By James Hamilton, J.D., LL.M.
Spring-loaded stock options granted to key company directors and executives by independent directors may not have been granted consistent with a fiduciary’s duty of utmost loyalty, ruled the Delaware Chancellor, since it could reasonably be inferred that the board of directors later concealed the true nature of the options grant. (In re Tyson Foods Inc. Consolidated Shareholders Litigation, Del. Chan. Ct. Aug 15, 2007).
More broadly, Chancellor Chandler explained that directors should not take a seat at the board table prepared to offer only conditional loyalty, tolerable good faith, reasonable disinterest or formalistic candor. It is against these standards, and in this spirit, that alleged actions of spring-loading or backdating should be judged.
On three separate occasions, the directors suspected that the share price would climb once the market learned what the board already knew. Armed with this knowledge, members of the compensation committee granted non-qualified stock options to select employees, ensuring that these options would shortly be in the money. When the option grants were later revealed to shareholders, however, the outside directors did not straightforwardly describe such strike-price prestidigitation. Rather, they provided minimal assurances to investors that these options rested within the limits of the shareholder-approved plan. A scheme that relies upon bare formalism concealed by a poverty of communication, said the court, does not sit within the scope of reasonable, good faith business judgment.
Against this backdrop, the court noted that executive compensation is not a realm in which less than forthright disclosure somehow provides a company with an advantage with respect to competitors. Thus, when directors speak out about their own compensation or that of management, shareholders have a right to the full, unvarnished truth. Sophism and guile on this subject does not serve shareholder interests. When directors seek shareholder consent to a stock incentive plan, or any other quasi-contractual arrangement, emphasized the Chancellor, they do not do so in the manner of a devil in a dime-store novel, hoping to set a trap with a particular pattern of words.
The conclusion that a grant of spring-loading options may not be an exercise of a good faith fiduciary rests upon at least two premises, said the court, each of which should be alleged by a plaintiff in order to show that a spring-loaded option issued by an independent board is nevertheless beyond the bounds of business judgment.
First, it must be alleged that the options were issued according to a shareholder-approved employee compensation plan. The second allegation is that the directors that approved spring-loaded options possessed material inside information soon to be released that would impact the company’s share price, and issued those options with the intent to circumvent otherwise valid shareholder-approved restrictions upon the exercise price of the options.