Merrill, Salomon Accused of Stock Option Mismanagement

February 4, 2003 ( - Participants in Microsoft's employee stock option program (ESOP) recently filed four securities arbitration claims against Merrill Lynch & Co and Salomon Smith Barney.

The law firm representing the Microsoft ESOP interests said the claims filed with the New York Stock Exchange (NYSE) and the National Association of Securities Dealers (NASD) relate to the alleged misuse of option financing programs that used affiliated banks of the brokerage firms to exercise employee stock options.   Seeking compensatory damages, the firm said it is pursuing arbitration suits for violations including the misuse of option finance programs, the misuse of stock option plans, failure to supervise, unsuitability claims, misrepresentation and material omissions of fact, according to a report by Dow Jones.

Violations occurred as the brokerage firms recommended to some Microsoft ESOP participants the use of alternative stock option financing through the affiliated banks, thus creating a conflict of interest because they stood to profit from the financing plans, according to allegations made by the ESOP participants.   Further, the suit claims some Microsoft employees were advised to use their company stock as collateral to secure loans for home purchases. This allowed the customers’ portfolios to increase borrowing power of the accounts while avoiding margin maintenance levels that would trigger a margin call.

Industry standards generally provide that if the equity-to-margin ratio reaches 30%, the securities in the account would have to be sold or additional funds would have to be deposited in the account, in an action known as a “margin call.”   However, a spokesman for the plaintiffs’ attorney said that because the affiliated bank financing does not provide margin calls, some ESOP participants saw their equity reduced by up to 90% as Microsoft’s stock price plummeted.

Additionally, firms are accused of mismanaging their clients’ portfolios by not providing a “zero cost” collar.   This option strategy can by implemented at the time of exercise to protect the value of the margined portfolio.