Many readers will recall the shocking scandal over stock option backdating in the early 2000s. The two-day Form 4 filing requirement has made option backdating nearly impossible. However, opportunities for spring loading and bullet dodging sometimes still occur, especially in times when the stock market is volatile (e.g., the last 12 months!). Spring loading can occur when a company issues stock options shortly before the release of information that it expects to cause a sharp increase in its stock price, for example, a strong earnings report, an acquisition, or other favorable news. Bullet dodging can occur when a company holds off on its regularly scheduled annual stock option awards until after the release of information that it expects to cause a sharp decrease in its stock price, for example, a weak earnings report or a governmental investigation.
Last year, Eastman Kodak awarded stock options in a manner that provided a classic example of “what not to do.” On July 27, 2020, Kodak’s board reportedly issued 1.75 million in stock options to the company’s Executive Chairman and CEO. Kodak shares closed at $2.62 on July 27, the day it issued the new options, and soared to as high as $60 two days later after Kodak announced to the public (prematurely, as it turned out) that it had been approved for a badly needed infusion of cash in the form of a loan from U.S. International Development Finance Corporation (“DFC”).
Interestingly, the company had adopted an internal policy regarding officer and director stock option awards, the Executive Compensation Committee Policy on Equity Awards. This Policy purported to govern “practices on the timing and pricing of certain equity awards, in order to establish objective guidelines and avoid risk of backdating of equity awards and any other unacceptable governance practices.” Among other things, the Policy stated that:
Timing of Public Announcements. The Company’s policy is that neither the Committee nor any employee of the Company will backdate any Equity Award or manipulate the timing of the public release of material information or of any Equity Award with the intent of benefiting a grantee under an Equity Award.
The Special Committee Report
Soon after the proposed loan was announced, it was halted and the SEC began an investigation into how the company disclosed the loan. In September, the company issued a press release with an 88-page Report to the Special Committee of the Board of Directors of Eastman Kodak Company Regarding the Events Surrounding the U.S. International Development Finance Corporation Letter of Interest Announcement. The Report considered the July 27, 2020 options grants and four other significant legal issues.
First, the Report considered the SEC’s approach to spring-loaded options grants, pointing out a number of ways in which false statements about spring-loaded options practices in a proxy statement or other public statements could potentially give rise to liability under the general anti-fraud provisions of the federal securities laws.
Next, the Report reviewed SEC enforcement actions and private securities litigation regarding spring-loaded options, observing that, to date, the SEC has never brought an enforcement action based on spring-loaded options practices. In the only SEC enforcement action to even reference spring-loaded options, the SEC expressly declined to bring charges based on that conduct.
However, the Report noted that there is a lengthy body of Delaware case law that indicates that, under some circumstances, granting options shortly before a positive news announcement could subject a company and its officers and directors to liability.
Analysis of the July 2020 Options Grants Under Applicable Securities Laws
In its analysis of the July 2020 options grants under applicable securities laws, the Report stated that the evidence reviewed by special counsel did not support a finding that Kodak made any false or misleading statements in connection with the July 2020 options grants. The Report concluded that
- The Executive Compensation Policy was not a false statement, even though it was made publicly available on the company’s website, along with other corporate governance documents.
- There was no intent to “manipulate” the timing of the July 2020 options grants to take advantage of the DFC loan announcement.
- The April Proxy complied with the Proxy Disclosure Rules and was not materially false or misleading.
In the end, the Report concluded that, while it did not find that anyone engaged in conduct that violated the law, the manner in which the options grants were awarded was “sub-optimal in a number of respects” and “less than ideal from a corporate governance perspective.”