eBay's Plan Too Big for Some Rulebooks

Two of eBay's (EBAY) biggest shareholders will vote against the company's plan to expand its options pool -- assuming that they stick to their guidelines.

Both Fidelity and Vanguard have proxy voting guidelines that instruct portfolio managers how to evaluate stock plans offered by companies in their portfolio. eBay's plan violates specific rules within each mutual fund company's proxy guidelines.

Neither Fidelity nor Vanguard discloses how it votes on particular proxy issues. A new regulation that will force mutual fund companies to disclose their proxy votes doesn't go into effect until next year.

However, in the first half of last year, Vanguard voted against 64% of the stock-based compensation plans proposed by companies it invested in, according to information sent to shareholders. Meanwhile, Fidelity's guidelines are a good indication of how the mutual fund company votes, said company spokesman Vin Loporchio.

"We follow our proxy voting guidelines in the overwhelming majority of cases," he said.

eBay representatives did not return calls seeking comment on potential opposition to its options proposal.

Fidelity and Vanguard, the fourth- and eighth-largest stakeholders in eBay, respectively, would be among the most high-profile -- and largest -- investors to vote against eBay's options proposal. The California Public Employee Retirement System, the nation's largest pension fund, has already said it will vote against the plan, but it holds a much smaller stake in eBay.

Scrutiny

Shareholders will get a chance to weigh in on eBay's options plan at the company's annual shareholder meeting June 26. If approved, eBay's proposal would increase by more than 50% the amount of options it could grant under its current options plan. The proposal would authorize the company to issue 14 million more shares, tantamount to more than 4% of the company's outstanding stock, to employees and executives in the form of options.

The plan has drawn scrutiny from investors and compensation critics because of eBay's past practices. The online auction company has been one of the most prolific dispensers of options in recent years.

At the end of the first quarter, eBay had about 39.7 million options outstanding that it had issued under its own stock plans. Those options were equal to about 12.5% of the company's outstanding shares.

But that's not all. Under its current options plans, eBay has an estimated 15.8 million shares, or 5% of outstanding stock, that it can still grant, regardless of how shareholders vote next week. Meanwhile, the company has issued thousands of shares under its employee stock purchase plan and could issue a million more under a separate stock plan proposal on its proxy ballot.

All told, shares that have been or could be issued under the company's current and proposed stock plans amount to more than 23% of outstanding shares, according to the Investor Responsibility Research Center. And that tally doesn't include about 1.7 million more options, equal to about 0.5% of outstanding shares, that eBay assumed through its acquisitions of Billpoint, Half.com and PayPal.

eBay's profligate use of options has come amid increased scrutiny concerning their use.

Arguing that options encourage short-term thinking and illegal accounting gimmicks, corporate critics have blamed their abuse in part for the accounting scandals at Enron and WorldCom. Critics have also charged that because companies don't have to expense options, they have been overly generous in handing them out, in the process diluting shareholder value.

Last year, for instance, eBay reported that it earned $249.89 million, or 85 cents a share. But including the cost of stock options, the company would have only earned $62.9 million, or 21 cents a share.

But that may not be the final word on options costs.

In its annual report this year, the company essentially restated how much its options cost it in 2000 and 2001. Its estimated loss for those two years, including options costs, was $127 million larger than the company estimated in its annual report filed last year.

The company's explanation, according to a published report, was that the difference was due to a "clerical error."

Accounting regulators are likely to require all companies to expense stock options beginning next year. Meanwhile, a number of companies, including some in the Internet and technology industries, have begun to either expense stock options voluntarily or curtail their use.

In contrast, eBay does not expense options and it hasn't moved to limit its use of them.

Out of Bounds

The company's largesse when it comes to options appears to violate both Fidelity and Vanguard's guidelines. Fidelity's proxy rules, for instance, call for the mutual fund company to withhold its vote on a stock plan proposal when the sum of the stock available under a company's stock plan adds up to more than 10% of outstanding shares.

Fidelity does give some leeway for companies with smaller market capitalizations, allowing their stock plan dilution to jump up to 15%. With a market capitalization of more than $32 billion, eBay hardly seems to qualify as a small-cap company. Regardless, its potential dilution tops that cap as well.

Likewise, Vanguard's rules instruct its managers to vote against stock plans when the total dilution resulting from those plans reaches more than 15% of outstanding shares. Vanguard guidelines also state that the company opposes stock plans when a company's annual options grants have exceeded 2% of outstanding shares.

eBay's average options grant has amounted to about 4.8% of outstanding shares over the last three years, according to the IRRC.

eBay's plan appears to violate other guidelines set by Fidelity and Vanguard as well.

Fidelity opposes plans that offer options at a discount to the fair market price of a company's stock on the day they are issued. eBay's proposal would allow it to grant options at 85% of the stock's fair market value.

Meanwhile, Vanguard opposes plans that allow for the repricing of underwater options. eBay's proposal would allow the company to reprice options, albeit only with shareholder approval.

The opinions of Fidelity and Vanguard matter because of their large stakes in eBay. As of March 31, Fidelity held 8.88 million shares of eBay, or about 2.8% of outstanding shares, according to LionShares. Vanguard held 5.65 million shares, or 1.8% of eBay's outstanding stock, at the end of the first quarter. The top 15 institutional investors in eBay held about 32% of the company's shares as of March 31, according to LionShares.

Opposition to eBay's plan has been gaining steam in recent weeks. Upstart proxy adviser Glass Lewis lambasted the plan in a recent report, calling it "excessive." Calpers representatives said the pension fund relied on Glass Lewis' research in reaching their decision to vote against the plan.

But opponents of eBay's proposal face an uphill battle. The company's co-founders, Pierre Omidyar and Jeff Skoll, hold about 30% of the company's outstanding shares. Other eBay directors and officers hold more than 3% more of the company's shares.

Meanwhile, Institutional Shareholder Services, the nation's leading proxy adviser, has come out in favor of eBay's options proposal. Despite the dilution caused by eBay's various stock plans, ISS determined that the cost of eBay's proposal falls below its cap.

ISS's stamp of approval could give cover to institutional investors who choose to vote in favor of the options proposal.

The Top 15

None of the top 15 institutional owners disclosed whether they are voting for or against eBay's option plan. Nine declined to disclose how they vote on proxy issues or the guidelines that they use. Among those holders were Capital Research & Management, Janus Capital Management, Alliance Capital Management and Barclays Global Investors, which, respectively, have the first-, second-, third- and fifth-largest stakes in eBay.

Because eBay is a member of the Nasdaq 100, the stock market's Financial Products Services group holds eBay shares on behalf of investors in its index fund. According to its bylaws, Nasdaq, eBay's eighth-largest institutional owner, votes its shares proportionally with other shareholders, company spokesman John Jacobs said. So, if other shareholders vote down a proposal by a 2-to-1 margin, Nasdaq will vote its shares in the ratio, Jacobs said.

Representatives of American Express Financial Advisors and Amerindo Investment Advisors, the 13th- and 14th-largest institutional holders of eBay, were not available for comment on how they plan to vote their shares. A spokesperson for Peregrine Capital Management, which holds the 12th-largest stake in eBay, declined to comment.

A regulation recently adopted by the Securities and Exchange Commission will force mutual fund companies to disclose their proxy votes once a year beginning in August 2004.

eBay shares closed down 92 cents, or 0.9%, on Thursday to $101.90. The company's shares are up more than 50% since the beginning of the year.

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