REGARDING THE PROXY STATEMENT DATED
OF
LEVEL 3
COMMUNICATIONS, INC.
The undersigned shareholders of Level 3 Communications,
Inc. believe that the Proxy Statement fails to disclose facts, which a
reasonable investor would find material in making his investment decision.
In the Proxy, Level 3 provides misleading information
in that it speaks of the need to prevent dilution of the public
shareholders. In reality, the effect of
the Proxy is to cause extraordinary dilution of the public shareholders. Further, the officers and directors are not
only in breach of their fiduciary duty to the shareholders to watch out for and
protect their ownership interests; but the officers and directors have actually
put themselves in a position which conflicts their personal interests with the
interests of the public shareholders.
If the Proxy passes, the public shareholders will
suffer irreparable harm.
If the Proxy does not pass, Level 3 will suffer no
irreparable harm.
In its Proxy dated
Under certain circumstances the issuance of shares under
the OSO program could cause public shareholders to experience a dilution of up
to 23% of their interests in Level 3.
The occurrence of such circumstances is dependent on the occurrence of
certain market conditions. While it is
impossible to predict market conditions, such circumstances as would cause such
an extreme dilution could be expected.
In 2001 seven officers realized 30% of the benefits of
the OSO program. In the event that this
percentage continues it could be expected that they would also realize 30% of
the benefits of any such 23% dilution.
Thus, if the 2001 pattern of awards to these officers continues, the
following is expected.
If the price of the stock goes to $11, these seven
officers could be expected to receive a possible 28 million shares under the
OSO program. This is of the 93.45
million shares, which could be issued – if the stock price goes to $11 and the
OSO program continues.
If the price of the stock goes to $9, these seven
officers could be expected to receive a possible 18 million shares -- even if
the OSO program is terminated. This is
of the 60.78 million shares, which could be issued – if the stock only goes to
$9.
The 23% dilution number is based on the presently
outstanding 405 million shares. Of these
shares 19 million are attributable to OSO grants already made. These OSO grants were made from the original
1997 authorization of 70 million shares authorized for the issuance of shares
of stock in the OSO program. With the
current Proxy, management requests an additional 50 million shares to be
authorized for the OSO program. This
would result in 101 million shares being authorized and available for the OSO
program. If all were to be issued, the
result would be a total of 506 million outstanding shares with 120 million of
these shares attributable directly to the OSO program. Thus, the dilution effected by the OSO
program would be 23%.
As will be described below, Level 3 has given no meaningful
reason why such shares must be authorized at the present time, as it will
suffer no significant harm if they are not authorized at this time.
The undersigned strongly urge that reasonable investors
would understand the importance of preparing and presenting to the shareholders
an amendment to the OSO program prior to requesting the shareholders to
authorize the issuance of 50 million shares of Level 3 stock, which could work
to significantly dilute the shareholders’ interests.
Through the Proxy the officers and directors speak
of the importance of reducing the dilution of the public shareholders. Nevertheless through the Proxy the officers
and directors act in such a manner as will cause serious dilution to the
shareholders. These actions are clearly
outside the spirit of the OSO program, which was designed so that “stockholders
receive a market related return on their investment before the OSO holders
receive any return on their options.”
(2001 Annual Report, p. 15) It is
also a breach of the fiduciary duty of the officers and directors to the
shareholders, as they take advantage of extraordinary circumstances to enrich
themselves at the expense of the shareholders.
The undersigned strongly urge that the OSO program be reviewed
and amended prior to the authorization of any additional shares of Level 3
stock.
Each quarter on a specific date employees are granted OSOs -- options to purchase shares of Level 3 stock. (OSO stands for Outperform Stock
Options.) These options are granted with
a certain “strike price” -- which is the price of Level 3 shares on the date
the options are granted. Later, shares
of Level 3 stock representing these OSOs may be issued
and sold to the employees who were granted the OSOs.[1] The price to the employee would be the strike
price (or as described below, the adjusted strike price). If the stock of Level 3 outperforms the
S&P from the date of the issuance of the options, a multiplier is triggered
so that the number of shares of stock, which may be issued and sold to the
employees increases. The multiplier
ranges from 1 to 8, depending on the percentage of outperformance. The highest multiplier is 8, which is effected
if the stock outperforms the S&P by 11% per annum. Outperformance may
occur even though both the S&P and the shares of Level 3 have gone down --
so long as the shares of Level 3 do not go down as much as the S&P, but
stay at a certain specified distance above the S&P.
Under extraordinary circumstances, such as the deep drop in
the price of the stock experienced over the past eighteen months, the amount of
stock issued under the OSO program may reach extraordinary levels. This is due to the following. When OSOs are
issued: the lower the price of the
stock, the greater the number of OSOs issued. So, one finds in Level 3’s early years (when
the price of the stock was high), relatively few OSOs
granted; and one finds in Level 3s more recent years (when the price of the
stock was low), OSOs granted in significantly larger
amounts. Later when stock may be issued
under the OSO program: if the strike
price has been exceedingly low, the stock will have most likely outperformed
the S&P by 11% per annum, and a multiplier of 8 will be included in the
formula for awarding shares of stock.
With the multiplier of 8 in the formula plus the large number of OSOs granted, the effect is to require the issuance and
sale of extraordinarily large quantities of stock to satisfy the OSO program.
Over the years OSOs have been
issued at various strike prices. Some
presently outstanding OSO’s are listed below.
