I’m still digging out from what I missed while on vacation, but this obscure speech from SEC Commissioner Paul Atkins last week could not go unreported on. Jesse Eisinger rightly calls out this absurdity by a man who’s job is ostensibly protecting investors:
"SEC Commissioner Paul Atkins gave a bizarre speech yesterday, defending the practice of "spring-loading" stock options, or issuing options ahead of good news.
At a corporate governance forum in Washington, Mr. Atkins said, "It is cheaper to pay a person with well-timed options than with cash," adding that spring-loading is OK because no one is harmed. "It benefits shareholders because fewer stock options are granted."
Yeah? Doesn’t he have to provide some evidence for this contention? Is there one real-life example where insiders were granted fewer options than they otherwise would have been because they knew the stock price would rise quickly afterwards?
The absurdity of his argument is exposed by the fact that companies have not made clear and timely disclosure of their spring-loaded grants. If there is no problem with spring-loading, then what were they hiding?
Damon Silvers, associate general counsel at the American Federation of Labor and Congress of Industrial Organizations in Washington, whose members hold more than $400 billion of union-sponsored pension funds, had a devastating rebuttal, as quoted in a Bloomberg article yesterday: "It’s also true that if you let your employees steal from the cash register, you don’t have to pay them that much."
It has long been a fringe, extremist, free-marketer view that insider trading should be legal, and Atkins seems to be parroting it. Is this who investors really want as an SEC commissioner?
You can learn more about Commissioner Paul S. Atkins at the SEC site.
Nice to know the men in charge of regulating the Securities industry are hacks or fools — neither an appetizing choice.
UPDATE: July 11, 2006 4:00pm
Jeff Matthews is similarly incensed: SEC COMMISH TO BIGS: “HELP YOURSELF
"But before we get into cases, let’s stop calling them “spring-loaded” option
grants, because that makes it sound as if the economic payoff for the insiders
is simply a bit more leveraged to a rise in the stock price than the payoff for
other shareholders when the company announces the expected good news.
what has happened is the insiders have given themselves a larger slice of the
shareholder’s pie when they know the value of that pie is about to increase. So
let’s call them “front-running” option grants, because that is exactly what they
On its face, the ability of management to grant themselves
front-running option grants violates the very SEC regulations Mr. Atkins has
been sworn to enforce. After all, Reg FD requires an even playing field for
investors: no tips to Wall Street’s Finest; no wink-wink, nudge-nudge to Fido;
no nothing to the big hedge funds prior to disclosure of market-moving news,
good or bad."
And the WSJ continues its recent habit of burying killer columns on Saturday: Can Companies Issue, Options, Then Good News?
July 7, 2006 3:16 p.m.
Can Companies Issue Options, Then Good News?
SEC Is Divided on Practice Known as ‘Spring Loading;’ Critics See ‘Insider Trading’
KARA SCANNELL, CHARLES FORELLE and JAMES BANDLER
July 8, 2006; Page A1
“Heckuva job, Atkins-y!” Smirk.
Why don’t large shareholders (funds, pensions) make a bigger stink about this garbage? Our agency problem is such a disaster. Irritating to no end.
oil inventories down 6 million and oil goes down .. i dont get it.
True, VLO is down a few pennies, depending on your timing/limits/stops, but OXY went up, PWI and PDS went up and PGH down on a downgrade.
Depends on where you are playing oil. Watch yourself on the knifes edge……peak driving season/politics/hurricanes VS slowing US economy leading to slowing global growth.
Have you seen the run-up in oil reits? If only I’d known!
I like Reich’s analogy:
I hate to be a contrarian, but the analogy that: “It’s also true that if you let your employees steal from the cash register, you don’t have to pay them that much,” is pretty flawed.
Unlike letting an employee steal from the cash register (implying the employee can take money at any time) those that would receive the “well-timed” options only get them when something good is about to happen. If this practice (that options will be given out before good news) is well known then there is still an incentive to improve earnings. The obvious problem is that this may incentivize the fabrication/manipulation of earnings statements. But this problem would exist regardless of whether corporate heads expected “well-timed” options beforehand, or bonuses afterward. So, stealing to me (which would come about due to manipulation of earnings statements and not the mere granting of such options) is not the appropriate word.
