Say on Pay, Lessons Learned

jscowart@pomlaw.com (Jason Cowart) — Thu, 23 Feb 2012 17:31:54 GMT

On February 22, 2012 the Harvard Law School Forum on Corporate Governance and Financial Regulation published a report entitled “Lessons Learned: The Inaugural Year of Say-on-Pay” Anne Sheehan, the Director of Corporate Governance at the California State Teachers’ Retirement System (CalSTRS), says “For CalSTRS the first year of Say-on-Pay was a learning opportunity as it helped us to refine our voting process for future years.”

Showing a number of charts and metrics considered in their votes Sheehan continued “CalSTRS believes that all companies should use value-creating performance metrics for short- and long-term incentive plans. While we understand that boards of directors require some flexibility when determining compensation, we believe the majority of executives’ incentive pay should be transparent and easily understood by shareholders. Although there is no one-size-fits-all solution to executive compensation, we believe the over-use of discretion in most plans can lead to outsized compensation levels and fails to meet the spirit of section 162(m) if the Internal Revenue Code which requires performance-based pay to be predetermined and objectively measurable…. we believe that poorly structured pay packages harm shareholder value by unfairly enriching executives at the expense of owners – the shareholders.”

As Kevin LaCroix of the D&O diary observes: “Sheehan’s post and her description of the approach of CalSTRS heading into the second say-on-pay cycle makes it clear that there will be continued pressure on many companies regarding their compensation practices and disclosures,”

Texas Supreme Court Rules on Noncompete Agreement's Enforceability

Wed, 28 Dec 2011 21:02:23 GMT

The Texas Supreme Court has once again affirmed its decision to make non-compete agreements more easily enforceable by employers against their employees. The Court was asked to consider whether a covenant not to compete signed by a valued employee in consideration for stock options, designed to give the employee a greater stake in the company’s performance, is unenforceable as a matter of law because the stock options did not give rise to an interest in restraining competition.

In the summer of 2011, the Texas Supreme Court issued its opinion in Marsh USA Inc. v. Cook, No. 09-0558 (Tex. June 24, 2011), holding that, under the terms of the Covenants Not to Compete Act, a covenant not to compete signed by an employee in consideration of stock options was enforceable because the company’s provision of stock options was reasonably related to the employer’s interest in protecting its goodwill. This was deemed a business interest worthy of protection, thus the noncompete agreement was not unenforceable on that basis. A motion for rehearing was thereafter filed, and the Court recently withdrew its prior opinion and substituted a new opinion in Marsh USA Inc. v. Cook, No. 09-0558 (Tex. Dec. 16, 2011).

Once again, the Court found there was a nexus between the covenant not to complete and the interest being protected, thereby meeting the requirement set out in Covenants Not to Compete Act (Texas Business and Commerce Code §15.50(a)), thereby making the noncompete agreement not unenforceable as a matter of law. Thus, employers have maintained their ability to enforce noncompete agreements against employees under such circumstances.

Dividing Stock Options During Divorce

sjohnston@pjckn.com (Steven P. Johnston) — Mon, 14 Nov 2011 14:00:00 GMT

Stock options are usually thought of as being granted to the high level C-Suite employees of large corporations. But the reality is that stock options are increasingly being provided to compensate employees at various levels on the company organizational chart.

A stock option is defined as "a right granted by a corporation to officers or employees as a form of compensation that allows purchase of corporate stock at a fixed price usually within a specified period." In the U.S., stock options are typically granted to employees in one of two forms: incentive stock options or non-qualified stock options. Stock options are usually subject to a vesting period, which is the period of time during the term of the option grant that the employee has to wait until he or she is allowed to exercise the options.

In Colorado, stock options are considered property, which means they are subject to equitable distribution among a divorcing couple depending on whether the options are classified as marital property or separate property. Marital property is presumed to be all property or assets acquired during the marriage unless an asset falls within certain exceptions. An asset a spouse acquired before the marriage is usually considered to be separate property, but it can be classified by a divorce court judge as marital property "to the extent that its present value exceeds its value at the time of the marriage," which means that the amount the asset has appreciated during the marriage is considered to be marital property. C.R.S. § 14–10–113(4).

The dilemma frequently encountered during a divorce in determining whether stock options are marital or separate property is whether the options were granted for the employee spouse's past or future services (i.e., whether the options were granted to compensate an employee for past performance or provide an incentive to the employee to perform well in the future). The Colorado Supreme Court has concluded that

to the extent an employee stock option is granted in consideration of past services, the option may constitute marital property when granted. On the other hand, an employee stock option granted in consideration of future services does not constitute marital property until the employee has performed those future services.

In re Marriage of Miller, 915 P.2d 1314, 1319 (Colo. 1996).

In later cases, Colorado trial and mid-level appellate courts were reading into this statement a requirement that there must first be a determination of whether the stock options had vested. This prompted the Colorado Supreme Court to clarify that

we do not find the issue of vesting determinative in ascertaining whether an interest in employee stock options constitutes marital property. Rather, we conclude that an employee stock option constitutes property for purposes of dissolution [i.e. divorce] proceedings only when the employee has an enforceable right to the options.

In determining whether one has an enforceable right to employee stock options, a court must look to the terms of the contract granting such options. If an employee has a presently enforceable right under the contract, regardless of whether the options are presently exercisable, such a right constitutes a property interest rather than a mere expectancy.

