|
OPTIONS
DATING UPDATE: Delaware Chancery Court Deals Blow to
Corporate Defendants in
Stock Options Backdating and Spring-Loading Cases
By Richard A. Levan and Conor L. Mullan
On February 6, 2007, the Delaware Court of Chancery issued two
decisions in derivative securities lawsuits that could significantly
impact future options backdating and spring-loading litigation.
That includes not just private suits, but SEC and criminal enforcement
actions as well.
The first case, Ryan v. Gifford, No. 2213-N, 2007 WL 416162
(Del. Ch. February 6, 2007), involved allegations in a derivative suit
that the board of directors of Maxim Integrated Products, Inc., a
California computer chip manufacturer, breached, among other things,
their fiduciary duty of loyalty by approving backdated option grants to
former Chairman and CEO John Gifford. The complaint alleged that
the backdated options were approved in contravention to the Maxim
shareholder-approved stock option plan, which prohibited the granting
of options at exercise prices below the closing price on the date of
the grant, and that the directors made false representations regarding
the option dates in public filings.
The director defendants moved the court to dismiss the case on its
merits. Chancellor William Chandler denied the motion and held
“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 is disloyal to the corporation and is therefore an act in
bad faith.” Id. at 11. The court noted that
the directors’ alleged misconduct “certainly cannot be said
to amount to faithful and devoted conduct of a loyal
fiduciary.” Id. at 12. Moreover, addressing
the defendants’ contention that the plaintiffs failed to comply
with the Delaware demand requirement before bringing suit, the
Chancellor stated:
A director who approves the backdating of
options faces at the very least a substantial likelihood of
liability, if only because it is difficult to conceive of a context in
which a director may simultaneously lie to his shareholders…and
yet satisfy his duty of loyalty. Backdating 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.”
Id. at 10 (quoting Aronson
v. Lewis, 473 A.2d 805, 815 (Del. 1984)).
The Chancery Court’s assessment of backdating practices in Ryan
v. Gifford – a clear pronouncement that backdating practices
involve deep-seated deception – is further expressed in a
spring-loading case issued on the same day.
In the second case, In re Tyson Foods, Inc., No. 1106-N, 2007
WL 416132 (Del. Ch. February 6, 2007), Chancellor Chandler held that
spring-loading – intentionally timing stock option grants so they
are awarded just prior to the release of positive news regarding the
company – can also give rise to a breach of fiduciary duty
claim. As in Ryan v. Gifford, the Tyson shareholders
alleged that the directors approved the spring-loaded options in
violation of the shareholder-approved stock option plan.
As the Chancellor observed, “[w]hether
a board of directors may in good faith grant spring-loaded options is a
somewhat more difficult question than that posed by options
backdating….” Id. at 18. “At their
heart, all backdated options involve a fundamental, incontrovertible
lie: directors who approve an option dissemble as to the date on which
the grant was actually made. Allegations of spring-loading
implicate a much more subtle deception.” Id.
This is so because spring-loaded options are set at the market price on
the date of the grant, which, as was the case in Tyson, does not
explicitly violate stock option plans.
Nonetheless, although acknowledging that an honest and fully
disclosed decision to grant spring-loaded options may be an appropriate
form of executive compensation, Chancellor Chandler concluded that
“[g]ranting spring-loaded options, without explicit authorization
from shareholders, clearly involves an indirect deception.”
Id. He further noted, “It is inconsistent with [a
director’s duty of loyalty] for a board of directors to ask for
shareholder approval of an incentive stock option plan and then later
to distribute shares to managers in such a way as to undermine the very
objectives approved by shareholders. This remains true even if the
board complies with the strict letter of a shareholder-approved plan as
it relates to strike prices or issue dates.” Id.
According to the court, the relevant issue in spring-loading cases
is whether a director acts in bad faith if he authorizes options with a
market-value strike price “when he knows those shares are
actually worth more than the exercise price.” Id. at
18. In the court’s opinion, such a situation results in a breach
of loyalty. Therefore, the court held that spring-loading will
give rise to a breach of fiduciary duty claim if: (1) the options were
issued according to a shareholder-approved plan, (2) the directors
possess material non-public information soon to be released that would
impact the company’s share price, and (3) the options are issued
with the intent to circumvent shareholder-approved restrictions on the
exercise price of the options.
* * * * * *
These two cases, both denying motions to dismiss, evidence a sharp
judicial hostility to options dating practices commonly followed by
many public companies. The impact of these twin decisions by such
an influential court should embolden plaintiffs’ counsel while at
the same time make it difficult for defendants to dismiss such claims
at the pleading stage. Corporate defendants will face an uphill battle
if cases like Ryan v. Gifford and Tyson are allowed to
stand.
The decisions should also make it substantially more difficult for
counsel for the 100-plus companies and their employees embroiled in SEC
backdating cases to negotiate favorable settlements with the SEC and
Department of Justice. While a few enforcement cases have come
down in recent weeks, the overwhelming majority of cases are still
waiting to be resolved and the language and reasoning of the Delaware
Chancery Court bodes poorly for such targets.
* * * * * *
If you have any questions regarding the article or related matters,
please feel free to contact Richard Levan or Conor Mullan at
215-568-9840 or rlevan@rlevan.com or
cmullan@rlevan.com.
RICHARD A. LEVAN is a partner at Levan
Friedman LLP and can be reached at rlevan@rlevan.com. Mr. Levan
formerly served as a senior official in the SEC’s Philadelphia
Office and as an Assistant U.S. Attorney in the Department of Justice
in Washington, D.C.
CONOR L. MULLAN joined Levan
Friedman LLP in 2005 as an associate, where he concentrates on
Securities Regulation and Litigation and White Collar Defense. He
can be reached at cmullan@rlevan.com.
|
