company has esop - wants to grant stock options to key employees - are

[EGB]

Company X has an ESOP which owns approximately 70% of X. X wants to grant stock options to some of its key employees which will cause some dilution. Do most companies take a conservative approach and obtain a fairness opinion or do most take the position that the decision to grant options is a business decision that does not relate to administration of the ESOP or use of the ESOP's assets? I would just like an idea of what the more common approach is. Also, if anyone knows of any specific cases, rulings, articles, etc. that specifically address the grant of options in a company maintaining an ESOP, please let me know. (I am already familiar with the Martin v. Feilin case). Thanks in advance for any comments.

[RLL]

The board of directors of Company X probably can grant the options if there are authorized but unissued shares (or treasury shares) available. If the options are intended to be "incentive stock options" (ISOs) under the IRC, shareholder approval is required. In some states or under some corporate charters or bylaws, shareholder approval may be required even if ISOs are not being granted.

The big issues here are whether the options represent "reasonable" levels of compensation for the grantees and who will be approving the grants.

Is there a board of directors (or compensation committee) composed of independent directors? Or are management directors granting options to themselves? Is there an independent compensation consultant advising the board of directors as to the propriety of the option grants? Who is looking out for the ESOP participants' interests? Is it in the best interests of the shareholders (including the ESOP) for the options to be granted?

The decision is one of fiduciary responsibility of directors under corporate law. But the fact that the ESOP owns 70% of Company X brings ERISA fiduciary responsibilty into the picture. No company would adopt a stock option plan that was unacceptable to the 70% shareholder. Accordingly, the ESOP of Company X must "approve" the plan....and who will be providing this approval on behalf of the ESOP? Independent trustee or fiduciary?

There is a need for independent safeguards under both ERISA and corporate law to protect the interests of shareholders and ESOP participants. Check out the DOL's interpretive bulletin on corporate governance for ERISA guidance. DOL made it clear that ERISA fiduciaries must concern themselves with matters such as executive compensation in companies in which the plan invests, particularly when the plan owns a significant interest.

[This message has been edited by RLL (edited 01-25-2000).]

[Guest Larry Goldberg]

I agree with RLL. Take a look at

§2509.94-2 "Interpretive Bulletin relating to written statements of investment policy, including proxy voting policy or guidelines." The DOL specifically addresses a fiduciary's role in monitoring executive compensation at a company where the plan owns enough stock to have an influence over policy.

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[IRC401]

Is the employer an S corp? Will granting options affect its ability to keep or convert to S corp status?

[EGB]

Thanks for your responses.

The corporation is not an S-corporation and the grant of the options will not affect its ability to convert to an S-corp.

The corporation wants to place the decision to grant the options with outside directors. The options are authorized, but unissued shares. The options will not be ISOs.