In re Marriage of Balanson, 25 P.3d 28, 39 (Colo. 2001).

Dividing stock options as part of a divorce can be complicated. Even after an initial determination has been made that a portion of one spouse's stock options are marital property, the options must still be valued. This usually requires the help of an expert.

Burying our noses in Groupon’s page-turner…

Tue, 27 Sep 2011 15:13:58 GMT

As if it were a young, tech-savvy Scarlett O’Hara, Groupon, Inc. sashayed onto Wall Street and captured the attention of many suitors. And, just as tongues wagged about Scarlett in her day, there have been plenty of juicy stories about Groupon’s break-up with its Chief Operating Officer after only five months; a secret-but-leaked memo that may delay its own debutante ball (otherwise known as an IPO), and its spat with the SEC, which led to a restatement of bodacious revenue figures with modest numbers more befitting of Scarlett’s rival, Melanie.

And what do we know about Andrew Mason, Groupon’s president (and arguably a moustache-free version of the dashing Rhett Butler)? Well, thanks to the 598-page* amended S-1 that it filed with the SEC at 5:15 p.m. last Friday, we now know about Mason’s employment agreements with the company. They are Exhibits 10.6 and 10.7 to the S-1/A; although the former document contains the interesting numbers, the latter one (an amendment dated December 15, 2010) provides some severance protection if Groupon ushers Mason to the door without cause. Beyond the details (which we’ll get to in a minute), we thought it was particularly interesting that it took this long for those contracts to see the light of day, given that Groupon filed its first S-1 back in early June.

Mason’s Employment Agreement, dated November 1, 2009, has a five-year term. It gave him a starting base salary of $180,000 per year, which rose to a minimum of $207,000 in 2010. And – since the agreement assured Mason that his salary would be reviewed every year “for possible increase (but not decrease)” and that his paycheck “shall be increased by no less than fifteen percent (15%) per annum” – he could already be earning much more than that, with another raise just a couple of months away. Of course, as with most fast-growing companies, it’s really about the stock, and Mason’s agreement spells out buckets of that: 300,000 Class A shares of restricted stock.

Given that various estimates value the company at $20 billion, that’s a nice little cushion.

Ditto for former Chief Operating Officer, Rob Solomon, whose Employment Agreement was attached as Exhibit 10.9 to the S-1/A. Solomon’s agreement started March 15, 2010 and would have run through March 15, 2014 – but for his abrupt departure last March. Besides a base salary of $350,000 and eligibility for a performance bonus of up to 33% of his salary, Solomon also got 685,000 stock options, which he could purchase “at the fair market value of the company’s stock options determined in accordance with GAAP, which… [as of March, 2010 was] estimated not to exceed $3.00/share.” An important section in his employment agreement added:

“In the event that Solomon’s employment with the Company is terminated, Solomon shall have ninety (90) days following such termination to exercise any vested Options;…”

Because Solomon resigned after March 16, 2011 (the date upon which 171,250 of the shares vested) and he got an additional 90 days after that in which to exercise stock options, he may also get to exercise the 42,813 shares that are scheduled to vest on June 16, 2011. Assuming that he has exercised – or does exercise – some or all of the vested options, he will become an even wealthier man.

Between the jittery market and Groupon’s need to get things in order before it goes public, it will probably be a few more weeks or months before that can happen. And there will certainly be many more stories about this highly-anticipated public offering. However, unlike the famous line that Rhett delivers to Scarlett just before he leaves her, it seems that everyone gives a damn about what shall become of Groupon.

Image source: Gone With the Wind

*The length of Groupon’s filing pales when compared to Margaret Mitchell’s classic book; a quick search of editions available on Amazon range between 960 and 1048 pages.

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WA: The Expert Must Be Heard!

Mon, 01 Aug 2011 13:15:17 GMT

Aubin v. Barton, 123 Wash. App. 592 (2004)

WA: Underlying Divorce Action

Student Contributor: Ben Doyle

Facts: Client sued attorney for malpractice following attorney’s representation in the dissolution of marriage. Client claimed that attorney’s conduct at a settlement conference did not meet the standard of care. Client was the grantee of stock options. Attorney failed to give correct advice concerning the separate property character of the stock options. Client claims that without attorney’s mistaken advice, he never would have entered into the settlement agreement that treated the options as community property. In the malpractice action, the court found, during the trial within a trial, that, if the action had gone to court, that court would have found that client owned 60% of the options and the remaining 40% were community property. The court found in favor of client and attorney appealed.

Issue: Whether the trial court erred not permitting expert testimony to reach the conclusion that the stock options were 60% clients separate property.

Ruling: The trial court had excluded expert testimony on the ground that only the attorney can testify at the trial within the trial. That exclusion was improper. The issue was whether the options were given for past services or for present and future services and the attorney’s expert witness, who had evidence contrary to the disposition of the court, should have been heard. The error was not harmless and the decision was reversed.

Lesson: If an attorney is being sued for malpractice, it is important to line up expert witnesses that can testify that the attorney’s conduct was not negligent. The court must determine the validity of the underlying claim and the attorney has every right to present evidence to defend his or her position.

