The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

The options backdating scandal may now be ancient history, but questions surrounding insurance coverage for the scandal’s consequences apparently continue to live on. In a September 9, 2011 opinion applying Maryland law, Southern District of New York Judge Naomi Reice Buchwald ruled in a coverage action brought by SafeNet’s excess D&O insurer that, among many things, there is no coverage under the policy for SafeNet’s $25 million options backdating-related securities lawsuit settlement.

 

The opinion addresses a number of recurring policy issues, including questions of claim interrelatedness and relation back; imputation of fraudulent misconduct; application of the consent to settlement provision; and imputation of application misrepresentations for purposes of policy rescission.  

 

Beginning in early 2006, SafeNet experienced a series of legal problems. These problems began with the company’s February 2006 announcement that it was restating prior financial statements. On May 18, 2006, the company announced it had received a subpoena from the U.S. Attorney as well as an informal inquiry from the SEC. Shortly thereafter, the company announced that it was forming a special committee to investigate its stock option granting practice. In September 2006 the company announced that the committee concluded that certain prior stock options had been accounting for using incorrect measurement dates and as a result its financial statements for the relevant periods would have to be restated.

 

These developments led to a variety of legal proceedings, including a securities class action lawsuits (about which refer here). There was also an SEC enforcement proceeding and a criminal investigation. The SEC proceeding resulted in the entry of a permanent injunction against the company’s former CFO, Carole Argo. Argo also pled guilty to a single count of securities fraud. The consolidated  securities class action litigation was later settled for $25 million.

 

For the period March 12, 2005 to March 12, 2006, the company carried $15 million of D&O insurance, arranged with a primary $10 million layer, and a $5 million layer of insurance excess of the primary. For the period March 12, 2006 to March 12, 2007, the company also carried $15 million of D&O insurance, arranged in the same way as the prior year.

 

On February 28, 2006, the company sent its primary carrier a copy of the initial financial restatement disclosure. Both the primary carrier and the excess carrier accepted this letter as a notice of circumstances that might give rise to a claim. The company advised the carriers of the various legal matters as they later arose. The carriers took the position that all of the subsequent notices and claims related back to the initial notice of circumstances and therefore the various matters implicated only the 2005-06 policies, regardless of when the later claims may have been made.

 

Later, after Argo entered her guilty plea, the primary carrier advised the company that it was no longer entitled to coverage under its policy. The excess carrier advised the company that due to the guilty plea, “a declination of coverage is in order in certain respects” under the excess policy, and that “rescission of the policy may be appropriate.” The excess carrier asked the company to enter a tolling agreement.

 

SafeNet later settled the securities class action lawsuit and paid the settlement amount. In the later coverage action, the parties stipulated that the company did not notify the excess carrier of the settlement negotiations and did not seek the excess carrier’s consent to settlement. In the later coverage action, the company contended that it spent more than $20 million in defense costs for itself and the directors and officers, including more than $10 million in defense costs for directors and officers other than Argo.

 

The excess carrier filed an action against Safeguard, Argo and the company’s former CEO, Anthony Caputo., seeking a judicial declaration of its coverage obligations and seeking a rescission of the renewal excess insurance policy. The defendants filed a motion to dismiss arguing amount other things that the case could not proceed without the primary carrier as a party and arguing further that the case was premature because the primary policy had not been exhausted. In a December 7, 2010 order (discussed here, scroll down), Judge Buchwald denied the defendants’ motions to dismiss. The parties then filed cross-motions for summary judgment.

 

In her September 9 opinion, Judge Buchwald denied the defendants’ summary judgment motion and granted the excess carriers’ motion in part and denied the excess carrier’s motion in part. Among other things, Judge Buchwald agreed that all of the claims relate back to the 2005-06 policy and that only the 2005-06 policy was implicated; that any loss incurred by Argo was precluded from coverage by the policy’s fraudulent conduct exclusion, but that coverage for the company’s loss was not precluded by that exclusion; that because the company had failed to obtain the excess carrier’s  settlement approval, there was no coverage under the excess policy for the $25 million securities class action settlement; and that to the extent that there is coverage under the renewal excess policy, the excess carrier was entitled to rescind the policy as to Argo and the company based on Argo’s application misrepresentations.

 

In contending that they were entitled to coverage under the 2006-07 renewal excess policy, the defendants had argued that the various option backdating problems were not even discovered until the middle of 2006 and therefore could not relate  back to the February 2006 notification sent to the carriers. In rejecting these arguments, Judge Buchwald found that in the class action lawsuit, the financial irregularities disclosed in February 2006 and the stock options backdating were “part of an interrelated course of conduct.” 

 

With respect to the policy’s relation back language, Judge Buchwald said that “these provisions make clear that the relation back of a claim turns upon the nature of the allegations in a subsequent Claim, not simply on the relationship in fact between an earlier notice of circumstances and a later Claim.” Because of the interrelationship between the two types of conduct and the “broad-relation back language” in the policies, she concluded that the subsequent matters relate back to the original notification and therefore only the 2005-06 policy was implicated.

 

Although she concluded that the fraudulent conduct exclusion precluded coverage for Argo, she concluded that the exclusion did not preclude coverage for the company. Even though policy language imputed “facts” and “knowledge” possessed by Argo to the company for purposes of determining the applicability of the exclusion to the company, the exclusion still does not apply to the company unless there has been an adverse judgment against the company. There was no adverse judgment against the company, and the judgment against Argo cannot be imputed to the company. Accordingly, notwithstanding Argo’s guilty plea and the imputation to the company of the facts and knowledge possessed by her, the exclusion does not operation to preclude coverage for the company.

 

However, the fact that the exclusion did not apply to the company does not mean that the company is entitled to coverage under the policy. Judge Buchwald concluded that the company was not entitled to coverage under the policy for the $25 million settlement because it had failed to get the carrier’s prior consent to settle. She said further that the she “could not conclude that the company was excused” from complying with the consent to settlement provisions. 

 

As for the question of whether or not there was coverage under the policy for the more than $10 million the company incurred defending the directors and officers other than Argo, Judge Buchwald concluded that because there was no record evidence that the company had actually indemnified any particular director and officer and the state of the record is “undeveloped” she could not decide the question of coverage for the defense fees.

 

Finally, although she had concluded that SafeNet’s claims did not implicate the renewal excess policy, Judge Buchwald concluded that to the extent the renewal policy does apply, the excess carrier was entitled to rescission as to Argo and as to the company. She found that because Argo admitted to knowingly and with intent to defraud causing the company to file inaccurate public filing, the carrier was entitled to rescission was to her. Moreover, Argo’s knowledge was imputable to other insureds. And while the policy allows individual insureds to establish lack of actual knowledge, it does not allow the company to establish that it lacked knowledge.

 

Discussion

This case is a veritable textbook of D&O Insurance coverage issues and Judge Buchwald’s opinion contains a number of rulings that could be important in many other cases.

 

Her ruling that the subsequent legal proceedings all relate back to the date of the initial notice, and therefore that only the 2005-06 policy is triggered, is likely to be of particular interest in many of the credit crisis related cases, in connection with many of which the insurance carriers are arguing that all of the various lawsuits filed against a particular company all relate back to a single, earlier policy year. Indeed that is the position that the carriers are taking in connection the Lehman Brothers lawsuits, as discussed in a recent post. The broad reading Judge Buchwald gave to the interrelated claim and relation back language here could prove to be very helpful for the carriers in many of these cases.

 

On the other hand, Judge Buchwald’s interpretation of the fraudulent conduct exclusion, and the limitations on what she was willing to impute to the company, will likely motivate carriers to quickly review  their policy language to see whether the imputation provisions in their fraud exclusion require an adjudication of the fraudulent misconduct even when the fraud has been  imputed. I suspect it came as a surprise here that if there was an adjudication of fraud as to Argo and that fraud was imputed to the company that the company could still retain coverage under the policy if the adjudication itself was not imputed to the company or there was otherwise no adjudication of the company’s fraudulent misconduct. I suspect many carriers are going to want to hold up their fraud exclusion and compare them to the fraud exclusion applicable here to see whether their fraud exclusion might operate as the fraud exclusion did here

 

As an aside, it is probably worth noting that Judge Buchwald was satisfied that a guilty plea represented an “adjudication” sufficient to trigger the exclusion. Perhaps that is a common sense interpretation, but I can certainly imagine the argument that a guilty plea is different from an adjudication, since there was no separate determination by a finder of fact, but merely an admission. Judge Buchwald’s conclusion that the guilty plea was sufficient would seem to undercut the argument that the exclusion could have said that an admission was sufficient to trigger the exclusion, but instead it required an adjudicated determination, which is different from an admission.

 

On the other hand, with respect to the topic of imputation, in her analysis of the rescission issues, Judge Buchwald found that Argo’s knowledge was imputable to the company under the applicable policy language. Thus Argo’s knowledge of application misrepresentations was sufficient to rescind coverage not only for herself but for the company as well. What observers may find most noteworthy about this is not just the imputation to the company but the fact that the application misrepresentations to which the imputation applied were in the form of misstatements in the company’s financial filings. In other words, the very financial misrepresentations that might attract a lawsuit might also wind up removing the company’s insurance coverage – at least where as here a senior corporate official has pled guilty to knowing fraudulent misrepresentation.

 

The final determination of significance in Judge Buchwald’s opinion is her conclusion that the company’s failure to obtain prior consent to settlement precludes coverage under the policy for the settlement. While a number of court have recently reiterated the enforceability of the consent to settlement clause (refer, for example, here), what is noteworthy here is that she found that the failure to obtain consent was not waived even where the carrier has said it has grounds to deny coverage, is contemplating rescission and has asked for a tolling agreement. The company undoubtedly felt like it had been left by the carrier to do the best it could to look after its interests, yet Judge Buchwald had found that the consent requirement had not been waive.

 

Judge Buchwald’s willingness to enforce the consent requirement even in these circumstances is yet another reminder of the critical importance of communicating with the carrier even under these types of strained circumstances. One protective step the company might have been able to take to avoid triggering a consent problem would be to obtain the carrier’s agreement that it would not raise the consent issue as an additional defense to coverage beyond those the carrier had said it believed it had grounds to assert.

 

Ad Nauseum: I was flipping channels earlier this week and I stopped to watch part of a major league soccer game. The field on which the game was being played had a billboard that said “Infinitum.” I idly wondered what product or service  the billboard might be referring to, and then it hit me – the billboard is nothing less than an “ad infinitum.”

 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Although some noteworthy settlements from the subprime-related securities class action litigation wave have started to accumulate (refer for example here), there are still some impressive settlements coming in from the prior scandal.

 

In the third largest options backdating-related securities class action lawsuit settlement, Maxim Integrated Products has agreed to settle the claims against all defendants in the options-related securities suit pending against the company for a payment of $173 million. According to the company’s May 5, 2010 press release (here), the after tax cost to the company from the settlement, which is still subject to documentation and court approval, would be $110 million.

 

As detailed in a prior post (here), on February 6, 2008, plaintiffs' lawyers announced (here) that they had initiated a securities class action lawsuit in the United States District Court for the Northern District of California against Maxim Integrated Products and certain of its directors and officers. The lawsuit relates to Maxim's January 17, 2008 announcement (here) that, as a result of its Board's special committee's investigation of the company's stock option practices, the company would be restating its financial statements to record non-cash, pre-tax charges of between $550 and $650 million for additional stock-based compensation expense. The company also announced that investors should not rely on the company's financial statements for the fiscal years 1997 through 2005 and corresponding interim reporting periods through March 25, 2006.

 

In order dated July 16, 2009 (here), the court denied in part the defendants' motions to dismiss, but perhaps more telling with respect to the timing and size of the securities lawsuit settlement, on April 23, 2010, following an eightday criminal trial, Maxim’s CFO Carl Jasper was found liable for securities fraud related to the backdating, as noted in this April 26, 2010 article by Zusha Elinson in The Recorder, here.

 

The SEC had previously sued the company and its CEO in an options backdating enforcement action (about which refer here). The CEO, Jack Gifford, who settled the SEC charges for a payment of $800,000 has since passed away.

 

The $173 million Maxim Integrated Product settlement is exceeded in dollar value among options backdating related securities lawsuit settlements only the $925.5 million total settlement of the UnitedHealth Group options-related securities lawsuit and the $225 million Comverse settlement. My complete tally of options related settlements and other case resolutions can be accessed here.

 

Adam Savett of the Securities Litigation Watch has also been tracking the options backdating related securities lawsuit settlements, and in his most recently updated tally (here), he reported that of the 39 total options backdating related securities class action lawsuits, 35 (not counting Maxim) have been resolved, with 8 dismissed and 27 settled (again, not including Maxim). Prior to the Maxim settlement, the 27 options backdating related securities class action lawsuits that had settled had been settled for an aggregate total of $2.15 billion and an average settlement of $79.7 million.

 

With the Maxim settlement, the aggregate is now $2.325 billion, and the average has also increased, as Savett’s forthcoming revised calculations undoubtedly will show. UPDATE: Savett has indeed updates his analysis, here. The updated average is $79.7 million, but if the outsized UnitedHealth Group settlement is excluded from the calculation, the average drops to $51.88 million. The median settlement is $16 million, and $14 million if the United Health Group settlement is excluded.

 

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

On January 27, 2010, NERA Economic Consulting released its updated annual review of Canadian securities class litigation entitled "Trends in Canadian Securities Class Actions: 2009 Update" (here). The report presents an interesting study of the evolution of class action litigation in a jurisdiction outside the U.S.

 

According to the report, there were eight new securities class action lawsuits filed in 2009, which is fewer that the ten filed in 2008 "but still greater than filings in previous years." With the addition of the eight new cases, there are now 23 pending securities class actions, representing more than $14.7 billion in claims. Most of these cases were filed in the last three years although some of the pending cases were filed almost 10 years ago.

 

Though the number of new filings is noteworthy, the more significant developments may be the class certifications in three cases and the ruling allowing the IMAX securities class action plaintiffs leave to proceed under the new Ontario securities laws. (My prior detailed discussion of the rulings in the IMAX case can be found here.). The NERA report comments that these rulings "may ultimately prove to be an inflection point" for securities class action litigation in Canada.

 

Though there were significant new filings in 2009, one noteworthy feature of the cases that were filed is the "absence in Canada of class actions filings relating to the credit crisis." This absence may be due in part to the relatively smaller impact of the credit crisis in Canada compared to the U.S. and the negotiated $32 billion restructuring of the Canadian Asset Backed Commercial Paper market, which may have preempted further litigation.

 

Six cases settled in 2009 for a total of approximately $51 million, for an average of approximately $8.5 million and a median of approximately $9 million (which is roughly comparable to the median settlement of U.S. securities class action lawsuits). 2009 settlements averaged 13.7% of the amount of claimed damages. Cases with cross-border litigation counterparts in the U.S. tended to settle for larger amounts both in terms of absolute dollars and as a percentage of claimed damages.

 

According to a January 27, 2010 article in the Vancouver Sun (here), the number of filings and the procedural developments (including the rulings in the IMAX case) are "a wake up call for publicly traded companies." Law firms are "advising their clients to revisit their compliance and corporate-governance procedures to protect against similar suits."

 

One lawyer quoted in the article says that he is also advising his clients to review their corporate insurance, as well. He goes on to state that "We’ve seen over the years there are a lot of problems in terms of clients don’t really have the type of coverage they need."

 

Yet, as for the question of whether there may be a flood of litigation, one plaintiffs’ attorney quoted in the article sounds a note of caution. The attorney, Dimitri Lascaris, who is one of the lead attorneys in the IMAX case, notes that that the Canadian system still provides for adverse costs, and even the liberalized standard under the new Ontario law are time consuming and expensive. So, he says, "we’re never going to achieve the level of activity in securities class actions that we see in the United States."

 

In light of these developments and their potential significance regarding insurance coverage, the session planned for the upcoming PLUS D&O Symposium (scheduled next Wednesday and Thursday in New York) on the topic of Canadian Securities Class Action Litigation is quite timely. The panel will be moderated by my friend Dave Williams from Chubb (Canada) and planned speakers include a number of prominent players in the area in Canada, including Dimitri Lascaris. Information about the Symposium can be found here.

 

The Securities Litigation Watch blog has a post about the NERA study here.

 

Excess Side A Carrier Contributes to Options Backdating Settlement: On January 25, 2010, a judge in the Western District of Pennsylvania preliminarily approved the settlement of the options backdating lawsuit that had been filed against Black Box, as nominal defendant and certain of its directors and officers. As part of the settlement, the company agreed to pay plaintiffs’ counsel $1.6 million and the company agreed to adopt certain corporate governance measures.

 

As reflected in the parties’ stipulation of settlement (here), as part of the settlement, the company is to receive a payment of $1.5 million from its Excess Side A carrier as well as another $500,000 from its EPL carrier.

 

According to a January 25, 2010 article about the settlement in the Pittsburgh Tribune-Review (here), the company also separately settled a claim against the company by its former CEO, who left the company in connection with the options backdating related matters. At the time he left, the CEO claimed, the company took away over $19.6 million in options related compensation. The company settled these claims for its agreement to pay $4 million.

 

The Black Box settlement marks the second instance of which I am aware in which an Excess Side A carrier contributed toward an options backdating related derivative lawsuit settlement. (The first instance is the Broadcom settlement, about which refer here.) This is yet another instance where Excess Side A insurance is being called on to provide protection outside of the insolvency context. As I have previously noted, the Excess Side A carrier’s contribution to these settlements may be a significant development for the carriers, who have offered the product in a largely low loss environment, at least outside the insolvency context.

 

The settlement with the CEO is an odd component of this settlement. There aren’t many of these cases where the former CEO who left as a result of backdating related issues walked away with a cash payment.

 

I have in any event added the Black Box settlement to my table of options backdating related lawsuit settlements and dismissal motion rulings, which can be accessed here.

 

SEC Will Issue Guidance on Climate Change Disclosure: On January 27, 2010, the SEC voted 3-2 to provide interpretive guidance on existing dislosure requirements to require climate change related disclosure under certain circumstances. The SEC's January 27 release can be found here. The SEC's release states that the interpretive release will be posted on the SEC web site as soon as possible. The news release identifies several examples of situations that might trigger disclosure requirements, including: impact of legislation and regulation; impact of international accords; indirect consequences of regulation or business trends; and physical impacts of climate change.

 

Suit Against Rating Agencies Dismissed, But Without Reaching First Amendment Issues: According to a January 27, 2010 Am Law Litigation Daily article by Andrew Longstreth (here), Judge Lewis Kaplan has granted the motions of Moody's and S&P to be dismissed from a securities lawsuit filed by certain investors who had invested in certain mortgage-backed securities underrwitten by Lehman Brothers. Judge Kaplan has not yet issued a written opinion but according to the article his opinion was based solely on the fact that the rating agencies didn't have anything to do with the offering documents at issue in the case. HIs ruling reportedly did not reach the rating agencies first amendment defenses (about which refer here.)  

