeks ago the Delaware Chancery court took a hard line against backdating option practices in Ryan v. Gifford (now available on the Chancery Court’s website here).
Another decision issued on the same day (2/6/07) is In re Tyson Foods, an opinion written by Chancellor Chandler. The relevant part of this case is the discussion on “spring loaded” option grants issued by the Company to favor executives. Ok, so what are “spring loaded” options? The court explains that the are options granted right before a company makes an announcement that is expected to have a positive result on the stock price. The converse of this practice are “bullet dodging” grants, where the grants are timed to take place after the impact of an announcement that is anticipated to depress stock price, thereby giving the benefit of a lower strike price.
This theory of liability is interesting because it is different than straight backdating. As the court points out, backdating has the inherent problem of falsifying information about the grant itself. The date of issuance is false, as is the representation to stockholders that the option was granted at fair market value on its grant date. Spring loading, however, does not necessarily face the same ethical issues. As the court notes, a company may be justified in knowing issuing options that are in the money to executives, as a means to retention and providing performance incentives. The problem lies with disclosure.
The court notes that “[t]he touchstone of disloyalty or bad faith in a spring-loaded option remains deception, not simply the fact that they are (in every real sense) ‘in the money’ at the time of issue. A board of directors might, in an exercise of good faith business judgment, determine that in the money options are an appropriate form of executive compensation…. A company with a volatile share price, or one that expects that its most explosive growth is behind it, might wish to issue options with an exercise price below current market value in order to encourage a manager to work hard in the future while at the same time providing compensation with a greater present market value. One can imagine circumstances in which such a decision, were it made honestly and disclosed in good faith, would be within the rational exercise of business judgment….”
The interesting common thread between both decisions is the overtone relating to good faith/bad faith by directors. Some commentators have already noted that this arises from the Disney decision from 2006 where the Delaware Supreme Court elaborated on what some see as a new duty by the board, one of good faith. This analysis seems to allow for a private right of action under state law against directors, where theories under federal law for insider trading have not gotten much traction with the courts. (“To act in good faith, a director must act at all times with an honesty of purpose and in the best interests and welfare of the corporation.”)
The court also notes in dictum that a director may be absolved of liability if shareholders have expressly empowered the board of directors (or relevant committee) to use backdating, spring-loading, or bullet-dodging as part of employee compensation, and that such actions would not otherwise violate applicable law. It seems like this language could be useful in drafting future plans, although it begs the question as to what impact it would have under 409A, where you may still run into a problem for issuing options below fair market value.
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