This certainly applies to our NVEI management.....Hope they follow the others..
30 Aug 2002, 06:49 AM EDT
Doubts Grow on 'Covering' of Options
By JOSEPH B. TREASTER and TRACIE ROZHON
Corporations across the country have halted a longstanding practice of allowing executives and directors to exercise stock options without putting up their own money in transactions that are often worth millions of dollars.
The decision to halt these arrangements — a routine practice at public companies — is being driven by uncertainty over whether they may now be considered loans and therefore criminal violations under a recently passed law aimed at curbing corporate abuses.
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These arrangements, usually called cashless exercises of stock options, allow executives to quickly cash out options granted by the company as part of their compensation. A stock option, granted by the company, gives an executive the right to buy stock at a set price, and he does so when the market price is higher. For example, an executive with 100,000 options priced at $10 would buy 100,000 shares for $1 million. If the stock was then trading for $20 a share, the total value would be $2 million and the executive would have an immediate gain of $1 million. But to start the process, he would need $1 million.
In the past, the company "covered" that amount until the trade was settled, usually within one to three days of the sale. That is the period in which the company is now thought to be making a loan — and the period in which, tax lawyers say, companies may be breaking the law.
Unlike some of the arcane accounting tricks that led to the recent corporate problems, cashless exercises of options are a common and, until now, completely legitimate form of employee compensation. Companies hand out stock options to give employees a chance to feel that they own part of the show. They hand them out to the top executives to lure them in the first place, or to keep them, and these high-level stock options can be worth millions of dollars.
According to experts on executive compensation, virtually all of the country's public corporations have stopped allowing these cashless exercises of executive options. Sandra L. Sussman, the executive director of the National Association of Stock Plan Professionals, estimated that at least 525,000 board members and executives had been affected. (Executives are usually considered those at the level of vice president and higher, heads of corporate divisions and any others who make policy within a company.)
"There are 15,000 public companies out there, and just about every one of them issues stock options to their executives," said Peter J. Romeo, a securities law specialist in the firm of Hogan & Hartson. "The likelihood is that a day doesn't go by without some executive somewhere doing a cashless exercise."
Though tens of thousands of rank-and-file employees also receive stock options as part of their pay, the new law applies only to executives. At Microsoft, a spokeswoman, Caroline Boren, said the company had stopped participating in cashless exercises — for board members and executives — pending clarification of the law.
Sullivan & Cromwell, a leading financial services law firm in New York, and many others around the country have advised clients to halt the cashless exercises.
"We're saying, `Hold off until we and others figure out how the law applies in this situation,' " said William J. Williams Jr., a partner and securities specialist at Sullivan & Cromwell.
The uncertainty over cashless exercises of options has also added to the headaches of accountants and tax lawyers as they struggle to understand all the ramifications of the Corporate Responsibility Act of 2002. The law, signed by President Bush on July 30, bars companies from making loans or arranging loans for executives, but it does not spell out exactly what constitutes a loan or the arranging of a loan.
Andrew L. Oringer, a lawyer at Clifford Chance Rogers & Wells in Manhattan, specializing in executive compensation, said he, too, was unclear whether the transactions were actually loans. But he said the law would probably apply equally whether the company in effect extended credit for the transaction or, as is sometimes the case, arranged for a broker to do it.
"The new law not only prohibits loans from the company but loans arranged by the company," Mr. Oringer said.
Many public corporations have already suspended payments on billions of dollars in executive life insurance for fear that they may violate the law. Many companies are also questioning whether they must also stop making loans to executives in connection with 401(k) retirement plans and for the purchase of homes.
But no affected corporate practice is as far reaching as that of the option transactions. In Washington, Mr. Romeo said that he advised about 100 major corporations and that he had not heard of one yet that had not halted the loans.
Mr. Romeo said that he did not consider the loans an abuse and that he thought they ultimately would be found to fit within the law. "But I can't tell clients there is no risk," he said. "No one can."
"Most of the companies," he said, "are saying, `Let's stop doing this for the time being.' "
Many corporate lawyers say that — though they cannot be sure — they doubt that Congress intended to prohibit the cashless exercises. But Senator Charles E. Schumer, who wrote the section in the law that focuses on personal loans to executives, said he thought the law did indeed apply to these transactions.
"I believe they probably are banned," Mr. Schumer said in an interview.
He said that when the law was written, "we were not aware of every type of loan that's made."
"But," he added, "the bottom line is that the corporation is not an arms-length lender to its top executives. And in this case, particularly since the loan is so short term and well collateralized, there's no reason they can't find financing apart from the corporation."
Where there is doubt, companies usually look to the Securities and Exchange Commission for guidance. But in a conference of securities lawyers broadcast on the Internet on Aug. 15, Mauri Osheroff, an associate director of the S.E.C., said the agency had not decided how to rule on such loans.
"I think that, at least for the immediate future, we'll let you all decide how to handle the interpretation, both as regards to cashless exercises and as regards to the number of other transactions that we've gotten questions about," she said.
In an interview last night, John J. Nester, an S.E.C. spokesman, declined to provide clarification. "We have no immediate plans to issue guidance on this," he said, "but we are sensitive to the concerns of lawmakers, market participants and the investing public."
AI
