After recent scandals that put executives under scrutiny for their compensation, the SEC has released a new bulletin regarding disclosure of “spring-loaded” stock options. In this article, we will explain the SEC’s bulletin and how it could affect your stock options.
At Gardner Employment Law, we pride ourselves in staying up to date on laws that impact our clients and their careers. We have experience in advising clients about their stock options, including the “fine print” of SEC rules. Give us a call if you want to protect and improve your compensation package.
What Are “Spring-Loaded” Stock Options?
Employers frequently award stock options as part of a compensation package. As we explained in “How Do Employee Stock Options Work,” stock options can incentivize an executive to remain with the company, especially if the company may be sold in the near future. Stock options grant the “option” to purchase your employer’s stock at a set price, also called the “strike price,” grant price, or the exercise price. Employees gain a financial benefit since the grant price set by the stock options often is less than the market price.
But what if the executives in the C-suite know of coming events likely to increase the value of the stock. Is it legal for those executives to issue themselves stock options at a lower exercise price triggered to take effect at or just before the favorable event occurs? That is the description of a “spring-loaded” stock option.
How Does the SEC View Spring-Loaded Stock Options?
In November 2021 the SEC addressed spring-loaded stock options in a Staff Accounting Bulletin (“SAB 120”). The bulletin advised that companies must disclose “spring-loaded” options and how they affect the executives’ compensation. Equity incentive awards are supposed to be valued for accounting purposes based on their fair value at the time of the grant. Spring-loaded awards granted before the public announcement of positive market-moving information can be expected to quickly increase in value as the market learns of information that was privately known to the company at the time of the grant but not reflected in the share price. The question becomes whether the options were based on “fair value.”
Spring-loaded stock options benefit the executives who are privy to the information regarding future company plans. The executives grant these options to themselves before the company announces information that might change the stock price in a favorable way. The SEC views this knowledge as “material nonpublic information” (MNPI). MNPI pertains to such things as the company’s earnings or a significant business transaction that will be announced. With spring-loaded stock options, executives can capitalize on market-moving information in order to enhance their earnings. Some experts believe that this scenario is very close to insider trading.
In its November 2021 “guidance” bulletin, the SEC requires companies to disclose, not only how spring-loaded awards impact executives compensation, but also the expected market volatility of a company’s stock and the company’s accounting policy about these options. This new SEC statement causes companies to more carefully consider using spring-loaded stock options. The bulletin states that “non-routine spring-loaded grants merit particular scrutiny by those responsible for compensation and financial reporting governance at public companies.”
While this new guidance does not explicitly contain any new penalties, it would serve companies and their executives well to always make accurate public disclosures. The SEC can recoup excess executive compensation that is not accurately disclosed in an issuer’s financial statements, a penalty that would occur regardless if the misstatements of compensation were the result of fraud, unintentional error, or any other factor.
What Caused the SEC to Tighten Its Watch Over Stock Options?
In October 2021, the SEC began reconsidering a rule proposal that arose out of the 2007-2009 financial crisis. In the past few years, several companies have experienced incidents that put their finances under the SEC’s microscope.
For example, as reported by the Wall Street Journal, in July 2020 Eastman Kodak’s stock reached its highest level in 6 years. This high mark came just after the company announced that it was set to receive a $765 million dollar loan for developing drugs to protect against the coronavirus. Kodak granted spring-loaded options to executives a day before the announcement. Some of those options vested the day they were granted, becoming immediately lucrative. Executive Chairman Jim Continenza stood to gain over $95 million upon release of the announcement via his spring-loaded shares. For reasons unknown, Chairman Continenza did not exercise his options, and the company has not been charged with any securities violations.
The Kodak story is not the only event that predicates the new SEC guidance. After direct violation of SEC disclosure rules, ProPetro, a Texas based oil company, was fined and issued a cease-and-desist order by the SEC. This proceeding culminated after ProPetro CEO, Dave Redman, had used the company credit card for personal expenses and failed to disclose investments of company stock in two private real estate transactions. In both of these examples, failure to report executive compensation and misuse of company funds and property led to public misinformation in company filings.
The SEC has made clear that it fully intends to investigate situations that violate SEC regulations. David Peavler, Director of the SEC’s Fort Worth Office, stated in a press release pertaining to the ProPetro incident, “The federal securities laws are crystal clear: Issuers must accurately disclose and record executive compensation and stock ownership.”
Are You Concerned About the Effect of Your Stock Options?
Current spring-loading scrutiny amplifies SEC disclosure requirements. Let this be a reminder that you must understand the implications of how your stock options are issued and reported. It is important to know the current SEC requirements so that you can improve your financial status within the legal guidelines.
Stock options and other share-based awards can have restrictions and guidelines that you may not know about. If you need help navigating how to effectively use your stock options, feel free to give us a call.