Spring Loaded Options and Demand Excusal: Weiss v. Swanson

We discussed the calculated timing of option grants in an earlier series of posts on option grant practices and the Delaware courts. In an unpublished opinion dated March 7, 2008, Vice Chancellor Lamb of the Delaware Court of Chancery denied a motion to dismiss a claim for breach of fiduciary duty against former and current directors and officers of Linear Technology Corporation who issued and received timed option grants. Weiss v. Swanson, C.A. No. 2828-VCL, 2008 WL 623324 at *1 (Del.Ch. Mar. 7, 2008).

Weiss alleged that on 22 occasions between July 1996 and July 2005, Linear Technology Corporation’s board of directors set the strike price of option grants below fair market value to the financial advantage of the defendant directors and officers without disclosing the practice to shareholders. Specifically, Weiss claimed that the board used material, inside information of which they had advanced knowledge to grant options before quarterly earnings releases when the news was good (“spring-loading”), and after quarterly earnings releases when the news was bad (“bullet-dodging”).

As Professor Erik Lie of the University of Iowa points out, timed option grants are not illegal per se when the following conditions are met: 1) none of the documents are fraudulent; 2) the practice is clearly communicated to shareholders; 3) the timing is properly reflected in earnings; and 4) the timing is properly reflected in taxes. Business Week adds that for many companies, the plan’s charter or the company’s bylaws may explicitly prohibit option grant timing.

The court agreed that plaintiff pled sufficient facts to show that the practice of spring-loading and bullet-dodging was material, becoming the first Delaware court to conclude that bullet dodging can be material information.  Weiss, at 13 ("Taking Weiss's allegations in this case as true, it is reasonable to infer that stockholders would consider the practice of timing options described in the complaint to be important in deciding whether to approve the option plans or to reelect board members.").  Nondisclosure of the practices "give rise to an inference that the Director Defendants, in violation of their fiduciary duties, intended to circumvent the restrictions found in the plans." 

In addition, the court found that demand was excused because all of the directors considering demand actually received the challenged options and, as a result, were not disinterested.  In addition, the court noted that the company conducted an internal investigation and concluded that there was "no evidence of fraud or misconduct" in connection with the challenged options.  As the court noted:  "Given the contrary inferences from the complaint, 'the court questions how it is that the interests of the corporation are not, or at least do not appear to be, adverse to the interests of the individual defendants." 

In considering a motion to dismiss in addition to demand excusal, the court concluded that the complaint sufficiently alleged a breach of fiduciary duty in connection with the improper disclosure of the option practices.  Moreover, the plaintiff adequately alleged a claim for waste.  "Weiss alleges that the defendants should not have received any of the timed options at all, and that the grants were approved without any valid corporate purpose."  

The primary materials for this post are available on the DU Corporate Governance website.