If the S&P falls, then the strike price of the stock is
adjusted downward by the same percentage as the S&P fall. Since the S&P has dropped significantly
since the date of the issuance of these OSOs, the
chart below also shows the strike prices “adjusted” for the drop in the
S&P.
|
Quarter OSOs Granted |
Number of OSOs Issued |
Original Strike Price |
Decline in S&P Since Issuance of OSOs |
Strike Price Adjusted for S&P as of 7/02 |
|
1st Quarter 2001 |
2 million |
$25.31 |
22.94% |
$19.50 |
|
2nd Quarter 2001 |
4.9 million |
$11.20 |
24.17% |
$8.49 |
|
3rd Quarter 2001 |
4.6 million |
$3.82 |
16.33% |
$3.20 |
|
4th Quarter 2001 |
4.3 million |
$5.58 |
16.26% |
$4.67 |
|
1st Quarter 2002 |
5 million |
$3.02 |
14.07% |
$2.60 |
|
2nd Quarter 2002 (expected)[2] |
5 million |
$4.50 |
10.92% |
$4.01 |
Since the strike prices of various outstanding OSOs are at extraordinarily low levels, particularly when
“corrected” for the drop in the S&P, it would be reasonable to expect an outperformance of the S&P by Level 3 stock in an amount
of at least 11% per annum and the awarding of extraordinary amounts of stock to
employees under the OSO program.
As discussed later in this paper, statements and actions of
the officers and directors indicate that they believe the value of the stock to
be significantly higher than the present market price. This is part of the expectation that the
price of the stock would rise by at least 11% per annum.
The extraordinarily low prices of Level 3 stock over the
past eighteen months have caused the issuance of an extraordinarily high number
of OSOs. With
an extraordinarily low strike price it will not be difficult to outperform the
S&P in an amount, which will trigger a multiplier of 8. As a result an extraordinarily high number of
shares of stock could be issued with respect to the OSO program. This amount could be so high as to cause
dilution of the public shareholders to the extent of 23% of their ownership
interests.
The following section and Appendix A set out examples that
demonstrate the severity of the situation.
The examples show that the interests of the employees,
particularly the officers and directors, and the public shareholders are no
longer aligned, but are actually at extreme odds. This is because it is in the interests of the
employees, particularly the officers and directors, to maintain the OSO program
in its present form as long as possible, so that they may enjoy the grants of
extraordinarily large number of OSOs issued with
extraordinarily low strike prices, resulting in the later grants of even more
extraordinarily large amounts of stock.
Some
might argue that the employees’ loss of the benefits of OSOs
in the early years is averaged out by these OSOs of
later years. However, a few examples
will show that the formula of the OSO program will result in the awarding to
the employees, and most particularly officers and directors, of such an
extraordinarily high number of shares of stock as to be egregious and over
reaching. In fact, 266% as many OSOs were issued at extraordinarily low prices in the five
quarters ending with the 1st quarter of 2002 than were issued in
Level 3’s entire cumulative operating history prior to 2001.[3] This extraordinary increase occurred at a
time when Level 3 operated with about half as many employees.
Furthermore, this more than 266% rise in OSOs
outstanding during the five quarters ending with the 1st quarter of
2002 occurred despite a massive reduction in the workforce and is due not only
to the factors described above, but also to an outsized percentage of awards
going to the top seven executives. See
the Section “OSOs Issued to Officers and
Directors in 2001.”
Whether or not the effects of a deep drop in the price of
the stock for an extended period were known at the time the OSO program was
established is unknown. However, it
seems clear that the effects were clearly known by the fourth quarter of
2001.
That the officers of Level 3 were fully aware of the effects
of the OSO program by the fourth quarter of 2001 is evidenced by the events
surrounding the issuing of two Special Grants of OSOs
to certain officers totaling 1,679,372.
As provided in the Proxy, the officers receiving such OSO awards
subsequently waived some of these awards with “irrevocable waivers,” and yet at
the same time the Board of Directors retained the right to modify or terminate
these “irrevocable waivers.” That not enough
shares of stock were available to fund such OSO grants was the suspected
reasoning behind these actions. It is
interesting to note that the fourth quarter of 2001 was the quarter in which
asset write down resulted in a significant reduction in shareholder equity, as
these same officers admittedly wrote down to zero more than $3 billion in
shareholder equity. See the Section, “OSOs Issued to Officers and Directors in 2001.”
Level 3 has made no effort to amend the OSO program, and
only recently seems to have devoted any attention to the problem of dilution of
public shareholders. Further, every
appearance and indication is that Level 3 intends to continue the OSO program
in its present form, so long as shareholders authorize the issuance of 50
million additional shares for its purposes.
As a result officers and directors who should be amending
the OSO program to protect the public shareholder from further excessive
dilution are actually benefiting personally from the OSO program and the low
price of Level 3’s stock to increase their own shareholder interests in Level 3
by extraordinary amounts – to the effect that public shareholders may be
diluted by as much as 23%.
The 2001 Annual Report of Level 3 makes the following
statement.
The OSO program was designed by the
company so that its stockholders receive a market related return on their
investment before the OSO holders receive any return on their options. The Company believes that the OSO program
better aligns employees’ and stockholders’ interests by basing stock option
value on the Company’s ability to outperform the market in general, as measured
by the S&P Index. (2001 Annual
Report, p. 15).
While the OSO program
may have been designed so that stockholders receive a market related return on
their investment before the OSO holders receive any return on their options, it
is abundantly clear that the OSO program has actually resulted in just the
opposite occurring.
