Thursday, May 21, 2009

What the Wall Street Journal (and Most Others) Don't Understand About CEO Hassan's "Special" Compensation. . . .

Lately, Schering-Plough's SEC filings have recited that "stock options granted on or after January 1, 2008" -- will not automatically vest on a Change of Control. That will be true for most pigs -- but CEO Fred Hassan is unlike most pigs. . . .

That is, it may be true as to other executives, but CEO Hassan negotiated "special grandfathering" of stock options, and other forms of equity compensation, for himself, and himself alone, in the event of a Change of Control, back in 2003, when he signed on -- here's his full employment agreement (the below is from Section 3(j) -- on page 4):


Without limiting the generality of the foregoing, during a Change of Control Period, the incentive, savings and retirement benefit opportunities (measured with respect to both regular and special incentive opportunities, to the extent, if any, that such distinction is applicable) and the other benefits provided to the Executive pursuant to Sections 3(d), (e), (f), (g), (h) and (i) shall in no event be less than the most favorable such opportunities and benefits provided to the Executive by the Company and its affiliates at any time during the 120-day period immediately preceding the Change of Control Date. In addition, notwithstanding anything herein or in the 2002 Plan to the contrary, upon the Change of Control Date, the Shares and the Options shall immediately vest in full, and the Options shall remain exercisable for the remainder of their stated term. . . .

That last bit nullifies any later action taken by the Board or Compensation Committee to limit the immediate, and full-vesting -- should a Change of Control occur, at least as to CEO Hassan.

And should the Merck transaction close, that is exactly what Fred Hassan will say: all options -- including those granted on May 1, 2009 -- even after the announcement of the proposed merger -- must vest in full as to Hassan, and Hassan alone.

Some pigs are, indeed, "more equal". Let's try to total it up, then:

Tonight's Wall Street Journal story correctly pegs his immediate cash portions at $17.7 million, plus pension benefits of $13.2 million, and medical benefits of $130,750 (just this year), or about $31 million.

But that's just small potatoes, compared to the equity portions: Mr. Hassan has various option grants of 1,100,000 shares (at $18.20), 220,000 shares (at $20.70), 880,000 shares (at $20.70), 200,000 shares (at $19.23), 800,000 shares (at $19.23), 167,200 shares (at $18.85), 668,800 shares (at $18.85) and 868,300 shares (at $22.91). So, all of these are exercisable at various prices between $18.20 and $22.91 per share. [I have dropped from the tally, the options that aren't likely to be in the money: they are 236,000 shares, and 944,000 shares, each exercisable at $31.57 -- but do not forget about these, if by some miracle, Schering-Plough trades into the $31.60 range by merger time.]

Don't forget -- he has his 900,000 share option mega-grant from early 2004 -- exercisable at $17.34.

He also has the 2003-era 200,000 deferred stock units, and the February 27, 2009 deferred stock unit grant of 195,610 shares -- free and clear. [So the jet just got gilded!]

Finally -- he has his "all other performance based" stock units covering 672,714 shares -- if just the target amounts are paid out in 2009, and early 2010. Now, to calculate -- [I advise making an EXCEL spreadsheet!] on the options, it is simply a matter of subtracting assumed NYSE market prices, from exercise prices -- and multiplying by numbers of shares -- to reach his potential gain, at any given NYSE quoted stock price. Similarly, on outright share-grants, one multiplies the full NYSE stock price, times the total number of shares -- all of those share-gains are his to keep. Simple -- and simply dizzying -- given the size of the numbers, and the endless parade of serial grants.

So, tallying up just the incremental effects -- CEO Hassan's ultimate pay-out will rise by over $7.74 million -- for every dollar over $22.91 that Schering-Plough's common stock rises, in NYSE trading, as of the reverse-merger date (click image to enlarge -- as if you'd need to!):

By my reckoning, if the merger were to close tonight, at $23.68 -- Schering-Plough's NYSE closing common stock quote -- Mr. Hassan would walk away with a grand total of $139.96 million. The NYSE stock price is likely to be closer to $26.25, when the merger occurs -- as that is nearer the March 9, 2009 pegged value -- and, in that case, his personal take-away would be a jaw-slacking $159.85 million.

Now, on top of all of this, remember, the company must pay his taxes -- must gross him up -- should he be hit with any so-called IRS Section 280G "excessive (non-performance based) compensation" taxes. I cannot accurately model the size of that gross-up, in any detail -- but it could add an additional 30 percent to his all-in expense to the company. If the tax gross-up clauses were to be triggered, his compensation costs would likely be north of $200 million (as the company accrues and pays the compensation -- and the taxes on it).

Astonishing, no? I think so.


UPDATED -- 05.22.09 @ 12:20 PM EDT: Jim Edwards, over at BNet-Pharma has linked this (Thanks, Jim!), and done some calculations of his own. He has left off all the option shares CEO Hassan received on May 1, 2009, and February 27, 2009. He also is valuing the options at $18.85 -- which puts many of them underwater. Worthless, actually. Schering-Plough hasn't traded below $21.60 since the first few days after the proposed merger announcement, on March 9, 2009. Today, it is at $23.70. So, on balance, though I respect Jim a lot -- I think my estimated payout is in the range (call it $140 million -- to $160 million) of the most-likely ones -- unless the entire reverse-merger with Merck is to be subsequently renegotiated. Neither of us tried to estimate the IRS Section 280G tax gross-up amounts.


Anonymous said...

