I recently came across an article by John L. Utz of Utz, Miller & Kuhn, LLC that does a great job of reinforcing the importance of reading an employee’s stock option agreement or the plan documents. Although the article itself is from 2006, the information within it is timeless. It reminds us in the post Sarbanes-Oxley period and well into the stock option backdating scandals, how important it is to have complete and accurate stock option documentation.

The article discussed the federal trial court decision in First Marblehead Corp. v. House.  The court held that “… the terms of the instrument approved by the company’s board of directors granting the option must control, despite any conflicting terms in the memorandum or worksheet provided to the executive.” By way of background from the Utz article:

“The executive had previously received a two-page memorandum setting forth the principal terms of the grant, which had indicated only that the options “must be exercised within 10 years of the date of grant.” There had been no mention in the memorandum of any three-month deadline for exercise following termination of employment.

“The executive never saw the specific grant of incentive stock options nor the complete plan document prior to his leaving the company. The executive contended that he believed he could exercise his stock options at any time within the 10-year period. He indicated that no one at the company ever told him anything about time limits for exercise upon termination of employment (and the employee did not inquire about any such limits).

“The court rejected the executive’s breach of contract argument that the written terms of the grant, and in particular the three-month deadline for exercise following termination, did not apply because the memorandum the executive received stated that
the options had a 10-year duration.”

Utz states that the lessons are: “recipients of stock option grants should carefully read the terms of their grants and the terms of the underlying stock option plan document [for employers] stock option plan documents and grants should be written carefully and precisely …”

From our perspective at Two Step, this case reiterates the important lesson that has been most recently illustrated in the stock option backdating scandals which is that stock option documentation must be carefully managed and retained. It will be required in any dispute like the First Marblehead case, in any investigation like the recent backdating scandals, or by auditors during their annual audit of compensation expense.

At least in this case, there was no dispute over the facts or the existence of each document.  In most cases, there is a tangled web of documents that relate to the board grants, the plan documents, the employee’s agreements, and the exercise documents. Sometimes there are inconsistencies that make it even more challenging. And even if not, think about the time spent trying to find all the documents related to a particular stock option.  How many Board minutes would have to be searched?

All documents need to be easily accessible and stored in a manner that connects all the pieces. It’s worth the time and effort to upload all the documents into a consolidated online system that can be searched and can connect each person’s name to all the related documents. The archaic methods of using three ring binders and file folders has not proven for most companies to be a solid plan that will prepare a company for future unforeseen events.