In February of 2000 Level 3 successfully offered 23 million
shares of its stock to the public at a price of $104 per share, receiving a
total of $2.4 billion. It is unlikely
that these shareholders will ever receive a return on their investment any
where near the gains that the recent OSO holders are likely to realize.
Furthermore, many other investors purchased stock of Level 3
at high levels, as the price of the stock was at one time as high as $132 per
share. Level 3 is certainly not
responsible for general economic conditions causing the price of its stock to
fall. Nevertheless, if Level 3 professes
that it desires its shareholders to receive a market related return on their
investment before OSO holders receive any return on their options, it must act
accordingly. In maintaining the OSO
program in its present form, Level 3 actions are completely at odds with its
professed intentions as clearly stated in its 2001 Annual Report. Thus, such statements in the 2001 Annual
Report and similar statements in the Proxy are misleading.
The Proxy makes the following statement:
“[T]he Company has strived to
deliver approximately 25% of the ‘outperformance’
value of the Level 3 Common Stock to employees.” (Proxy, p. 16.)
This Statement referring to employees sharing in up to 25%
of the outperformance of the stock price is
disingenuous. In reality, employees, and
most particularly officers and directors, are increasing their share of the ownership
of the company – so that under certain circumstances they may in effect own 23%
more of the entire company as a result of the OSO program.
As almost all of this dilution would occur when the price of
the stock reaches $10 per share, it is completely misleading to speak in terms
of Level 3 desiring its public shareholders to receive a market return on their
investment prior to the employees receiving any return on their options. When the stock reaches $10 per share, the
employees, particularly officers and directors, will receive a huge return on
their options, increasing their ownership of Level 3 and diluting public
shareholders by 23%. Meanwhile, with
respect to the public shareholders, the $10 per share figure is 92% lower than
the stock’s $132 high. It is also 40%
lower than the price the stock was at when Level 3’s chief executive officer told
shareholders the stock was worth "many multiples" of its then current
stock price of $43 per share. While we
recognize that a public shareholder who bought the stock at less than $10 would
not be harmed, Level 3 has a significantly large number of public shareholders
who purchased the stock at prices far greater than $10.
Public shareholders in the State of
The egregious effects of the OSO program are best explained
by examples. Each example assumes that
the S&P remains at the same level it is today. To calculate the effects of each situation, a
complicated formula found in the OSO program is applied.
Appendix A describes the examples in greater detail.
Example One: OSO
Program continues; Stock price reaches $11; Public Shareholders diluted
18%. If the public price of the
stock reaches $11 per share and the S&P remains flat, up to 93.45
million shares of authorized stock could be issued to employees under
the OSO program. Thus, public shareholders
would experience a 18% dilution when the price of the stock reaches $11, so
long as the OSO program remains unchanged.
Example Two: OSO
Program continues; Stock price reaches $9; Public Shareholders diluted 16%. If the public price of the stock reaches $9
per share and the S&P remains flat, up to 80.78 million shares
of authorized stock could be issued to employees under the OSO program. Thus, the public shareholders would
experience a 16% dilution when the price of the stock reaches $9, so long as
the OSO program remains unchanged.
Example Three: OSO
Program is not continued; Stock price reaches $9; Public Shareholders diluted
12%. This example assumes
that no additional OSOs are issued and the OSO
program in its present form is ended. Thus,
if the public price of the stock reaches $9 per share and the S&P remains
flat, it is reasonable to expect that up to 60.78 million shares
of authorized stock could be issued to employees under the OSO program. Thus, public shareholders would experience
a 12% dilution when the price of the stock reaches $9, even if the OSO program
is terminated as of
Example Four: OSO
Program is not continued; Stock price reaches $13; Public Shareholders diluted
15%. This example assumes that no
additional OSOs are issued and the OSO program in its
present form is ended. Thus, if the
public price of the stock reaches $13 per share and the S&P remains flat,
it is reasonable to expect that up to
78.07 million shares of authorized stock could be issued to
employees under the OSO program. Thus,
the shareholders would experience a 15% dilution when the price of the stock
reaches $13, even if the OSO program is terminated as of
In 2001 seven officers
realized approximately 30% of the benefits of the OSO program. In the event
that this percentage continues it could be expected that they would also
realize 30% of the benefits of any 23% dilution.
Thus, 28 million of the
93.45 million shares, which may possibly be issued under Example One, could be
expected to go to seven particular officers – if the OSO program
continues. See the section entitled, “OSOs Issued to Officers and Directors in 2001.”
Even if
the OSO program were discontinued effective as of
Thus, 18 million of the
60.78 million shares, which may possibly be issued under Example Three, could
be expected to go the seven particular officers -- even if the OSO program is
discontinued.
The extraordinary effects of the OSO program are also
garnered at the regular employee level.
For instance, in Example One, the average bonus to each eligible
employee would be approximately $156,780.[4]
An interesting feature of the OSO program is that it
contains an anti-dilution clause.[5] This would occur in situations such as Level
3 changing its capital structure or taking on other equity partners, such as
the proposed
In 2001 seven officers of Level 3 received a total of
4,763,896 OSOs.
Of these, 1,679,372 were issued as Special Grants.[6] The following list includes each officer who
participated in these OSOs.