“Where it is alleges that an attorney committed malpractice in the course of litigation, the trial court hearing the malpractice claim retries, or tries for the first time, the client’s cause of action that the client contends was lost or compromised by the attorney’s negligence, and the trier of fact decides whether the client would have fared better but for the alleged mishandling.

ConocoPhillips’ black gold means green for CEO…

Thu, 28 Jul 2011 14:09:49 GMT

Rummaging around in corporate disclosures the way we do here at footnoted, it sometimes helps to have a reminder to step back and look at the bigger picture. We got that kind of a reminder from a reader recently, who pointed us to the immense payday that the chairman and chief executive of ConocoPhillips (COP) [...]

Jim Mulva, of course, has run ConocoPhillips since 2002 and been chairman since 2004; before that, he ran Phillips Petroleum for several years, and was on its board from 1994 on. Over time, he’s accumulated a tidy stash of stock options – as of the end of its last fiscal year, about 7.5 million, of which 88% are exercisable. Of those, about half, or 3.5 million, are going to expire by mid-November, according to the company’s March proxy.

We’d be very surprised if Mulva let them expire, of course. They’re very much in the money, with strike prices between $25 and $32 or so. Given that ConocoPhillips shares closed at just over $73 a share on Wednesday, our rough estimate is that those about-to-expire options are worth something like $155 million now. Put all his exercisable options together, and you’re closer to $255 million.

All of which takes on new significance given the company’s plan to split itself in two.

Following what seems to be a trend among big oil companies — first combining into globe-spanning conglomerates, and then splitting apart again, as DealBook’s Michael J. De La Merced notes — ConocoPhillips announced a couple weeks ago that it would spin off its refining operations to shareholders.

When Marathon Oil (MRO) did the same thing early this month — spinning off Marathon Petroleum (MPC) — the move was preceded by a stock run-up of about 33% between the time it announced the plan in mid-January and its completion July 1. A similar pop for ConocoPhillips would bring its shares to around $100. Of course, given Marathon’s earlier move, it’s possible a good deal of that upside is already baked into ConocoPhillips’ price, which has had a good run lately.

Still, unless something goes very wrong between now and the first half of next year, when the spin-off is supposed to be completed, then Mulva stands to make a bundle on his options. He has more coming to him than that, however. His nearly 3 million shares of unvested restricted stock or stock units would be worth some $217 million at current prices. Plus, as of December 31, his company pension had ballooned to about $62 million, and he had accumulated a deferred-compensation account of $45.6 million, counting both his contributions and the returns the company has promised to pay him on those amounts.

Put together everything he’s entitled to today, and it’s over $360 million, not counting those unvested restricted shares. ConocoPhillips shareholders have done pretty well over the years — trouncing the S&P 500, though more or less tracking the integrated oil & gas segment and trailing the likes of Exxon Mobil (XOM) and Chevron (CVX).

For Mulva, by contrast, the results are a little more clear-cut.

Image source: ConocoPhillips presentation [PDF]

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Sirius XM updates its CFO’s earnings…

Tue, 26 Jul 2011 15:08:51 GMT

It’s officially earnings season, and in Sirius XM Radio’s (SIRI) case, a second-quarter release is due in no more than a week. Meanwhile, as a footnoted reader and tipster pointed out, the satellite radio broadcaster seemed eager to give us some preliminary reading with a sort of earnings statement for its CFO, packaged neatly in [...]

As footnoted regulars know, the meat of Friday filings is often in the afternoon dump. So the 8-K in question seemed harmless enough at first glance. On the one hand, it extends CFO David Frear’s employment term to July 20, 2015, providing a base annual salary of $850,000. On the other, it grants severance benefits of a lump-sum salary-and-bonus payment plus a year’s worth of health and life insurance. All business as usual.

What kept us reading instead of turning straight to the waiting hoard of unread filings, though, was the load of bonus stock options Frear netted for staying with his company:

“In connection with the execution of the Employment Agreement, we granted Mr. Frear an option to purchase 16,000,000 shares of our common stock at an exercise price of $2.18 per share . . . The Option will generally vest in four equal installments on each of July 21, 2012, July 21, 2013, July 21, 2014 and July 21, 2015.”

Our tipster worked some black magic — Black–Scholes modeling magic, to be precise — to find that these options are worth at least a whopping $17.6 million.

That’s more than $4 million vesting each year, surpassing even Frear’s fiscal 2010 compensation of just over $3.3 million, which we found in Sirius’s latest proxy. (The same proxy also goes to show Sirius is no stranger to huge option awards — CEO Mel Karmazin received $35.2 million worth back in FY 2009.)

That Black–Scholes figure may even underestimate the options’ long-term value because it assumes random changes in stock price rather than the upward trend we seem to be seeing with Sirius. After all, consumers should be returning steadily to their digital entertainment as the economy recovers.

As fans of pay-for-performance, we do tip our hats to the fact that the bonus was awarded in equity rather than cash. But it’s worth noting that the options are in essence a reward for signing the new employment agreement, which makes them more pay-for-signature than pay-for-performance.

With CFO earnings at Sirius coming along so well, it’s no wonder that show host Howard Stern responded the way he did when Frear himself suggested a paycut late last year.

The question that stands is how well the company earnings have kept pace with the CFO earnings.

Image source: dierk schaefer via Flickr

This post was written by footnoted intern Andy Cheng, a rising junior at the University of Chicago. Special thanks to our tipster for pointing us to the filing!

