Outgoing SEC Chief Urges Greater Scrutiny of Stock Option Grants
Arthur Levitt is trying to rally public support for a plan to give shareholders a say in how their companies dole out stock option grants--the lucrative deals that can provide a windfall for corporate insiders at what some critics say is the expense of stockholders.
This isn’t a new issue for Levitt, the outgoing chairman of the Securities and Exchange Commission and a leading advocate for investor rights. He’s been lobbying for rule changes at the major stock exchanges that would require a shareholder vote on employee stock option plans that are particularly costly to existing stockholders.
But now he’s asking shareholders to help. Call, write, fax or e-mail, but make your voice heard in the debate over so-called shareholder dilution rules, he says. The value of your investments are at stake.
“It goes to the credibility of our markets,” Levitt said in a recent interview. “It’s shareholders’ money. To make a grant of their money to executives without shareholder approval is just plain wrong.”
Critics such as Levitt contend that employee stock option plans, which give executives the right to buy their companies’ shares at a set price in the future, are becoming so generous that they’re significantly eroding the value of publicly held shares.
Worse, because of a glitch in the nation’s securities laws, company owners--read: shareholders--often don’t get to vote on these plans. Any plan that’s “broad-based”--in other words, is open to a wide swath of employees rather than just to top managers--can be approved by company directors without a shareholder vote.
Option advocates argue that option grants are needed to attract and keep valued employees. Since the value of an option is ultimately tied to stock performance, they note, options are a valid form of performance-based compensation.
Precisely how much shareholders are affected by stock option grants is debatable--the effects can be calculated a variety of ways with differing results.
However, there is no debate on one issue: To satisfy option holders, companies sell millions of new shares at discount prices each year, diluting the value of each existing share.
“You may not be able to tell precisely how much of your wealth is being transferred, but don’t be fooled; it is occurring,” said Nell Minow, editor and founder of the Corporate Library, a Web-based service that tracks corporate employment agreements at major corporations.
Almost everyone is in favor of some stock-option-based compensation. The dispute is over how much stock is reasonable and whether shareholders should be able to veto plans they deem excessive.
For the last five years, a shareholder vote has not been required for certain types of broad-based stock option plans, largely because of rule changes at both the SEC and the major stock exchanges. Plans that are open only to top managers must be put to a vote.
Increasingly, companies are tossing out executive stock plans and passing broad-based plans to get around the voting requirement.
Precisely how costly are these plans to shareholders? A recent study by benefits consulting firm Watson Wyatt Worldwide found that the average corporate stock option plan dilutes the voting clout of existing shareholders by 13%. In the technology industry, the reduction is even greater--roughly 23%.
What the dilution costs individual investors in dollars is tough to calculate. But institutional investors such as banks and mutual funds say the cost is high enough to require shareholder oversight.
“Our members don’t want to micro-manage pay levels, but we do want to make sure that there is adequate disclosure and that shareholders have adequate protection to look over these plans,” said Ann Yerger, director of research at the Council of Institutional Investors in Washington. “The dilution levels of these plans have exploded over the past several years.”
At the urging of incensed institutional investors, which include mutual fund giants such as TIAA-CREF and Fidelity Investments, the New York Stock Exchange agreed that it would reinstate rules requiring that shareholders be allowed to vote on some option plans, such as those that include top officers and those that cause significant dilution to public shareholders.
However, the NYSE is willing to impose the rule only if its main competitor, the National Assn. of Securities Dealers Automated Quotations System imposes similar requirements.
Nasdaq, home of many option-happy technology companies, has resisted. But last month Nasdaq asked member companies to comment on a version of the NYSE stock option proposal.
The comment period is just getting underway, but many Nasdaq members--particularly tech companies--say they’re opposed to additional shareholder oversight.
“Stock options are a vital ingredient to the strategy of a high-tech company,” said Anthony R. Muller, executive vice president and chief financial officer of JDS Uniphase in San Jose. “We are all seeking to maximize stockholder value. The important thing is the energy, creativity and the skills of many of our employees who create that stockholder value.”
Muller believes that some tech industry option plans would be rejected by institutional investors simply because they didn’t fit into a set formula that works for other less-competitive industries. That would make technology companies less competitive and innovative in the long run, he says.
Institutional investors vehemently disagree.
“We set two different benchmarks for dilution depending on whether the company is in a human-capital-intensive industry or not, and then we have people evaluate each case,” says Ken Bertsch, director of corporate governance at New York-based mutual fund giant TIAA-CREF. “It’s a fairly nuanced process.”
Bertsch and other institutional investors say that when stock option plans are put to a vote, very few are defeated.
“Shareholders are pretty supportive. The only time these plans are defeated is when the companies are way out on a limb,” he said. “There is a clear role for shareholder scrutiny here.”
Nasdaq says it welcomes Levitt’s call for shareholder input.
“What’s at stake is the rightful balance between shareholder and management interests and, in the end, public confidence,” said Nasdaq spokesman Scott Peterson. “Broad response to Nasdaq’s request for comment is critical to identifying and achieving that balance. We applaud [Levitt’s] assistance.”
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Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past Personal Finance columns, visit The Times’ Web site at https://www.latimes.com/perfin.
