An article in yesterday’s NYT describes the genesis of option backdating at Micrel Inc., a silicon valley semiconductor company:
Throughout the 1990’s, Silicon Valley companies were locked in an intense battle to recruit employees, and stock options were their primary tool.
* * *
So when new hires began complaining that the [Micrel’s] volatile share price meant that colleagues who had arrived just days earlier were receiving stock options worth thousands of dollars more, Micrel executives moved to satisfy the troops. They raised with their auditor, Deloitte & Touche, the idea of adopting a new options pricing strategy similar to one that other tech companies, including Microsoft, used at the time.
Instead of granting options at the market price on a new employee’s hire date, Micrel proposed setting the price at the lowest point in the 30 days from when the grant was approved.
It seemed like an ideal solution. The 30-day window could help Micrel attract and reward new hires on a more equal footing, while helping to retain existing employees. And if it were extended up the corporate ladder, the prospect of built-in gains and tax breaks, worth millions of dollars, could enrich senior executives.
Deloitte allegedly approved the strategy but five years later reversed course. By then, however, the practice had become the norm in Silicon Valley and perhaps ultimately led to the option backdating scandal we’re now in the midst of.
The origin of backdating is a lot earlier than Micrel. The first company to be in the forefront was Brocade followed by Mercury (April 2005). Then Erik Lie of Iowa did some research published by WSJ early this year that set all these events in motion.
I think you’re unfortunately right about the rule making that’s coming.
To my knowledge, very few companies disclose anything about their grant practices. Excluding the flagrant backdating, which really is inexcusable, have investors really been harmed by this? Isn’t it somewhat taken for granted that management will try to time its grants at what it believes is a low point in the trading range?
People tend to conveniently forget that during the late ’90s, it was extraordinarily difficult for tech companies to retain highly skilled employees. One of the primary retention tools was low-priced options with longer vesting periods. It’s not an accident that Microsoft and Micrel (in your example) were using this technique. It wasn’t just individual greed, it was necessary to keep skilled technical employees. If a company couldn’t refresh options and if those options weren’t in the money, there would almost certainly be a competitor (or two or three) who would offer very attractive comp packages. In the current mania over executive comp, this important bit of history has gotten thrown out.
I can’t think of a legal theory that makes sense either (assuming the comp committee knew of the material, non-public info at the time of grant). There was some more handwringing on the issue yesterday in the LA Times (see here). The article indicates that the SEC will give some guidance on the “spring-load” issue as part of the new executive comp rules. Maybe then we’ll get an answer, but my guess is the SEC will just turn it into a disclosure issue.
I’m curious as to your and your readers’ views on the basic timing issue involved in certain of these cases: can the board properly grant options in advance of undisclosed positive news? Take this example. Regularly scheduled quarterly board meeting, at which the audit committee will review the results of the quarter before they are released and the comp committee will make option grants. If the quarter is at the high end of estimates or better, is it permissible under the securities laws for the comp committee to make the grants? If not, please explain the legal theory that would prohibit the grant. For the record, my view is that it is permissible under the securities laws. I’ve seen a lot of handwringing in the press over this issue, but no one (including the SEC to my knowledge) has posited a legal theory of liability that really makes any sense. Thoughts?