- Delaware Opens Door For Plaintiffs in Stock Option Cases
- March 5, 2007
- Law Firm: McGuireWoods LLP - Richmond Office
On February 6, 2007, the Delaware Chancery Court issued two decisions denying motions to dismiss complaints alleging spring-loading of options, In re Tyson Foods, Inc. Consol. Shareholder Litigation, and backdating of stock options, Ryan v. Gifford. Although at the motions stage of a proceeding, the courts are more generous to the plaintiff (by assuming that all the plaintiff's allegations are true) than they are at the stage when the plaintiff has to establish liability (by a preponderance of the evidence), these decisions open the door for trials against compensation committees on breach of fiduciary duty claims if intentional backdating or spring-loading can be proven.
In re Tyson Foods, Inc. Consol. Shareholder Litigation
This case relates to a variety of complex issues, one of which is the grant of spring-loaded options (options granted in anticipation of the release of favorable news).
Between 1999 and 2001 Tyson Foods, Inc.'s Board of Directors' compensation committee granted various options to its employees. These options were granted pursuant to a plan which set the minimum exercise price at the fair market value of Tyson's stock on the grant date. The plaintiffs alleged that the compensation committee granted spring-loaded options and in so doing violated its fiduciary duties. In support of their claim, the plaintiffs identified four instances of allegedly well-timed option grants. The announcements following the challenged options grants involved: (i) an acquisition; (ii) cancellation of a previously announced acquisition; (iii) fourth-quarter earnings release; and (iv) better than expected earnings release.
The Court concluded that the plaintiffs had alleged adequately that Tyson's compensation committee violated its fiduciary duty by acting disloyally and in bad faith with regard to the grant of options. The Court established a two-part test to be satisfied by a plaintiff contending that a spring-loaded option issued by a disinterested and independent board is nevertheless beyond the bounds of business judgment:
- The plaintiff must allege that the options were issued according to a shareholder-approved employee compensation plan.
- The plaintiff must allege that the directors who approved the spring-loaded options (a) possessed material non-public information soon to be released that would impact the company's share price, and (b) issued those options with the intent to circumvent otherwise valid shareholder-approved restrictions upon the exercise price of the options (for example, did the committee "know" that the stock price was going to go up following the upcoming press release?).
This case is troubling from a compensation committee member's standpoint because the 2-prong test will be fairly easy to satisfy for most "spring-loading" situations. To prevail, the directors would need to show that the information they had was not material or that they did not intend to circumvent exercise price requirements (presumably they could do this by showing what they did in fact intend, but that could be a difficult burden). Commentators have suggested that this case will be appealed on the theory that the plans, by using a market price concept, do not contain an implicit requirement for options to be granted at a "fair" price. Market pricing may or may not be fully reflective of value at a given time, for a variety of reasons.
Ryan v. Gifford
This case relates to a fairly extreme case of granting backdated options. The stock options in question were granted to Maxim Integrated Products, Inc.'s CEO and chairman under the following circumstances:
- Every challenged option grant occurred during the lowest market price of the month or year in which it was granted.
- A Merrill Lynch analysis found that Maxim's average annualized return of 243% on option grants to management was almost 10 times higher than the 29% annualized market returns in the same period.
- The options were granted, not at set or designated times, but by a sporadic method.
- The stock option plans in question do not grant the board discretion to alter the exercise price by falsifying the date on which the options were granted.
If the claims are proven, the Court felt that these grants not only raised a doubt that the actions of Maxim's compensation committee were a product of the valid exercise of business judgment, but also that the board effectively breached its duty of loyalty. Chancellor Chandler stated "that the intentional violation of a shareholder approved stock option plan, coupled with fraudulent disclosures regarding the directors' purported compliance with that plan, constitute conduct that that is disloyal to the corporation and is therefore an act in bad faith." In concluding that the shareholder-plaintiff should be excused from having to make a demand to the company before suing, the Court went on to state that “[b]ackdating options qualifies as 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.”