　

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Over the years, legislative reforms of the U.S. securities laws have cycled back and forth, between initiatives, on the one hand, to discourage abusive litigation and, on the other hand, to restrain corporate misconduct. In the current Wall Street bailout, post-Madoff environment, sentiment may be running high for legislative reforms that could expand liabilities under the federal securities laws. But though the time for reform may be now, the window of opportunity may be short.

 

According to a January 2010 Wall Street Lawyer article by Boris Feldman of the Wilson Sonsini firm entitled "The Coming Counter-Reformation in Securities Litigation" (here), the best shot for reforms favorable to the plaintiffs’ bar "may be right now—before the mid-term elections in 2010 can create a filibuster firewall in the Senate." In his article, Feldman looks at the most likely areas of reform and the likelihood of the initiatives’ success.

 

The "most important priority for the plaintiffs’ bar" will be the institution of private securities liability for aiding and abetting violations of the securities laws. (There are in fact already current Congressional initiatives to accomplish that very change, about where refer here and here.) This change, were it enacted, would made the biggest difference in the "big frauds," where the "primary wrongdoer is usually bust." If the company’s professionals were "on the hook," then the "entire calculus would change," as the "pot" would then "consist of more than a claim in bankruptcy and some D&O insurance policies."

 

The "real battle" about prospective aiding and abetting liability, according to Feldman, will be how -- not whether-- it is instituted. Questions such as who bears the burdens of proof and persuasion and the state of mind required for liability "will determine whether aiding and abetting liability is a measured response to the current situation or a license to subject outside advisors to in terrorem risk."

 

The next likely target for the plaintiffs’ lawyers, Feldman suggests, is the discovery stay, which has been one of the PSLRA’s "great frustrations" for the plaintiffs’ bar. Feldman suggests that the plaintiffs’ will seek to modify the discovery stay, rather than try to have it overturned. He suggests that one alternative might be a "good cause" exception to the stay. Another alternative is the creation of an exception to the stay for documents already produced to governmental authorities.

 

Feldman also suggest that the plaintiffs’ bar may attack the PSRLA’s pleading requirements, or alternatively seek to rely on initiatives to set aside the "facial plausibility" pleading standard of Twombley and Iqbal (about which refer here).

 

Finally, Feldman suggests that the plaintiffs’ bar may see to limit the impact of Dura Pharmaceuticals, perhaps through reforms specifying that the loss causation issue is to be addressed only at the summary judgment or trial stage.

 

One area Feldman suggests that plaintiffs are unlikely to seek reforms is with respect to the PSLRA’s lead plaintiff requirements. Though these provisions were controversial when first enacted, the plaintiffs’ bar has now "adapted happily" to the requirements, and with institutional investor relationships firmly in place, there is "no incentive for the plaintiffs’ bar to tinker with these provisions."

 

Feldman closes by noting that the "electoral clock is ticking," with the likelihood of legislative action, if any, before fall 2010. He confesses "surprise" that the legislative reforms were not launched a year ago, when the 2008 electoral results were still fresh. Feldman notes that the fact that the plaintiffs’ bar missed this opportunity "may have something to do with absences in their leadership ranks in recent years."

 

Feldman suggests that the "most likely" way these reforms may come about is through the activities of the Financial Crisis Inquiry Commission, which, Feldman notes, has "strong ties to the plaintiffs’ bar" (about which refer here), a fact that may allow the plaintiffs’ bar "to try to get some of their reforms into the recommendations of the Commission."

 

I note that Feldman published his article before last week’s special election in Massachusetts. The election of Republican Scott Brown to the Senate seat vacated by the late Edward Kennedy seems to have scrambled everything. Although I don’t profess to have any particular insight into Congressional dynamics, I wonder whether the possible November effect Feldman anticipates in his memo has now been pushed forward through the calendar. The "filibuster firewall" may already be gone. Without a doubt, every member of Congress facing election this fall is proceeding with significantly greater wariness in the wake of the recent Massachusetts senatorial election. All of which makes me wonder whether or not the window of opportunity on some of these legislative proposals may have been substantially narrowed, if not altogether closed.

 

Opt-Outs Down and Out: Much has been written (refer for example here) about the growing phenomenon of class action securities lawsuit settlement opt-outs – that is, the investor class members who choose not to participate in the class action lawsuit settlement and instead pursue their own individual claims. One of the recurring themes has been how much better the opt-outs do than they would have if they remained in the class.

 

However, as shown in the outcome of a recent case involving Aspen Technology, there is no guarantee that the opt outs will do better by proceeding separately.

 

Aspen and several of its directors and officers had been sued in a securities class action lawsuit in November 2004 (about which refer here). The securities class action lawsuit ultimately settled for $5.6 million, but several class members representing 1.4 million shares of common stock opted out of the class action settlement and filed their own "direct action" lawsuit against the defendants in Massachusetts state court.

 

As reported on the Securities Litigation Watch blog (here), the Aspen Technology investors’ direct action lawsuit didn’t go so well for them. In a January 13, 2010 opinion (here), Massachusetts (Suffolk County) Superior Court Justice Judith Fabricant ruled that "no fraud occurred" and that "defendants are entitled to judgment on all counts of the complaint." In a memo about the decision (here), Skadden, the defense firm in the case, reports that Justice Fabricant also awarded defendants recovery from the plaintiffs of their costs in the case.

 

Options Backdating Securities Suit Dismissal Affirmed: One of the 39 options backdating related securities class action lawsuits involved claims against Jabil Circuit. The case may have been among the more noteworthy options backdating-related securities lawsuit filings, because Jabil Circuit was among the small group of companies specifically mentioned by name in the original March 2006 Wall Street Journal article ("The Perfect Payday") that launched the options backdating scandal. Among other things, the article calculated the likelihood that the Jabil options grants occurred randomly as "one in a million."

 

As noted in an earlier post (here), the Jabil Circuit options backdating-related securities lawsuit was dismissed without prejudice in April 2008. In a January 2009 order (here) on the defendants’ renewed motion to dismiss, the complaint was dismissed with prejudice.

 

In a January 19, 2010 decision (here), the Eleventh Circuit Court of Appeals affirmed the lower court’s dismissal of the case, holding the plaintiffs’ allegations "fail to meet the heightened pleading standards" under the PSLRA.

 

Among other things, the court said that "the allegations of misrepresentations, responsibility for granting misdated options, and personal profiteering fail to raise a strong enough inference of scienter" and that "the allegations contained in the complaint do not create an inference of scienter that is at least as probable as a non-fraudulent explanation—namely that none of the Appellees knew of the accounting errors until the investigation began in 2006"

 

I have updated my table of the outcomes in the Options Backdating-related lawsuits to reflect the Eleventh Circuit’s decision in Jabil Circuit. The table can be accessed here.

 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Broadcom Corporation, which previously settled its options backdating related derivative suit for $118 million, announced on December 29, 2009 (here) that it had settled the separate options backdating related securities class action lawsuit pending against the company and certain of its directors and officers in exchange for its agreement to pay $160.5 million. The settlement is subject to court approval.

 

Because the company provided its D&O insurers with complete releases in connection with the prior derivative settlement, Broadcom apparently is funding the class action settlement entirely out of its own resources. Broadcom’s press release states that it will be recording the settlement amount as a one time charge in its fourth quarter 2009 financial statements.

 

Broadcom’s option backdating issues were of course recently in the news in connection with Judge Cormac Carney’s dramatic December 15, 2009 dismissal of the criminal indictments that were pending against several individual former directors and officers of the company. With the dismissal of the criminal charges and the settlements of the derivative and class action cases, Broadcom seems one step closer to finally putting its option backdating issues to rest. Judge Carney also dismissed the options backdating-related SEC enforcement action as well, though the SEC action dismissal was without prejudice. Judge Carney did also "discourage" the SEC from refilng its complaint.

 

In light of the circumstances surrounding Judge Carney's dismissal of the criminal indictments, the size of the class action settlements is interesting. It certainly seems that given the concerns that Judge Carney noted in dismissing the indictments that the class action plaintiffs might face some formidable obstacles on key aspects of their case, including in particular in establishing that the defendants acted with scienter.

 

The dismissal of the criminal indictments doesn't seem to have prevented a very substantial settlement of the class action, however. Indeed, the timing of the class action settlement, coming just two short weeks after the indictments were dismissed, seems to suggest that the elimination of the criminal case somehow opened the way for the class action settlement. Who knows, perhaps with the prosect of finally putting the options backdating woes in the past, the company moved quickly to get the class action case settled so that it might move on.

 

The Broadcom class action settlement is the third largest of the options backdating-related class action settlements, after the UnitedHealth Group settlement ($925.5 million) and the Comverse Technology settlement ($225 million). The Broadcom settlement, at $160.5 million, is just slightly larger than the $160 million Brocade Communications class action settlement.

 

With the addition of the Broadcom settlement, 32 of the 39 options backdating-related securities class action lawsuits that were filed have now been resolved. 23 of the cases have been settled and nine have been dismissed. My complete list of options backdating related lawsuit resolutions can be accessed here.

 

According to data that Adam Savett of the Securities Litigation Watch has been maintaining (here) , and with the addition of the Broadcom class action settlement, the 23 options backdating related settlements total approximately $1.94 billion. The average options backdating class action settlement has been $84.3 million, but if the massive UnitedHealth Group settlement is taken out of the equation, the average drops to about $44.1 million.

　

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In a December 28, 2009 press release (here), the plaintiffs’ lawyers announced the settlement of the Comverse Technology options backdating-related derivative lawsuit. This derivative lawsuit settlement is separate from, but related to, the previously announced $225 million settlement of the Comverse Technology options backdating-related securities class action lawsuit (about which refer here).The bulk of the derivative lawsuit settlement consists of the previously disclosed agreement of Comverse’s former CEO Kobi Alexander to pay Comverse $60 million to be applied to the class action lawsuit settlement.

 

The derivative lawsuit stipulation of settlement (which can be found here), is dated December 17, 2009, the same day as the class action lawsuit settlement was announced. The settlement consists of a number of different components, the most significant of which is Alexander’s agreement to pay the $60 million to Comverse. As reflected in the company’s December 18, 2009 filing of Form 8-K (here), Alexander is to pay the $60 million into the derivative settlement fund and then the amounts are to be transferred to the class action settlement fund.

 

Alexander, as readers will no doubt recall fled to Namibia to evade options backdating charges, where he remains a fugitive. Due to his absence in Namibia, the arrangements for his payment of the $60 million are complicated, and are set out in a separate agreement (here). Among other things, Alexander has agreed to transfer certain investment accounts, real estate assets, insurance policies and other assets. Among other things, Alexander also agreed to relinquish his counterclaims against the company.

 

The company’s former General Counsel, William Sorin (who previously pled guilty to options backdating related criminal charges), also agreed to make two payments for the benefit of Comverse totaling $1 million, in addition to the more than $3 million he previously paid to the SEC. He also agreed to relinquish his counterclaims against Comverse seeking $2.2 million in damages relating to deferred compensation, lost wages and cancelled or revoked options and restricted stock.

 

The company’s former CFO, David Kreinberg, agreed to pay $75,000 for the benefit of Comverse, in addition to the $2.39 million he previously paid to the SEC. Kreinberg also agreed to relinquish his counterclaims for $4.3 million in damages relating to deferred compensation, lost wages, and cancelled or revoked options or restricted stock, as well as an additional $1 million in attorneys’ fees for which he had been seeking indemnification.

 

Comverse’s auditor during the time of the backdating scheme, Deloitte & Touche, agreed to pay the company $275,000.

 

Several individual defendants who had served on Comverse’s compensation committee will also collectively forfeit 155,000 in unexercised stock options.

 

The derivative lawsuit settlement stipulation also provides that "Comverse shall cause Comverse’s insurance carrier, on behalf of the Individual Defendants except for Mr. Alexander, Mr. Sorin, and Mr. Kreinberg, to pay to Comverse $1 million" by the later of either August 30, 2010 or thirty days after the derivative lawsuits and class action lawsuits are finally dismissed.

 

Finally, Comverse agreed to adopt or to keep in place certain corporate governance reforms.

 

Neither the company’s 8-K nor the plaintiffs’ lawyers’ press release mentions it, but the derivative suit’s stipulation of settlement also provides that Comverse will pay the plaintiffs’ attorneys’ fees of $9.35 million. Neither the settlement documents nor the company’s 8-K specify whether this amount will be offset in whole or in part by the payment of insurance.

 

Given the fact that insurance is expressly mentioned in the stipulation in connection with the $1 million payment, the inference is that, other than with respect to the $1 million payment, insurance funds are making no other contributions to the settlement. (There is also nothing in the documents expressly confirming that the carrier has agreed to pay the $1 million amount.)

 

In the absence of insurance payments (other than with respect to the $1 million payment), the $9.35 million in plaintiffs’ attorneys’ fees seems like a heavy burden to impose on the company, which may explain why neither the plaintiffs’ lawyers’ press release nor the company’s 8-K mentioned this amount.

 

It is complicated to calculate the relation between the burdens the derivative lawsuit imposed on the company compared to the benefit to company from the lawsuit. On the one hand, the plaintiffs in the derivative suit would cite Alexander’s agreement to pay the $60 million as benefit the derivative suit produced. I hope some of us can be forgiven for being confused about which lawsuit produced the $60 million payment.

 

Setting the $60 million aside, the other benefits to the company from the derivative settlement appear, at least relative to the size of the derivative plaintiffs’ $9.35 million attorneys’ fees, relatively modest. 

 

That said, the plaintiffs’ lawyers’ undoubtedly would argue that the $60 million settlement contribution should not be set aside but rather represents a very significant benefit to the company from the derivative lawsuit, and that benefit is the context within which the $9.35 million attorneys’ fees should be assessed. The size of Alexander's $60 million settlement contribution is noteworthy, but Alexander's fugitive status and location in Namibia, as well as the complex state of his financial affairs given his fugitive status, unquestionably add an extraordinary degree of difficulty to the negotiation of his contribution.

 

Another insurance question arises from the settlement’s requirement that Kreinberg relinquish his claim for indemnification of $1 million in attorneys’ fees. The agreement appears to be silent on the question whether Kreinberg can, notwithstanding his indemnification relinquishment, still seek payment of his attorney’s fees from the company’s D&O insurance carrier.

 

Kreinberg might contend (assuming for the sake of argument that policy funds remain) that he is entitled to have his fees paid under Side A of the policy, relating to amounts for which indemnification is unavailable. An interesting question is the extent to which the policy’s presumptive indemnification clause would presume indemnification notwithstanding Kreinberg’s indemnification relinquishment, which the carrier might assert as a basis to assert that Side A has not been triggered. (I suspect the carrier might well assert other defenses to coverage as well.)

 

I have in any event added the Comverse derivative settlement to my register of options backdating-related lawsuit resolutions, which can be accessed here.

　

　

　

• Email This
• Print
• Comments
• Trackbacks
• Share Link

According to a December 17, 2009 press release from the lead plaintiff’s attorneys, the parties to the Comverse Technology options backdating related securities lawsuit have agreed to settle the case for $225 million dollars. A particularly noteworthy feature is that the settlement amount includes a $60 million individual contribution from the company’s former CEO, Kobi Alexander, who famously fled to Namibia after the options backdating allegations surfaced.

 

The $225 million settlement represents the second largest of settlement of an options backdating-related securities class action lawsuit. The only larger backdating settlement is the mammoth $925 million settlement of the UnitedHealth Group options backdating securities suit (about which refer here and here). A complete list of options backdating settlements and case resolutions can be found here.

 

According to data compiled by Adam Savett of the Securities Litigation Watch, and taking into account this latest settlement, of the 39 options backdating related securities class action lawsuits that have been filed, 22 have now settled, along with nine that have been dismissed, meaning that there are still nine of the securities suits yet to be resolved. The $225 million settlement far exceeded the prior average options backdating securities suit settlement of about $74 million (or $31.82 million if the outsized UnitedHealth Group settlement is dropped out of the equation). The aggregate amount of all the options backdating securities suit settlements is, with the Comverse settlement, now up to $1.785 billion. UPDATE: The Securities Litigation Watch has updated its analysis to reflect the Comverse settlement, here.

 

Alexander’s extraordinary agreement to contribute $60 million to the settlement out of his own funds represents something of a milestone. The plaintiffs’ lawyers press release says that the amount "one of the largest recoveries from a former executive to settle a federal securities class action." By way of comparison, former UnitedHealth Group CEO William McGuire agreed to pay $30 million in settlement of the securities class action claims against him, as well as to have certain unexercised options grants canceled.

 

Regardless of where the amount falls in terms of size of individuals’ settlement contributions, it undoubtedly is the largest contribution by an individual defendant while simultaneously evading extradition. Alexander’s getaway to Namibia provided one of the more interesting subplots of the entire options backdating episode. You do kind of wonder exactly how he is going to handle the currency transfers. UPDATE: The parties' agreement regarding this settlement, which can be found here, specifically references various investment accounts of Alexanders that were seized by the U.S. Marshall's service. The agreement indicates (see page 17-19) that Alexander will cooperate and facilitate in the forfeiture of those accounts.

 

In addition, none of the information available to date about the securities class action settlement reveals whether the settlement resolves or even addresses the separate lawsuit that Comverse filed against Alexander and the firm’s former General Counsel, in which the company sought to recover $70 million in damages. Nor does the available information disclose whether or not the settlement resolves or addresses the separate lawsuit that Alexander filed against Comverse for more than $72 million of severance and other compensation.

 

The details surrounding the settlement contributions from Comverse itself are not entirely clear, either As of the time and date of this blog post entry, the parties have not yet filed their settlement agreement with the court, not has the company made any disclosures about the settlement. The information publicly available about the settlement does not disclose whether or not insurance will make any contribution to the settlement. However, at least one media story about the settlement suggests that the company will make its contribution in a number of payments during 2010, which, at least to the extent of those payments, seems inconsistent with funding for the settlement from insurance. UPDATE: According to Ben Hallman's December 18, 2009 article in the AmLaw Litigation Daily (here), Comverse intends to finance its $165 million share of the settlement by selling auction rate securities back to UBS, and if that doesn't work it will cover the amount with a a mix of cash and stock. Under the settlement agreement, Comverse's payments are to be paid into the settlement escrow account in a series of staged payments during 2010 and 2011.

 

Clearly there are still some details yet to be revealed about the settlement. I will supplement this post if I am able to unearth more details about the settlement.

 

One final note about the Comverse Technology options backdating issues is that this is one case that has resulted in a successful criminal prosecution. Even though the company’s former CEO is still evading extradition in Namibia, prosecutors did secure a criminal guilty plea from the company’s former General Counsel. In the wake of the dismissal of all of the individual indictments in the Broadcom case that I blogged about yesterday, it is notable that this is one case where the criminal charges stuck – again, notwithstanding Alexander’s evasion of arrest.

