Employees are forced to mismanage their grants.


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Illustrates that Companies and the Wealth managers promote the premature exercisesin violation of the fiduciary duties and violate Rule 10 b-5 by forcing inefficient strategies.

John Olagues

Published in: Economy & Finance, Business
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Employees are forced to mismanage their grants.

  1. 1. .John OlaguesTruth In Options504- 875-4825www.optionsforemployees.com/articlesolagues@gmail.com
  2. 2. Below are links to the Google Stock Plan document and tothe Cisco Incentive Stock Plan document:Googlehttp://www.secinfo.com/d14D5a.r3mD3.d.htm#1stPageCiscohttp://www.secinfo.com/d14D5a.v5RKa.d.htm Although both of the Stock Plan documents prohibit transferring orpledging the employee stock options (Google allows a limited form ofselling to selected banks and under some circumstances theCisco options can be transferred to family members), neither ofthese documents have a prohibition against hedging withexchange traded calls and puts.Nor is there any prohibition against hedging in the Options AwardAgreements.
  3. 3. The Stock Plan and Award Agreements are thedocuments that constitute the contract between thecompany and the grantee regarding the granted equitycompensation.Since there is no prohibition against hedging in thecontract documents, why do many companies discouragethe strategy? Some even tell their employees thathedging is prohibited by the plan.If holders of employee stock options are prohibited fromhedging ESOs, then why is it not written in the StockPlan documents?
  4. 4. The answer is that the company officials know that there is generallyno prohibition in the company documents but they know thatpremature exercises benefits the company in three ways as below.1. The employee forfeits the remaining "time premium", which thecompany recaptures.2. The employee pays an early tax, and the company gets an earlydeduction from income tax, equal to the difference between what thegrantee buys the stock for and what the stock could be sold for in themarket.3.The employee pays the exercise price early and thatadds to the cash flow to the company.Therefore, the company encourages premature exercises by ESOholders.
  5. 5. But when most of the plans were established, there wasno prohibition against hedging. And the plans requirethat if there is a change to the plan which may beadverse to the grantee, the company needs the approvalof the grantee.So the companies can not just insert aprohibition against hedging into their present plans,because that diminishes the value of the ESOs to theexisting grantees and those who relied on there being noprohibition.
  6. 6. So the companies try to make employees think that there isa prohibition when there is none. But there is a drawbackto that strategy and that is if the company adviser tellsthe employee he can not hedge and the stock goes downafter he is told that he can not hedge, the company wouldbe liable for damages.Also, in my opinion, the advisers who tell their clients thatthey can not hedge when the documents clearly allowhedging, open themselves up to a liability similar to thecompanys liability.The difference in after tax value that the grantee will receiveis on average about 40% more from hedging compared witha premature exercise strategy with the stock 90% above theexercise price. So the liability is not incidental.
  7. 7. In this part of the presentation, I will refer to the specific parts ofthe plans and discuss the fact that in both the Google and CiscoStock and Options plans, there is very limited transferability andno pledgeability but no prohibition from hedging.I will also discuss the fact that both plans mention that the planscan not be amended without the approval of the optionee.Thisprevents the company from adding a prohibition from hedgingwhen none was there prior. In the Google plan, Paragraph 4b(v) discusses the duties andabilities of the Administrator but he does not have the discretionto prohibit hedging. Paragraph 14 discusses the ESOs non-transferability. There is no prohibition against hedging there.Paragraph 18 c) discusses the fact that the plan can beamended only with the participants approval. See the linkhttp://www.secinfo.com/d14D5a.r3mD3.d.htm#1stPage
  8. 8. In the Cisco plan, we find that the plan does not prohibithedging but does prohibit transfers or pledging. Article 1, Paragraph D, under Administration of the Plan ,illustrates the limitations of the Administrator.Article 2, Paragraph G under Options Terms describes theprohibition against transferring, selling and pledging buthedging is not mentioned. Article 5, a paragraph which is titled Amendment to thePlan does not allow an amendment which may effect therights and obligations of optionees in the plan unless withthe is approval from the optionees.http://www.secinfo.com/d14D5a.v5RKa.d.htm
  9. 9. In summary, Google and Cisco have no prohibitions againsthedging. Holders of ESOs are free to manage their equitycompensation as they see fit as long as it is consistent with thePlan Documents and Options Agreements and 10 b-5, withoutfurther approval from anyone.Those who tell grantees that they are not allowed by thecompany to hedge when the documents permit hedging aresubjecting themselves to liability.