The New York Stock Exchange's pending proposal to exempt broadly based employee stock option plans from shareholder approval represents the exchange's biggest step backward on shareholders' rights since it abandoned its one-share, one-vote rule a decade ago.
If the exchange goes forward with its proposal, and the Securities and Exchange Commission approves it, NYSE-listed companies will be able to transfer huge amounts of wealth from pension funds and other shareholders to executives, without obtaining shareholder approval.
This amendment could allow disproportionate benefits to go to a few highly compensated top executives.
DECISION BY END OF SUMMER?
Remarkably, both the NYSE and the SEC earlier approved the proposal without soliciting or receiving written comments from a single shareholder or investor group. But the exchange's April 15 announcement that it had changed its rules evoked such an outcry that it had no choice but to reconsider the amendment and actively solicit comments. The exchange says it wants to take final action by the end of the summer.
The most objectionable feature of the proposed new rule involves adoption of "broadly based" stock option plans. The NYSE would define as broadly based any stock option plan "in which at least 20% of an issuer's employees are eligible to receive stock or stock options, and the majority of those eligible are neither officers nor directors."
Traditionally, the NYSE does not require shareholder approval for broadly based stock and stock option plans.
Critical comment has focused on eligibility. Plans could have broadly based eligibility requirements but give most of their awards to top executives and still be exempt from shareholder approval. Moreover, the so-called 20% test is not an exclusive safe harbor. Companies could still qualify for the exemption even if they didn't meet the 20% test if they could convince the NYSE staff that a plan is broadly based. These two loopholes are an open invitation to abuse.
But the bigger problem with the exchange's proposal is that it fails to address a more fundamental question: Why should listed companies be able to significantly dilute shareholders without obtaining shareholder approval?
Stock option plans transfer enormous wealth from shareholders to employees. The amount of dilution experienced by public shareholders as a result of stock option grants has increased steadily in recent years, as stock option plans have become a popular means to motivate and reward employees throughout the organization. The size of executive stock option grants has grown dramatically, and many companies now offer stock options and grants to their directors as well.
Institutional investors have supported this trend, believing that stock ownership, and stock option plans, ultimately serve shareholders' best interests. However, institutional investors believe strongly that option grants should be made pursuant to plans submitted to and approved by shareholders, particularly when dilution levels are high or awards go to officers and directors. This remains one of the few effective checks that shareholders have on use of option plans.
HOW INDEPENDENT ARE BOARDS?
While it might seem that board-level compensation committees will protect shareholders' interests, board oversight is, in fact, no substitute for shareholder approval. The independence and effectiveness of compensation committees remain open to question. In too many instances, directors who themselves own paltry amounts of stock are willing to rubber stamp options plans concocted by top management and their pay consultants.
The NYSE should drop its proposal and draft new rules that include the following:
* Shareholder approval should be required for all stock and stock option plans that have a material dilutive effect. The definition of "material dilutive effect" should be cumulative, taking into account dilution from all existing plans.
* Officers and directors should be ineligible to participate in broadly based plans.
* Shareholder approval should be required for all plans that grant stock or stock options to officers or directors.
At a time when stock exchanges around the world are strengthening shareholder protections and improving corporate governance, the New York Stock Exchange is moving in the opposite direction. Rather than start another "race to the bottom" -- as it did a decade ago when it dropped its one-share, one-vote rule -- the NYSE should shelve its current proposal on stock option plans and come up with an alternative that strengthens, rather than weakens, its standards.