The real problem that I see is that “well-timed” options do not have the same implied disincentive to avoid bad times that “regular” stock options do. If you hold a “regular” stock option then you face the potential of your option being worthless if the company goes through bad times – whereas “well-timed” options avoid the bad times altogether. Of course one could decline to grant “well-timed” options if the company had been performing poorly prior to the good news, but I am sure we might be pretty skeptical about the likelihood of that happening.
So, in my view, a system of “well-timed” options is analogous to giving out bonuses at each point where the company performs well, while “regular” options are like giving out bonuses which implicitly take the bad times into account.
Hence, I happen to think that the “regular” options have a better incentive structure because it is just as important to codify the disincentive to do poorly as it is to put an incentive on doing well. But, at the same time, I wouldn’t call the “well-timed” options “stealing”.
The major reason for the breakdown in accountablility of corporate managers(execs) to owners(shareholders) is mutual funds.
Mutual funds are a product rather than a share. The very term “mutual fund share” is misleading, as mutual fund shares dont carry any rights in the management of the fund – other than an investment policy. Mutual fund shareholders cannot vote out the fund managers or elect them. They can sell the shares if they dont like how the fund is run, but they cannot force the fund management to act.
So when a large piece of corporate shares are held by mutual funds, the corporate management have only to get the approval of the fund managers to get by. It then becomes a mutual(!) back scratching club between the fund managers and execs.
So for the vast majority of coroporate shares, there is no chain of accountability from the executive to the real owner (the mutual fund shareholder). The mutual fund product breaks that chain. Of course, the whole idea of a mutual fund is to relieve the investor of shareholder responsibilites, but along with that comes this draw back. Index funds are really bad for accountability when seen in that sense. A system in which mutual fund managers are supposed to act in the best interest of their shareholders, but are not accountable to their shareholders, is not bound to work.
Because of this break in accountability, the whole mutual fund idea makes sense for corporate governance only if institutions hold a minority of shares, and leave an active majority of shareholders who act for the best returns.
Berkshire is a notable exception, being structured as a holding company, where the BRK shareholders can kick out Buffet if they have enough votes.
«I like Reich’s analogy:»
I have better one: it is like allowing members of the FOMC to trade in bonds the day before they have a meeting. That would also reduce the cost to the Federal Government of paying them a salary :-).
Hey isn’t it a splendid idea?
«Unlike letting an employee steal from the cash register (implying the employee can take money at any time) those that would receive the “well-timed” options only get them when something good is about to happen. If this practice (that options will be given out before good news) is well known then there is still an incentive to improve earnings.»
First of all there are are two option related ways to help poor executives: springloading and bottom-timing.
But in both cases the incentive is for the executive to manufacture bad news, and then profit as shares bounce back. Because options pay not on good news, but improved news. Which is a very different thing.
Suppose that an executive can backdate (in which case the incentive is more directly to manufacture bad temporary news) or springload options, and that he expects to make 200m of earnings over the year without much effort. Which quarterly distribution of earnings is going to maximize his wealth:
Q1: 50m Q2: 50m Q3: 50m Q4: 50m
Q1: 20m Q2: 80m Q3: -10m Q4: 110m
The second series probably improves his bonus too…
Now, ask yourself: why aren’t variable elements of compensation tied to goals relative to GDP or industry averages, instead of company specific deltas?
«Berkshire is a notable exception, being structured as a holding company, where the BRK shareholders can kick out Buffet if they have enough votes.»
Berkshire is an exception because Buffett is a honest and capable man, not a ”now I can grab whatever I can” CEO like others. Character makes for a lot of difference really.
As to why executives can ignore shareholders, looking at funds is misleading… Looking at Delaware Chancery Court law and what it says about proxy slates is a lot more interesting.
Free-marketers do not support insider trading!!