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BREAKING NEWS: Texas Supreme Court Issues Opinion Enforcing Non-Compete Supported by Stock Options and Goodwill

russell.cawyer@khh.com (Russell Cawyer) — Fri, 24 Jun 2011 14:19:24 GMT

The Texas Supreme Court has issued an opinion this morning holding that noncompetition agreements supported by stock options and good will are not unenforceable as a matter of law. I previewed this case here. As I have time to digest the majority, concurring and dissenting opinions, I'll provide more thoughts on this case.

You can download the majority opinion here.

Concurring opinion here.

Dissenting opinion here.

Employee Stock Ownership Plans

Mon, 23 May 2011 14:51:00 GMT

Editor’s Note: The following post comes to us from E. Han Kim, Professor of Finance and International Business at the University of Michigan, and Paige Ouimet of the Finance Department at the University of North Carolina at Chapel Hill.

In our paper, Employee Stock Ownership Plans: Employee Compensation and Firm Value, which was recently made publicly available on SSRN, we investigate whether adopting a broad-based employee stock ownership plan enhances productivity by improving team incentives and co-monitoring. That is, does employee capitalism work? If so, how are gains divided between shareholders and employees?

We find that small ESOPs increase productivity. Unlike Jones and Kato (1995) on Japanese ESOPs, our evidence of productivity gains is based on the effects on two main beneficiaries of such gains: employees and shareholders. Because our evidence indicates both stakeholders gain from adopting small ESOPs, we infer employee share ownership increases the size of the economic pie by improving worker productivity.

This causal interpretation is substantiated by our evidence on how the division of productivity gains is related to employee mobility within an establishment’s industry and location of work place. We find that when labor mobility increases, increasing workers’ bargaining power vis-à-vis shareholders’, employees’ share of gains increases and stockholders’ share decreases.

Click here to read the complete post...

The Effect of Managerial Traits on Corporate Financial Policies

Mon, 25 Apr 2011 13:26:14 GMT

Editor’s Note: The following post comes to us from Ulrike Malmendier of the Economics Department at the University of California, Berkeley, Geoffrey Tate of the Finance Department at UCLA, and Jon Yan of Stanford University.

In our forthcoming Journal of Finance paper, Overconfidence and Early-life Experiences: The Effect of Managerial Traits on Corporate Financial Policies, we provide evidence that managers’ beliefs and early-life experiences significantly affect financial policies, above and beyond traditional market-, industry-, and firm-level determinants of capital structure. We begin by using personal portfolio choices of CEOs to measure their beliefs about the future performance of their own companies. We focus on CEOs who persistently exercise their executive stock options late relative to a rational diversification benchmark. We consider several interpretations of such behavior — including positive inside information — and show that it is most consistent with CEO overconfidence. We also verify our measure of revealed beliefs by confirming that such CEOs are disproportionately characterized by the business press as “confident” or “optimistic,” rather than “reliable,” “cautious,” “practical,” “conservative,” “frugal,” or “steady.”

Click here to read the complete post...

Excessive Executive Compensation Comes in All Forms: Salary, Stock Options, Restrictive Stock Grants, Repurchasing of Corporate Stock and Good Old Dividends

steven@berklawdc.com (Steven Berk) — Thu, 21 Apr 2011 20:35:06 GMT

This is Part II of the Corporate Observer's Special Reports on Executive Compensation (Part I can be found here). Please enjoy this second installment, on the gradual but substantial shift of wealth towards the executive class.

Our interest in executive compensation grows out of being hit in the face with the startling data illustrating a massive redistribution of wealth over the past decade away from the middle class and into the pockets of senior executives. Noted executive pay scholar Albert Meyer had this to say in the WSJ:

Middle-class America experienced a lost decade in their retirement accounts, whereas executives enjoyed record compensation packages through the subterfuge of stock option programs… There has been a massive wealth transfer from middle-class America’s retirement accounts to the bank accounts of the privileged few. The social consequences of this wealth transfer bear scrutiny.

Such a profound change takes more than a few executives getting a raise here and there. It takes the efforts of an army. First, a cottage industry of consultants devoted to devising new and innovative ways to compensate CEOs; second, a willing and too often a greedy executive class; and third, the almost blind consent of the Board of Directors and those “specialists” on the compensation committees. Where is the army on the other side? Who devises plans so shareholders (like pension funds and college accounts representing millions of average folks) can benefit from increases in corporate value?

Stock options have become an increasingly important component of executive compensation. Seems like a good idea on its face. Executives receive more value for increasing the stock price; it would seem to align the priorities of stockholders and execs. A higher stock price benefits all, right?

Sadly, in practice corporate gaming and greed take over. Too many managers have been caught manipulating the short term earnings to get a bump in the stock price. Or at a higher level, they were managing for the market – being slaves to analysts and making the quarterly numbers. Often that meant reporting soft earnings or camouflaging toxic liabilities for the next guy or the guy after that to swallow. “Call in the consultants” stock options alone won’t work.

Next, restrictive stock grants became a popular tool. “Mr. CEO, we want you to stay and make us a stronger company; long term value is what we are all about. Here is a million shares of stock, but you’re going to have to wait 5 years to “begin” cashing in.” This is better—it hedges against some of the short term greed—but still far from perfect. CEOs have been known to use those restrictive shares as a hedge or collateral for larger cash positions. In fact, senior management can promote corporate stock repurchase programs that, given the rules of supply and demand, will increase the price of the stock and thereby increase the value of their restrictive stock.