 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

There has been widespread news coverage of the dramatic December 15, 2009 decision of Central District of California Judge Cormac Carney to throw out the options backdating related criminal charges against Broadcom co-founder Henry T. Nicholas III and CFO William Ruehle, based on prosecutorial misconduct.

 

But even though many of press accounts have reproduced some of Judge Carney's harshest words – particularly his statement that the government’s treatment of a third defendant, Henry Sameuli, was "shameful and contrary to American values of decency" – the excerpts do not come close to capturing the depth and breadth of the Judge’s condemnation of the prosecutor’s conduct.

 

The transcript of the December 15 hearing at which Judge Carney delivered his ruling can be found here. I strongly recommend taking a few minutes and reading the entire transcript (it is relatively short), because only a complete reading truly conveys the extent of Judge Carney’s censure.

 

His reproach of the prosecutors is comprehensive, extensive and scathing. Judge Carney dropped a bomb on the prosecution. Not by accident, as if he got a little angry and then got carried away. No. Judge Carney clearly and consciously intended to summon every molecule of the power of his position and marshalled every tool in the arsenal of language. Judge Carney's decision is a case-hardened, bunker-buster, heat -seeking bomb -- that hit the bulls-eye.  

 

Among other things, he cites the prosecutors for "intimidating and improperly influencing" witnesses, which "compromised the truth process and compromised the integrity of the trial"; for making improper leaks to the media; for improperly pressuring Broadcom to terminate Samueli; for obtaining an "inflammatory indictment" of Samueli; and crafting "an unconscionable plea agreement" with Samueli.

 

Assistant U.S. Attorney Andrew Stolper, the lead prosecutor in the case, received particularly sharp criticism. Among other things, Judge Carney said that "the lead prosecutor somehow forget that truth is never negotiable." Of the case against Ruehle, Judge Carney said that to submit it to the jury "would make a mockery of Mr. Ruehle’s constitutional right to compulsory process and a fair trial."

 

In addition to the sheer potency of Judge Carney’s rhetoric, there are several other interesting aspects to Judge Carney’s rulings, some of which have not been fully noted in press reports.

 

The first is that Judge Carney’s decision to dismiss the case against Nicholas came during Ruehle’s trial. Nicholas was to be tried separately later. There was not even a motion on behalf of Nicholas pending. Moreover, Judge Carney’s dismissal of the indictment of Nicholas came just days after Judge Carney dismissed Samueli’s prior guilty plea, following Samueli’s testimony at Ruehle’s trial. Judge Carney’s decisions to first dismiss Samueli’s guilty plea and then to dismiss the case against Nicholas shows the extent of the concerns that were raised in Judge Carney’s mind as Ruehle’s trial unfolded.

 

Second, Judge Carney not only dismissed the criminal cases, he dismissed the SEC’s options backdating related enforcement action without prejudice –again, even though that SEC enforcement action was not formally before Judge Carney at the time. Judge Carney allowed the SEC thirty days to file an amended complaint, but he did also "discourage" the SEC from proceeding further, since "the government’s misconduct has compromised the integrity and legitimacy of the case" and the evidence during Ruehle’s trial "established that the SEC will have great difficulty proving that the defendants acted with reckless scienter."

 

Judge Carney also ordered the government to show cause why the separate drug distribution-related indictment against Nicolas should not be dismissed, and scheduled a date in February 2010 for the matter to be heard. Among concerns Judge Carney noted about the drug indictment is "government’s threats to issue a grand jury subpoena to Dr. Nicolas’ 13-year old son and force the boy to testify against his father."

 

Third, as part of discouraging the SEC from refiling its complaint, Judge Carney raised fundamental questions that go to the heart of the entire options backdating brouhaha --immediately after he had said that the SEC will have difficulty proving scienter. He said:

 

The accounting standards and guidelines were not clear, and there was considerable debate in the high-tech industry as to the proper accounting treatment for stock option grants. Indeed, Apple and Microsoft were engaging in the exact same practices as those of Broadcom.

 

These remarks suggest that, in addition to all of Judge Carney’s other concerns about the prosecutor’s misconduct, he also has fundamental concerns about whether there could possibly have been a culpable state of mind in connection with backdating. His reference to the uncertainty of the applicable standards and extent of the practices (even Apple and Microsoft!) certainly seems to raise questions about whether any criminal prosecution or even enforcement action is appropriate, not just the one against the Broadcom defendants.

 

Judge Carney clearly is quite sure that there was something wrong with the prosecutor’s actions in prosecuting the case, but he doesn’t seem to be sure at all whether or not there is actually anything wrong with backdating itself. Could these two points be related? Hmmm...

 

Indeed, this fundamental problem with the backdating allegations may explain why prosecutors have had so much trouble obtaining and retaining backdating convictions. Thus, for example, the conviction of former Brocade Communications CEO Gregory Reyes was overturned, again for prosecutorial misconduct (based on improper statements prosecutors made to the jury), and McAfee’s former general counsel, Kent Roberts, was acquitted.

 

It does sort of make you wonder whether Kobe Alexander might  now having second thoughts about his decision to flee to Namibia rather than face the criminal charges for alleged options backdating at Comverse.

 

Though the Broadcom criminal indictments have been dismissed and the SEC enforcement action has also been dismissed, possibly for good, an enormous amount of damage has been done. There is not only the terrible toll that the legal actions took on the lives of the individual criminal defendants. There is the almost unbelievable cost that all of these actions imposed on the company and its insurers.

 

As I noted in a prior post (here), Broadcom agreed, as part of the settlement of the options backdating-related shareholders’ derivative lawsuit, to settle its claims against its directors’ and officers’ liability insurers for $118 million, all of which represented a payment to the company in reimbursement of defense expenses incurred in connection with the various backdating-related legal proceedings. In the recitals to the insurance settlement, the parties stated that at point Broadcom’s cumulative legal expenses exceeded $130 million.

 

It is very hard not to conclude that entire sorry options backdating scandal has been an enormous waste, of time, talent and money.

 

There have been a number of interesting blog posts about Judge Carney’s dismissals of the Broadcom indictments, including items on the SEC Actions blog (here) and on the Ideoblog (here). The WSJ.com Law Blog has a post (here) comparing Judge Carney to Judge Rakoff.

 

Special thanks to Nancy Adams of the Mintz Levin firm for forwarding me a copy of the hearing transcript.

 

Even More Failed and Troubled Banks Next Year?: According to yesterday’s Wall Street Journal (here), the FDIC is looking to increase its budget by 35% next year and to add 1,600 new staffers, as the agency struggles to deal with the complications from the wave of failed and troubled banks. Among the reasons that agency Chairman Sheila Bair cited to justify moves is that the increases  "will ensure that we are prepared to handle an even larger number of bank failures next year, if that becomes necessary, and to provide regulatory oversight for an even larger number of troubled institutions"

 

The suggestion that the FDIC must be prepared for even more failed and troubled banks in 2010 is disturbing. There have already been 130 failed banks this year, and at the time of the FDIC’s last Quarterly Banking Profile, the FDIC reported that there were 552 Problem Institutions as of September 30, 2009, as noted here. Put simply, the FDIC thinks in order to be prepared for 2010, it has to be ready to deal with more than 130 additional bank failures next year and more than 552 troubled institutions.

 

Clearly, the banking industry’s problems are deep and continuing. The problems associated with failed and troubled banks are among the most significant concerns as we head into 2010.

 

Goodbye to All That: The blogosphere is losing one of its most talented and esteemed members. Yesterday, our friend, law-school compatriot and fellow blogger, Mark Herrmann, of the incomparable Drug and Device Law Blog, announced that he is retiring from blogging. Alas.

 

Herrmann, who has been a partner at Jones Day since before dinosaurs roamed the earth, is leaving Big Law to go be a client -- I mean , to become Vice President and Chief Counsel - Litigation at AON Corporation. As a result, Herrmann no longer thinks he will have as much time to write about legal issues surrounding medical drugs and devices -- go figure. 

 

Herrmann is moving on to do God's work, defending against unscrupulous types who would presume to sue insurance brokers. But as a result, the blogosphere is losing one of its most intelligent, cantankerous and amusing voices. Have no fear, his blogging partner (A blogging partner! What a concept! I should have thought of that!), Jim Beck, will be carrying on the fine tradition of the Drug and Device Law Blog.

 

Everyone here at The D&O Diary wishes Herrmann every success at AON. May the force be with you, Mark. Welcome the world of insurance brokerage, dude.

 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Former McAfee General Counsel Kent Roberts, accused of options backdating-related misconduct, was acquitted following a criminal jury trial and the SEC later dropped its separate enforcement action against him. But that apparently is not enough for Roberts – he wants vengeance.

 

On September 16, 2009, he filed a lawsuit in the Northern District of California (complaint here), in which he alleges that the company, certain of its officers and directors and its outside advisors conspired to scapegoat him for the company’s backdating problems, as part of a campaign supposedly dubbed "Project Shield," to shift attention and options backdating blame away from the company and its senior officials.

 

Background

The events leading up to the filing of this complaint do help explain Roberts’s anger. Among other things, the criminal trial against him on fraud charges got off to a startling beginning when literally on the eve first day of trial, the company for the first time produced to prosecutors and to the defense 16 pages of previously subpoenaed documents that allegedly corroborated Roberts’ contention that he had not initiated the backdating of the options grant he received and that was the basis of the criminal prosecution.

 

Roberts was not the only one infuriated by this belated production – according to press reports, Judge Marilyn Hall Patel said "somewhere or another, heads will have to roll, this is outrageous." Roberts’ criminal defense attorney said at the time that the belated production underscores the defense contention that the company had engaged in a pattern of selectively releasing information in order to scapegoat Roberts for the company’s options issues.

 

The criminal trial nevertheless went forward, and on October 3, 2008, the jury acquitted Roberts of all charges, except one on which the jury was unable to reach a verdict. Judge Patel was quoted as having said, "I would strongly recommend against pursuing this further. This was not a case where any money was lost as a result of this."

 

In March 2009, the SEC dropped its separate civil complaint against Roberts (although, interestingly in light of the reputational damage allegations in Roberts’ recently filed complaint, while the SEC’s complaint against Roberts and related litigation press release can be easily found on the SEC’s website, I was unable to find anything on the SEC’s website indicating that the SEC had withdrawn the complaint. It may be there, but I couldn’t find it, which seems seriously wrong to me.)

 

Roberts’ Complaint

So long the accused, Roberts is now the accuser. His long, detailed and fascinating complaint is written in a febrile and vehement tone.

 

Roberts alleges that the company’s then-CEO and members of the company’s board "instituted a campaign of diversion, manipulation, and falsehood aimed at shifting the attention of federal authorities away from [the CEO’s] and McAfee’s misdeeds." He further alleges that the company’s board "literally dubbed the campaign ‘Project Shield,’" which he alleges was designed to make him the "scapegoat."

 

Roberts not only contends that he was scapegoated, but he also alleges that he was offered up in order to divert attention from actual, and much more significant, options backdating allegedly connected to company officers and board members. Among other things, Roberts alleges that the company’s board "engaged in a deliberate effort to divert attention onto Roberts in order to protect more senior company officers and directors whose conduct with respect to stock options was extensive and potentially unlawful."

 

As part of this alleged process, Roberts alleges, the company, its senior officers and its outside advisors orchestrated a campaign to selectively provide information and documents to government investigators to cast blame on Roberts and draw attention away from other company option grant related activity. He alleges that this selective and slanted provision of information to the government resulted in his criminal prosecution and in the SEC enforcement action against him. He also alleges that the CEO and board members provided "false accounts" in SEC depositions about conversation that had with Roberts.

 

The complaint alleges that McAfee "employed delay, misinformation, and selective disclosure to slant the evidence" away from the company grants "to depict Roberts to federal investigators as the individual behind the wrongdoing." The complaint further alleges that the company’s dealings with the governmental authorities were "deliberately tainted with deception, misinformation and withheld information."

 

As further detailed in a September 17, 2009 article by Ross Todd on the AmLaw Daily (here), Roberts’ complaint also contains a number of very specific allegations against McAfee’s outside attorneys and against the counsel to the board’s special litigation committee.

 

Roberts alleges that the company’s "manipulation of evidence through Project Shield was a substantial factor in causing Roberts’ unwarranted prosecution" that "substantially and irreparably damaged Roberts’ career." Roberts accuses the company of malicious prosecution, defamation and false light invasion of privacy, and seeks to recover unspecified compensatory and punitive damages.

 

Discussion

Roberts’ complaint is a fascinating document. Regardless whether or not his lawsuit succeeds, he will always have the option of selling the movie rights to his story, which reads like a Grisham novel. I found particularly compelling his account of the series of separate meetings with the CEO and board members in which (he contends) he himself brought to their attention an incident in which the company’s comptroller changed the date of one of Roberts’ option grants, and the next thing he knew he was being terminated and escorted out of the building. The company’s conduct (at least as depicted in Roberts’ obviously self-serving account) comes off as hasty and ill-considered.

 

But it is important to put these events in context, particularly the pressure and scrutiny McAfee and other companies were under at the time. The companies were under enormous pressure to demonstrate (under the then-applicable McNulty Memo and its predecessor the Thompson memo, about which refer here, specifying the guidelines for corporate prosecution) that it was "cooperating fully" with government officials. One of the criticisms of these guidelines at the time was that they forced companies to offer up its employees in order to try to avoid its own potential criminal prosecution – not to say that that necessarily happened here, but the circumstances as portrayed in Roberts’ complaint certainly do suggest that possibility.

 

For all the feverish tone of Roberts’ complaint, it probably should be noted that, at a minimum, he was aware of and went along with the backdating of his options grant. According to the press reports linked above, the jury did conclude that Roberts had breached his fiduciary duty to the company, even if they also concluded that the government had not proved that he had set out to defraud the company. To me, this seems like important context within which to consider Roberts’ outrage.

 

The complaint does raise some interesting insurance questions. The only defendant named in the complaint is the company itself. Because the typical public company D&O insurance policy covers the company only for securities claims, and because Roberts has not filed a securities claim against the company, there likely would not be coverage under the typical D&O insurance policy for Roberts’ complaint as it currently stands (although Roberts does allege a variety of allegedly misleading statements in the company’s disclosure documents, which could raise some interesting issues). I express no views here whether or not the company’s Commercial General Liability policy would provide coverage.

 

Though no individuals are named as defendants, several individual directors and officers are expressly alleged to have engaged in a variety of supposedly wrongful actions. The possibility that the complaint could be amended to name the individuals as defendants does suggest that the complaint could at least represent a potential claim under the D&O policy.

 

The more interesting question is whether any claims against individual directors and officers based on the complaint’s allegations would be covered claims. Many (but not all) D&O policies contain omnibus exclusions, often within the policy exclusion for bodily injury and property damage, intended to preclude coverage for personal injury claims. These exclusions, when they appear, are not uniform. At a minimum, the kinds of claims asserted in the Roberts complaint underscore the need to consider the language of these personal injury exclusions carefully, if they cannot be removed altogether. Given the breadth and variety of Roberts’ allegations, at least some of his claims, if extended to individual defendants, might not be entirely excluded even by a D&O policy that had a personal injury exclusion. Obviously, the argument for coverage would be stronger if there were no personal injury exclusion.

 

But in the end, what makes the filing of this complaint so interesting is the way that Roberts’ tale manages to retrace the precise arc of the entire options backdating scandal – from the early, overwrought days when the scandal first emerged, to the long, slogging process that followed, with its by a proliferation of lawyers and prosecution of legal claims, to the empty void left when all was said and done, presenting a question of what the whole thing was really all about to begin with.

 

To be sure, there were some significant options backdating settlements, including the recent $118 million Broadcom settlement (about which refer here). But the fact that the Broadcom settlement was just about options backdating related attorneys’ fees merely serves to underscore the question of what the whole options backdating frenzy has accomplished in the end. (The options backdating derivative lawsuit filed with respect to McAfee settled for approximately $30 million, refer here.)

 

The one thing that the options backdating scandal unquestionably did was create an enormous amount of work for lawyers. As Roberts’ complaint itself illustrates, once these kinds of forces are unleashed, they continue to expand outward indefinitely like some fundamental force of physics. I guess Roberts’ complaint just represents the inevitable next phase of that process – litigation about litigation.

 

Hat tip to the Courthouse News Service for a copy of the complaint.

 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In what is one of the largest ever shareholders’ derivative lawsuit settlements, the parties to the consolidated federal options backdating related derivative lawsuit involving Broadcom Corp. have agreed to settle the case for $118 million, to be funded entirely by the company’s D&O insurance carriers. The settlement does not include the company’s co-founders, Henry Samuels and Henry T. Nichols, III, against whom the suit will continue. As discussed below, the settlement has a number of interesting features, including certain details surrounding the insurers' settlement participation, particularly the substantial participation in the settlement of Broadcom's Excess Side A insurance carriers.

 

As reflected in Broadcom’s August 28, 2009 filing on Form 8-K (here), and the accompanying stipulation of settlement (here), the $118 million settlement, which is subject to court approval, is to be funded by the company’s D&O insurers and includes $43.3 million that "Broadcom had already recovered in connection with prior reimbursements from its insurers (subject to a reservation of rights that will be released upon settlement approval."

 

The stipulation also provides that in connection with the settlement Broadcom will pay plaintiffs’ attorneys’ fees and costs of $11.5 million.

 

There are a number of interesting things about this settlement. The first is its size. The settlement’s total value of $118 million would make this the second largest options backdating related derivative lawsuit settlement, exceeded only by the $900 million UnitedHealth Group options backdating derivative settlement (about which refer here and here).

 

Indeed, the $118 million settlement may be among the largest shareholders’ derivative settlements of any kind, exceeded or equaled only by a small handful of prior derivative settlements (including, in addition to the UHG settlement noted above, the $115 million AIG derivative settlement and the $122 million Oracle derivative lawsuit settlement).

 

These settlements are of course all dwarfed by the  $2.876 billion judgment entered against Richard Scrushy in the HealthSouth shareholders' derivative lawsuit, but that astronomical judment represents its own peculiar point of reference, like some odd parallel universe. 

 

But notwithstanding the settlement’s size, the net overall benefit to the corporation on whose behalf the lawsuit nominally was filed is an interesting issue. Not only is $43.3 million of the total settlement amount in the form of previously reimbursed defense expense, and not only is the settlement amount further reduced by the plaintiffs’ attorneys’ fees of $11.5 million, but the roughly $63.2 million remainder from the $118 million total is more than offset by litigation expenses the company has incurred in connection with the options backdating scandal.

 

As stated in the recitals in the separate Insurance Agreement (here) filed as an exhibit to the settlement stipulation, Broadcom has "advised the Insurers that it has claims for reimbursement exceeding $130 million in respect of the Broadcom Stock Option Matters, of which approximately $85 million remains outstanding."

 

Broadcom and its directors and officers were and are involved in a diverse range of lawsuits and claims as a result of the options backdating scandal, not just the shareholders derivative lawsuit. But the fact is that the remainder of the forthcoming cash settlement payment (after payment of plaintiffs’ attorneys’ fees) effectively represents only a partial offset of the company’s enormous options backdating related litigation expenses.

