In 1998, at the height of the tech bubble, public companies were minting money in the form of stock options. In November of that year, Analog Devices CEO Jerald Fishman called a compensation committee meeting, one week earlier than scheduled, to award management 7.36 million options at a strike price of $57.50 each, according to a complaint filed in 2004 by the Securities and Exchange Commission. On December 1 the Norwood, Massachusetts–based company issued an earnings report, the price of the stock rose to $65, and the options were suddenly worth more than $55 million.
Could a U.S. company still engage in spring-loading, as such timing of options grants is known? In fact, it could. Despite regulatory crackdowns in recent years on how companies account for options grants — and severe penalties imposed in cases of the backdating of options — the SEC has been tolerant of spring-loading. Still, the practice was considered questionable when the SEC filed its complaint against Analog Devices, accusing the company of both spring-loading and backdating. In May this year the chip maker agreed, without admitting or denying guilt, to pay $3 million to settle charges that it improperly backdated $30.7 million worth of options. But the commission let the spring-loading allegations drop.
Spring-loading does not violate existing regulations, according to SEC commissioner Paul Atkins, an outspoken free-market Republican who announced in May that he will step down this year when a successor is confirmed. Atkins says outlawing spring-loading would require new rules because “classic insider trading theory does not fit. Insider trading is illegal because there is an inequality of information.” He tells Institutional Investor: “If management is hiding information from its board, the company is open to legal challenge. But with most spring-loading cases, the board and the management make an arrangement in equal knowledge of the facts.”
Atkins argues that spring-loading can benefit shareholders, on the theory that it allows the board to issue fewer options, thereby limiting dilution of earnings. He contends that if the practice is to be curtailed, it should be done in the market by investors pressuring management to stop the practice. That pressure could be applied in the form of lawsuits or direct appeals to a company’s board of directors or its CEO and senior managers. Investors could also resort to proxy battles.
The Analog Devices case has infuriated corporate governance experts who view spring-loading as form of insider trading. “It’s not an option, because the value was created before the option. It’s a gift,” says Charles Elson, chair of corporate governance at the John L. Weinberg Center for Corporate Governance at the University of Delaware. Kurt Schacht, managing director of the CFA Institute Centre for Financial Market Integrity in Charlottesville, Virginia, asserts that company outsiders “would be sent to jail if they traded on the sorts of information that is available in spring-loading cases. Spring-loading should be illegal.”
Schacht concedes that directors have the right to issue options at a discount. But, he says, “you should have to declare the amount of the discount as income so there is a tax consequence.” Instead, companies are attempting to “game the system” and are undermining “the whole notion of trust.”
There are signs that shareholders are pushing back. Herbert Denton, founder and president of activist investment group Providence Capital, says “management would be foolish to try and get away with spring-loading in the current climate, because shareholders would clamp down hard on abuses.” Last year, in fact, William Chandler III, chancellor of Delaware’s Court of Chancery, issued a stinging rebuke to Tyson Foods over a spring-loading case brought by shareholders. Tyson settled out of court in January for $4.5 million.
Governance experts still want a formal ban and might get their way. With Atkins, the only SEC commissioner to be so permissive on spring-loading, departing, and elections on the way, Providence Capital’s Denton says, “It’s the autumn of spring-loading.”
