Backdating and spring loading
Chandler III, made it clear that backdating is illegal and that corporate boards need to act swiftly to rectify the wrong doing.
What surprised many was his further discussion on “spring loading”.
In such circumstances, directors may lose the indemnification and other liability protections afforded by the Delaware General Corporation Law and may be personally liable for resulting damages to the company. Notably, neither case involved a finding of liability; instead, both decisions merely allowed the cases to proceed. The plaintiffs claimed that these announcements increased Tyson's stock price and put the newly granted options "in the money." In each instance, the announcement resulted in a significant increase in Tyson's stock price.
While we expect to see more lawsuits alleging that managers or compensation committee members authorized the grant of options in a manner prohibited by such plans or while in possession of material, nonpublic information, it is likely that in many "spring-loading" cases, plaintiffs will have substantial difficulty proving that a compensation committee "knew" that the company's stock price would increase. The plaintiffs alleged that the options were granted pursuant to a stock incentive plan approved by Tyson's stockholders that required, as equity plans typically do, the exercise price of every option to be at or above the fair market value of Tyson's stock on the date of grant.
To quote one of the decisions, intentional backdating is one of those " 'rare cases [in which] a transaction may be so egregious on its face that board approval cannot meet the test of business judgment, and a substantial likelihood of director liability therefore exists.' " Disclosures Critical. 6, 2007), 2007 WL 416132, involved allegations that members of Tyson Foods' compensation committee violated their fiduciary duties by approving spring-loaded options from 1999 to 2003.
Depending on the circumstances, where directors intentionally violate a stockholder-approved option plan by backdating options, and a company makes fraudulent disclosures regarding the directors' purported compliance with such plan in SEC filings or other public disclosures, the directors may be deemed to have acted in bad faith. The alleged instances of "well-timed" option grants included several instances in which grants were made immediately preceding the announcement of a material divestiture or acquisition or the announcement of highly favorable quarterly earnings.
If, for example, the compensation committee approves awards at a.m. This return was 20 times higher than the annualized returns for the company's stock during the same five-year period.
Unfortunately, it circumvents the law and the original intent of the option.
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.
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.