Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New by David Einhorn (tohfa e dulha read online TXT) 📕

of those options to vaporize. They had a better sense of the status of the investigations than public market participants. For a year and a half, they refused to comment beyond standard disclosures prepared by their lawyers. If Allied executives knew of any material bad news in the investigations (or bad news anywhere in the business) and they exercised their options and sold before that news became public, they could later be accused of civil, or even criminal, insider trading.

Many of the employee options were “in the money,” meaning the price at which employees could exercise them was below the price of the stock. Allied’s outstanding options had an average exercise price of about $22 at the end of 2005, so, for example, if the stock were trading at $30, employees could exercise the option to buy the stock at $22 and immediately sell the shares on the market for $30, making about $8 a share in profit. Allied’s executives were poised to make hundreds of thousands, and in some cases, millions of dollars, from their options.

Exercising the roughly thirteen million vested, in-the-money options that were outstanding, and then selling the stock en masse, would drive down the price of the stock. Allied’s stock is not tremendously liquid and usually only a few hundred thousand shares trade a day. Each sale would require the executive to file a Form 4 with the SEC and disclose the sale within a day or so. A big part of the confidence story Allied and its supporters advanced in 2002 was, “If there was fraud, insiders would be selling.” The company’s line was that since executives weren’t selling—and, in fact, they made symbolic purchases of trivial numbers of shares to signal the market with news of insider buying—everything must be fine.

Large insider sales would make news immediately, and Allied couldn’t allow that. The quandary for senior executives was how to get their money out without risking insider trading accusations and also without pushing down Allied’s stock with news of their sales. After all, CEO Walton held about $24 million worth of options at the end of 2005, and COO Sweeney held about $12 million. They would be the two top beneficiaries of the proposed plan.

So Allied proposed a stock ownership initiative whereby employees with vested in-the-money options could tender them to the company in exchange for their value paid half in stock, half in cash. Because the company was near the legal threshold in the number of options it could issue (the law caps BDC’s at 20 percent of outstanding shares; Allied was at 18 percent), the company said canceling existing options would make more available to employees and new hires. According to the proxy, “Stockholders are not being asked to approve the stock ownership initiative. Stockholders are being asked to approve the issuance of shares to satisfy the common stock portion of the OCP (option cancellation payment). Should stockholders not approve the issuance of shares, the Board of Directors may elect to revise the composition of the OCP to an all cash payment,” the company said, in what sounded like a threat. Obviously, if the payments were all cash, then the employees would not receive any stock as part of the stock ownership initiative.

I have never seen a plan like it. I asked around and couldn’t find anyone else who had seen a plan like it, either. This program would effectively enable insiders to sell up to $397 million of stock back to the company without burdening the open market with millions of shares of insider sales. Why would anyone want to buy 9.5 percent of the company’s outstanding shares from the employees? “What do they know that we don’t?” the market would ask, assuming the worst.

Also, because the sales would be to the company, there would be no presumed information disadvantage that insiders held over other shareholders. So, if management foresaw a bad ending to the investigations, they might not be held liable for insider trading in the same fashion as if they’d exercised their options and sold in the open market.

Based on our analysis of the proxy, if everyone participated, about thirteen million vested in-the-money options would be exchanged for 1.7 million shares and $53 million in cash. Prior to the exchange, if the stock rose a dollar, employees would be $13 million richer. Afterward, they would become only $1.7 million richer. Allied disingenuously asserted that owning 1.7 million shares directly better aligned employee’s interests than owning thirteen million in-the-money options. Dale Lynch, who had taken over as head of Allied’s investor relations, told The Wall Street Journal, “We think this is a very elegant, transparent way to get stock into the hands of employees.” Again, opacity as transparency.

On the downside, executives would be protected. With stock options, if the price falls below the exercise price, the options have no intrinsic value. After the deal, employees would get to keep the $53 million in cash and the shares wouldn’t become worthless unless the stock hit zero. This plan would actually reduce the insiders’ exposure to the stock, not increase it.

Cue a joke from my dad’s book: A fellow owned a bar. One day he noticed that every time his bartender sold a drink, he would put one dollar in the cash register and one dollar in his pocket. Several months passed. The owner came back to his bar. This time he noticed that when the bartender sold a drink, he put nothing in the till and both dollars in his pocket. The owner went up to the bartender and asked, “What’s wrong, aren’t we partners anymore?”

As I see it, the tender offer only made sense as a clever maneuver by senior executives to get their money out before the stock collapsed. Allied was on the ropes, and this proposal showed me that the people running the company knew it.

In September 2006, Hewlett-Packard chairwoman Patricia Dunn was accused of spying on other board members because she was concerned about leaks.