Indeed dividends, a shareholder’s reliable old friend, provide another arrow in the executive’s quiver of pay options; this despite being issued more grudgingly to shareholders over the past quarter century. Yep. When the company issues a dividend those top corporate executives are paid just like everyone else. But unlike most of us they have amassed millions of shares. A 5% dividend becomes a huge chunk of change and is often heaped on top of a seven- or eight-figure salary, stock options, etc.

Determining the right mix of executive compensation is a tough balance to be sure and it is not black and white. But the numbers don’t lie. The pendulum has swung over to the executives and remains there. Shareholders must devise ways to create some momentum in the other direction.

The Market Value of Corporate Votes

Fri, 08 Apr 2011 13:32:58 GMT

Editor’s Note: The following post comes to us from Avner Kalay, Professor of Finance at the University of Utah; Oguzhan Karakas of the Finance Department at Boston College; and Shagun Pant of the Finance Department at Texas A&M University.

In our paper, The Market Value of Corporate Votes: Theory and Evidence from Option Prices, which was recently made publicly available on SSRN, we propose a new method to measure the market value of the right to vote. We quantify the market value of the right to vote as the difference in the prices of the stock and the corresponding synthetic stock. The synthetic (non-voting) stock is constructed using option prices, particularly facilitating the put-call parity relationship. The main insight is that the owners of common stocks have both cash flow rights and voting rights, whereas holders of synthetic stocks have the cash flow rights but not the voting rights. Hence, the difference in the price of the stock and the synthetic stock quantifies the market value of the vote during the expected life of the synthetic stock.

Click here to read the complete post...

National Semi CEO leaves money on the table…

Tue, 05 Apr 2011 15:11:10 GMT

You’ve no doubt heard by now of Texas Instruments’ (TXN) $6.5 billion deal for National Semiconductor (NSM), that was announced after the market closed yesterday. As the WSJ notes in this piece, the $25 a share price represents a 78% premium over National Semi’s closing price yesterday. Given that hefty premium, we decided to take [...]

Given that hefty premium, we decided to take a closer look at some of National Semi’s recent filings. And we were a bit surprised to see several Form 4s, including this one filed late yesterday showing that National Semi CEO Donald Macleod sold 257,930 shares at prices no higher than $14.45 a share on March 31, April 1 and yesterday — the very day the deal was announced. Granted, these were 10b5-1 sales, but it still had to hurt to leave that kind of money — about $2.6 million dollars — on the table.

Unfortunately for Macleod, those sales weren’t the only ones. There were two other Form 4s filed since March 16 (see here and here) that show that Macleod sold another 342,000 shares at prices that were never higher than $15 a share, which means that all told he left around $6 million on the table.

Now granted, it’s hard to generate too much sympathy — my grandfather used to say “my piles are bleeding for you” — for a CEO not getting any richer. And, obviously, there’s the not-so-insignificant matter of getting out of a 10b5-1 plan without creating too much of a ruckus. Still, given that Macleod no doubt knew about Texas Instruments’ offer for several weeks, if not months (we’ll learn more details once the Background of the Deal is filed with the SEC), it’s hard not to imagine this hurting just a teensy bit.

Footnoted friend (and master of all things Form 4) Ben Silverman over at Insider Score told us last night that it obviously would have been difficult for Macleod to suddenly drop his 10b5-1 plan without tipping his hat. Ben described this as being somewhat similar to the Angelo Mozilo case, in which the former Countrywide CEO tried to shield himself by claiming that his well-timed sales were just a matter of his 10b5-1 plan. Another friend — Broc Romanek of The Corporate Counsel has written extensively about this here.

For us, these disclosures remind us of why we tend to rely less on Form 4s and more on other types of SEC filings to pick up on the types of hidden signals that companies — and more specifically, their lawyers and accountants — leave in filings. Putting too much stock in Macleod’s trading patterns here would have meant leaving a lot of money on the table here.

Image source: Stepahnie’s Best Shots via Flickr

With a .300 batting average on predicting deals, we upped the ante and issued three more deal picks that are only available to footnotedPro subscribers. For more information on a subscription to footnotedPro, contact us at pro@footnoted.com. FootnotedPro: Interesting, Actionable. Profitable.

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Another kind of dough-nut at Krispy Kreme…

Mon, 07 Feb 2011 15:28:34 GMT

Krispy Kreme Doughnuts (KKD) holds a special place here at footnoted, and not just because of their signature melt-in-the-mouth-sugary glazed doughnuts (sickeningly delicious as those are). The Winston-Salem, N.C., purveyor of fried dough was an early subject of these pages, and has popped up regularly since — it looks like this post will take its appearances to an even baker’s dozen — on everything from cozy related-party transactions to doughnut sludge and sewer problems. Most recently, we looked at the puffed-up pay and incentives offered to company management.

Well, they’re back, and this time with revisions to the company’s stock incentive plan, originally adopted in 2000 and modified since then, and filed with an 8-K on Thursday. At first, the company’s summary of the changes sounds almost as pleasing for investors as Hot Doughnuts Now — after all, the filing says the amendments were made

“in order to (a) add a minimum vesting requirement for stock options and stock appreciation rights … (b) provide that underwater stock options and stock appreciation rights may not be exchanged for cash without shareholder approval; and (c) make certain minor technical changes.”

