Issued on the same day as Ryan v. Gifford, the Delaware Court of Chancery handed down its decision in In re Tyson Foods, Inc. Consolidated Shareholder Litigation, 919 A.2d 563 (Del. Ch. 2007). Whereas Ryan v. Gifford dealt with the backdating of stock option grants, the Tyson decision dealt with the similar but somewhat different issue of alleged “spring loading” of stock option grants. “Spring loading” is the practice of issuing stock option grants shortly prior to the release of information likely to drive up the price of the issuer’s stock. As a result, the optionee receives options that are almost instantly “in the money.” Although this case did not include claims of “bullet dodging,” the practice of granting options after the release of materially damaging information so that employees receive lower-priced options, the Court indicated that its comments would be equally applicable in such cases.
In Tyson, stockholders of Tyson Foods, Inc. (“Tyson” or the “Company”) brought derivative and class actions against the Company, its controlling stockholder, and current and former directors and officers to recover for breach of fiduciary duties by (i) approving consulting contracts, awards of other compensation, “spring loaded” options, and related-party transactions; (ii) failure to investigate self-dealing payments; (iii) failure to comply with terms of previously settled stockholder litigation involving similar claims; and (iv) misrepresentations in proxy statements. One of the plaintiffs, an individual stockholder, was spurred to litigate after becoming aware of an SEC investigation regarding the proper classification of perquisites to Tyson executives. Another lawsuit was the result of an investigation commenced prior to the SEC’s by another Tyson stockholder, Amalgamated Bank (“Amalgamated”). Amalgamated’s action included both class and derivative claims alleging breaches of fiduciary duty and proxy disclosure violations. These stockholder actions were consolidated. Defendants moved to dismiss, primarily on the basis that the statute of limitations had run and/or that plaintiffs had failed to state claims upon which relief could be granted.
The acts challenged in plaintiffs’ complaint were complex and spanned a ten-year period. For the most part, they implicated members of the Tyson family, who controlled the Company, and other insiders. For present purposes, only the granting of “spring loaded” options is discussed. Tyson’s capital structure included Class A and Class B common stock, which were low-vote and high-vote shares, respectively. In 2001, Tyson adopted a Stock Incentive Plan (“Plan”) granting the board permission to award options to purchase Class A shares of the Company’s capital stock. Tyson vested in its Compensation Committee and Compensation Subcommittee complete discretion as to when and to whom they would distribute such options. Although plaintiffs alleged that Plan required the price of the options to be no lower than the fair market value of the Company’s stock on the date of the grant, the Company’s 2004 Proxy Statement (“Proxy”) suggests that plaintiffs were only partially correct.
Indeed, the Proxy differentiates between incentive stock options and nonqualified options. As to the former, “the exercise price…may not be less than the fair market value of the Class A Common Stock on the date of the grant….” Nonqualified stock options, on the other hand, “may be made exercisable at a price equal to, less than, or more than the fair market value of the Class A Common Stock on the date that the option is granted.” The Compensation Committee’s discretion to set an option price is thus determined by whether the option at issue is an incentive or nonqualified option. For purposes of defendants’ motion to dismiss, this distinction is not particularly relevant because plaintiffs alleged that defendants “spring loaded” options, while representing in public disclosures that such options were granted at market prices. The Court of Chancery accepted these allegations as true, which it must on a motion to dismiss, but noted that it is conceivable that a director might show that stockholders expressly empowered a board, or committee thereof, to use “spring loading,” “bullet dodging,” or backdating as part of an employee compensation plan. Plaintiffs identified four specific instances on which the Compensation Committee granted options to key employees, which grant was followed shortly by the release of information that drove up Tyson’s stock price. The subsequent release of information in two instances was the day after the grants in question, both of which were in 2001. In another case, the release of information came within two weeks of the grant, again in 2001. As to the final grant in question, the material information was released four days later. This final option grant was in 2003.
Defendants offered two principal challenges to plaintiffs’ “spring loading” claim. First, defendants argued that plaintiffs were in possession of all the information they needed to bring their claims on the dates of certain of the option grants (i.e., the options granted in 2001). Accordingly, argued defendants, the applicable statute of limitations had run by the time plaintiffs filed the complaint. Second, defendants argued that plaintiffs did not allege facts sufficient to rebut the presumption that the members of the Compensation Committee acted loyally. These challenges, both of which were rejected by the court, will be addressed in turn.
The Court held that the statute of limitations that applied to the option grants prior to 2003 was tolled because plaintiffs alleged that defendants knowingly “spring loaded” options to key employees while publicly disclosing that those same options were granted at market value. According to the Court, “[s]uch partial, selective disclosure–if not itself a lie, certainly exceptional parsimony with the truth–constitutes an act of ‘actual artifice’ that satisfies the requirements of the doctrine of fraudulent concealment.” An alternative basis for tolling the statute of limitations is the doctrine of equitable tolling, which according to the Court, entitled plaintiffs to rely on the good faith of their fiduciaries in making disclosures:
It is difficult to conceive of an instance, consistent with the concept of loyalty and good faith, in which a fiduciary may declare that an option is granted at “market rate” and simultaneously withhold that both the fiduciary and the recipient knew at the time that those options would quickly be worth much more. Certainly at this stage of the litigation, plaintiffs are entitled to the reasonable inference of conduct inconsistent with a fiduciary duty. (Emphasis in original.)
