Desimone and Spring Loaded Options: Just Another Form of Compensation

We are still discussing the backdating cases that have recently come out of Delaware.  Specifically, we are discussing the most recent, Desimone v. Barrows.

Remember those arguments by Henry Manne that insider trading should be allowed because it was just another form of compensation and helped make markets more efficient?  In case you missed it, he's still at it.  A recent iteration of his analysis can be found here.

The theory lives on, only this time the proponents is the Delaware Court of Chancery.  In Desimone, the court considered the practice of spring loading stock options.  This is the practice of deliberately pricing options just before the issuance of good news.  This could be manipulated in a number of different ways.  With options scheduled to be issued, good news could be deliberately delayed.  Alternatively, with good news coming out, the option exercise date could be moved up, with the options issued before the disclosure.  What did the court in Desimone think of manipulating option prices based upon information known only to the board? 

• "But if directors consciously granted options in advance of the issuance of positive information as a bonus, disclosed their motivations candidly, and accounted for the options in good faith reliance on experts, it is difficult to perceive the existence of a fiduciary duty claim other than for excess compensation. Because the directors would have disclosed their motivations openly, the state law obligations of fair disclosure would have been met."

In other words, it's just another form of compensation.  Lets think about this.  You miss a few baseball games and work hard and the company can give you stock options while aware that your company is about to merge.  Moreover, you have to disclose the terms of the options but apparently do not have to disclose that in fact the receiving officers were aware of the merger.  The board does, apparently, have to "disclosed their motivations candidly," not a view always held by Delaware courts.  See In re MONY Group Inc. S'holder Litig., 853 A.2d 661, 682 (Del. Ch. 2004) ("Therefore, disclosures relating to the Board's subjective motivation or opinions are not per se material, as long as the Board fully and accurately discloses the facts material to the transaction."). 

Moreover, why limit spring loaded options to employees.  In connection with a merger, plenty of employees at the assorted investment banking firms, accounting firms, and law firms working on the deal also probably missed some baseball games or barbecues.  Under the reasoning in Desimone, they also could be given spring loaded options as a reward. 

The opinion, in other words, indicated that there was nothing inherently wrong with using inside information to benefit insiders and, presumably, anyone else deemed appropriate by the company.  As with Manne's theories of insider trading, it is just another form of compensation.  The attendant secrecy, the use of information not available to shareholders, the potential for abuse, and the inadequacy of the approach as a form of compensation (the amount to be paid, since it depends upon the increase in share prices is, in most cases, unpredictable) does not seem to matter. 

To the extent this becomes the law, it will be another area where fiduciary duties will not adequately protect shareholders and federal law will need to preempt this view (as it may well already do).  Fortunately, this is not yet the law in Delaware, as this post on Tyson indicates.