All well and good, and it does seem to do that. However, the hitch is in the fine print (much as it is [PDF] with all those lovely doughnuts), in the plan itself, where the company says that, yes, underwater awards can no longer be replaced with cash without shareholder approval. And, yes, minimum vesting will be 3 years (including graduated vesting), or 1 year for awards tied to performance criteria other than continued service. Yet there are a couple big exceptions:

“[T]he Plan’s administrator may provide for (a) acceleration of vesting of all or a portion of an award in the event of a participant’s death, disability or retirement, or upon the occurrence of a change in control of the Company; and (b) the grant of an award without a minimum vesting period (or the acceleration of vesting of all or a portion of an award for any reason), but only with respect to awards for no more than an aggregate of 10% of the total number of shares authorized for issuance under the Plan.”

For one thing, that 10% limit for minimum-vesting-free awards doesn’t impress us as much as it might: The plan itself specifies that it can deliver a a minimum of 12.5 million shares in various ways. That’s a full 18.5% of the 67.5 million shares outstanding as of the 10-Q that the company filed December 1. Being able to grant options, SARs or restricted stock covering 1.25 million shares, or $9 million (almost 2% of the company’s market-cap) at recent prices, seems like plenty.

Presumably, with the company’s shares on a roll over the last year, company executives figure it’s no big deal. We’ll see.

Image source: House of Sims’ via Flickr.

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Qwest just won’t go quietly into the night…

Thu, 23 Dec 2010 16:01:50 GMT

We’ve been waiting — patiently, which isn’t something that we do very well — for Qwest (Q) to go quietly into that good night following its deal with CenturyTel (CTL) that was announced back in April. The company, which in many ways was the inspiration for footnoted and which has been the focus of more [...]

How else to explain this 8-K that was filed at 5 pm yesterday? Here’s a snip:

On December 21, 2010, in order to preserve economic benefits to our stockholders of approximately $120 million that would otherwise have been lost in connection with our pending merger with CenturyLink, Inc., we approved (i) the immediate accelerated vesting of restricted stock and performance shares…

But it’s worth reading the whole filing since it kind of reminds us of the justifications that we make when we’ve spent a bit too much money at the mall: we’re really saving money because everything is on sale for 50%.

We particularly liked the part where the filing mentions the mighty sacrifice made by Chairman and CEO Ed Mueller — whom, you might recall, snagged a third plane back in August — foregoing $10 million in severance that he would have been entitled to. But according to the accelerated vesting schedule, Mueller will wind up with around $55 million and the five executive officers identified in the chart will collect $129 million, which is not a bad way to kick off the holiday.

We also liked the part in the filing that noted that this sort of thing is normally subject to a shareholder vote, but that Qwest’s board decided to make an exception in this case. This may be a longshot, but we’re guessing that given the sorry history of Qwest, few investors would have approved this “savings”.

Image source: Zalubowski/AP

There’s still time to vote for Qwest (and four other companies) in our annual worst footnote of 2010 contest. Footnoted wishes all of our readers that celebrate the holiday a wonderful Christmas with their families. We will be back on Monday.

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J. Crew union based on more than money?…

Thu, 16 Dec 2010 15:59:20 GMT

Theoretically, J. Crew Group, Inc. (JCG) is entertaining takeover offers from other suitors until 11:59 p.m. on Jan. 15, 2011; a minute later, and it agrees to tie the knot with private equity fund TPG Group Holdings Advisors, Inc. and affiliates of private equity firm Leonard Green. But that doesn’t mean that all suitors are equally attractive, and it’s pretty clear from the pre-merger proxy that J. Crew filed last week that its senior executives have millions of reasons – many monetary, some not – to prefer this union over others.

Of course, there’s history between J. Crew and TPG. In 1997, TPG’s affiliates acquired a tad more than 85 percent of the company, a majority stake held until the 2006 IPO reduced its ownership to about 39.2 percent. But nostalgia only gets a suitor so far, so it’s nice that there is plenty of money to sweeten the deal.

If it goes through, thanks to the accelerated vesting of his equity awards, Chairman/CEO Millard “Mickey” Drexler will get almost $151.46 million… just for his stock options. He’s also got 10,000 restricted shares worth another $435,000. And if Drexler owes any excise taxes on his change in control payments, J. Crew has agreed to pay them on his behalf. According to the filing, that could amount to $0, or it could be as much as $3.2 million; it all depends on whether the company keeps Drexler after the merger occurs and other criteria are met.

Drexler’s commitment to the deal is clear: On behalf of himself and trusts he controls, he’s rolling over 2,287,545 shares of stock (including 20,000 restricted shares) worth nearly $100 million in exchange for a serious stake in the new J. Crew.

A couple of months ago, when the parties were hammering out the terms of the deal, according to the filing, members of special committee

“…concluded based on Drexler’s statements at the meeting that Mr. Drexler would be unwilling to work for any third party other than TPG.”