 

The corporation’s recovery of disputed legal expenses is unquestionably a benefit to the corporation, but how much additional litigation expense was generated along the way? It does seem to raise certain questions about the efficiency of the process. Indeed, in an August 31, 2009 American Lawyer article about the settlement (here), Susan Beck commented that "we’re still scratching our heads over this one."

 

The answer to the question of why the derivative lawsuit was a necessary vehicle to secure this extent of defense expense reimbursement from the carriers lies in the way Broadcom's D&O insurance was structured

 

The Insurance Agreement accompanying the settlement shows that Broadcom had a total of $200 million of D&O insurance, arranged in various layers, with $100 million of "traditional" D&O insurance, and an additional $100 million of Excess Side A insurance. Excess Side A insurance  only provides protection to individual directors and officers (and not to the company itself) and only against loss that is nonindemnifiable, whether due to insolvency or legal prohibition. This element of insurance for nonindemnifiable loss is critical to understanding this settlement.

 

The Insurance Agreement recites that the insurance carriers believed they had certain defenses to coverage, but that in connection with the settlement, these coverage issues were being compromised. In exchange for relinquishing these potential coverage defenses, the carriers each paid amounts less than their full policy limits, with each successive carrier contributing a correspondingly smaller amount.

 

The Insurance Agreement specifies the dollar amount each carrier is to contribute to the settlement. Among other things, the Insurance Agreement shows that the Excess Side A insurers will contribute a total of $40 million, with each of the successive Excess Side A carriers contributing a correspondingly smaller amount.

 

Given the number of carriers involved, the complexity of the coverage issues and the sheer quantity of dollars involved, the completion of this settlement is an extraordinary accomplishment. I tip my hat to all of the lawyers involved in putting this together.

 

The key to understanding the inner logic of this deal is to recognize that without the existence of a shareholders' derivative lawsuit against the individual directors and officers creating the type of nonindemnifiable loss that is the sole type of loss for which the Excess Side A policies provide coverage, the Excess Side A policies would not have been triggered.

 

The defense expenses incurred in connection with the other options backdating related litigation matters are presumptively indemnifiable. The company's payment of these indemnifiable amounts, in and of itself, would not have triggered the Excess Side A policies.

 

However, the derivative lawsuit's claim against the individual defendants for the harm to the corporation caused by the backdating includes claims on the corporation's behalf for the enormous litigation expense the company incurred due to the alleged misconduct. The settlement of the claims in the derivative lawsuit against the individual defendants to recoup the harm to the corporation was not indemnifiable, triggering a potential payment obligation for the Excess Side A carriers.

 

So if, for example, there had been no derivative lawsuit, and the company had, say, tried to recoup its defense expense from the carriers directly in a declaratory judgment action, the Excess Side A carriers would have taken the position that because there was no nonindemnifiable loss, their policies were not implicated. The derivative lawsuit, asserting nonindemnifiable claims against the individual defendants, triggered the Excess Side A policies, which ultimately contributed a total of $40 million toward the settlement.

 

The fact that the Excess Side A carriers are contributing so significantly to this settlement is particularly noteworthy. When the options backdating scandal first arose and the wave of derivative lawsuits began to flood in, it was a topic of discussion in the industry whether the options backdating scandal might be the event that would break through and produce significant aggregate losses for the Excess Side A insurers. Whether or not other options backdating claims have hit Excess Side A insurers, the Broadcom options backdating derivative lawsuit settlement certainly did, and the Excess Side A insurers’ $40 million contribution toward the settlement in and of itself makes this settlement a noteworthy event.

 

With jumbo derivative settlements now a more frequent occurence, Excess Side A insurers could begin to accumulate substantial claims losses. The rising tide of corporate bankruptcies as a result of the global financial meltdown could also produce significant Excess Side A claims losses ahead. Both developments underscore the value to policyholders of the inclusion of this kind of insurance within their D&O insurance program.

 

I have in any event added the Broadcom options backdating-related derivative settlement to my chart of options backdating related case resolutions, which can be accessed here.

 

Citigroup Subprime ERISA Class Action Dismissed: Following close on the heels of his dismissal of the Citigroup subprime-related derivative lawsuit (about which refer here), on August 31, 2009, Southern District of New York Judge Sidney Stein granted the defendants’ motion to dismiss the Citigroup subprime-related ERISA class action as well. A copy of Judge Stein’s August 31 opinion can be found here.

 

The plaintiffs had alleged that the defendants had breached their fiduciary duties under ERISA in a number of ways, most significantly by offering Citigroup stock as an investment option even though defendants knew or should have known that Citigroup was an imprudent investment. Among other things, Judge Stein held that the Plan itself required the Citigroup stock to be offered as an investment option and therefore the defendants had no discretion in that regard.

 

With respect to the plaintiffs’ allegations that the defendants had failed to give complete and accurate information, Judge Stein held that the defendants did not have an affirmative duty to disclose financial information about Citigroup because ERISA fiduciaries are not required to provide investment advice, and to the extent the defendants did provide information about Citigroup it was not in their capacities as ERISA fiduciaries, and, in any event, "plaintiffs have failed to allege facts showing that the defendants knew the statements were misleading."

 

I have in any event added the Citigroup ERISA class action dismissal to my register of subprime and credit crisis-related case resolutions, which can be accessed here.

 

Special thanks to Courtney Scott at the Tressler, Soderstrom law firm for providing me with a copy of Judge Stein’s opinion in the ERISA class action suit.

 

• Email This
• Print
• Comments (2)
• Trackbacks
• Share Link

I found myself talking about options backdating for the first time in months yesterday, and it wasn’t just because of the Ninth Circuit’s blockbuster August 18, 2009 opinion (here) reversing and remanding for retrial the conviction of former Brocade CEO Gregory Reyes – although that certainly is a highly noteworthy development.

 

What triggered much the discussion was the publication in the yesterday’s Wall Street Journal of an article entitled "Backdating Likely More Widespread" (here), which caused several callers  to ask me whether I thought we might see a new wave of options backdating litigation. But while the academic research on which the Journal article was based is certainly interesting, I am skeptical that the new "revelations" will result in a renewed wave of options backdating lawsuits.

 

The Journal article is based on the August 16, 2009 study by University of Houston professors Rick Edelson and Scott Whisenant, entitled "A Study of Abnormally Favorable Patterns of Executive Stock Option Grant Timing" (here). The authors conducted the study because previously "no attempt" had been made "to first isolate a sample of specific companies that committed backdating and then to study the characteristics of such sample." The authors claim that their paper "demonstrates" that a "reliable sample of companies, with both disclosed and undisclosed backdating activities, can indeed be constructed," based on publicly available information.

 

The authors applied a complex probability technique to 4,008 companies with respect to which they had sufficient data, from which they were able to "extract" a sample of 141 companies that had "abnormally favorable patterns of stock option grants at a very stringent confidence level," many more than the two or so companies that would be expected to have this luck by chance.

 

The authors divided the 141 companies into the 49 companies that disclosed backdating and the 92 that have not. While prior research had shown that companies that disclose backdating suffered negative stock returns, the authors conclude that the companies that failed to disclose backdating suffered a higher rate of unfavorable stock market results, from which the authors further conclude that it was not public disclosure of the backdating that "drove the destruction of wealth associated with options backdating"; to the contrary, they conclude that "vigorous enforcement and disclosure" may "ameliorate backdating related losses."

 

The authors also conclude that higher market capitalization companies were substantially more likely to have disclosed backdating, which the authors suspect reflects regulators’ or other discovery mechanisms to be biased toward larger companies.

 

The authors’ conclusions are striking, which explains the Journal’s prominent discussion of the academics research (that and the fact that it is August and the new cycle is a little slow right now). As the Journal put it, the research suggests that "the majority of companies that improperly backdated stock options never were caught by regulators or confessed to the practice." The practice, the Journal observed, "might have been more widespread than thought at the time."

 

But while the authors’ research may be noteworthy, I strongly doubt that it will result in a wave of new backdating lawsuits. First and foremost, the authors’ report doesn’t name any names. Even though the Journal identified four of the companies, the other companies the authors identified as having undisclosed backdated stock options are not identified.

 

Second, as the Journal article mentions, the statute of limitations is highly relevant here. Much of the backdating took place before the Sarbanes-Oxley Act was passed, now over seven years ago. This temporal consideration underscores another important point, that this is really old news by now, and even the academics’ spin on the topic can’t change that. (More on this point below.)

 

Third, I can’t see the plaintiffs’ lawyers getting excited now to file a new round of options backdating cases. While there were some notable exceptions, by and large, many of the plethora of options backdating cases the plaintiffs’ lawyers scrambled to file between 2006 and 2008 didn’t turn out all that great for the plaintiffs.

 

Fourth, the kind of case that turned out particularly poorly for the plaintiffs was the purely statistically based "must have been backdating" kind of case. The courts proved skeptical of these kinds of allegations, but that is the very kind of case (and the only kind of case) the authors’ research would support. Indeed, the authors themselves are quoted as saying that their analysis is "purely statistical" and that the authors don’t claim "to provide categorical or absolute legal proof that any specific company engaged in backdating."

 

Would you want to take that case now if you were a plaintiffs’ lawyer – particularly if you knew that the case almost certainly would involve a smaller company and would have to be one other than the nearly 170 companies that were already sued. (Seriously, what would make anyone think the good cases are the ones that haven’t been discovered yet?)

 

My own view is that the whole backdating story has long since been exhausted, which is a factor that undoubtedly will have to be weighed in the prosecutorial decision of whether or not to retry Gregory Reyes. The backdating scandal had its time, but that time is long past. Indeed, the authors themselves acknowledge that based on their research, "backdating appears to have been substantially eliminated."

 

What’s the point of continuing to beat on this ancient topic now? In the words of the old Joan Baez song entitled Winds of the Old Days, "the 60s are over now, set him free." (A little anachronism there, but you get my point.)

 

And so, while I could be proven wrong, I don’t expect to see a bunch of new options backdating cases. Time will tell of course, but basically, the plaintiffs’ bar (and the rest of the world) has moved on to other things. As I have noted recently (here), the recent data strongly suggest that the plaintiffs’ bar already appears to be working off a backlog. I doubt they will rally to rake over the coals of a long dead scandal.

 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In the latest twist in the long-running options backdating saga, and in what appears to be a significant milestone in the options backdating-related gatekeeper claims, on June 15, 2009, Vitesse Semiconductor announced (here) that it had reached a settlement with its former auditor, KPMG LLP, in connection with the option backdating related allegations. In the settlement KPMG agreed to pay $22.5 million and to forgive past indebtedness.

 

As discussed at greater length here, in June 2007,Vitesse sued KPMG in Los Angeles County Superior Court alleging that KPMG had been negligent in auditing the company’s stock option grants and financial statements during the years 1994 to 2000. Vitesse later amended the complaint to include the years 2001 to 2004.

 

Vitesse itself had been the subject of an options backdating-related securities class action lawsuit in the Central District of California, as described here. Vitesse settled that lawsuit for a payment $10.2 million in cash, $8.75 million of which came from the company’s D&O insurance carrier, and the balance in payments from individual defendants. The settlement also included the transfer of shares of Vitesse stock from Vitesse and from the individual defendants.

 

The plaintiffs in the options backdating securities lawsuit had also sued KPMG and as reflected here, on June 16, 2008, the parties to the securities lawsuit filed a stipulation of settlement in which KPMG agreed to contribute $7.750 million toward the class settlement.

 

KPMG’s recent $22.5 million settlement of Vitesse’s own lawsuit is in addition to KPMG’s separate $7.750 million contribution to the settlement of the securities class action lawsuit.

 

As I recently noted (here), the options backdating securities class action lawsuits themselves appear to be winding down, but until word circulated of KPMG’s settlement with Vitesse, I had not heard of the resolution of any cases that companies themselves had filed against their outside professional advisors.

 

Even if there were prior outside gatekeeper settlements that I missed, the KPMG settlement with Vitesse has to be the most significant settlement between an outside gatekeeper and a company with respect to the options backdating scandal. It will be interesting to see whether the final stage of the options backdating saga includes further significant gatekeeper claim resolutions. Given the magnitude of the KPMG settlement, it would certainly seem that there could be other significant settlements and perhaps even the assertion of additional claims.

 

I would be very interested to know if readers are aware of the resolution of any other cases that companies have filed against their outside professionals in connection with the options backdating scandal.

 

As noted here, KPMG is also the subject of a trustee’s claim in connection with the New Century Financial Corp. bankruptcy proceeding. KPMG also remains a defendant in the New Century subprime-related securities class action lawsuit, after its motion to dismiss in that case was denied, as discussed here.

 

How Will GM Sell Cars Now?: General Motors certainly faces a daunting challenge trying to sell cars as a bankrupt company. I have posted a video link below of an irreverent but particularly funny take on what a bankrupt GM’s ads might look like. The spoof ad does a great job ripping conventional car ad clichés, which clearly won’t work now (if they ever did).

Hat tip to the Planet Money blog for the link to the video. Warning, the ad contains language some might consider offensive.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Remember options backdating? There is still a raft of unresolved options backdating cases out there, but at least one of the remaining options backdating related securities class action lawsuits has now been settled.

 

On June 9, 2009, Marvell Technology announced (here) that it has reached an agreement to settle the case for a payment to the class of $72 million. I have added the Marvell case to my table of options backdating case resolutions, which can be accessed here.

 

With the addition of the Marvell case, 27 of the 39 options backdating-related securities class action lawsuits have now been resolved. Nine have been dismissed and eighteen have been settled. Twelve of the 39 have not yet been resolved. A complete list of the options backdating lawsuits can be found here.

 

According to the Securities Litigation Watch "Options Backdating Scorecard" (here), the average options backdating class action settlement (including the Marvell settlement) $82.5 million, but if the $895 million UnitedHealth Group settlement is excluded, the average settlement (again including the recent Marvell settlement) $34.71 million, which suggests that the Marvell settlement was well above the prior adjusted average options backdating securities class action lawsuit settlement.

 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In a prior post (here), I discussed Judge William Alsup’s rejection of the proposed settlement of the options backdating-related derivative lawsuit involving Zoran Corporation, in which the parties had proposed to resolve the case without any cash payment to the company. A more recent case presents another example of a court’s similar unwillingness to approve an options backdating derivative lawsuit settlement in the absence of any cash payment to the company. The events ensuing after the settlement’s rejection represent a rather noteworthy and surprising outcome.

 

In a January 8, 2009 order (here), Judge Sam Sparks of the Western District of Texas rejected the proposed settlement of the Cirrus Logic options backdating-related derivative lawsuit. Judge Sparks first noted that "while the Settlement consists of no monetary benefit to Cirrus, it does include a provision by which Plaintiffs’ attorneys will be paid $2.85 million in fees by Cirrus’ insurer."

 

With respect to his obligation to determine that a proposed derivative settlement is "fair, reasonable and adequate," Judge Sparks said this "does not mean that the settlement must be fair to the attorneys (as the Stipulation of Settlement no doubt is) but that it must be fair in light of the corporation’s interests."

 

Judge Sparks went on to observe that the parties had "utterly failed to convince the court that it is fair."

 

Judge Sparks stated that the supposed "substantial benefits" were "for the most part, cosmetic." He found that the proposed governance reforms "appear far too meager." He added that "the Court simply is not convinced that the proposed reforms alone present any meaningful compensation to Cirrus for the extreme damages Plaintiffs claimed were suffered by the corporation as a result of the backdating." The proposed reforms "confer so little value" that that the settlement, Judge Sparks found, could only be approved "by showing that the suit brought by the Plaintiffs was virtually meritless."

 

The plaintiffs’ lawyers had argued that their proposed attorneys’ fees were "well within the range of attorneys’ fees paid in shareholder derivative backdating cases, especially given the substantial benefit to Cirrus brought through the prosecution of the Litigation." However, Judge Sparks said with respect to these proposed fees and their purported justification that

 

For obtaining a minimal (if not non-existent) benefit to Cirrus, Plaintiffs’ attorneys under the terms of the Stipulation of Settlement would earn $2.85 million in attorney’s fees for a suit that has been pending less than two years. Although the Court would prefer to give deference to all parties’ counsel’s views and opinions regarding whether the settlement is satisfactory given the risks of continued litigation, the Court simply cannot fathom (and was entirely unconvinced by Plaintiffs’ counsel at the hearing) how counsel feels they could have earned these fees. Viewed objectively, the attorneys are requesting top-dollar fees for their inability to be successful in this case. By approving this Stipulation of Settlement, the Court would be compensating Plaintiffs’ counsel handsomely and encouraging plaintiffs’ attorneys in the future to go on fishing expeditions against corporations. Sometimes when at [sic] attorney goes fishing he catches fish, and sometimes he does not – but when he does not he should not eat filet mignon afterwards.

 

Duly chastised by Judge Sparks’ vituperative rejection of their initial proposed settlement, the parties regrouped and on March 10, 2009, they submitted a revised proposed settlement stipulation (here).

 

The revised settlement not only includes significant alternations to the proposed governance reforms, but also provides that Cirrus’ D&O insurer will pay its "remaining Limit of Liability" of $2,850,000 directly to Cirrus, "in consideration of which Plaintiffs and Plaintiffs’ Counsel will waive and relinquish any claim for attorneys’ fees and expenses."

 

Although Judge Sparks’ January ruling rejecting the initial proposed Cirrus settlement makes no reference to Judge Alsup’s earlier rejection of the Zoran settlement, both decisions are very much in the same vein. (To be sure, Judge Alsup’s rhetoric, replete with words such as "collusive" is more heavily freighted than that of Judge Sparks, although the outcome in both cases was more or less the same.)

 

Certainly, both opinions underscore the fact that courts take their responsibilities to absent class members very seriously and in particular that courts will take a dim view of proposed settlements in which plaintiffs’ attorneys’ reap substantial fees but in which the purportedly harmed corporation receives no monetary benefit.

 

The surprising finale in the Cirrus Logic case, in which plaintiffs’ attorneys wound up waiving their fee in order to complete the settlement, highlights how critical it may be for plaintiffs’ attorneys to be able to demonstrate in the first instance that it is the corporation and not the attorneys that benefit the most from a proposed settlement.

 

I noted in my prior discussion of Judge Alsup’s rejection of the Zoran settlement that there may be an increasing sense in which the plaintiffs’ attorneys seem to be growing weary of the options backdating cases and indeed may just want them to go away. The plaintiffs’ attorneys’ willingness to resolve the Cirrus Logic case without any provision for the payment of their own fees would certainly seem to corroborate this point. Whether or not the plaintiffs’ attorneys want the options backdating cases in general to go away, the specific lawyers in the Cirrus Logic case pretty clearly were committed to bringing an end to that particular case. Given some of Judge Sparks’ comments, who could blame them?

 

I have in any event added the revised proposed Cirrus Logic settlement to my updated table of options backdating settlements and case resolutions, which can be accessed here.

