The Advisors' Blog

– Art Meyers, Seyfarth Shaw

This query was recently posted in the Q&A Forum:

“In the wake of the options backdating scandal, companies adopted equity grant policies that typically provide for fixed grant dates that occur during open window periods. In the case of an options exchange program, would you expect that the same considerations should apply to the grant date (i.e., the closing date of the exchange offer) of the new options to be granted? I would expect that it would, as otherwise, a claim could be made that the new options were timed to take advantage of material non-public information.

The second and related question is whether the same considerations should apply to the launch date of the options exchange program when the exchange ratios are set for a value-for-value option exchange. If there was negative news, that news might adversely affect the ratios and participating employees arguably could claim that they were harmed (although the disclosures in the tender offer documents typically state that the valuations could change and the employees would know the news before the expiration date, so that they could withdraw). However, if there was positive news, the participating employees likely would be receiving a greater number of options than they would have received if the exchange ratios had been calculated at the later date. Do you think this is a significant concern such that the SEC might question the timing?”

I responded that I think that exchange programs raise similar backdating issues as option grants, but they are perhaps a bit easier to resolve because the program is publicly-known and there is sufficient lead time to plan. Very few companies have the ability to conduct an exchange without shareholder approval and a tender offer. It seems to me that the shareholder approval process (both the CD&A and the specific proposal) as well as the tender offer provide good opportunities to both communicate the general terms of the timing of the exchange and any necessary modifications to the company’s grant practice policies.

The company will be able to establish the specific exchange period well in advance. It will presumably use the same care for the exchange that it uses in establishing regular grant cycles, or in making off-cycle awards. It ought to be able to plan for an exchange occurring during an open window. Also, the NEOs and directors are usually ineligible to participate in the exchange, thus eliminating a significant class of potentially problematic insiders. Of course, there is the risk that the exchange period may be required to be lengthened or that new material inside information arises (regarding an M&A transaction, for example) during the regrant period.

I believe that many of the timing issues can be dealt with by including within the terms of the tender offer (as most companies do) a right of the company to declare certain electing participants ineligible for the program during or shortly after the window. Presumably the directors, NEOs, company counsel and other compliance personnel ought to be able to reach a consensus at the end of the window whether anyone needs to be declared ineligible. Replacing options with restricted stock or restricted stock units would seem to take off some pressure too. The only blackout period required by law on option regrants would be the BTR rules applicable if a company is changing service providers for its 401(k) plan and has a stock fund that will be closed for more than three days.