However, Drexler softened that stance a few weeks later, even informing the board (at a period of time during which negotiations with TPG and Leonard Green had broken down) that “he would be open to continuing his employment with the Company following a sale to an acquiror other than TPG.” We know from the lengthy Background of the Merger section in the filing (pages 18-34) that Drexler also subsequently offered to “actively engage in the solicitation of alternative proposals in connection with a post-signing ‘go shop’ period, and he recused himself from the board’s decision to do the deal with TPG.

But does Drexler’s stance mesh with events? Some might wonder, based on some of the unusual facts surrounding the deal, as chronicled by this Wall Street Journal commentary – including a slew of close ties and quiet conversations between company and TPG officials.

Of course, the deal will give millions to executives other than Drexler, as well. In distant second place – but still doing quite well for herself – is J. Crew’s style icon, Jenna Lyons, who is the President and Executive Creative Director. She’s poised to get more than $11.4 million for her stock options. (Nearly 59 percent of those are currently unvested, but – thanks to accelerated vesting – will nonetheless bring her close to $6.69 million.) Lyons will also get another $2.175 million for her restricted shares. If the company terminates Lyons after the deal closed (and there’s a snowball’s chance of that happening…), she’ll also get severance pay; but some (perhaps most) in the fashion industry believe that Lyons will stay with J. Crew as long as Drexler does.

Going private certainly has advantages beyond showering senior executives with gobs of money. For example, the executives and directors will be able to grow and steer the company as they wish, without answering to shareholders every quarter when the sales numbers are released. But until 12:00 a.m. on January 16, 2011 – theoretically, at least – anything can happen.

Image source: Derek Purdy via flickr

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Lucky CEOs and Lucky Directors

Tue, 07 Dec 2010 13:33:30 GMT

Editor’s Note: Lucian Bebchuk is a Professor of Law, Economics, and Finance at Harvard Law School. Yaniv Grinstein is an Associate Professor of Finance at the Johnson Graduate School of Management at Cornell University. Urs Peyer is an Associate Professor of Finance at INSEAD.

The December issue of the Journal of Finance features our article Lucky CEOs and Lucky Directors. This study integrates two discussion papers we circulated earlier, Lucky CEOs, and Lucky Directors.

Our study contributes to understanding the corporate governance determinants and implications of backdating practices during the decade of 1996-2005. Overall, our analysis provides support for the view that backdating practices reflect governance breakdowns and raise governance concerns. (For recent expressions of the opposite view that backdating did not reflect governance breakdowns, see the recent op-ed by WSJ columnist Holman Jenkins, who argues that backdating was a “meaningless accounting violation.”)

In particular, we find that:

(i) Opportunistic timing has been correlated with factors associated with greater influence of the CEO on corporate decision-making, such as lack of a majority of independent directors, a long-serving CEO, or a lack of a block-holder with a “skin in the game” on the compensation committee;
(ii) Grants to independent directors have also been opportunistically timed and that this timing was not merely a by-product of simultaneous awards to executives or of firms’ routinely timing all option grants;
(iii) Lucky grants to independent directors have been associated with more CEO luck and CEO compensation;
(iv) Rather than being a substitute for other forms of compensation, gains from opportunistic timing were awarded to CEOs with larger total compensation from other sources; and
(v) Opportunistic timing was not driven by firm habit but rather, for any given firm, the use of such timing was itself timed to increase its profitability for recipients.

Our analysis suggests that the existence of CEO and director lucky grants as a variable that can be useful to research studying the governance and decision-making of firms. We therefore make available on the website of the Harvard Program on Corporate Governance a dataset (available here) of CEO and director luck indicators based on our work.

Here is a more detailed outline of what our paper (available here) does:

Click here to read the complete post...

A new dawn for CEO’s pay at Sunrise …

Fri, 03 Dec 2010 15:27:54 GMT

Sunrise Senior Living (SRZ) is apparently in something of a hurry to keep its chief executive on board and happy: Yesterday, it disclosed a new employment agreement with him attached to an 8-K filing, a full year before his current deal was due to expire. Mark Ordan, who has run the nursing-home and assisted-living chain [...]

Mark Ordan, who has run the nursing-home and assisted-living chain since 2008 and helped found Fresh Fields Markets before that, keeps his base salary of $650,000 a year, and target bonus of $975,000 (with a maximum bonus of of $1.95 million). But the big money is in a $3 million cash signing bonus, plus a new slug of options on 1 million shares at Wednesday’s closing price of $3.94 a share. Those options vest over the next three years.

In return, Sunrise shareholders get Ordan’s promise not to quit without good reason, or without the board’s approval (and not to compete for two years after departure). If he does quit, he has to give back the $3 million bonus — assuming Sunrise can make him, since the bonus is to be paid out within a couple of weeks. After all, possession is nine tenths of the law, as they say, and these kinds of clauses seem to invariably give rise to disputes over whether an executive quit or was pushed out.

If he leaves with the board’s consent, he has to give up most or all of the options, depending when it happens. But if he gets the boot within two years after there’s a deal to sell the company, he gets all the options immediately.

While employed, Ordan also gets

“an executive medical and dental insurance plan providing supplemental first-dollar coverage for the Executive and his eligible dependents for those items not covered under the Company’s general health plan (for example, prescriptions, orthodontia, eye surgery or other coverage which may be excluded from the group medical plan), at the expense of the Company.”