 

Special thanks to a loyal reader for a copy of Judge Sparks’ January 8 opinion.

 

Curses, Foreclosed Again: It may be supposed that growing wave of residential mortgage foreclosures is sufficiently awful that there would be no need for further dramatization. However, that supposition fails to reckon with Hollywood’s capacity to sensationalize anything, even something as banal as a bank officer’s decision to foreclose on an overdue mortgage. 

 

"Drag Me to Hell," a new movie by Sam Raimi, the director of the "Spiderman," involves a young bank office (Alison Lohman) who, in order to show herself worthy of a promotion, decides to foreclose on a home owned by a frail eldely woman. In response, the old woman lays a curse on the bank officer, whose career and life suddenly becomes very dark and gruesome. The ensuing mayhem may somehow be metaphorical of the financial chaos in which we all find ourselves.

 

I have linked below to a trailer for the movie. After viewing the trailer it may be unnecessary to actually see the movie, which in at a time when everybody is trying to save a few bucks may be good thing. However, the movie itself may be too dark to satisfy any populist need for vengence on supposely cruel and insensitive banks.

 

Hat tip to the NPR Planet Money blog (here) for the link to the trailer.

 

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

On March 9, 2009, in a short but strongly worded opinion, Judge Andrew Guilford of the Central District of California dismissed with prejudice the third amended complaint in the subprime-related securities class action lawsuit filed against Impac Mortgage Holdings. A copy of the opinion can be found here.

 

Background

As discussed here, on October 6, 2008, Judge Guilford had dismissed plaintiffs’ second amended complaint with leave to amend. Plaintiffs filed their third amended complaint on October 27, 2008, and the defendants renewed their motion to dismiss.

 

The third amended complaint essentially alleged that contrary to the company’s public statements and to the company’s own underwriting guidelines, the company’s Alt-A loans were being sold to less creditworthy borrowers, so that the Alt-A loan portfolio was as risky as a portfolio of subprime mortgages. The plaintiffs further alleged that at the same time, the company misrepresented its true financial condition by its failure to write down the value of its loan portfolio. Further background regarding the lawsuit can be found here.

 

The March 9 Opinion

In his March 9 opinion, Judge Guilford noted that the in opposing dismissal the plaintiffs had quoted from the court’s opinion in the New Century case denying the motion to dismiss (about which refer here), contending that this case, like the New Century case, is about a "staggering race-to-the-bottom of loan quality and underwriting standards as part of an effort to originate more loans for sale through secondary markets."

 

Judge Guildford said that he "disagrees" with this characterization, noting that in his view, "this case is about a company involved in a volatile industry at the onset of a long, destructive economic downturn."

 

The specific basis on which Judge Guilford granted the motion to dismiss is his finding that the third amended complaint "fails to plead a strong inference of scienter." He found that the former employees’ statements on which the plaintiffs relied were just "vague accusations and conjecture." The third amended complaint’s reference to follow due diligence or loan guidelines were just generalizations lacking connection to specific actions or events.

 

The plaintiff had also relied on the "core operations inference" to try to satisfy the scienter requirement. While noting that there may be rare instance in which an event is so prominent that it would be "absurd" to suggest that key officers lacked knowledge of it, this, Judge Guilford found, was "not one of those exceedingly rare cases."

 

Discussion

Judge Guilford’s opinion joins a growing list of subprime and credit crisis-related securities lawsuits in which dismissal motions have been granted. (To access my running scorecard of subprime and credit crisis-related securities lawsuit settlements, and dismissal motion denials, refer here.) To be sure, there have also been a number of cases, including some higher profile cases – particularly the Countrywide case (about which refer here) and the New Century case (refer here) – where dismissal motions have been denied.

 

However, Judge Guilford’s express rejection of the Impac plaintiffs’ attempt to compare their case to the New Century case, and to use that as a way to avert dismissal, may suggest the constraints that plaintiffs in other cases may face in trying to rely on the Countrywide and New Century dismissal motion denials.

 

It should be noted that relatively few of the dismissal motion denials thus far have been with prejudice. Indeed, of the dismissals granted, only the Impac dismissal and the dismissal in the NovaStar Financial case (about which refer here) have been with prejudice. However, in both of those cases, the courts seemed particularly concerned with the fact that defendant companies had been caught in an industry-wide or even economy wide downturn, and as a result were openly skeptical of plaintiffs’ claims of fraud.

 

It is still too early to generalize about how these cases are faring or will fare overall, as most of them are only in their earliest stages. But at a minimum it appears that some courts, fully aware of the global financial turmoil, are viewing at least certain of these cases with skepticism. By the same token, there have been courts that have found the plaintiffs’ initial pleadings to be sufficient to survive a motion to dismiss.

 

Judge Guilford’s refusal to consider the core business operations inference stands in contrast to the opinion denying the motion to dismiss in the RAIT Financial subprime-related securities case, where the court held that the allegations regarding the defendant company’s core business operations were adequate to satisfy the scienter requirement. As I noted in my discussion of that ruling (here), earlier courts had rejected this theory as inconsistent with the PSLRA’s pleading requirements, but more recently courts, for example, in the Ninth Circuit (refer here) and the Seventh Circuit (refer here), have taken it up. As noted in a recent commentary by the Katten Muchin law firm entitled "Reform Act Under Attack?" (here), the core operations theory "has made a comeback in 2008," which the authors contend is inconsistent with the PSLRA’s meaning and intent.

 

In any event, I have added the Impac dismissal to my list of subprime and credit crisis securities lawsuit resolutions, which can be accessed here.

 

The "Ultimate Solution" to Corporate Financial Misconduct?: In a March 10, 2009 press release (here), Fuwei Films, a China-based plastic films manufacturer whose shares trade on Nasdaq, reported that it had "become aware" of an "initial verdict" by the Jinan Intermediate People’s Court, in the city of Jinan, in the Shandong province. The verdict related to an action brought against three major shareholders of the company, for misappropriation of state-owned assets worth tens of millions of renminbi, during the reorganization of Shandong Neoluck Plastics. The three shareholders were identified as Mr. Jun Yin, Mr. Tongju Zhou, and Mr. Duo Wang.

 

According to the press release, the verdict found the three individuals guilty of the charges. The court "sentenced Mr. Yin to death, with a stay of execution of two years." The other two defendants received life imprisonment. The court will transfer to the Chinese government all of the personal property of the three defendants, including their holdings in two entities that owned approximately 65% of Fuwei’s common shares.

 

The press release stated that "none of these individuals is currently involved in Fuwei’s day-to-day operations."

 

Prospective investors will be happy to know that with this bit of unpleasantry put to rest, the company will now "be able to focus exclusively on executing Fuwei’s strategy to emerge from the current economic crisis." In light of the court-ordered ownership change, it is probably good that the company added that "we believe the Chinese government will support our long-term growth."

 

Special thanks to a loyal reader for the link to the Fuwei press release.

 

Options Backdating Update: The Securities Litigation Watch has updated (here) its helpful scorecard of the options backdating-related securities lawsuits. As reflected in the scorecard itself (here), of the 39 options backdating related securities lawsuits, 26 have now been resolved – nine have been dismissed and 17 have settled.

 

According to the Securities Litigation Watch, the average settlement for these cases is $83.1 million. However, if the largest settlement (United Health) is removed, the average is $32.37 million, which is roughly line with the overall average class action settlement level noted by Cornerstone in its recently released study of securities lawsuit settlements.

 

My own detailed running tally of the options backdating lawsuits settlements and dismissal motion grants and denials can be accessed here.

 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Among the many lawsuits that have flooded in as part of the subprime and credit crisis litigation wave has been a profusion of lawsuits against the mortgage-backed securities issuers and their securities offering underwriters. These lawsuits, typically filed under the ’33 Act and alleging misrepresentations in the offering documents, claim that investors who purchased securities in the offering have been harmed due to the deterioration in the performance of the underlying mortgages.

 

As discussed below, questions about the damages claimed in these lawsuits could present serious hurdles as the cases go forward.

 

Background

A recent example of the class action securities litigation filed on behalf on investors in these mortgage-backed securities investments may be found in the January 26, 2009 press release (here) in which the plaintiffs’ lawyers described the lawsuit they filed in the Eastern District of New York against Deutsche Alt-A, Inc., and certain other defendants in connection with the offering of mortgage-backed pass-through securities by 32 mortgage loan trusts.

 

As described in the press release, the complaint (here) alleges that the offering documents failed to disclose that:

 

sellers of the underlying mortgages to Deutsche Alt-A were issuing many of the mortgage loans to borrowers who: (i) did not meet the prudent or maximum debt-to-income ratio purportedly required by the lender; (ii) did not provide adequate documentation to support the income and assets required to issue the loans pursuant to the lenders’ own guidelines; (iii) were steered to stated income/asset and low documentation mortgage loans by lenders, lenders’ correspondents or lenders’ agents, such as mortgage brokers, because the borrowers could not qualify for mortgage loans that required full documentation; and (iv) did not have the income or assets required by the lenders’ own guidelines necessary to afford the required mortgage loan payments, which resulted in loans that borrowers could not afford to pay.

 

The complaint alleges as the underlying mortgages have deteriorated, "the Certificates are no longer marketable at prices anywhere near the price paid by plaintiff and the Class and the holders of the Certificates are exposed to much more risk with respect to both the timing and absolute cash flow to be received than the Registration Statement/Prospectus Supplements represented."

 

 

This case is only one of several recent lawsuits in which the same or similar allegations have been raised. Plaintiffs’ lawyers have raised similar allegations against, for example, mortgage-backed pass through certificates sponsored by JP Morgan Acceptance Corporation (refer here); mortgage backed securities sponsored by GS Mortgage Securities Corp. (refer here); mortgage pass-through certificates sponsored by Washington Mutual (refer here); and mortgage-pass through certificates sponsored by Residential Asset Securitzation Trust (refer here). By my count, there have been more than a dozen of these types of lawsuits filed in connection with the current subprime and credit crisis-related litigation wave.

 

Like many of these cases, the Deutsche Alt-A case was originally filed in state court, and removed by defendants to federal court. (The removal petition, which accompanies the complaint, can be found here.) The federal court subsequently denied the plaintiffs' motion to have the case remanded to state court, in this case on the relatively narrow and specific ground that that one of the entities that originated the underlying mortgages, American Home Mortgage Corporation, is in bankruptcy in the federal court in Delaware, and the securities case is related to the bankruptcy proceeding. A copy of the January 8, 2009 opinion denying the remand motion can be found here.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the removal petition and complaint in the Deutsche Alt-A case.

 

Damages Analysis

In each of these cases, the harm claimed is similar to that alleged in the Deutsche Alt-A case; that is, that as a result of problems associated with the underlying mortgages, the securities are "no longer marketable at prices near the price paid" and the holders are exposed to much more risk with respect to the timing and absolute cash flow."

 

These allegations raise some interesting and perhaps novel questions, as discussed in a January 2009 article from the Milbank Tweed law firm entitled "Subprime Litigation Against Issuers and Underwriters of Mortgage-Backed Securities—Where are the Actual Losses?" (here).

 

As the memo notes, these lawsuits embody "the relatively untested assumption" that the current paper value of these securities is "the appropriate reference point" for determining whether the investors have "suffered a loss that is ripe for litigation (and the extent of any such loss)."

 

The authors note that these securities are not listed on any public exchanges, but rather all trades are privately negotiated. The securities themselves are essentially contracts that entitle the owner to certain portions of principal and interest from the pools of mortgages that serve as collateral for the securities. The securities also have various forms of credit enhancement, such as overcollateralization, subordination and excess spreads, so that defaults on the underlying mortgages will not necessarily trigger a default on the payment obligations on the securities themselves.

 

As a result, an investor could continue to receive payments under the securities as scheduled, even if GAAP accounting might require the carrying value of the securities to be reduced.

 

These circumstances lead the authors to ask

 

Is the fear that certain tranches of the [mortgage backed securites] might not be paid in full a sufficient basis for brining a claim under the ’33 Act? Is such a claim a ripe case or controversy for the courts? And is the fact that some "paper measure of price" for the [mortgage backed securities] tranche has declined since the time of purchase enough to overcome these hurdles?

 

In considering these questions, the authors note that the typical offering documents for these kinds of securities expressly warn that a secondary market for the securities may not exist and that investors may not be able to sell the securities at the price they hope to obtain. For most investors in these types of securities, this consideration is generally of less concern, because the investors "expect to make money by holding the bond through maturity and receiving the income stream they bargained for, not by trading on a secondary market."

 

Nevertheless, the lawsuits relating to these securities claim damages based on the decline in their valuation and the fears that payments may be at "risk" in the future. The memo reviews the well-publicized difficulties associated with valuing these securities, and notes the probable lack of valuation uniformity among holders of these securities, given the flexibility of the relevant accounting standards. As a result, the securities holders may face challenges in establishing with sufficient certainty that they have suffered an "economic loss," as the securities laws arguably require. These difficulties are particularly where, as is the case with many of these securities, the investors continue to receive all payments due to them.

 

The authors suggest that generally there is no basis in law for seeking damages where the damages cannot be quantified and may never come to pass. They suggest that defendants in these cases will attempt to argue based on these principles that investors "who continue to be paid the full amount of any principal and interest payments due to them may have little choice but to ‘wait and see’ whether feared, modeled, or projected losses…come to fruition (i.e., become ‘clear and definite’) before being able to state claims under the securities laws."

 

The authors add that this argument may be particularly compelling where "intervening events such as legislative or executive action….could drastically alter the future payment outlook for many mortgage-backed securities."

 

These lawsuits against the issuers of mortgage-backed securities represent a significant number of the subprime securities lawsuits. Plaintiffs’ lawyers seem inclined to file these lawsuits, undoubtedly in part due to the degree of investor concern about their investments. Whether and to what extent these cases ultimately will succeed remains to be seen. As the law firm memo demonstrates there may be a host of questions surrounding these lawsuits. At a minimum it will be interesting to see what the courts make of these cases, and in particular the alleged damages, as the lawsuits proceed.

 

A more academic overview of many of these issues may be found in the paper Harvard Law School professor Allen Ferrell and Babson Business School Professors Jennifer Bethel and Gang Hu entitled "Legal and Economic Issues in Litigation Arising from the 2007-2008 Credit Crisis" (here).

 

Largest FCPA Penalty Ever Against U.S. Company: Fast on the heels of Siemens recent agreement to pay $800 million to settle bribery allegations (about which refer here), Halliburton has now agreed to pay $559 million to settle charges that one of its former units bribed Nigerian officials during the construction of a gas plant.

 

According to Halliburton’s January 26, 2009 press release (here), Halliburton has agreed to pay $382 million to the U.S. Department of Justice in eight installments over the next two years. In addition, Halliburton agreed to pay the SEC $177 million in disgorgement. Both settlements are subject to final approval by the relevant authorities.

 

As reported on the WSJ.com Law Blog (here), the Halliburton penalty is by far the largest ever for a U.S. company, far surpassing the prior record of $44 million by Baker Hughes in 2007. More detail about the Halliburton agreement can be found on The FCPA Blog (here).

 

The Halliburton settlement is further evidence of a point I have made numerous times on this blog, that FCPA enforcement activity represents a growing area of concern. As I discussed most recently here, an important part of this exposure is the threat of civil litigation that frequently follows on after the enforcement proceeding. The sheer magnitude of the Siemens and Halliburton settlements suggest that potential FCPA liability could represent a significant exposure for corporations and their directors and offices.

 

Blast from the Past: Another Options Backdating Settlement: The options backdating cases are a vestige from another time and place, yet they remain, like so much cosmic dust, reminders of a distant catastrophe. In a recent development in one prominent case, the Delaware Chancery Court has approved a settlement that is noteworthy in at least a couple of respects.

 

As reflected in a January 2, 2009 opinion by Chancellor William Chandler in the Ryan v. Gifford case (here), the court has approved the settlement of the options backdating case involving Maxim Integrated Products, over shareholder objections. Under the settlement, which is detailed in the opinion, the defendants agreed to pay a total of $28,505,473 in cash. In addition, the defendants agreed to cancel, reprice or surrender claims with respect to certain options they continued to hold. The company also agreed to certain corporate governance reforms.

 

The settlement is noteworthy in a couple of respects. The first is simply that it involves the Ryan v. Gifford case, in which Chandler had written an influential and important February 2007 opinion denying the defendants’ motion to dismiss (as discussed here). Because of this opinion, the case is among the more prominent of the options backdating cases.

 

The other noteworthy aspect of the settlement is the individual defendants’ significant contribution toward settlement. Of the $28.5 million settlement amount, $21 million was paid by insurance. The balance of the cash was paid by the individual defendants. John Gifford, the company’s former CEO, agreed to make his own cash payment of $6 million to Maxim, even though, as the Court noted, he was "covered by insurance." The court’s statement in this respect seems to suggest that there were additional insurance funds available to fund this amount, but that as part of the settlement Gifford nevertheless agreed to pay this amount out of his own assets. Other individuals agreed to pay lesser amounts.

 

It is not entirely clear whether the insurance would in fact have covered the amounts of these individual payments. For example, in connection with the payments by the individuals other than Gifford, the court noted that the amounts paid "represent the entire amount that they were alleged to have benefitted from the exercise of backdated stock options." To the extent these amounts represent disgorgement or return of ill-gotten gains, the policy’s coverage would not apply. The court’s opinion is not as specific with respect to Gifford’s payment, but to the extent his contribution also represents his return of benefits from the exercise of backdated options, the insurance coverage similarly would not likely apply.

 

In any event, the size of the settlement, the prominence of the case and the significance of the individuals’ contributions make this a noteworthy settlement. I have added the settlement to my list of options backdating lawsuit settlements, dismissals and dismissal motion denials, which can be accessed here.

 

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

We interrupt our regularly scheduled stream of dispatches from the credit crisis front to provide a quick update on the now seemingly remote options backdating scandal. Even though the whole world has moved on and though options backdating pales by comparison to what followed, many options backdating cases continue to grind on. At least a couple of these cases recently settled, and there appear to be many more yet to come.

 

First, on December 11, 2008, Amkor Technologies announced (here) that it had reached an agreement to settle the option backdating-related securities class action lawsuit that had been filed against the company and certain of its current and former directors and officers in connection with the company’s historical stock option practices. Background regarding the lawsuit can be found here.

 

According to the company’s press release, the plaintiffs have agreed to dismiss the case in exchange for a payment of $11.25 million. The company said that its directors and officers liability insurance carrier has agreed to pay $9 million of the settlement amount and the company will pay the balance.

 

Second, and also on December 11, 2008, the parties to the options backdating-related shareholders’ derivative suit filed against Foundry Networks, as nominal defendant, and certain of its directors and officers, filed a notice of a proposed settlement (here). According to the parties’ filing, the company will receive cash payments of $2.117 million, of which $1.637 represents payments from the individual defendants and $400,000 represents payments from the company’s insurer. Certain shares granted to certain individuals have been repriced and the company also agreed to certain governance changes. The company also agreed to pay plaintiffs’ attorney’s fees and expenses of $1.2 million.