OSOs (includes Special Grant Grant
Issued
Special
Grants)
James Q. Crowe 1,698,754 597,372 4th
Quarter 2001
John F. Waters 300,884 100,000 3rd Quarter 2001
Thomas C. Stortz
294,664 100,000 3rd Quarter 2001
Kevin J. O'Hara
853,521 290,000 4th Quarter 2001
Charles C. Miller, III 605,582 196,000 4th Quarter 2001
R. Douglas Bradbury 554,355 196,000 4th
Quarter 2001
Total OSOs 4,763,896 1,679,372
Besides the seven officers above, the following grant of OSOs is noteworthy:
Walter Scott, Jr. 145,000
4th
Quarter 2001
Thus, in 2001:
It is interesting that Messrs. Crowe, Bradbury and Scott “irrevocably
waived” their right to exercise any OSOs received by
them in 2001 and in the 1st quarter of 2002. Yet, the Board of Directors has retained the
right to modify or terminate these “irrevocable waivers.” From this, it could be surmised that as long
as insufficient shares of authorized stock are available for these waived OSOs, the Board of Directors would conserve cash and let
the waivers stand. However, it can also
be surmised that as the Board of Directors were the people who authorized the
special grant of OSOs, they would be expected to
terminate the waivers just as soon as sufficient shares of authorized stock
became available for this purpose.
In addition, Messrs. O’Hara and Miller have irrevocable
agreed to waive the right to exercise any OSOs
granted to them during 2001 and the first quarter of 2002 to the extent that
the number of shares that could be issued would exceed an aggregate of 275,000
shares per individual.
In other words, when the Special Grants were awarded, those
awarding them were aware that insufficient numbers of stock were authorized to
be issued on their exercise.
Nevertheless, it appears that a plan was designed to insure that the
officers would receive the OSOs once sufficient
shares were authorized. It seems that
given the extraordinarily low strike price for the fourth quarter of 2001, these
officers were anxious to receive OSOs in that
particular quarter and were not interested in waiting to receive a grant of OSOs in a later quarter, after additional shares were
authorized, as the price of the stock might have risen and the value of the OSOs would be significantly lessened.[7]
A few examples best illustrate why the top officers were
so anxious to receive OSOs at the end of 2001. For these, see Appendix B, which sets out
Examples of the value of the OSOs to the top
Officers.
Finally, in Level 3’s earnings call regarding the 4th
quarter of 2001, it stated that the average merit pay raises for 2002 would not
go beyond 3%. Yet, the Proxy sets forth
the pay raises for the top seven officers, which without regard to OSOs and based on salary alone, are as follows: Mr. Crowe:
4%; Mr. Choksi: 36%; Mr. Waters: 37%; Mr. Stortz: 12%; Mr. O’Hara: 32%, and Mr. Bradbury: 15%.
It is interesting to note that the fourth quarter of 2001
was the quarter in which these same officers admittedly wrote down to zero more
than $3 billion dollars in shareholder equity.
The outstanding OSOs have been
issued, and Level 3 has an obligation to honor them. However, with respect to the future of the
OSO program and how Level 3 intends or does not intend to change it is unclear
at this time. The Proxy states that
Level 3 intends to modify it in some way.
However, from conversations with the Investor Relations Department of
Level 3, shareholders have been told that Level 3 intends to continue the OSO
program in its present form should the 50 million additional shares be
authorized.
The Proxy also states the following.
"The Compensation Committee of
the Board has determined that LTI compensation grants by the Company are to
be set at levels necessary to control the overall amount of dilution to public
stockholders, even in the situation of extreme common stock price
appreciation, while maintaining the goal of delivering on average no more than
approximately 25 percent of the outperformance to
employees. The Company believes that if
modifications to the LTI compensation grants are not made, in situations of
relatively strong Level 3 Common Stock price performance (that is, stock price
appreciation that is in excess of at least 100% per year from current price
levels), LTI compensation grants could lead to unacceptable levels of
dilution to public stockholders and the delivery of an unacceptable
percentage of outperformance to employees.” (Proxy, p. 16, emphasis added).[8]
Despite the above statement Level 3 has failed in the
Proxy Statement to disclose exactly what it expects to do in the future to
handle the problem of extraordinary dilution of public shareholders. Thus, it
is necessary to make assumptions. The most
reasonable assumption is that the program will continue in its present
form. If Level 3 were planning to change
the OSO program in some reasonable way, it surely would have set this out in
the Proxy. Shareholders would be
foolhardy to vote for the issuance of an additional 50 million shares, which
could cause their own significant dilution, without knowing more about Level
3’s intentions for its OSO program.
That Level 3 has failed to disclose what it intends to
do in the future goes directly to the heart of our belief that the company
has failed to disclose facts that a reasonable investor might find
material. What Level 3 intends to do
with the OSO program in the future is most material. Because of the material nature of the OSO
program, waiting for any proposed change in the OSO program to be revealed at
the Annual Meeting will work significant harm to the shareholders, as by then
it will be too late to manage a meaningful vote against the Proxy. For Level 3 to pretend otherwise is
completely disingenuous.
In this regard it is important to note that the same
officers and directors offering assurances of vague modifications are the
drafters of the original plan. This
increases the need of shareholders to have all the facts necessary to use their
own judgment in determining the adequacy of any changes prior to voting
on them.
On the other hand, it will cause Level 3 no significant harm
to wait for the authorization of additional shares. Level 3 has given no significant reason why
the additional 50 million shares must be authorized at this time.
Presently, sufficient shares of authorized stock are
available for funding all present obligations under the OSO program. Level 3 specifically states in the Proxy:
“The Company believes that taking into account the
voluntary restrictions, there are sufficient shares available under the Plan to
settle exercises of previously granted OSOs.” (Proxy, p. 17)
In the event insufficient shares of stock were available,
cash of the company would need to be used.