Curiously, though, Sunrise only extended Ordan’s deal for one year. (An automatic extension in the new pact only kicks in at the end of each contract year.)

Sunrise has had a rocky ride of late, as The Wall Street Journal chronicled late last year, and at $4.20 a share or so, its stock price is just a fraction of what it was at its lofty peaks of three years ago. Ordan has made some progress since then, selling some properties, hashing out a deal with some German lenders, resolving an SEC investigation without penalties, and settling a lawsuit with a big customer. There’s still a long way to go if the company ever hopes to return to its glory days.

As an aside, this is a filing that should make punctuation mavens purr with delight: Throughout, Sunrise refers to Ordan’s bounty as “Re-Signing Options” and “the Re-Signing Bonus.” Ah, the difference a couple of tiny hyphens can make!

Image source: *clairity* via Flickr

————

See more of what’s in the filings: Check out FootnotedPro, where we highlight unusual opportunities and potential problems well in advance of the market. For more information or to inquire about a trial subscription, email us at pro@footnoted.com.

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If You Think Your Alimony or Child Support Will Be Based Solely on Your Salary, Think Again

Tue, 28 Sep 2010 01:39:59 GMT

I recently heard a person say that their spouse believed his alimony and child support would be based solely on his salary. I am sure he would like that but that statement is wishful thinking at best. If he was correct, several hundred thousand dollars each year would be his alone and not considered for support. Aside from potentially being unfair, it is not the law.

In fact, in New Jersey, the definition of income from support purposes includes all sources of income. In fact, the Child Support Guidelines includes, but is not limited to 23 possibilities for income, as follows:

a. compensation for services, including wages, fees, tips, and commissions;
b. the operation of a business minus ordinary and necessary operating expenses (see IRS Schedule C);
c. gains derived from dealings in property;
d. interest and dividends (see IRS Schedule B);
e. rents (minus ordinary and necessary expenses - see IRS Schedule E);
f. bonuses and royalties;
g. alimony and separate maintenance payments received from the current or past relationships;
h. annuities or an interest in a trust;
i. life insurance and endowment contracts;
j. distributions from government and private retirement plans including Social Security, Veteran's Administration, Railroad Retirement Board, deferred compensation, Keoughs and IRA's;
k. personal injury awards or other civil lawsuits;
l. interest in a decedent's estate or a trust;
m. disability grants or payments (including Social Security disability);
n. profit sharing plans;
o. worker's compensation;
p. unemployment compensation benefits;
q. overtime, part-time and severance pay;
r. net gambling winnings;
s. the sale of investments (net capital gain) or earnings from investments;
t. income tax credits or rebates (excluding the federal and state Earned Income Credit and the N.J. homestead rebate);
u. unreported cash payments (if identifiable);
v. the value of in-kind benefits; and
w. imputed income

Case law has expanded the definition of income to include the exercise of stock options. No doubt, restricted stock, warrants, and other deferred compensation, when realized, is income for alimony and child support purposes too.

While the case law, referring to the IRS definitions, treats stock options as income when exercised, a questioned unanswered by NJ law is whether a party can interminably hold options, and not cash them in, if the result would be to deprive their children of support. Put another way, if someone chooses not to exercise options, but could, can income be imputed? That is an interesting issue that will probably be litigated one day.

Until then, it is clear that if something looks like income, it probably will be included for calculation of alimony and child support.

What Is Rule 701 and Do I Need To Worry About It?

Sat, 18 Sep 2010 02:00:42 GMT

If you are a non-public company granting stock options or other compensatory equity awards to employees or consultants, you need to be familiar with Rule 701 and worry about complying with it. Rule 701 is the federal securities law exemption for compensatory equity issuances. If you are unfamiliar with the securities law in general, what you need to know is this--you can't sell stock or issue stock options without either registering the securities with the Securities and Exchange Commission (a very expensive proposition), or availing yourself of an exemption from the registration requirement. You also have to worry about state securities law exemptions with regard to stock options or other compensatory equity award issuances. (In Washington, this exemption is found at RCW 21.20.310(10).)

Rule 701 is the federal exemption from registration for compensatory equity awards granted pursuant to written compensatory benefits plans or written compensation agreements. Rule 701 is a broad exemption. There are no forms that need to be filed with the SEC, or any fees that need to be paid to the SEC, but Rule 701 does have conditions and limitations.

You need to be aware that among other limitations Rule 701 has strict mathematical limits that you cannot exceed, and special disclosure requirements that are triggered once the value of the equity awards you grant under Rule 701 exceed $5M during any consecutive 12-month period.

What are Rule 701's mathematical limits?

Under Rule 701, the aggregate sales price or amount of securities sold or options granted in reliance on the rule during any consecutive 12-month period cannot exceed the greater of the following:

$1,000,000 (calculated by multiplying the option exercise price times the number of options granted, in the case of options);
15% of the total assets of the issuer, measured at the issuer's most recent annual balance sheet date (if no older than its last fiscal year end); or
15% of the outstanding amount of the class of securities being offered and sold in reliance on the rule, measured at the issuer's most recent annual balance sheet date (if no older than its last fiscal year end).

As a practical matter, what does this mean? Before every set of option grants you need to make sure that you are operating within these mathematical constraints. In addition, if you have granted more than $5M in equity awards during any 12 month period, you will have specific disclosure obligations. You can find Rule 701 here.

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