Defendants’ final effort to shield themselves with the statute of limitations fared no better. Defendants posited that plaintiffs were on inquiry notice of the alleged “spring loading” by virtue of the public disclosure of the date and price of the option grants. That, however, would have required the plaintiffs to “sift through a proxy statement” to find the relevant pricing and timing data and compare that to a “year’s worth of press clippings and other filings” in order to discern a correlation between the prices at which options were granted and the subsequent releases of favorable news that propelled the underlying stock price upward. Plaintiffs cannot be held to that burden, noted the Court, particularly when the pattern for which they must search was concealed by those charged with the duty of protecting the interests of the Company’s investors.
Regarding defendants’ substantive challenge to the “spring loading” claim, plaintiffs conceded that the Compensation Committee had sole authority to grant options, but nevertheless argued that the whole board could be sued on this count because the Compensation Committee was required, under the terms of the Plan, to consider recommendations by Tyson’s chairman and CEO, each of whom were option recipients. The Court disagreed, holding instead that it was irrelevant that the committee was required to seek recommendations from the chairman and CEO. The Compensation Committee retained independent authority and discretion to grant options under the Plan. As such, only the members of that committee were proper defendants on the “spring loading” claim. Like a board of directors, an independent committee thereof enjoys the presumption that its decisions are protected by the business judgment rule. In the Tyson case, plaintiffs failed to plead facts sufficient to rebut the independence of the Compensation Committee. Plaintiffs’ claim nevertheless survived defendants’ motion to dismiss because plaintiffs demonstrated that the granting of “spring loaded” options was not within the bounds of the Compensation Committee’s business judgment because those acts, under the circumstances alleged, could not have been in good faith. The Court observed that “[w]here a director is independent and disinterested, there can be no liability for corporate loss, unless the facts are such that no person could possibly authorize such a transaction if he or she were attempting in good faith to meet their duty.” (Emphasis in original)
At the outset, it is important to recognize that the option-timing issue in Tyson is somewhat different than the backdating issue in Ryan v. Gifford. Backdating, according to the Court, always involves a lie to stockholders because the directors who approve the grant misrepresent the date on which the option was actually granted. Charges of “spring loading,” on the other hand, “implicate a much more subtle deception.” The deception is subtle because it is indirect. A board of directors that receives stockholder approval for a stock option incentive plan but then distributes shares in accordance with that plan in a way that undermines the purpose of the plan cannot be said to act in good faith:
The relevant issue is whether a director acts in bad faith by authorizing options with a market-value strike price, as he is required to do by a shareholder-approved incentive option plan, at a time when he knows those shares are actually worth more than the exercise price. A director who intentionally uses inside knowledge not available to shareholders in order to enrich employees while avoiding shareholder-imposed requirements cannot, in my opinion, be said to be acting loyally and in good faith as a fiduciary. (Emphasis in original)
In order to establish a director’s disloyalty and bad faith in connection with the granting of “spring loaded” options, the Court delineated three elements that a plaintiff must plead: (i) options were issued pursuant to a stockholder-approved employee compensation plan; (ii) directors approved “spring loaded” or “bullet dodging” options while in possession of material non-public information soon to be released; and (iii) directors issued the options with the intent to circumvent stockholder-approved restrictions on the exercise price of the options. As in the Ryan v. Gifford case, the Court’s opinion in the Tyson case was on a motion to dismiss. Accordingly, the Court must accept as true all of plaintiffs’ well-pleaded allegations and draw reasonable inferences therefrom in favor of plaintiffs. Should the case proceed through discovery and ultimately go to trial, plaintiffs will bear the burden to prove each of the elements delineated by the court, including scienter. While it remains to be seen what plaintiffs will be able to prove in this case, as a general matter, scienter can be a difficult element to prove for any plaintiff. To satisfy the scienter element, a plaintiff must demonstrate that a director knew or had reason to know, at the time of the grant, that the shares were worth more than the exercise price. Thus, a plaintiff must plead not only that a director was in possession of material inside information about to be released, but also that the director knew or had reason to know that such information, upon its release, would increase the market value of the underlying stock. Without demonstrating this scienter element, a plaintiff cannot adequately allege that a director authorized an option with a market-value strike price at a time when he or she knew the underlying shares were worth more than the exercise price of the option.
Subsequent to the Court’s denial of Defendants’ motion to dismiss, the outside director defendants moved for judgment on the pleadings regarding Plaintiffs’ allegations of “spring loading.” The Court denied that motion on August 15, 2007. In re Tyson Foods, Inc., 2007 WL 2351071 (Del. Ch.).