Most agree that this is an unacceptable use of cash in today’s economic
environment.
Level 3 also states in the Proxy:
“The Board believes that the stockholders’ failure
to approve the proposal to increase the number of shares reserved for issuance
under the Plan would require the redesign of the Company’s compensation
programs the result of which would be for the Company to use a significantly
greater portion of the Company’s cash on had and cash generated by operations
to compensate its employees.” (Proxy, p.
17)
Since sufficient shares are
presently available, the above paragraph is disingenuous. If additional shares were not issued at this
time, Level 3 would have sufficient time to amend its OSO program in a manner
causing less harm to its public shareholders.
After an amendment of the OSO program to more closely align the
interests of the employees with its public shareholders, additional shares
could be authorized.
Critical to this analysis is the following, which is
repeated from above. Certain officers
and directors of the company have irrevocably waived their right to exercise
any OSOs received by them in 2001. Nevertheless, the Board of Directors has the
right to modify or terminate these waivers.
From this, it could be surmised that as long as insufficient shares of
authorized stock are available for these waived OSOs,
the Board of Directors would conserve cash and let the waivers stand. However, it can also be surmised that as the
Board of Directors were the people who authorized the Special Grants of OSOs, they would be expected to terminate the waivers just
as soon as sufficient shares of authorized stock became available for this
purpose.
Whether or not a stock option plan is needed to provide the
appropriate incentives and compensation to Level 3’s communications employees
is not necessary to decide at this time.
If it is determined to be appropriate, then the OSO program may be amended
to accommodate the interests of the employees as well as the public
shareholders. Today’s economic
environment includes many thousands of highly qualified communications
engineers presently out of work. Whether
OSO’s are needed is a real question. At the least, to put the program on hold,
pending its amendment, should not be a problem to Level 3’s retaining of good
employees in today’s environment.
In the event that the OSO Program is not ended in its
present form, and OSOs continue to be issued at low
prices, significant long-term effects can be expected in future years. Level 3 has indicated that if the Proxy
passes, the OSO program will continue in its present form. Thus, depending on market conditions, it
could well happen that additional shares of stock would need to be authorized
for the OSO Program beyond the 50 million shares requested in the Proxy. As current shareholders will have been
diluted, their votes in these circumstances will also have been diluted, and
they will find it increasingly difficult to end the OSO Program in its present
form. Thus, further and further dilution
could be expected over the years.
C-OSO PROGRAM AT
LEVEL 3
In July of 2000, Level 3 instituted its C-OSO program as an
extension of its OSO program. In this
program, the employee is guaranteed to receive the value of at least one share
of stock at the time the C-OSO is exercised.
However, if the value would be higher when calculated as an OSO, the
employee would receive that higher value.
This program was instituted shortly after Level 3’s successful public
offering of 23 million shares of its stock at a price of $104 per share. Thus, as the price of the stock fell, and the
regular OSOs became worthless to the employees, those
employees with C-OSOs had no risk, in that they were
guaranteed the value of at least one share of stock at the time of the
exercise of the C-OSO.
From Level 3’s 2000 Annual Report:
"In July 2000, the Company adopted a
convertible outperform stock option program, ("C-OSO") as an
extension of the existing OSO plan. The program is a component of the Company's
ongoing employee retention efforts and offers similar features to those of an
OSO, but provides an employee with the greater of the value of a single share
of the Company's common stock at exercise, or the calculated OSO value of a
single OSO at the time of exercise.
C-OSO awards were made to eligible employees employed on the date of the
grant. The awards were made in September
2000 and December 2000. Each award vests over three years as follows: 1/6 of
each grant at the end of the first year, a further 2/6 at the end of the second
year and the remaining 3/6 in the third year. Each award is immediately
exercisable upon vesting. Awards expire four years from the date of the
grant."
From Level 3’s 2001 Annual Report: “C-OSO awards were made to eligible employees
employed on the date of the grant. The
awards were made in September 2000, December 2000, and September 2001."
The 400,000 "Special Grants" issued in the 3rd
quarter of 2001 are C-OSOs.
The undersigned shareholders regret that the preparation
of this paper was necessary.
Unfortunately, they believe that with the Proxy Statement, Level 3 has
not only failed to provide shareholders material information necessary to the
making of an investment decision, but has provided misleading information in
that it speaks of the need to prevent dilution but then works to cause
dilution. Further, the officers and
directors are not only in breach of their fiduciary duty to the shareholders to
watch out for and protect their ownership interests, but have actually put
themselves in a position that conflicts their personal interests with the interests
of the public shareholders.
Dated:
__________________*
Shareholder
___________________*
*This
document was signed in its original form as delivered to certain critical
readers, but for broad public distribution purposes, the signers prefer that
attention not be focused on them, but rather on the document.
APPENDIX A
Various Examples
of Extraordinary Dilution,
Which may be
Expected under Certain Reasonably Expected Market Conditions
The following examples best explain the egregious effects of
the OSO program.
Assumptions:
Each example assumes that the S&P remains at the same
level it is today.
Each example assumes that the Proxy is passed authorizing
the continuation of the OSO program in its current form and the additional 50
million shares.
Examples One, Two and Three assume that all OSOs issued prior to the third quarter of 2001 are
worthless.
Example Four includes the OSOs
issued during the second quarter of 2001, but assumes all OSOs
prior to that are worthless.
