Exploring Corporate Governance Around the World

By Allison Garrett, Senior Vice President for Academic Affairs at Oklahoma Christian University

Tuesday, July 11, 2006

Springloading Options: Insider Trading?

After SEC Commissioner Atkins opined recently that springloading options is not insider trading, the audience of corporate governance experts disagreed by a large majority. Here's a link to the survey (http://blog.issproxy.com/2006/07/icgn_discussion_on_springloadi.html).

Here's my take on this admittedly fuzzy issue. Insider trading is illegal because of the imbalance in knowledge of the counterparties. In a typical transaction, we don't know exactly whom the counterparties are because the transaction occurs on a stock exchange. Nevertheless, when someone with material non-public information trades, this is inherently unfair to others in the market at the same time.

With respect to a grant of options and the eventual exercise of those options, the company is the counterparty. Presumably the company has all of the material non-public information that optionees have. Where two insiders having equal information engage in a transaction, there may have been insider trading in a technical sense on both sides because both have engaged in a transaction while in possession of material, non-public information.

At the time of the option grant, though, investors in the market are trading in the company's securities. Springloading is a form of hidden compensation for the executive because options are granted while good news is delayed. Thus, the executive has acquired securities -- albeit in the form of options -- while in possession of material, non-public good news.

The insider trading theory is a little messy because it previously has not been applied in this sort of situation. Fraud might be an easier theory to apply. The theory is that shareholders should have been informed of the practice. Information about such a practice is the type of compensation information that should be disclosed by a company in its proxy statement each year. It is arguably material because a shareholder considering whether to buy, sell or hold securities might believe that the practice reflects an unethical "tone at the top." In the case of springloading, corporate executives might delay the release of good news or hastily grant options prior to the release of the good news in order to build in appreciation over the strike price.

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