 

I have added these two settlements to my running table of options backdating-related lawsuit settlements, dismissals and motion denials, which can be accessed here. The Amkor settlement is, by my count, the sixteenth options backdating-related securities lawsuit settlement, and approximately six of the cases were also dismissed. Given that there were according to my count (refer here) 39 options backdating-related securities lawsuits filed in total, there still may be as many as 17 of these cases yet to be resolved.

 

The individuals’ cash contribution toward the Foundry Networks settlement, if not indemnified, would represent an unexpected element, as it remains an unusual settlement element for directors and officers to make cash settlement contributions out of their own assets.

 

OK, enough about that. We now resume our regularly scheduled programming, which is already in progress.

 

California Countrywide Subprime-Related Derivative Case Dismissed: In a December 11, 2008 order (here), Judge Mariana Pfaelzer dismissed the Countrywide subprime-related derivative case pending in the Central District of California.

 

Judge Pfaelzer previously had denied the defendants’ motion to dismiss the derivative case, in a strongly worded May 2008 opinion (about which refer here). However, in July 2008, Bank of America acquired Countrywide in a stock for stock merger. As a result, and as discussed here, in October 2008, the Delaware federal court dismissed the parallel Countrywide subprime-related derivative case pending in that court, because of the plaintiffs’ lack of standing to pursue the claim owing to the plaintiffs’ inability to show "continuous ownership" due to the BoA transaction.

 

The plaintiffs in the California Countrywide subprime-related derivative case argued that, notwithstanding the merger, they could still satisfy the "continuous ownership" rule and therefore still had standing based on a merger-related exception to the rule recognized in the Ninth Circuit. After detailed consideration of Erie Doctrine issues, Judge Pfalzer declined to exercise equitable powers associated with the merger-related exception, and granted the defendants’ motions to dismiss the derivative claims due to the plaintiffs’ lack of standing.

 

Judge Pfaelzer’s ruling on the derivative claims was without effect on the plaintiffs’ merger related class claims, which she previously had stayed in favor of parallel proceedings pending in Delaware Chancery Court. In addition, the Countrywide subprime-related securities class action lawsuit remains pending before Judge Pfaelzer, as a result of her recent dismiss motion denial in that case, discussed here.

 

In any event, I have added the dismissal of the California Countrywide Derivative lawsuit to my list of subprime lawsuit settlements, dismissals and motions denials, which can be accessed here.

 

Special thanks to Michael Delhegan of the Tressler Soderstrom firm for providing a copy of Judge Pfalzer’s December 11, 2008 opinion.

 

Standalone Insurance for Independent Directors: In prior posts (most recently here), I have noted the considerations that may militate in favor of standalone insurance protection for independent directors. In a December 12, 2008 memorandum entitled "Independent Directors Require Additional Protection in Financial Crisis Litigation" (here), the Baker & McKenzie firm suggests that "there is an increasing interest by independent directors in coverage that protects only a company’s independent or outside directors, not its officers."

 

The memo reviews the origins of IDL insurance and examines why "it may be a useful tool for both attracting high quality independent directors, and as a means of protecting and retaining the best talent." Among other reasons suggesting the need for IDL protection is the increasing susceptibility of traditional D&O insurance limits to erosion or depletion through defense expense or indemnity protection for other persons insured under the D&O policy, a phenomenon on which I previously commented here.

 

More About the NY Insurance Commissioner’s Recent Opinion: In a recent post (here), I commented on the recent opinion of the New York Insurance Commissioner’s office requiring D&O insurance policies to incorporate a duty to defend. The opinion and its implications are reviewed at greater length in a December 2008 Client Advisory from the Edwards, Angell, Palmer & Dodge law firm entitled "The New York Insurance Department Will No Longer Approve D&O Policies Lacking ‘Duty-to-Defend’Coverage Feature" (here).

 

This memo contains a detailed analysis of the opinion and raises a number of important considerations about what the opinion does and does not mean. The memo also notes difficulties that carriers may face as the attempt to adapt to the opinion, and also suggests alternative responses available to the carriers, including seeking legislative relief.

 

Special thanks to John McCarrick of the Edwards Angell firm for sending along a copy of the memo.

 

And Finally: By far the best thing I have seen written on the Madoff scandal is the column that Wayne State Law Prof. Peter Henning wrote as a guest column on the DealBook blog, here.

 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

As I noted in a prior post (here), NERA Economic Consulting, in a May 15, 2008 paper (here), had asked the question whether options backdating-related securities class action lawsuits were settling for less than data from prior class action settlements would predict. In the May 15 paper, looking at the settlements to date, NERA found that the options backdating-related securities lawsuit settlements were well below predicted amounts.

 

NERA has now published an October 22, 2008 paper (here) that revisits its earlier analysis in light of intervening options backdating-related securities settlements.

 

With respect to the previously observed expectations gap, NERA had hypothesized in its earlier paper that either suits alleging backdating are generally viewed as weaker or the weakest cases had simply settled most quickly.

 

In its most recent paper, NERA revisits these hypotheses in light of three recent settlements – Brocade Communications, UnitedHealth Group and Monster Worldwide – finding that there may be support for the conclusion that the initial settlements may have been low because the weakest cases settled first. In these three more recent dispositions, the settlements were either at or well above predicted ranges. Indeed, NERA found that the UnitedHealth Group case was as much as five times greater than the predicted amount.

 

At the same time, NERA noted that four of the more recent settlements were more consistent with prior observations, in that the settlements were below predicted ranges.

 

In its earlier report, NERA had concluded that on average the options backdating cases were settling for about 38% of the predicted amount. With the addition of the intervening settlements the average settlement is up to about 74% of predicted amounts. However, this increase is largely driven by the inclusion of the UnitedHealth Group settlement. Without the UnitedHealth Group settlement, the average of the options backdating settlements drops to 43% of the predicted amounts.

 

Nevertheless, based on its analysis (and I am simplifying here), NERA still cannot reject the hypothesis that options backdating-related securities settlements are on average no different than settlements in non-backdating cases with similar level of investor losses and other similar traits.

 

NERA notes that of the overall options backdating-related securities lawsuits, 17 remain to be settled, which represents a larger group of cases than the 15 cases that have settled to date. It remains to be seen whether or not these remaining cases will or will not settle within expected ranges.

 

My table showing all options backdating related case dispositions, including settlements and dismissals both for all options backdating-related securities lawsuits and options backdating related derivative lawsuits, can be found here.

 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

From the earliest days of the options backdating scandal, one of the recurring questions has been the potential extent of outside director liability exposure (refer, for example, here). On September 17, 2008, In a development that may also have significant implications for more recent events, the SEC filed settled options backdating-related charges against three former outside directors of Mercury Interactive.

 

A copy of the SEC’s September 17 press release regarding the settled charges can be found here. A copy of the Complaint can be found here.

 

 

The SEC’s complaint alleges that the three outside directors “recklessly approved backdated stock option grants, and reviewed and signed public filings that contained materially false and misleading disclosures about the company’s stock option grants and company expenses.”

The complaint alleges that the three individuals approved 21 backdated stock option grants between 1997 and April 2002. The complaint alleges that the three were aware that options with an exercise price lower than the date on which the options were actually approved created a compensation expense. Nevertheless, the complaint alleges, they repeatedly executed stock option documents while “failing to observe, among other things, that the exercise price of stock options they were approving was less than the market price of the company’s stock at the time of approval.”

 

 

The three individuals are alleged to have routinely signed unanimous consents “despite being presented with numerous facts and circumstances indicating that management was backdating option grants.” In addition to signing options grants made with earlier “as of” dates, on a few occasions the three “signed multiple written consents presented to them by management for the same grant with different grant dates that had more favorable prices.”

 

 

Without admitting or denying the allegations, the three agreed to permanent injunctions and each will pay a $100,000 financial penalty to settle the charges.

 

 

In light of the current circumstances, in which scapegoat hunting is in high gear, the SEC enforcement division’s statements about outside director liability may be instructive. SEC enforcement division director Linda Thomsen is quoted as saying, among other things, that “today’s action serves as further notice that misconduct by outside directors, as well as company management, will not be tolerated.”

 

 

Another enforcement division official is quoted as saying that, even though they understood how options expensing worked, “time and again, directors approved in-the-money option grants that had been backdated” and that the directors “recklessly approved option grants despite numerous facts and circumstances indicating to them that the grant dates they were approving were improperly backdated.”

 

 

While options backdating enforcement actions may seem like yesterday’s news (or even the day before yesterday’s news), these developments have significance today. If nothing else, they demonstrate the SEC’s willingness to pursue enforcement actions against outside directors, at least in certain circumstances, particularly if apparently knowing and active violations are involved.

These developments also underscore the continuing liability exposures to which outside directors potentially may be subject, and the need to address these exposures as part of any well-designed directors’ and officers’ liability insurance program. The SEC’s willingness to pursue outside directors for options backdating-related violations also suggests that today’s even more dramatic circumstances potentially could involve significant outside director liability exposure. The SEC’s interest in the possibility must be presumed.

 

 

Some readers may want to know what happened to the Mercury Interactive managers that proposed the backdating options for the directors’ approval. The SEC previously filed civil fraud charges against the company and four former officers (refer here). The company agreed to pay a $28 million penalty. The case against the former officers remains pending. A securities class action lawsuit arising from the Mercury Interactive options backdating allegations settled for $117.5 million (about which refer here).

 

UPDATE: The Race to the Bottom blog has an interesting post (here) discussing the SEC enforcement proceeding against Mercury Interactive's outside directors. Professor Brown suggests that this case represents another instance where federal regulatory authorities may be creating federal standards of director conduct, in a gradual preemption of state law.

 

 

Despite Settlements, Auction Rate Lawsuit Proceeds: Following the recent high-profile auction rate securities settlements, one of the unanswered questions was what impact the settlements would have on the previously pending auction rate securities lawsuits. There are still no definitive answers. But, notwithstanding the settlements, at least one auction rate securities lawsuit is going forward.

 

 

As reported in the September 17, 2008 Wall Street Journal (here), Judge Gary Sharpe of the Northern District of New York has ruled that they auction rate securities lawsuits that Plug Power filed against UBS can go forward notwithstanding UBS’s recent $19 billion action rate securities buy-back settlement. A copy of the transcript of the September 17 hearing in the case can be found here. (Hat tip to the Wall Street Journal Law Blog, here, for the transcript link.)

 

 

According to Plug Power’s Amended Complaint (here), the company had alleged that, based on supposed assurances that the auction rate securities investments were safe and liquid, the company had bought $62.9 million in auction-rate securities backed by student loans. After the market for the securities seized up in February 2008, the company was (and remains) unable to liquidate its investments. The securities make up nearly half of the company’s investment portfolio.

Under the UBS auction rate settlements, institutional investors’ securities are expected to be bought back in 2010. The Journal quotes Plug Power’s attorney as saying that “we need the funds before 2010 and they’re not providing us a guarantee that they will be able to pay out.”

 

 

The disfavored position of institutional investors is one of the features of the auction rate securities settlements I noted at the time (refer here). Other institutional investors may be motivated similarly to Plug Power to proceed with litigation notwithstanding the buy back settlements. And the September 17 ruling in the Plug Power case suggests that at least some of the cases may go forward notwithstanding the settlements.

 

 

As noted in a September 18, 2008 post on the Securities Docket (here), plaintiffs’ attorney Daniel Girard of the Girard Gibbs law firm argues that private litigation still has a role to play in the auction rate securities debacle. He points out that many billions worth of these investments are not yet part of any settlement and that even with regard to the securities covered by the settlements, it will be a considerable time before the buybacks kick in (this in connection with investments that supposedly were liquid and just like cash.).

 

 

BAE Systems Lawsuit Dismissed: In prior posts discussing civil litigation arising out of corrupt practices investigations (for example, here) one of the cases to which I have frequently referred is the derivative lawsuit filed in the District of Columbia by shareholders of BAE Systems. (For background regarding the BAE Systems case, refer here and here).

 

 

In a September 11, 2008 opinion (here), Judge Rosemary Collyer dismissed the BAE Systems derivative lawsuit on the grounds that the plaintiff lacked standing to bring the lawsuit.

The court’s ruling, while narrow, is interesting. The court held that as a result of the “internal affairs doctrine,” the law of the United Kingdom (the country in which BAE Systems is incorporated) governs the case. Under U.K. law, beneficial owners of a company’s securities lack standing to sue derivatively.

 

 

The plaintiff in the derivative suit did not directly own BAE systems shares but rather owned American Depositary Receipts (ADRs) as a result of which its ownership is merely beneficial under U.K. law. Accordingly, the plaintiff lacks standing to sue derivatively under U.K. law, and the court granted the defendants’ motion to dismiss.

 

 

Even though the court’s holding is narrow, it is significant in at least one respect. That is, it underscores the numerous potential obstacles that any plaintiff will face in attempting to use U.S. courts to assert civil liability in connection wtih a foreign domiciled company’s allegedly corrupt activities. Notwithstanding these obstacles, however, I continue to believe that the threat of civil litigation arising from corrupt practices investigations remains significant.

 

 

As the Wall Street Journal noted in its September 12, 2008 article entitled “U.S., Other Nations Step Up Bribery Battle” (here), anticorruption enforcement activity is an increasingly important prosecutorial priority worldwide, in which cross-jurisdiction cooperation is an increasingly important factor. As prosecutorial activity affects an increasing number of companies, investor interest n recovering civil damages for alleged harm to companies from the allegedly corrupt practices will continue to grow.

 

 

Special thanks to a loyal reader for the link to the BAE Systems decision.

 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

According to news reports (here), on September 8, 2008, Judge Jeremy Fogel of the Northern District of California preliminarily approved the settlement of the Apple options backdating derivative litigation.

 

As reflected in the parties’ Stipulation of Agreement of Settlement (here), the plaintiffs in the consolidated Apple derivative action agreed to dismiss the action subject to the defendants agreement to pay $14 million to the company; the defendants’ agreement to pay the plaintiffs’ counsel’s various attorneys’ fees and costs totaling $8.85 million; and the company’s agreement to adopt certain corporate governance reforms. According to the Stipulation, the various derivative lawsuits "were a material factor in obtaining the $14 million payment from Apple’s liability insurers." The total cash value of the various payments is $22.85 million.

 

UPDATE: An alert reader has raised an important question about my statement that the total cash value of this settlement is $22.85 million. The reader said the following in an e-mail to me: "You describe the settlement as involving a cash payment of $22.85 million based on the $14 million D&O settlement paid to Apple and the $8.85 million fee award expense payment made by Apple to the plaintiffs. However, as a practical matter aren't you 'double counting' since, presumably, the plaintiff fee awared was paid by Apple from the D&O proceedsit received from its carriers?"

 

Assuming this reader's analysis is correct, this is a very important distinction. The Stipulation of settlement is consistent with the reader's hypothesis, but not definitive. The Stipulation is clear that the $14 million payment is coming from Apple's D&O carriers. It also says that the $8.85 million is to be paid by Apple. It is not clear whether or not the D&O insurers will be reimbursing Apple for the $8.85 million or if the $14 million is the only payment that the D&O insurers will be making in connection with the settlement. It would be helpful if any reader with more specific knowledge of the insurance arrangements pertaining to this settlement would let me know.

This reader's question also suggests another component that is relevant to these insurance issues but that is not addressed in the Stipulation, and that is the question of defense expense. In a case like this where there are regulatory proceedings and special litigation committee activities as well as civil litigation, there frequently are disputes about which defense fees are covered and which are not. In a case like this one, the aggregate amount of all fees could well exceed $10 million. To the extent the insurer's $14 mllion payment is the total amount of insurance remitted to Apple, leaving the company to absorb both the $8.85 million of plaintiffs' attorneys' fees and expenses as well as all of the related defense expense, the $14 million payment could even be less than the amounts for which the company itself is reponsible.

 

The settling defendants include the Company; its Chairman, Steven Jobs; and certain other present and former directors and officers of the company. Judge Fogel set a final settlement hearing for October 31, 2008.

 

I have already received inquiries from persons questioning the size of the Apple options backdating derivative lawsuit settlement. The questioners are concerned that the settlement amount is seemingly small, especially in light of who the company is and the nature of the allegations.

 

There is no doubt that the Apple options backdating allegations have been very high profile. In addition, parallel SEC enforcement proceedings did result in the payment of some significant fines. On August 14, 2008 former Apple general counsel Nancy Heinen agreed to pay $2.2 million to settle options backdating charges (about which refer here), and last year former Apple CFO Fred D. Anderson agreed to pay $3.5 million to settle SEC claims against him (about which refer here).

 

The consolidated amended complaint also contains some apparently serious allegations. As discussed here, the amended complaint raised certain options springloading allegations, including the allegation that three Apple executives received a windfall when they were granted options to buy over 2 million shares the day before the announcement of a significant technology investment and other developments sent Apple’s shares up 48 percent. The amended complaint also alleges that Jobs himself received backdated options that were later cancelled in exchange for restricted stock.

 

Despite these allegations and notwithstanding the SEC settlements, the plaintiffs’ case faced certain potentially significant challenges. First, in a December 19, 2007 opinion (here), Judge Fogel had dismissed the plaintiffs’ initial pleadings, with leave to amend. In issuing this ruling, Judge Fogel did not even reach the demand futility issue, deferring that to a later date.

 

The plaintiffs filed their consolidated amended complaint on December 18, 2006 (refer here), seeking to overcome the deficiencies in the original pleadings. However, just days later, on December 29, 2006, Apple announced the completion of the special investigative committee’s investigation of the company’s stock option practices.

 

A joint statement by the committee’s co-chairs, former Vice President Al Gore and audit committee chair Jerome York, stated that Apple’s board "has complete confidence in the senior management team." The company’s 10-Q issued the same day (here) stated that the committee "found no misconduct by current management." (The 10-Q did go on to say that the investigation had "raised serious concerns about the actions of two former officials"—presumably Heinen and Anderson).

 

It is no surprise to me that faced with an apparently skeptical court and an unhelpful (if also somewhat controversial at the time) investigative committee report, the plaintiffs’ found it expedient to settle. The questions I have received have not reflected concerns about the fact that the plaintiffs settled; the concerns have had more to do with the amount of the settlement.

 

If you disregard for a moment that a high-profile company like Apple is involved, there is nothing particularly unusual about the size of this options backdating derivative settlement, at least in the context of other options backdating derivative settlements. Setting to one side the UnitedHealth Group derivative settlement (about which refer here), the options backdating derivative lawsuit settlements to date have been relatively modest, and the total value of the Apple derivative settlement is well within range of the other settlements.

 

As reflected in my running table of the options backdating lawsuit case resolutions (which can be accessed here), the total value of very few of the options backdating derivative settlements has exceeded seven figures. Indeed, the Apple settlement is actually one of the larger options backdating derivative settlements. The total cash value of only three derivative settlements exceeds the Apple settlement: UnitedHealth Group; Cablevision ($34.4 million, about which refer here); and Electronics for Imaging ($24 million, refer here).

