SEC probing springloading and backdating of executive stock option grants

The Los Angeles Times reports that the Securities and Exchange Commission is examining whether companies timed stock option grants so executives would benefit from company news. Specifically, the agency is investigating whether companies backdated grants to periods when their companies’ stock prices were lower in order to provide larger gains for executives, to the detriment of other option holders.

Additionally, the SEC is also looking into possible instances of so-called spring-loading. In this practice, a company purposely schedules an option grant ahead of expected good news or delays it until after it discloses business setbacks that are likely to send shares lower.

Many companies offer stock option grants on the same date each year, in part to guard against allegations of manipulation. But according to a recent study by the Corporate Library, some companies may be timing the public release of news, if not the options themselves. For instance, the article notes a company might hold off on releasing favorable news until shortly after options have been granted, hoping that the public release of information will boost its share price and make the options more valuable.

This is a very significant issue as far as shareholders and non-executive employees are concerned. By giving executives options, executives have a strong incentive to raise the value of the company’s shares. But this incentive would be significantly weakened if the option grants are being timed to help ensure the holders with an easy profit.

The Times quotes Brandon Rees from AFL-CIO as saying “Option backdating is totally unfair to shareholders who don’t have the luxury of a time machine to go back and purchase stock at historic lows,” and of course he is correct. Additionally, options manipulation would undermine the utility of options as a reward to employees.

It will be interesting to see how seriously corporate lawyer and GOP Congressman-turned-SEC Chairman Christopher Cox takes this issue beyond offering prefunctory rhetoric. In addition to the “executive pay rule”, expected to be made sometime in the summer, the handling of these corporate governance concerns will provide a key test of the seriousness of the Bush SEC in terms of going after corporate crooks and protecting shareholders and workers.