Examples One and Two assume that Level 3 issues one more
quarter of OSOs at a low strike price. What is to happen with OSOs
for the second quarter 2002 is rather vague.
As the Proxy Statement is completely unclear and does not reveal this
material information, certain assumptions must be made. We have assumed that with the authorization
of the 50 million additional shares, the OSO program will continue in its
present form. Thus, with the passage of
the Proxy it is fully expected that at least one more quarter of OSOs will be issued with an extraordinarily low strike
price.
Examples Three and Four assume no additional OSOs are issued beyond the OSOs
issued in the first quarter of 2002.
Example One
The public
shareholders would experience a 18% dilution when the price of the stock
reaches $11, so long as the OSO program remains unchanged.
If the public price of the stock reaches $11 per share and
the S&P remains flat, it is reasonable to expect that up to 93.45
million shares of authorized stock could be issued to employees under the
OSO program. Thus, public shareholders
would experience a 18% dilution when the stock reaches $11.
To make this determination the analyst must work through the
following.
First, regarding the 4.6 million OSOs
issued at a strike price of $3.82 in the third quarter of 2001. If the stock is trading at $11 per share,
it will have outperformed the S&P by the required percentage and stock will
be issued as requested by employees in accordance with the OSO formula. The outperformance
is $7.18 ($11 minus $3.82), which is enough to trigger a multiplier of 8. The $7.18 of outperfomance
is then multiplied by 8, resulting in each option being worth $57.44. From this, each option would also be worth
5.22 shares of Level 3 stock at a price of $11.
Because 4.6 million options were granted, it could be expected that in
this situation Level 3 would need to issue 24.01 million new shares of stock to
cover the options (5.22 shares times 4.6 million).
Second, regarding the issuance of 4.3 million OSOs at a strike price of $5.58 in the fourth quarter of
2001. If the stock is trading at $11
per share, it will have outperformed the S&P by the required percentage and
stock will be issued as requested by employees in accordance with the OSO
formula. The outperformance
will be $5.42 ($11 minus $5.58), which is enough to trigger a multiplier of 8,
resulting in each option being worth $43.36.
From this, each option would also be worth 3.94 shares of Level 3 stock
at a price of $11. Because 4.3 million
options were granted, it could be expected that in this situation Level 3 would
need to issue 16.94 million new shares of stock to cover the options (3.94
shares times 4.3 million options).
Third, regarding the issuance of 5 million OSOs at a strike price of $3.02 in the first quarter of
2002. If the stock is trading at $11
per share, it will have outperformed the S&P by the required percentage and
stock will be issued as requested by employees in accordance with the OSO
formula. The outperformance
will be $7.98 ($11 minus $3.02), which is enough to trigger a multiplier of 8,
resulting in each option being worth $63.84.
From this, each option would also be worth 5.8 shares of Level 3 stock
at a price of $11. Because 5 million
options were granted, it could be expected that in this situation Level 3 would
need to issue 29 million new shares of stock to cover the options (5.8 shares
times 5 million options).
Fourth, regarding the issuance of the expected 5 million OSOs at a strike price of $4.50 in the second quarter of
2002. If the stock is trading at $11
per share, it will have outperformed the S&P by the required percentage and
stock will be issued as requested by employees in accordance with the OSO
formula. The outperformance
will be $6.50 ($11 minus $4.50), which is enough to trigger a multiplier of 8,
resulting in each option being worth $52.
From this, each option would also be worth 4.7 shares of Level 3 stock
at a price of $11. Because 5 million
options were granted, it could be expected that in this situation Level 3 would
need to issue 23.5 million new shares of stock to cover the options (4.7 shares
times 5 million options).
Conclusion. A
total of 93.45 million shares of stock (24.01 plus 16.94 plus 29 plus 23.5)
could be issued, and public shareholders would experience a 18% dilution of
their ownership interests when the price of the stock reaches $11.
Example Two
The public
shareholders would experience a 16% dilution when the price of the stock
reaches $9, so long as the OSO program remains unchanged.
If the public price of the stock reaches $9 per share and
the S&P remains flat, then up to 80.78 million shares of authorized
stock could be issued to employees under the OSO program. Thus, public shareholders could experience a
16% dilution.
To make this determination the analyst must work through the
following.
First, regarding the 4.6 million OSOs
issued at a strike price of $3.82 in the third quarter of 2001. If the stock is trading at $9 per share,
it will have outperformed the S&P by the required percentage and stock will
be issued as requested by employees in accordance with the OSO formula. The outperformance
is $5.18 ($9 minus $3.82), which is enough to trigger a multiplier of 8. The $5.18 of outperfomance
is then multiplied by 8, resulting in each option being worth $41.44. From this, each option would also be worth
4.6 shares of Level 3 stock at a price of $9.
Because 4.6 million options were granted, it could be expected that in
this situation Level 3 would need to issue 21.16 million new shares of stock to
cover the options (4.6 shares times 4.6 million).
Second, regarding the issuance of 4.3 million OSOs at a strike price of $5.58 in the fourth quarter of
2001. If the stock is trading at $9
per share, it will have outperformed the S&P by the required percentage and
stock will be issued as requested by employees in accordance with the OSO
formula. The outperformance
will be $3.42 ($9 minus $5.58), which is enough to trigger a multiplier of 8,
resulting in each option being worth $27.36.
From this, each option would also be worth 3.04 shares of Level 3 stock
at a price of $9. Because 4.3 million
options were granted, it could be expected that in this situation Level 3 would
need to issue 13.07 million new shares of stock to cover the options (3.94
shares times 4.3 million options).
