Risk & Compliance

Disclosing Stock-Option Plans

As Nasdaq and the New York Stock Exchange poll members about shareholder approval of stock-option plans, an SEC lawyer pens a proposed rule on full...
David KatzDecember 19, 2000

Are companies that issue stock options to a broad base of employees, as well as directors and officers, trying to slip a fast one past investors?

Or should company management, operating in a tight labor market, be cut some slack and be permitted to offer stock options to rank-and- file employees and higher-ups without shareholder scrutiny?

The answers to those questions have been hard to come by, since the New York Stock Exchange (NYSE) and Nasdaq haven’t required companies offering broad-based stock-option plans—many of them dot-coms and technology companies—to get shareholder approval or even disclose the existence of the plans.

Amid the surge in stock-compensation arrangements in recent years, however, institutional investors have complained loudly that stock options dilute the value of their shares. The investor outcry has focused attention on the exchanges’ requirements for approval of stock-option programs.

“Stock-option plans, which move stock into other people’s hands,” says Peter Clapman, senior vice president in charge of corporate governance for TIAA-CREF, a big New York-based institutional investor, pose “an issue shareholders should vote on.”

The complaints seem to have spawned a push for change on two fronts by the Securities and Exchange Commission. Pressed by SEC Chairman Arthur Levitt to move for shareholder approval for all plans that offer stock to directors and officers, both NYSE and Nasdaq are polling their members on the issue.

At the same time, the SEC is moving swiftly to get companies to disclose facts about all stock options. Mark A. Borges, counsel for SEC Commissioner Laura S. Unger, is penning a proposed disclosure rule that will likely be “published before the end of the year” for public comment, he told CFO.com.

“Chairman Levitt expressed concern about the number of plans that aren’t being submitted to shareholders for approval, [and has] directed the staff to see that all plans are disclosed to shareholders,” Borges said.

Borges, who brought the rule-making job along with him from his previous post in the SEC’s corporate finance division, said that after being published, the rule would be subject to a comment period of 30 to 60 days and could then be approved by the SEC early next year.

“If we go forward and adopt these rules, companies would be required each year to disclose the existence of the [stock-option] plan and the number of shares they have reserved for that plan…regardless of whether they’re seeking approval for it,” he said.

“If a company has five plans, you’ll know they have five plans,” Borges added, “and [that] the company doesn’t have an additional plan they haven’t told anybody about.”

Borges said he did not want to go into further detail on the substance of the rule before it is published.

For his part, Chairman Levitt has been twisting arms on the issue of shareholder approval of stock options. In a speech on November 9, he said he had recently called on Nasdaq and NYSE to require “shareholder approval for all plans that grant options or award stock to officers and directors.”

Levitt praised NYSE for committing itself “to push hard” (if Nasdaq does so too) for that change and slammed Nasdaq for not committing itself to the cause.

“If the markets do not act in short order, the Commission should,” Levitt declared in his speech.

Of course, many of Nasdaq’s issuers are precisely the kinds of capital-short companies that have felt the need to offer stock options in lieu of high salaries to lure talented employees.

On Dec. 5, Nasdaq began soliciting broad comment about how it should respond to Levitt’s request that the exchanges enact a stern proposal by a special NYSE task force on stockholder-approval policy.

The new NYSE proposal would require shareholder approval of all stock-option plans under which officers and directors may receive grants. (For the full text of Nasdaq’s bulletin on the issue plus the report of the NYSE’s Special Task Force on Shareholder Approval Policy, click on to:)

Currently, an SEC-approved NYSE pilot program is in place that exempts stock-option plans from shareholder approval if a majority of the plan’s full-time U.S. employees are eligible for options and if a majority of the shares are awarded to employees who are not officers and directors.

With the pilot program set to expire Sept. 30, the NYSE applied to the SEC this summer to extend it to 2003. Letters from institutional investors protesting the extension were “one of the factors” in getting Levitt involved in the process, according to Borges. The SEC then extended the pilot program first to the end of November this year and then to the end of February 2001, Borges said.

A Widespread Problem?

“What’s in dispute is, how extensive are these practices?” said Borges, referring to the contention among investors that many issuers are using the broadly based plan exemption to slip plans past investors. Are such practices “as extensive as shareholders believe, or are they isolated situations?”

“Borges, says, in fact, that he “doesn’t know it’s a problem…Hopefully that’s what disclosure will tell us.”

A recent survey of high-tech firms suggests how widespread non-disclosed plans are in the New Economy. Daniel Silver, vice president of info services at iQuantic Inc., in San Francisco, said that out of 161 high-tech companies the company polled as part of its Equity Practices survey in March and April, 27 percent said they have a stock option plan not approved by shareholders.

Silver said the survey found that non- shareholder plans are getting heavy use at high-tech companies. Thirty-two of the companies surveyed who supplied data reported that of their total stock-option grants, a median of 44 percent came out of a non- shareholder-approved plan.

In its online request for comments on stock- option approval, Nasdaq speaks of its attempt “to strike an appropriate balance between the voice of management and the voice of shareholders…” But a Nasdaq official’s remarks to CFO.com seemed to fall, not unexpectedly, on the side of New Economy firms.

“We are concerned that an entire constituency has been omitted from reasonable input,” into the process of stock-option rule making, the official said, referring to such firms. “Nasdaq issuers have not had an opportunity to have meaningful input on the issues of submitting all broad-based plans to shareholder approval.”

“If shareholder approval is required, what would be the impact on retaining employees?” the Nasdaq executive asked. “How long would it take to get approval?”

Speaking of “less well-capitalized issuers” that are “building their business[es],” the official turned the institutional investor argument for the necessity of shareholder approval of stock option plans around on its head.

If companies struggling to compete for talented workers on the basis of salary alone “don’t get shareholder approval [to issue stock options], and lose employees, that could have a very negative effect on shareholder value,” the executive said.

The deadline for submitting comments to Nasdaq is Jan. 5. A Nasdaq official said the exchange is soliciting input from institutional investors, lawyers, and accountants, as well as issuers, and would wait until “all this information is digested, summarized, and evaluated” before deciding what action to take.

While not commenting on when Nasdaq could reach a decision, the executive said that the exchange “would certainly endeavor to move as expeditiously as possible.”

Based on comments on officials from both organizations, NYSE seems in a more conciliatory mood than Nasdaq. The latter exchange has pondered the issue of shareholder approval of stock options on its own in the past, according to the Nasdaq official.

NYSE, the Nasdaq official said, has “separately gone off [on] its own approach to these issues…Obviously…the matter has escalated as a result of their proposal.”

On the other hand, Ray Pellecchia, a spokesman for NYSE, says that a “strong consensus” of the NYSE task force held “that were there to be a change with respect to shareholder approval of stock-option plans, that the markets should move together,” the spokesman said.

NYSE, he said, will send out a mailing requesting comments on its proposal and post a request for comments on its Web site (http://www.nyse.com). “We are not going to set a deadline on responses. We know our companies will get back with us promptly,” he said.

After it gets an adequate number of responses, exchange officials will discuss them among themselves and “develop a joint proposal [which would] then be reviewed by the [stock exchanges] and then the SEC.”

TIAA-CREF’s Peter Clapman says his organization plans to “weigh in and write to Nasdaq” in favor of the NYSE proposal.

He calls the issue “very crucial” for institutional investors. The ability of companies to adopt stock options without shareholder approval “means that [issuers] can be diluting shareholders year after year in ways that are not appropriate for good corporate governance,” Clapman says.

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