The Employee Ownership Update
July 1, 2009
Special Employee Voting Rights End at SAICScience Applications International Corporation (SAIC), once the second-largest majority employee-owned company in the U.S., has changed its stock structure to eliminate the 10-to-1 voting rights that preferred shares held by employees were given when the company went public three years ago. Shareholders (including employees) voted on the change in June. SAIC's board concluded that the arrangement (similar to one at Google) was putting off potential investors. SAIC stock has been basically flat since its IPO, after consistently rising by about 15% per year over its 30-plus years as a private employee-owned company. The culture at SAIC has changed substantially since the IPO. Once structured around a series of semi-autonomous (and sometimes competing) teams, the company has now moved to a more traditional corporate model. SAIC is one of a number of majority employee-owned companies to go public, most of whom share a similar history. At the start, leaders pledge to maintain the company's employee ownership culture along with substantial actual ownership. Over time, both the culture and the ownership share tend to dwindle. A good article on the subject appeared in the San Diego Union Tribune on June 19.
SEC Approves Path for Monetizing Employee OptionsOn June 17, the Securities and Exchange Commission (SEC) issued a new rule allowing employees with vested stock options to use them as collateral to purchase call options on the same company's stock as a way to obtain some cash value for the shares they can exercise. Call options allow an investor to sell a right to buy shares at a given price (say, $50) to an investor who can purchase the shares at that price ($50 in this example) over some period of time. If they are at a higher value (say, $60) when purchased, the option holder can profit. If the right expires, the investor gets to keep the premium made from the sale. In effect, this strategy hedges potential losses by giving up the right to some potential gains. Until this ruling, vested options could not be used as the sole collateral to purchase call options because such transactions were considered to be "naked."
Currently, one company (iOptions Group LLC) has a patent on a business model to do this and has been urging the SEC to allow it. The patent might be challenged in court, however. Many companies do not allow executives to engage in hedging strategies on their options because they want the executives to have a continued stake in the company after exercise. Whether companies would extend that to all employees if this approach becomes widely available is not known. The ruling can be found at this link.
Things Not to Do in an ESOPWe have just started work on a book of things not to do in an ESOP. We'll be covering a whole range of bad choices, from the imprudent to the ill-considered to the illegal, in each case basing a general principle on one or more brief case histories (often anonymous). We would welcome any stories you might want to share.
One recent "don't do that" story involved an S corporation ESOP that did not have enough cash in the accounts of eligible participants to handle current distributions. There was, however, cash in the accounts of two ineligible participants—ineligible because they had sold their stock to the ESOP when the company was a C corporation and taken a tax deferral. They were thus not eligible to have any of those shares allocated to them. But there was cash in their accounts, and the company's lawyer advised the company it could borrow that cash to make the payments, then pay it back just to the two participants, with no interest, through future ESOP contributions.
That raised a whole raft of problems. First, where did the cash come from? If it was a "make-up" contribution for their not getting shares, that is a plan violation. If contributions are made to the ESOP, they cannot be made to specific people. The company cannot borrow money from the ESOP, and, if it could, couldn't repay it at zero interest.