I wonder how many car washes needed to be cut to come up with those dollars?! Wait, I know, we just PTP'd a few more staff members.

Greed~simple-greed. And the Board lets it happen.

Condor said...

Indeed. Is there any wonder why Hans Becherer did not stand for re-election?

Is there any wonder what sorts of sentiment will appear -- in the "Survey on Executive Compensation"?

I think not.


Anonymous said...

So, a hypothetical: Fred and crew are 'guilty' with all the supposed issues around Vytorin. Who pays the legal fees? I assume there could be two components a corporate side of life and a personal/individual side. In either case what would be the cost? Then kick in the $ associated with all the potential settlements.

Could that be another reason J/J walked away? Merck is in it anyway because of the joint venture-they will be dragged down if there is a smoking gun.

By buying S/P, Merck can clean house, pay-off the S/P EMT and then tell the regulators they found out and got rid of everyone.

Maybe Merck is trying to limit the toxicity. Where J/J didn't want to get dirty.

Condor said...

On legal fees -- Schering-Plough's charter and by-laws provide indemnification for Hassan.

Moreover -- Hassan's employment agreement, from 2003, requires that the company maintain his D&O protections for a potentially UNLIMITED AMOUNT OF TIME -- after he leaves (this really is an extra-ordinary agreement -- even in the CEOs' stratosphere-style markets):

"13(h) The Company shall indemnify the Executive and hold him harmless to the fullest extent provided under the Certificate of Incorporation of the Company and its Bylaws, and shall maintain one or more policies of directors and officers liability insurance insuring the Executive, in each case to the fullest extent as similarly situated members or former members of the Board and similarly situated statutory officers or former statutory officers of the Company; provided, however, that for the avoidance of doubt, if at any point no such policies are in place for the applicable similarly situated individuals, the Company shall have no obligation to provide any such policies to the Executive. The obligations of the Company to the Executive under this Section 13(h) shall continue to be valid, binding and enforceable both before and after the Executive has ceased to be a director, officer, employee or agent of the Company and its Affiliated Companies and all other corporations, partnerships, joint ventures, trusts and other enterprises for which the Executive served in such capacity at the Company's request for as long as the Executive may be subject to the claims for which such indemnification applies. . . ."

This last bit -- ". . . .for as long as the Executive may be subject to the claims for which such indemnification applies. . . ." means that ALL his Vytorin suits will be covered.

The only carve-out to this protection would presumably be for Hassan's own gross negligence, or willful misconduct (as required by applicable law).

So -- Merck pays his legal fees -- potentially forever, or until all suits prior to his departure are settled, or finally-adjudicated.


Condor said...

To be clear -- these indemnifications will cover his personal liability, as well.

Moreover, the company must advance the legal fee amounts, on a rolling monthly basis, as the legal bills come in -- (or pay "prime minus one" interest, if it doesn't promptly do so!) -- unless, and until a jury or judge finds Hassan's fees request "frivolous". So, Merck cannot really afford to "wait to the end" -- to reimburse him. That's in Section 12(b), thus:

". . . .(b) The Company shall pay the Executive promptly as incurred, to the full extent permitted by law, all legal fees and expenses which the Executive may reasonably incur (together with interest thereon at the prime rate from time to time published in The Wall Street Journal, minus one percentage point, for any amount incurred and not paid within sixty days after Executive's request therefor) as a result of any contest (regardless of the outcome thereof) by the Company, the Executive or others of the validity or enforceability of, or liability under, any provision of this Agreement or any guarantee of performance thereof (including as a result of any contest by the Executive about the amount of any payment pursuant to this Agreement), unless the trier of fact in such contest determines that the Executive's position in such contest was frivolous or not maintained in good faith; provided, however, that in no event shall the Company be required to make reimbursements pursuant to this Section 12(b) that exceed $250,000 in the aggregate, other than for any such contest by the Company unless the Company prevails as asserted on all material claims forming the basis for the Company's contest. . . ."

Welcome to the AE Black Cardholders' world.

The $250,000 limit is knocked out -- unless and until the Company proves Hassan is entitled to nothing -- on all claims. It will never be able to do that, at least on these facts, as we now understand them.


Condor said...

The end of mine got cut off -- that last paragrpah should read:

"The $250,000 limit is knocked out -- unless and until the Company proves Hassan is entitled to nothing -- on all claims. It will never be able to do that, at least on these facts, as we now understand them. That is -- I do not think the currently available evidence would allow a jury to find "willful misconduct", or "gross negligence" occured via Hassan's actions or failures to act. Now, I could be wrong -- that is what the shareholders' derivative suits are all about. We'll see, though. . . ."


Jim Edwards said...

I agree that the WSJ undercounted Hassan's pay, but have used some more conservative numbers. Check it out:

Anonymous said...

This is such a travesty to the hardworking staff at S/P. Absolutely-disgusting.

Where is the 'integrity' that Frank and the EMT always talked about?

Anonymous said...

You should make the plane 'gold' covered....

Fred "Goldfinger" Hassan.

Condor said...

What?! These graphics aren't "free enough" for ya'?!

Okay, next time -- next time. . . .

Thanks for the comments -- do stop back! I'll have the whole "Air Hassan" private jet fleet fully-gilded, by then. . . .


Condor said...

Done -- see above!

A mini-gilding job, completed.


Anonymous said...


if only you could make it (him) crash (legally) at least some people would feel better.

Anonymous said...

Given the new agreement with Novartis over fometerol and its backup, do you think it has any bearing on where S/P will wind up with J&J?