Academic journal article Journal of Corporation Law

Stock Option "Springloading": An Examination of Loaded Justifications and New SEC Disclosure Rules

Academic journal article Journal of Corporation Law

Stock Option "Springloading": An Examination of Loaded Justifications and New SEC Disclosure Rules

Article excerpt


Since 2006, corporations have come under fire for using what has been dubbed "stock-options fraud"1 as part of their executive compensation packages. The practices of option "backdating"2 and "springloading"3 have received widespread attention from government regulators: Congress has heard testimony about these matters,4 and some senators have made statements about possible legislative action to address public concerns.5 Recently, the U.S. Securities and Exchange Commission (SEC) enacted new reporting rules requiring public corporations to disclose, in detail, the role that options play as part of executive compensation packages in an effort to improve transparency in the use of options.6

Notwithstanding the SEC's new rules, questions of the legality of backdating and springloading continue to float. While both backdating and springloading strike many as fraudulent, or at least unethical, neither is per se illegal.7 Indeed, even officials at the SEC have expressed contradictory views in the options debate.8 This Note focuses on the legality of stock option springloading as a compensation technique.

Part II of this Note provides information about the reasons for the growth of stock options as a part of executive compensation and the purposes stock options serve. Part II then discusses the current debate surrounding option timing practices, both backdating and springloading. Finally, Part II looks at the development of and policy reasons for insider trading prohibitions for use in comparing that practice to springloading.

Part III examines statements made by SEC Commissioner Paul Atkins in defense of springloading's legality, first looking at whether springloading in fact causes harm to shareholders, and then examining the practice in the context of the business judgment rule. Part IV offers the recommendation that while springloading does not fit squarely within the elements of a traditional insider trading action, springloading should not be permitted without consequence in order to fulfill the policy goals of insider trading prohibitions. Although not a typical insider trading regulation, the new SEC disclosure requirements provide legal repercussions against a corporation that fails to provide shareholders with information about option timing practices, thus serving to enforce the policy considerations of insider trading.9


A. Role of Stock Options and Growth as a Component of Executive-Compensation Packages

The role of stock options as a portion of executive compensation grew considerably during the 1990s.10 This increase was largely due to a new theoretical view of the role of executive compensation: a company's performance should determine the level of management's compensation.11 Because the value of stock options corresponds to the underlying market price of the company's stock, stock options became a powerful compensation device, used to link executive payoffs to corporate performance (as measured through the stock price).12

1. The Agency Problem

Underlying this discussion of compensation and managerial incentives is the theory of agency.13 An agency problem exists anytime the objectives of the principal and the agent conflict and the principal must incur costs to monitor the agent.14 The principal/agent division leads to conflict when an agent has a different risk tolerance than the principal and, therefore, pursues a course of action that the principal himself would not take.15

Agency problem is entwined with the corporation:16 separation of ownership and control is a fundamental element of a publicly traded corporation.17 Shareholders compose the ownership interest in the firm (the principal).18 But the managers (the agents)19 are the decision makers in charge of the operations of the corporation, affecting the interests of the shareholders.20 Agency problem manifests itself when managers use their control of the firm's assets to benefit themselves21 rather than to optimize the value of the firm. …

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