 

By and large the options backdating derivative settlements (in the cases that have not been dismissed outright) have been relatively modest, consisting in many cases only of a payment of plaintiffs’ attorneys’ fees and the agreement to adopt certain governance reforms. Although there were a truly impressive number of options backdating derivative lawsuits filed (168 by my count, as reflected here), very few of them seem to be resulting in significant payouts.

 

As the options backdating scandal recedes in the rear view mirror, it definitely has started to seem like less and less of a big deal, particularly in the context of the current daily diet of government bailouts, floundering investment banks, and multibillion dollar securities buybacks – with one big exception, as noted below.

 

And Speaking of UnitedHealth: The UnitedHealth Group cases have definitely been the most notable big-dollar exception in the options backdating scandal. The company was back in the news again today with the announcement (here) from the options backdating securities lawsuit lead plaintiff, Calpers, that the company’s former CEO William McGuire had agreed to pay $30 million and its former general counsel David Lubben had agreed to pay an additional $500,000 in settlement of the options backdating securities claims pending against them. McGuire’s own press release about the settlement can be found here.

 

Taken together with the $895 million previously announced settlement (refer here) in the UnitedHealth Group options backdating securities lawsuit, the aggregate value of the options backdating securities settlements in the case now totals $925.5 million, certainly a large number by any measure. This settlement total is also in addition to the UnitedHealth options backdating derivative settlement, which had a total value of over $600 million.

 

Although the various press releases are not specific in this respect, the implication is that McGuire’s $30 million settlement payment will come out of his own personal assets, rather than insurance or corporate indemnity. If that is the case, this settlement would represent one of the larger individual payments of its kind.

 

Fifth Circuit Affirms Options Backdating Securities Lawsuit Dismissal: In a September 8, 2008 per curiam opinion (here), the Fifth Circuit affirmed the dismissal of an options backdating related securities lawsuits. (The district court’s October 4, 2007 dismissal can be found here. Background regarding the case can be found here.)

 

The Fifth Circuit affirmed the district court’s dismissal on loss causation grounds. The holding is interesting because the company’s stock actually did drop on the date of the alleged corrective disclosure.

 

The Fifth Circuit held that the press release in question was not sufficient to satisfy the requirements to establish loss causation because "although the stock price dropped dramatically on the day of the 1 August 2006 press release, no new facts concerning Cyberonics’ stock-option accounting were disclosed in that release which demonstrated that the ‘truth became known’ about Cyberonics’ challenged financial statements." Therefore the Fifth Circuit concluded, "a causal connection between the material misrepresentations and the loss was not adequately pled."

 

Special thanks to Neil McCarthy of Lawyer Links for alerting me to the Fifth Circuit’s opinion.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Even though the current subprime litigation wave seemingly has swept the prior scandal into the past, lawsuits based on options backdating allegtions stubbornly continue to come in. Within recent days, plaintiffs’ lawyers have filed two new options backdating-related derivative lawsuits. The options backdating scandal may now be well over two years along, but it continues to generate new litigation activity and controversy.

 

First, as described in an August 1, 2008 article in the Seattle Intelligencer (here), on July 17, 2008, a shareholder filed a lawsuit in King County (Wash.) Superior Court on behalf of Costco Wholesale Corp. against 20 of its current and former directors and officers. According to the article, the suit seeks “unspecified financial damages and internal company reforms.” A copy of the complaint can be found here.

 

Second, as discussed in a July 30, 2008 Kansas City Star article (here), on July 29, 2008, a shareholder of Epiq Systems filed an options backdating-related shareholders derivative lawsuit on the company’s behalf against nine current and former directors and officers. A copy of the complaint can be found here.

 

The Epiq complaint alleges that the company “has secretly backdated millions of options to its top officers and directors for nearly a decade, reporting false financial statements and issuing false proxies to shareholders.”

 

With the addition of these two most recent lawsuits, my current tally of the total number of options backdating-related derivative lawsuits now stands at 168. The number of options backdating-related securities class action lawsuits stands at 39, including two new lawsuits filed in 2008. My updated list of the options backdating-related lawsuits can be found here.

 

Regular readers know that I have also been tracking options backdating-related case dispositions and settlements (here). Though the list of dispositions and settlements is now quite lengthy, the reality is that the vast majority of the options backdating cases are yet to be resolved. The fact that so many remain unresolved, together with the fact that new lawsuits continue to be filed, suggest that it will be quite some time before all of the options-backdating litigation is finally put to rest.

 

Special thanks to a loyal reader for the link to the Epiq article and for information about the Costco case.

 

Thoughts About Crisis Longevity: It is worth contemplating the likely long duration of the options backdating phenomenon in the context of the current subprime and credit crisis litigation wave. The subprime and credit crisis problems are so much more pervasive and so much more serious, and it likely that the related litigation will continue to emerge for months and perhaps years to come. It may be correspondingly even longer before the full dimensions of the subprime-related litigation wave can be fully assessed.

 

Indeed, in the Financial Times August 3, 2008 first anniversary retrospective of the subprime crisis (here), the paper specifially notes, "A year later, there is still no sign of an end to these problems. Instead, the sense of pressure on western banks has risen so high that by some measures this is now the worst financial crisis seen in the west for 70 years."

 

We may have options backdating litigation around for quite a while yet, but we will be living with the consequences of the subprime crisis for years to come.

 

Cross-Eyed Bear: When the history of the subprime crisis is finally written, the collapse of Bear Stearns will be a key part of the narrative. By the same token, the litigation involving Bear Stearns will also be a key part of the litigation history. The amount of litigation involving Bear Stearns is massive, but an August 4, 2008 Fortune article helpfully provides a comprehensive list and overview, here.

 

As the article correctly notes, "fortunately for former senior Bear executives like Jimmy Cayne, Alan Greenberg and Alan Schwartz, J.P. Morgan Chase agreed to indemnify Bear's officers and directors for six years against these lawsuits."

 

Really Big Box Stores: I was surprised to learn, while writing this post, that Costco is as big of a company as it is. The companies’ current market capitalization is approximately $27 billion, with annual sales (2007) of $64 billion.

 

By most measures, those statistics would qualify Costco as a big company. But its competitor big box retailer Wal-Mart Stores manages to make Costco look modest by comparison. Wal-Mart’s current market cap is $230 billion and its 2007 sales were $378 billion.

 

If Wal-Mart were a country, and if its revenue were supposed to be equivalent to GDP, Wal-Mart would be the 25^th largest economy in the world (according to the rankings of the International Monetary Fund, here) --  larger than Saudi Arabia, Austria or Greece. Or as big as Kuwait, New Zealand and Algeria combined. That’s big.

 

If you are still straining to comprehend how big Wal-Mart truly is, you may want to check out this amazing animation video (here) depicting the efflorescence of Wal-Mart stores across a map of the United States. Wal-Mart is amazing, this video simply makes that fact easier to grasp.  

 

A very special hat tip to Tom Kirkendall at the Houston’s Clear Thinkers blog (here) for the link to the cool Wal-Mart growth video. Kirkendall’s site also links to this very cool BBC video (here) tracking electronically the balletic conduct of commerce in the British Isles.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Subprime-related litigation may be all the rage, but the latest securities class action lawsuit harkens back to the era of the prior scandal-driven event. On July 8, 2008, plaintiffs’ attorneys filed an options backdating-related securities class action lawsuit against MRV Communications and certain of its directors and officers.

 

A copy of the plaintiffs’ attorneys’ July 8 press release can be found here, and a copy of the complaint can be found here.

 

The lawsuit follows the company’s June 5, 2008 announcement (here) that it has "established a committee of independent directors to review the company’s historical stock option practices." During late 2006 and early 2007, the company had previously conducted "an informal and voluntary review" of its share practices and found no problems. However, in the course of reviewing transactions involving two European subsidiaries, the company identified information suggesting that "the conclusions reached in the earlier review were incorrect," and the company is now undertaking a comprehensive review, not just limited solely to the European subsidiaries.

 

The company also indicated that financial reports issued during the period 2002 to 2008 may be affected and "the company expects to restate its financial statements for the impacted period." The company indicated that investors should not rely on the company’s financial statements issued during those periods. The company’s share price dropped 24% on the news.

 

According to the plaintiffs’ counsel’s press release,

during the Class Period, defendants made false and misleading statements concerning the Company's employee stock option grant practices and financial results. Defendants allegedly caused or allowed MRV to issue statements that failed to disclose or misstated the following: (i) that the Company had problems with its internal controls that prevented it from issuing accurate financial reports and projections; (ii) that because of improperly recorded stock-based compensation expenses the Company's financial results violated GAAP; and (iii) that the Company's public disclosures covering a seven-year period presented an inflated view of MRV's earnings and earnings per share, which would later have to be restated.

Even though the options backdating scandal may now seem like ancient history, new options backdating lawsuits have continued to filter in during 2008. Indeed, the MRV Communications lawsuit is the third new options backdating related securities class action lawsuit to be filed during 2008. (The prior two involved TeleTech Holdings, about which refer here, and Maxim Integrated Products, refer here.)

 

The one thing that is clear is that we still have a very long way to go before we have seen the end of the options backdating scandal. This may be an important thing to keep in mind when assessing the current subprime and credit crisis mess, which is in my view an infinitely bigger deal than the options backdating scandal. It undoubtedly will be many, many years before we reach the end of the subprime mess.

 

In any event, I have added the MRV Communications lawsuit to my running tally of options backdating-related securities class action lawsuits, which can be found here. With the addition of the MRV Communications lawsuit, the current tally of options backdating related securities class action lawsuits now stands at 39.

 

Finally, I have substantial grounds on which to suspect that MRV Communications was also named as nominal defendant in a shareholders’ derivative lawsuit filed in the Los Angeles County Superior Court. I have not yet been able to verify this filing, so I have not yet added MRV Communications to my list of options backdating related derivative lawsuits. I would be grateful if any reader out there who can verify the filing of the MRV Communications options backdating-related derivative complaint would please let me know.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for the link to the MRV Communications complaint.

 

Updated Options Backdating Settlement Analysis:  And speaking of the Securities Litigation Watch, Savett has posted on the blog (here) an updated version of his analysis of the value and timing of the options backdating-related class action settlements. The updated analysis accounts for the recent UnitedHealth option backdating class action settlement.

 

And Finally: Readers interested in the blogosphere’s internal dynamics of will be interested to follow the sequence events that ensued after I added The D&O Diary’s post last night about mid-year FCPA enforcement and litigation activity.

 

The post was quickly picked up by Dick Cassin’s excellent FCPA Blog (here). The FCPA Blog clearly (and deservedly) enjoys a strong and influential readership, which apparently includes, among others, Dan Slater at the WSJ.com Law Blog, who added his own post (here) referencing back to my item. The Law Blog’s inclusion of a picture of The D&O Diary’s author made this sequence perfect and complete.

This blogging stuff never ceases to amaze me.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

About the UnitedHealth Group Class Action Settlement: UnitedHealth Group announced on July 2, 2008 (here) that it reached an agreement to settle its high profile options backdating-related securities class action lawsuit for $895 million. A July 3, 2008 Law.com article discussing the settlement can be found here.

 

Not only is this settlement the largest options backdating related securities lawsuit settlement to date, it is one of the largest securities settlements ever. The settlement does at least provide some counterweight to the view that some have expressed (refer here) that the options backdating related lawsuits may be settling low compared to historical standards.

 

This settlement, together with the $750 million Xerox settlement announced in March 2008 (including $80 million from the company’s auditor) and the flood of high profile, high stakes subprime-related litigation, may also undercut the view that has been expressed that overall settlements may begin to decline as the cases from the era of corporate scandals cycle out of the system.

 

It is probably worth noting that, as reported in the July 3, 2008 Wall Street Journal (here), the UnitedHealth settlement has not yet been completely resolved, as the settlement does not include United ealth’s former CEO William McGuire, nor does it include its former General Counsel, David Lubben.

 

Although it has not received nearly as much attention, it is also noteworthy that in its July 2 press release UnitedHealth also announced that it had also settled for $17 million the options backdating related ERISA lawsuit pending against the company and certain of its officials. As far as I am aware, this is the roughly half dozen options backdating related ERISA lawsuit to have settled. (To see a complete list of options backdating related ERISA lawsuits, refer here.)

 

Derivative litigation related to the options backdating woes at UnitedHealth previously resulted in the largest reported derivative settlement, as I discussed in a prior post, here.

 

I have added the UnitedHealth options backdating securities class action lawsuit settlement and ERISA lawsuit settlement to my table of the options backdating related settlements and dismissals, which can be accessed here.

 

Credit Rating Lawsuits: As I discussed in a recent post (here), even though the credit rating agencies’ conflicted role has been a central topic in the discussions surrounding the subprime meltdown, the plaintiffs’ lawyers have largely avoided drawing the credit rating agencies into the subprime litigation. However, lawsuits filed just in the past several days suggest that this may be changing, in addition to the lawsuit discussed in my prior post.

 

Though the plaintiffs’ lawyers had not generally been targeting the credit rating agencies for their rating activities, they have previously filed lawsuits on behalf of the shareholders of Moody’s (refer here) and  of The McGraw Hill Company, parent of Standard & Poor’s (refer here), alleging misrepresentation in their financial disclosures.

 

As described in a July 1, 2008 press release (here), plaintiffs’ lawyers have now initiated a shareholder securities class action lawsuit against Fimalac, S.A., the corporate parent of Fitch’s rating agency. According to the press release, the complaint (which can be found here) alleges that the defendants failed to disclose with respect to Fitch’s ratings of Residential Mortgage Backed Securities (RMBS) and Collateralized Debt Obligations (CDO) that:

(i) the information upon which Fitch based its ratings of RMBS and CDOs was misleading and in many cases fraudulent; (ii) to continue to collect fees for its ratings, Fitch was applying lax standards or no standards at all when issuing its RMBS and CDO ratings; and (iii) Fitch was failing to monitor the credit quality of RMBS and CDOs after issuing its initial ratings, as Fitch was obligated to do, and many of these securities had deteriorated badly after Fitch had issued its ratings. Fitch is now under investigation by the New York Attorney General, the Connecticut Attorney General, the Ohio Attorney General and the SEC as a result of its practices of rating billions of dollars of securities without a reasonable basis for doing so and Fimalac’s stock is trading at approximately 50% of its Class Period high.

But the new Fimilac shareholder lawsuit is directed against Fimilac as a reporting company, not directly against the company for Fitch’s rating agency activities. As I noted in my prior post, plaintiffs' lawyers have largely avoided allegations against rating agencies for their rating activities. However, in a lawsuit initiated in New York state court on June 3 , 2008 and removed to federal court on June 23, 2008, plaintiffs have alleged that entities affiliated with Credit Suisse, and the Moody’s, S&P  and the Dominion Bond Rating Service (DRBS) rating agencies misrepresented the values of Mortgage Pass-Through Certificates issued by the Home Equity Mortgage Trusts. (Refer here for background regarding the lawsuit.)

 

The basis of the claims of liability against the rating agencies in the Home Equity Mortgage Trust lawsuit, as alleged in paragraph 87 of the complaint (here), is that  the rating agencies  “prepared valuations, i.e., assigned ratings to the Certificates, in connection with the Offering, as defined in Section 11 (a)(4) of the Securities Act.” These allegations are similar to the allegations against the credit rating agencies in the HarborView case discussed in my prior post.

 

Whether or not these cases against the credit rating agencies for their rating activities ultimately go forward remains to be seen. As I have previously discussed (here), the credit rating agencies will contend that their rating activities are protected by the First Amendment.

 

In addition, it remains to be seen whether the Home Equity Mortgage Trust case will go forward in state or federal court. As discussed at length in my prior post (here), the ’33 Act expressly provides for concurrent state court jurisdiction and also expressly proscribes removal of state court ’33 Act actions to federal court. As discussed here, in at least one case, a federal court has concluded that a ’33 Act claim that has been initiated in state court and removed to federal court must be remanded back to state court.

 

One More Note About the Fimalac Lawsuit:  Fimilac is a foreign-domiciled company whose shares do not trade on U.S. exchanges. Many of its shareholders obviously are domiciled outside the United States. If these non-U.S. shareholders were to be included in the class, the new class action complaint against Fimilac might present the complicated f-cubed litigant problem (which I discussed most recently here). However, the plaintiffs’ counsel in the Fimilac case purport to represent a class composed solely of U.S. residents, apparently as a way of avoiding the f-cubed litigant problem.

 

As I discussed in my recent post relating to the new securities class action filed against EADS (refer here), these attempts to plead around the issues involving foreign-domiciled  plaintiffs still test the outer limits of the jurisdictional reach of U.S. securities laws against foreign-domiciled companies whose shares do not trade on U.S. exchanges. The case against Fimilac will be interesting to watch for reasons other than the involvement of a credit rating agency.

 

And Finally: The news about the dismissal of the lawsuit against Richard Grasso has gained a great deal of press attention. Indeed, the Wall Street Journal, in a July 3, 2008 editorial (here), congratulates Grasso and fellow defendant Kenneth Langone for their success in fighting the lawsuit, which the Journal viewed as an example of the overreaching of former New York AG Eliot Spitzer.  

 

The Journal’s editorial is perhaps closest to the mark in its observation that “Mr. Grasso is fortunate he had the resources to fight back.” Had Grasso not had the wherewithal to resist, he might never have tasted vindication. Readers of this blog will be particularly interested to know that it was insurance funds – a very large amount of insurance funds – that ultimately allowed Grasso to succeed.

 

According to Langone, and as reported on Bloomberg (here), in defending themselves against the lawsuit, Grasso, Langone and the NYSE directors “spent more than $70 million fighting the case, all covered by insurance.”

 

So Grasso is indeed fortunate that he had the resources to fight back, but perhaps contrary to the Journal’s suggestion, and even Grasso’s own prior comments (refer here) it was not his own treasure that financed the fight.

 

The expenditure of the mind-boggling sum of $70 million in litigating this case is yet another reminder of the extraordinary costs associated with the kind of high stakes litigation in which directors and officers can become involved. As I recently noted (here), the escalating expense associated with this kind of litigation has important implications for limits adequacy assumptions.

 

While it may be that only extraordinary cases consume these astonishing quantities of money, a company’s D&O program is expected to be able to respond even to catastrophic claims. As seems to be increasingly apparent, the costs associated with just defending a catastrophic claim could exhaust many insurance programs. All of this may suggest the need to reexamine conventional assumptions about limits adequacy.

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

Cablevision: On June 4, 2008, Cablevision Systems announced (here) that it had entered a stipulation to settle the options-backdating litigation pending against the company, as nominal defendant, certain of its directors and officers, and other defendants. Although the Cablevision settlement is only the latest in a growing list of options backdating-related lawsuit resolutions (as is detailed on my running tally, which can be accessed here), the settlement is noteworthy both regarding the nature of the allegations involved and regarding certain aspects of the settlement, particularly as pertains to the individuals’ contributions to the settlement.  