Third, regarding the issuance of 5 million OSOs at a strike price of $3.02 in the first quarter of
2002. If the stock is trading at $9
per share, it will have outperformed the S&P by the required percentage and
stock will be issued as requested by employees in accordance with the OSO
formula. The outperformance
will be $5.98 ($9 minus $3.02), which is enough to trigger a multiplier of 8,
resulting in each option being worth $47.84.
From this, each option would also be worth 5.31shares of Level 3 stock
at a price of $9. Because 5 million
options were granted, it could be expected that in this situation Level 3 would
need to issue 26.55 million new shares of stock to cover the options (5.31
shares times 5 million options).
Fourth, regarding the expected issuance of 5 million OSOs at a strike price of $4.50 in the second quarter of
2002. If the stock is trading at $9
per share, it will have outperformed the S&P by the required percentage and
stock will be issued as requested by employees in accordance with the OSO
formula. The outperformance
will be $4.50 ($9 minus $4.50), which is enough to trigger a multiplier of 8,
resulting in each option being worth $36.
From this, each option would also be worth 4 shares of Level 3 stock at
a price of $9. Because 5 million options
were granted, it could be expected that in this situation Level 3 would need to
issue 20 million new shares of stock to cover the options (4 shares times 5
million options).
Conclusion. A
total of up to 80.78 million shares of stock (21.16 plus 13.07 plus 26.55 plus
20) could be required to be issued.
Thus, public shareholders would experience a 16% dilution of their
ownership interests when the price of the stock reaches $9.
Example Three
The public
shareholders would experience a 12% dilution when the price of the stock
reaches $9, if the OSO program were terminated as of
Example Three is exactly the same as Example Two, except no
additional OSOs are issued beyond those actually
issued during the first quarter of 2002.
Thus, if the public price of the stock reaches $9 per share and the
S&P remains flat, it is reasonable to expect that up to 60.78 million
shares of authorized stock ((21.16 plus 13.07 plus 26.55) could be issued
to employees under the OSO program.
Thus, public shareholders would experience a 12% dilution.
Example Four
The public
shareholders would experience a 15% dilution when the price of the stock
reaches $13, even if the OSO program were terminated as of
This example assumes that no additional OSOs
are issued and the OSO program in its present form is ended. However, this example differs in that it also
recognizes the 4.9 million OSOs with a strike price
of $11.20, which were issued during the second quarter of 2001.
Thus, if the public price of the stock reaches $13 per share
and the S&P remains flat, it is reasonable to expect that up to 78.07
million shares of authorized stock could be issued to employees under the
OSO program. Thus, the shareholders
would experience a 16% dilution when the stock reaches $13, even if the OSO
program is terminated as of March 31. 2002.
To make this determination the analyst must work through the
following.
First, regarding the 4.9 million OSOs
issued at a strike price of $11.20 in the second quarter of 2001. If the stock is trading at $13 per share,
it will have outperformed the S&P by the required percentage and stock will
be issued as requested by employees in accordance with the OSO formula. The outperformance
is $1.80 ($13 minus $3.80). What
multiplier is triggered is uncertain, as we do not have access to these
specifics of the formula. Thus, a
multiplier of 3 is used. The $1.80 of outperfomance is then multiplied by 3, resulting in each
option being worth $5.4. From this, each
option would also be worth .41 shares of Level 3 stock at a price of $13. Because 4.9 million options were granted, it
could be expected that in this situation Level 3 would need to issue 2.01
million new shares of stock to cover the options (.41 shares times 4.9
million).
Second, regarding the 4.6 million OSOs
issued at a strike price of $3.82 in the third quarter of 2001. If the stock is trading at $13 per share,
it will have outperformed the S&P by the required percentage and stock will
be issued as requested by employees in accordance with the OSO formula. The outperformance
is $9.18 ($13 minus $3.82), which is enough to trigger a multiplier of 8. The $9.18 of outperfomance
is then multiplied by 8, resulting in each option being worth $73.44. From this, each option would also be worth
5.64 shares of Level 3 stock at a price of $13.
Because 4.6 million options were granted, it could be expected that in
this situation Level 3 would need to issue 25.76 million new shares of stock to
cover the options (5.64 shares times 4.6 million).
Third, regarding the issuance of 4.3 million OSOs at a strike price of $5.58 in the fourth quarter of
2001. If the stock is trading at $13
per share, it will have outperformed the S&P by the required percentage and
stock will be issued as requested by employees in accordance with the OSO
formula. The outperformance
will be $7.42 ($13 minus $5.58), which is enough to trigger a multiplier of 8,
resulting in each option being worth $59.36.
From this, each option would also be worth 4.56 shares of Level 3 stock
at a price of $13. Because 4.3 million
options were granted, it could be expected that in this situation Level 3 would
need to issue 19.60 million new shares of stock to cover the options (4.56
shares times 4.3 million options).
Fourth, regarding the issuance of 5 million OSOs at a strike price of $3.02 in the first quarter of
2002. If the stock is trading at $13
per share, it will have outperformed the S&P by the required percentage and
stock will be issued as requested by employees in accordance with the OSO
formula. The outperformance
will be $9.98 ($13 minus $3.02), which is enough to trigger a multiplier of 8,
resulting in each option being worth $79.84.
From this, each option would also be worth 6.14 shares of Level 3 stock
at a price of $13. Because 5 million
options were granted, it could be expected that in this situation Level 3 would
need to issue 30.7 million new shares of stock to cover the options (6.14
shares times 5 million options).
