Desimone, Spring Loaded Options and Insider Trading

We are finishing up a series of comments on the backdating cases arising out of Delaware, with the last one tomorrow.  We have noted that, after taking a hard line towards various option practices, including spring loading and backdating, the Chancery Court in Desimone shifted.  The opinion made it absolutely clear that stock options deliberately timed to be issued in advance of good news (so called spring loaded options) are a matter of fiduciary duty, no different than paying a bonus or increasing health benefits.  In the effort to validate the practice, however, the court recognized one small possible impediment, the federal proscriptions on insider trading. 

The opinion, however, addressed the concern, assuring companies in Delaware that spring loaded options were not a violation of federal law.  As the court concluded:

• "And because the parties to the option grant -- the corporation and the recipients -- were both aware of the information, it would be difficult to frame the transaction as insider trading under any prevailing theory. Under traditional insider trading theories, liability is premised on an information mismatch between a buyer and a seller. That rationale does not pertain. Nor would spring loading fit within a misappropriation theory of insider trading because the non-public information belongs to the company itself, thereby precluding the company (i.e. the "source" of the information) from being the victim of any deceptive act."

The law in this area is not resolved.  It is true that the Supreme Court in Chiarella focused on the informational imbalance between the buy and the seller but that was in part because it reflected the case in front of the Court.  In O'Hagan, however, the Court focused not on the harm to shareholders but the integrity of the market.  Deliberately manipulating good news in order to ensure lower option exercise prices (prices that ultimately harm other shareholders by increasing the degree of dilution that will occur when they are exercised) may well be deemed damaging to the integrity of the market.  We quote Chairman Cox on this issue from testimony given back in 2006:

• "Well, as you note, Senator, because spring loading as it is not legally but in parlance defined refers to timing option grants to occur just before expected good news it is bound up with concepts of insider trading. Whenever insiders in a company are conducting transactions and the company securities well in position of material non-public information these insider trading issues exist and the category of cases that the commission is going to be interested in are those in which insider trading can be established and has occurred. I think that we can dichotomize that category of cases on the one hand, from the mere fact that options are being granted at a time when management possesses inside information, because management, virtually at all times, possess inside information so one has to look to the integrity of the option plan and the procedures by which the options are granted."

So, with respect to spring loading, the Blog's advice to those reading Desimone is not to try this at home.