Accounting Rules Allow “Spring-loading,” “Bullet-dodging” Option Grants
Christopher Cox, SEC Commissioner, said last month that the practice of “spring-loading” is “bound up in the notion of insider trading,” according to CFO.com, suggesting that companies might still face legal action, but said that the SEC focused on insider trading in cases where it has occurred and can be proved.
“Spring-loading” occurs when a company purposely schedules an option grant ahead of the announcement of good news that will boost the stock price. “Bullet–dodging” involves setting the grant date just after a negative announcement that will be followed by a rebound in the stock price.
Taub told Reuters that the SEC was not trying to endorse the practice, and added “the accounting for those kinds of options is clear. We felt our hands were tied.”
“There are people in our building who have varying feelings about whether spring-loading is good or bad. Accounting-wise we felt stuck.”
“This is accounting literature written in the 70’s that clearly did not hold up well. We don’t get to enforce the accounting standards we wish existed, we have to enforce the accounting standards that do exist,” Taub went on to say, according to Reuters.
Cox made his comments on “spring-loading” and “bullet dodging” at a Senate Finance Committee hearing in September. Cox had said in July that “backdating is more easily determined than spring-loading, because of the nature of the evidence,” the LA Times reports.
SEC Commissioner Paul Atkins has argued that there is nothing wrong with spring-loading. Boards award options based on business judgments, Atkins said, according to the Wall Street Journal. “An insider-trading theory falls flat in this context, where there is no counterparty who could be harmed by an options grant. The counterparty here is the corporation and thus the shareholders.”
In the case of Analog Devices Inc., a Norwood, Mass., technology company, the SEC questioned the propriety of stock option grants made by the company because it did not adequately disclose that it priced stock options before the release of good financial results, the Journal says. Analog Devices is also being investigated for backdating stock options.
In another case, the SEC is looking at grants made to executives of Cybertronics Inc., a Houston medical-device maker that made grants to several executives on the day a Food and Drug Administrations advisory panel recommended approval of a Cybertronics device. Trading in the stock was halted that day and the grants used the exercise price of the previous day.
It is not clear what the tax implications are for spring-loading, says S. James DiBrnardo, a partner at Morgan Lewis & Bockius LLP, the Journal says. DiBernardo says the Internal Revenue Service (IRS) might argue that spring-loaded options are also discount options like backdated options. But he says that the IRS would have a much more difficult time proving their case, because they would have to prove the “true” market value on the date the spring-loaded options were granted.