Conclusion. A
total of up to 78.07 million shares of stock (2.01 plus 25.76 plus 19.60 plus
30.7) could be issued, and public shareholders would experience a 15% dilution
of their ownership interests.
APPENDIX B
EXAMPLES OF THE
VALUE OF THE OSOs
ISSUED IN THE 4TH
QUARTER OF 2001 TO THE TOP FOUR OFFICERS
The following examples best explain the egregious effects of
the OSO program as it relates particularly to the top four officers.
All examples assume that the S&P rises 16% between now
and the 4th quarter of 2003 to offset the 16% drop since the 4th
quarter 2001.
Example A
If the price of
the stock is $10, four officers may expect to profit by 19.939 million.
If the stock is trading at $10 per share, it will have
outperformed the S&P by the required percentage and stock will be issued as
requested by employees in accordance with OSO formula. The outperformance
is $4.42 ($10 minus $5.58), which is enough to trigger a multiplier of 8. The $4.42 of outperfomance
is then multiplied by 8, resulting in each option being worth $35.36. From this, each option would also be worth
3.53 shares of Level 3 stock at a price of $10.
Because 1.278 million options were granted, it could be expected that in
this situation Level 3 would need to issue 4.511 million new shares of stock to
cover the options (3.53 shares times 1.278 million). 4.511 million new shares are worth $45.11
million dollars in the open market at $10 per share; but the top four officers
will only need to pay the strike price of $5.58 or a total of $25.171
million. Thus, their profit is $19.939
million.
Example B
If the price of
the stock is $15, four officers may expect to profit by $60.43 million.
If the stock is trading at $15 per share, it will have
outperformed the S&P by the required percentage and stock will be issued as
requested by employees in accordance with OSO formula. The outperformance
is $9.42 ($15 minus $5.58), which is enough to trigger a multiplier of 8. The $9.42 of outperfomance
is then multiplied by 8, resulting in each option being worth $75.36. From this, each option would also be worth
5.02 shares of Level 3 stock at a price of $15.
Because 1.278 million options were granted, it could be expected that in
this situation Level 3 would need to issue 6.415 million new shares of stock to
cover the options (5.02 shares times 1.278 million). 6.415 million new shares are worth $96.225
million in the open market at $15 per share; but the top four officers will
only need to pay the strike price of $5.58 or a total of $35.795 million. Thus, their profit is $60.43 million.
Example C
If the price of
the stock is $20, four officers may expect to receive $120.84 million.
If the stock is trading at $20 per share, it will have outperformed the S&P by the required percentage and stock will be issued as requested by employees in accordance with OSO formula. The outperformance is $16.42 ($20 minus $5.58), which is enough to trigger a multiplier of 8. The $16.42 of outperfomance is then multiplied by 8, resulting in each option being worth $131.36. From this, each option would also be worth 6.56 shares of Level 3 stock at a price of $20. Because 1.278 million options were granted, it could be expected that in this situation Level 3 would need to issue 8.38 million new shares of stock to cover the options (6.56 shares times 1.278 million). 8.38 million new shares are worth $167.6 million in the open market at $20 per share; but the top four officers will only need to pay the strike price of $5.58 or a total of $46.76 million. Thus, their profit is $120.84 million
[1] An OSO
award vests in equal quarterly installments over two years. No OSO award, including a vested OSO award,
granted prior to
[2] Note: While not yet issued, OSOs
are likely to be issued for the second quarter of 2002. It is not unreasonable to expect that the OSO
program would continue in its present form with the authorization of these
additional shares. The Investor
Relations Department of Level 3 has informed shareholders who have called and
asked that in the event of the authorization of the 50 million new shares, the
issuance of options for the second quarter of 2002 can be expected to occur. In any event the company has failed in the
Proxy Statement to disclose what it expects to do in the future; and thus, it
is necessary to make assumptions. This
goes directly to the heart of our belief that the company has failed to
disclose facts that a reasonable investor might find material. What the company intends to do with the OSO
program in the future is most material.
[3] As of
[4] This
approximately $156,780 bonus for each eligible employee is determined as
follows. Assuming the facts of Example
One, with the stock price reaching $11 per share, 93.45 million shares could be
issued under the OSO program. Each share
would have an average strike price of roughly $3.75, which eligible employees
would pay. Thus, 93.45 million shares at
$3.75 would cost those exercising these options $350,437.5 million. However, with a market value of $11 per
share, the shares would be valued at $1,027,950 million. Thus, their immediate gain would be $677,512.5
million. Approximately 30% of this would
benefit officers and directors; so regular eligible employees would share among
themselves the benefit of $474,258.75 million (70% of $677,512.5 million). Approximately, 3025 communication employees
would be eligible to share in this benefit.
Thus, a $474,258.75 million benefit shared among 3025 employees results
in an average benefit to each of $156,780.
[5] Article
IX of the 1995 Amended and Restated Stock Plan, as amended as of
[6] The
Special Grants totaling 1,679,372were issued in two amounts: 400,000 OSOs issued
in the 3rd quarter of 2001 and 1.279 million OSOs
issued in the 4th quarter of 2001.
[7] The strike price on the Special Grants is
$5.58, which is presently adjusted to $4.67.
Thus, the total OSOs received for the fourth quarter
of 2001 is closer to 2 million.
[8] “LTI”
refers to Long Term Incentive and may be considered with regard to this
reference to be equivalent to OSO.