Stock Options and Drug Cartels
July 28, 2022
Spoiler Alert: This blog entry discusses the plot of season 4 of Ozark. Read at your own risk.
If we learned anything from season 4 of Ozark, it’s that if you are going to do business with drug cartels, you’d better have nerves of steel. But there are also some lessons to be learned regarding stock compensation.
What Do Stock Options Have to Do with Drug Cartels?
In real life, I think it’s pretty unlikely that anyone involved in the illegal drug trade is receiving stock options. But here’s the set-up in Ozark: a pharmaceutical company whose primary product is an opioid pain medication needs to source raw ingredients for their manufacturing process, so they work out a deal with the head of a Mexican drug cartel for shipments of heroin. Okay, even as I write it, it sounds completely ridiculous, but I swear it seems believable in the show.
During the meeting to hammer out the details of the arrangement, the head of the drug cartel, Javi, announces that he wants part of his payment to be in the form of stock options granted to his mother. Clare, the CEO of the drug company, says that this is impossible—it would out the entire arrangement. But Javi has a plan—the stock options will be granted to his mother, who is not on any law enforcement list.
Later that night, Javi is lured back to Clare’s office under the premise that she has drawn up the paperwork for the options. Once there, he is killed. But eventually, the options are granted to his mother, who assumes control of the cartel after his death. Clare makes a point of explaining to Javi’s mother that the amount of options granted is sufficient for her to “reap the benefits” but not so much that the options will “raise eyebrows” with the board.
If you are like me, you were pretty excited to hear stock options referred to in a TV show. I love it when my profession breaks into popular media. Unfortunately, my husband and the cats were not so interested in hearing my analysis of what worked and didn’t work about the stock options subplot, so I’m writing a blog entry about it instead.
Why Stock Options?
If you’ve been keeping up with the NASPP/Deloitte Equity Incentive Design Survey and its predecessors, you know that it isn’t all that common for public companies to grant stock options these days. Less than half of companies in the 2021 survey grant stock options and those that do typically grant them only to senior level employees.
It isn’t clear whether the pharmaceutical company in Ozark is a public company. If it is and its current granting practices align with that of other public companies, granting an option to a non-officer might attract the attention of the board regardless of the amount. On the other hand, the company is trying to come back from the opioid scandal which means they are arguably in a growth phase. Stock options can be a better vehicle of choice for companies that expect to experience significant growth.
Stock options are considerably more common among private companies, particularly start-ups. In this case, however, the pharmaceutical company is a large, mature, family-owned corporation. As such, I think it would be unusual for it to grant stock options in high enough amounts that a grant of options to a supplier would go unnoticed by the board.
Can Companies Grant Stock Options to Suppliers?
We all know that companies can grant equity instruments to employees and to others who are providing a service to the company, such as consultants and outside directors. But what about entities that are providing goods to the company—can they be offered equity? Sure, why not? Equity can be offered as payment for goods that are provided to the company.
Not only that, but the equity instruments can be accounted for in the same manner as equity awarded to employees. When ASC 718 was amended in 2018 to expand the scope to include grants to nonemployees, the expansion included equity issued in payment for either goods or services.
Complying with US securities laws will be more complicated. Typically public companies register their equity plans on Form S-8 and private companies rely on Rule 701 to exempt their equity awards from registration. In this case, however, it’s not clear that either Form S-8 or Rule 701 would cover the grant.
Both Form S-8 and Rule 701 cover securities issued to “natural persons” for “bona fide services.” Neither can be relied on for grants issued to an entity. If the stock options were granted to one of the cartel’s legitimate businesses, they wouldn’t be covered under either Form S-8 or Rule 701. As it turns out, that isn’t a problem in this case because the stock options are granted to a person (Javi’s mother). But I’m not sure that either Form S-8 and Rule 701 could be relied on for securities issued in exchange for goods (not to mention an illegal substance).
Of course, the whole transaction likely violates several other laws that are outside the scope of my blog so maybe securities laws are the least of Clare’s concerns.
Can CEOs Grant Equity Awards Without Board Approval?
Most US companies are incorporated in the state of Delaware, which permits the board to delegate authority to approve grants to an officer. But this authority is limited to grants issued to officers and other employees; grants to nonemployees should be approved by the board or a committee of the board.
The delegation of authority should also be limited in scope, i.e., it must specify the maximum number of awards or shares that can be approved by the officer. In addition, the officer may only determine the individuals who will receive grants and the number of shares they are granted; all other terms of the awards (vesting, forfeiture provisions, etc.) should be determined by the board or compensation committee.
Chances are, however, that, as CEO, Clare is a member of the board; she could be considered a “committee” of the board (under most state corporate laws, a committee can be one person) and could be delegated authority to approve grants to nonemployees. Likewise, her authority to approve grants would not need to be subject to the above limitations. Even without these limitations however, it is likely that an excessively large grant would attract scrutiny from the board.
At one point, another character suggests that the company’s shareholders might question the grant. This is unlikely. Because Javi’s mother is not an officer or director of the company, there is no reason for the company to ever disclose the grant to its shareholders.
Would the CEO Draw Up the Grant Paperwork?
Perhaps one of the most unrealistic ideas in the episode is that the CEO would draw up the paperwork herself. If only Javi had an understanding of stock plan administration, he would have known he was walking into a trap.
Are There Global Considerations?
A further complication to the transaction is that both Javi and his mother reside in Mexico. Anytime the recipient of a grant is outside the US, the laws of the country where they are located must be considered. This can be especially tricky when the grant recipient isn’t an employee. It is not always clear how compensation paid to nonemployees is taxed outside of the United States. In normal circumstances, i.e., a grant for legal goods or services, the stock plan administrator of the pharmaceutical company would be wise to review the grant with the company’s global advisors.