The options backdating problems at Cablevision drew a great deal of attention when first disclosed. The company revealed that it had awarded options to a Vice Chairman after his 1999 death, but backdated the options to make it appear that the grant was awarded when he was still alive. A front page September 22, 2006 Wall Street Journal article entitled “Cablevisions Gave Backdated Grant to Dead Official” (here) quoted Columbia Law Professor John Coffee as saying that “trying to incentivize a corpse suggests they were not complying with the spirit of the shareholder-approved stock-option plan.” The ISS Corporate Governance Blog referred (here)  to the awards as “Sixth Sense” options (“I pay dead people.”)

As if that were not enough, the company also disclosed that it had also awarded options to its outside compensation consultant, Lyons Benenson & Co., but the grant had been accounted for as if the consultant (Harvey Benenson) were an employee. As I noted in a blog post at the time (here), the derivative lawsuit allegations were amended to include allegations against the compensation consultant.

According to the Stipulation of Settlement (here), the Cablevision derivative lawsuit was settled for cash payments and other consideration that the parties have represented to the court has an aggregate value of $34.4 million. Specifically, the parties agreed that Cablevision will received a cash payment of $10 million from its D&O insurer, and “cash payments from and/or relinquishment of value and/or the waiver of specific claims by certain individuals” totaling $24.4 in valued. The plaintiffs’ counsel will seek payment of fees and expenses of no more that $7.116 from the settlement fund.

The description of the components of the individuals’ $24.4 million contribution makes for some interesting reading. First, the compensation consultant, Harvey Benenson, and/or his firm, Lyons Benenson, agreed to pay $2 million over three years, at 6 percent interest, secured by his Connecticut home. He will also forfeit $1.5 million severance he claimed.

The estate of former Vice Chairman Marc Lustgarten (the recipient of the Sixth Sense option grant) relinquished all claims to $4.9 million in stock options and restricted shares, including those granted improperly after his death.

A number of other individuals agreed to return specified amounts in connection with prior option grant exercises and to relinquish other unexercised options or waive other stock or share rights.

In addition to these individual contributions, and in what is to me the most interesting part of this settlement, Cablevision Chairman Charles Dolan agreed to make a $1 million cash payment to Cablevision, “to facilitate the resolution of the case.” His son, Chief Executive James Dolan, will also make a $1 million contribution, in addition to returning $366,250 for previously exercised options.

What makes this agreement of the two Dolans to pay $1 million each interesting is Section 3.4 of the Stipulation of Settlement, which provides that the Settling Defendants “will not seek insurance coverage, reimbursement, contribution or indemnification for any of the consideration they provide …from any source, including but not limited to Cablevision, other Settling Defendants, any of the Insurers, or any other Related Person.”

The various individual defendants’ returned options exercise proceeds or waived benefits arguably would not have been covered under the typical D&O policy in any event, as it appears to represent the return of compensation to which they were not entitled (coverage for which arguably would be excluded under most policies). However, there might well have been at least a colorable basis on which the Dolans might have been able to argue that their million dollar payments would be covered, assuming the typical D&O policy and assuming other potential policy provision did not otherwise preclude coverage. The language of Section 3.4 appears to represent a deliberate effort to ensure that the Dolans and the other defendants directly bore the cost of their settlement contributions.

There was a time following the Enron and World Com settlements when there was a concern that indemnity and insurance bar provisions might become a regular feature of the settlement of claims against corporate officials. These fears were largely unrealized, and the presence of an indemnity and insurance bar remains an unusual settlement feature. Nevertheless, the possibility that these provisions might become more commonplace is a concern for corporate officials and their advisors.

It remains to be seen whether these types of provisions will be a part of other options backdating settlements, but in light of recent judicial concerns about possible collusive options backdating settlements (refer here), litigants may feel some pressure to show that the settlement was both arms’-length and represents real value. To that extent at least, there could be some pressure for other options backdating litigants to consider incorporating settlement provisions like an indemnity and insurance bar.

A June 6, 2008 Newsday article describing the Cablevision settlement can be found here. A copy of the June 7, 2008 Wall Street Journal article about the settlement can be found here.

Marvell Technology: It its June 6, 2008 filing on Form 10-Q (here), Marvell Technology disclosed that on March 5, 2008, the company had entered a stipulation of settlement regarding the consolidated options backdating-related shareholders’ derivative lawsuit that had been filed against the company, as nominal defendant, and certain of its directors and officers. According to the 10-Q, the settlement includes “certain corporate governance enhancements and an agreement by us to pay up to $16 million in plaintiffs’ attorneys’ fees, an amount less than the $24.5 million that we received from a recent settlement with our directors’ and officers’ liability insurers.”

There are a number of interesting things about this settlement, particularly concerning the $16 million plaintiffs’ attorneys’ fee. At least in the absence of any other details about the settlement in any of the company’s disclosure document or even in the court filings to date, the amount of the plaintiffs’ attorneys’ fee seems, well, high. For example, compare the $16 million fee in the Marvell Technology settlement to the $7.116 million fee amount agreed to in the Cablevision case. The Cablevision case involved some fairly noteworthy complications, and the settlement of the Cablevision case resulted in the payment of significant amounts back to the corporation. By contrast, at least as far as can be discerned from the company’s recent 10-Q, the Marvell Technology settlement involved no cash payment to the company.

The $8.5 million increment of the insurance settlement in excess of the $16 million plaintiffs’ counsel’s fee is not explained in the 10-Q. It could be supposed that that $8.5 million represents a benefit to the corporation (although it could just as easily represent a reimbursement to the company for its own fees incurred in defense of the lawsuit). Even if the $8.5 million represents some benefit that accrued to the company as a result of the derivative lawsuit, the expenditure of $16 million in fees to recover $8.5 million seems like a poor exchange.

The question of what the company got out of the lawsuit is relevant and likely to be asked in light of the concerns that Judge Alsop raised in connection with the recent Zoran options backdating-related derivative lawsuit settlement (about which refer here). The Marvell Technology settlement could be argued to have the same issues as the Zoran settlement, in which, as Judge Alsop stated, “the corporation would receive no cash, all the cash is going to the counsel.” Of course, the $8.5 million insurance settlement increment could be argued to represent some cash to the company, but the ratio of the benefit to the corporation versus the benefit to plaintiffs’ counsel does not favor the settlement.

According to Marvell’s 10-Q, the settlement still requires court approval. Perhaps with the benefit of a full explanation of the settlement, the merits of the settlement might be more apparent. However, the description of the settlement in the 10-Q does at least suggest some serious questions.

A June 9, 2008 Law.com article discussing the Marvell Technology settlement can be found here. Special thanks to Zusha Elinson of The Recorder for providing a link to the 10-Q.

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

In a very interesting May 15, 2008 paper entitled “Do Options Backdating Cases Settle for Less?” (here), NERA Economic Consulting takes a look at the options backdating-related securities class action lawsuits settlements to date, and concludes that “in the cases that have settled to date, the amounts paid to plaintiffs have been substantially lower than in comparable non-backdating class actions.” NERA’s analysis is that the options backdating class action lawsuits are settling for half the amounts forecast by NERA’s own prediction model.

Having made this rather provocative observation, NERA then concedes that only a fraction of the options backdating-related securities class action lawsuits filed have yet settled. Clearly one factor that may be involved is that the weakest cases may have settled first, a consideration that the NERA study expressly acknowledges.

Nevertheless, in attempting to understand the variation between the settlements to date compared to the expected range of settlements based on NERA’s model, the NERA report does consider the possibility that “shareholder suits with backdating allegations are perceived as weaker on the merits than other class actions.” The report also considers the possibility that future options backdating settlements, which might include more serious cases, could be more in line with other securities class action settlements.

I have several observations about the NERA analysis, the first of which is that is important for all of us to keep a running tally of outcomes, to make sure we all know and keep track of what is happening. The fact that this study comes from NERA suggests that it will (appropriately) carry weight and credibility.

That said, it should also be noted that the NERA study is based on a small sample, only six settlements out of 37 options backdating related securities class action lawsuits. (The total number of lawsuits according to my tally, here, is only 36, but I am willing to go with their number for these purposes, which is close enough anyway.)

Not only is the sample small, but it seems to have been amputated at a couple of critical points. That is, for reasons that are not explained in the report, the NERA dataset does not include either the Mercury Interactive settlement ($117.5 mm) or the Vitesse Seminconduct settlement ($10.2 mm). If I know NERA, there are probably some very good reasons why they excluded these settlements, but the report does not explain or even refer to the omission of these settlements. Given the size of the Mercury Interactive settlement in particular, the omission of these settlements could have had a significant impact on the analysis, so their omission could be significant.

UPDATE: Dr. Branko Jovanovic, one of the author's of the NERA report, was kind enough to call me and politely point out that the report actually refers, in footnote 3, to the fact that the report's authors chose to exclude the Mercury Interactive and Vitesse Semiconductor settlements from the analysis because some but not all defendants had settled. (That's what I get for trying to write blog posts in a hotel room in Toronto without the ability to print out and read documents in hard copy form. Reading the report on a laptop screen, I just missed the footnote). Dr. Jovanovic points out that if the two settlements had been included, it would have increased the difference between expected and actual settlements.

The other thing about NERA’s analysis is that as a result of the small dataset, extreme individual results could be skewing the average. In particular, according to the report, the Rambus options backdating related securities class action lawsuit of $18 million, was only 8.3% of predicted. For me, an outlier result like that suggests that it is not representative, and in fact some case specific factor may explain the outcome. In any event, an extreme result like that clearly pulls down the average. While the exclusion of the Rambus result would still not eliminate the variation from the predicted range, it would reduce the difference.

I also think it is significant in considering whether the options backdating cases are or are not deviating from expectations that dismissals should be taken into account as well as settlements. According to my running tally of option backdating related settlements, dismissals and denials (which may be accessed here), six of the 37 (or is it 36?) options backdating related securities class action lawsuits have been dismissed. (Some of these dismissals are without prejudice). I am not 100% sure which way this cuts, but I think the number of dismissals is a relevant consideration to any analysis of whether or not outcomes are within predicted ranges. The dismissals may also provide some explanation, or at least context, for the variation between settlements to date and predicted ranges.

All of that said, I reiterate my appreciation to NERA for their effort to keep track of what has happened so far. The value of NERA’s analysis is in its provision of a status update, which is a sevice that we can all hope that NERA will continue as the cases develop.

For the sake of completeness, I urge all readers interested in these topics to review the analysis of options backdating securities class action settlements on the Securities Litigation Watch blog (here), which among other things notes that these cases are settling more quickly on average than other cases, which clearly might be a factor in explaining settlement outcomes. The SLW's analysis not only takes into account the settlements that NERA's report omits, but it also considers the dismissals as well.

One final observation is that NERA's analysis relates solely to options backdating securities class action settlements, and does not refer to or include options backdating derivative lawsuit settlements.  For further information regarding options backdating derivative lawsuit settlements, please refer to the table I am maintainting, here.

CFO.com has an article discussing the NERA report here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

As reflected in my running tally of options backdating lawsuit settlements (which can be accessed here), a number of the options backdating-related derivative lawsuits have settled for some combination of an agreement to pay the plaintiffs’ attorneys’ fees, some adjustment to the company officials’ options grants, and the company’s adoption of corporate governance reforms. But two April 7, 2008 opinions by Judge William Alsup of the United States District Court of the Northern District of California in separate options backdating derivative cases may raise potentially troublesome questions whether settlements in this form, without some cash payment directly to the corporation, are sufficient. As a minimum, the two opinions have important implications for the way settlements are presented to the court, and could also have important effects on the settlement dynamic in other cases going forward.

The first and most detailed of the two opinions relates to the options backdating derivative suit filed on behalf of Zoran Corporation, about which lawsuit I first wrote here. In a June 5, 2007 opinion in the Zoran case (here), Judge Alsup had previously denied the defendants’ motion to dismiss, as I previously discussed here.

Following the dismissal denial, the parties to the Zoran case entered settlement negotiations, resulting in a February 26, 2008 stipulation of settlement, which the parties presented to the court on March 3, 2008. At the preliminary approval hearing, the plaintiffs’ damages expert, at the court’s request, presented a report calculating the plaintiffs’ maximum damages as $16 million (including prejudgment interest), which incorporated both the alleged damaged cause to company by the defendants’ option grants as well as by option grants to the rank-and-file employees.

The proposed Zoran settlement involved: the payment of up to $1.2 million of the plaintiffs’ attorneys’ fees and costs; the repricing or cancellation of certain of defendants’ options, which repricing or cancelation was represented to the court to have a value of $1.65 million; the company’s adoption of certain corporate governance reforms; and the grant of a broad claims release.

In an April 7, 2008 opinion (here) that contains some remarkably harsh language, Judge Alsup denied the parties’ request for preliminary approval of the settlement.

The parties undoubtedly knew the settlement was in trouble when Judge Alsup opened his analysis by stating that the class action procedure can “lend itself to abuse” and “one form of abuse is a collusive settlement.” Judge Alsup said that a collusive settlement “usually comes with a cash award to counsel, a broad release of claims, and a cosmetic non-cash recovery for the abused shareholders.” Courts, Judge Alsup notes, must take care that absent shareholders are treated fairly; here, he concludes, the settlement “falls short of deserving preliminary endorsement.”

In considering the settlement, Judge Alsup turned first to the substance of the plaintiffs’ claims (the implication being that the claims appeared to be meritorious), and to a declamation upon the plaintiffs’ expert’s $16 million damages estimate. Judge Alsup then addressed each of the settlement components, finding each component lacking.

First, Judge Alsup noted that the parties were not proposing to restore to the corporation the gains the defendants made from the sale of options, but rather that certain other options would be canceled or repriced. The option cancelation was represented to have very substantial value to the corporation, but the two sides’ experts had reached different conclusions about the value. Judge Alsup found that by using the most conservative valuation method and valuation date, the value of the cancellation was only $216,955, a small fraction of the value both sides had represented to the court.

The court next turned to the repriced options, with respect to which Judge Alsup noted, with incredulity, that the options had actually been repriced in December 2006, which was not only over a year before the settlement was presented to the court, but was even before the plaintiff filed the consolidated amended complaint. The court said that “it should have been plainly disclosed that the defendants were proposing to settle based on an old concession rather than a new consideration.” The court went on to note that “even if the flaw could somehow be ignored,” the value of the repriced options had been “exaggerated.” If a “meaningful” valuation date were used, the value of the repriced options is “zero.”

Judge Alsup had similar concerns with respect to the corporate governance reforms, in that several of the reforms “were already adopted by Zoran’s board well before the parties sat down to discuss settlement terms.” The reforms in any event “do not compensate the company for damages suffered by the company as a result of defendants’ backdating.” The reforms are “hard to accept in lieu of some substantial portion of the $16 million in damages asserted by the plaintiffs’ expert.” Judge Alsup also found that the claim release was overbroad, and swept in circumstances that were not asserted in the amended complaint.

In concluding that the settlement was inadequate, Judge Alsup stressed that “the corporation would recover no cash, all the cash is going to counsel,” and even the supposed value of the $16 million of the foregone benefits is “illusory” and he concluded that this “low end settlement” did not deserve approval.

Judge Alsup was clearly troubled that he had been obliged on his own to ferret out the settlement’s weaknesses, many of which were contrary to counsels’ representations.

Judge Alsup concluded his opinion with a rather stern lecture on counsels’ “duty of candor,” which he said requires counsel to “lay out the weaknesses as well as the strengths” of the settlement. He also stressed that it is “unfair to try to slip a weak or collusive settlement past the judge, hoping he or she will sign off or will not stumble upon the right questions.” A $1.65 million settlement, while at the low end, might be adequate, but the “main vice is that the proposal does not come even close to the $1.65 million settlement it was advertised to be.”

Many of the problems the court identified clearly were the result of communications issues. The parties perhaps could have avoided some of the difficulties by making joint valuation presentations that were scrubbed and scrutinized ahead of time. The court was also clearly upset to discover upon inquiry (rather than being told) that some of the remedies proposed had been undertaken prior to the settlement agreement; better communication around these settlement components potentially could have averted some of the court’s concerns.

But there are other aspects of the court’s commentary that are not merely the consequence of poor communication. First and foremost, Judge Alsup appeared to be troubled by how little the corporation would be getting, and in particular that the corporation would be getting no cash. He was also troubled that the settlement’s putative $1.65 million value, even if valid, was at the “low end” of plaintiffs’ damages analysis. In a sign that may have important implications for other settlements, he was also clearly skeptical that the noncash portions of the settlement – including even the corporate governance reforms, to which he attached little value --had value commensurate with the claimed injuries to the corporation.

But while there clearly are important implications from Judge Alsup’s ruling in the Zoran case, before fully considering those implications, it is important also to review Judge’s Alsup’s opinion (here), also dated April 7, 2008, in the CNET Networks options backdating-related derivative lawsuit, which provides even further context.

In his CNET Networks opinion, Judge Alsup refused even to consider the parties’ proposed settlement. Judge Alsup had previously granted defendants’ motion to dismiss (refer here), on the grounds that demand was not excused, but stayed the case to allow the plaintiffs to seek discovery through the Delaware courts and to attempt to replead. In response to an inquiry from the court about status, the parties advised the court that settlement negotiations were underway, and the parties then presented a joint motion to lift the stay for the limited purpose of seeking a preliminary approval of a settlement. Judge Alsup said that it found these actions “disappointing” because the parties did not, as they had represented to the court they would, complete discovery, nor did plaintiff file an amended complaint. Instead the parties sought to settle the case, about which Judge Alsup said

any settlement, at this early stage, seems very premature, for the Court could not be in a position to evaluate a settlement until we know what claims are viable and what depositions, discovery, and damage assessments show about the strength and magnitude of those claims. At this stage, moreover, plaintiff has no standing at all to negotiate on behalf of the corporation and its shareholders. Plaintiff has never been excused from the demand requirement. Plaintiff is not in any way authorized to release claims on behalf of any shareholders or the corporation. It would be hard to see how plaintiff could do so intelligently without first framing the claims and then performing sufficient due diligence through formal discovery and investigation, including a full damage report. Now, any legitimate settlement reached later may be tainted by what could appear to have been collusion. To deal with this eventuality, all notes and materials generated by or during the recent settlement discussions should be preserved. For the Court’s views on collusive settlements see In Re Zoran Corporation Derivative Litigation.

Judge Alsup went on to note that “the best way to tee up this case for settlement is to find out first whether the plaintiff even has standing to sue (the demand issue) and thus to release claims on behalf of the corporation,” and then to evaluate which options were backdated and the dollar value to the corporation of these claims. “It would,” Judge Alsup said, “be very hard to evaluate a settlement without due diligence, including depositions and documents.”

Judge Alsup’s two opinions taken together represent a strong statement that, because of the court’s responsibilities to absent class members, the court must take its obligation to review proposed settlements very seriously. The court clearly should not be expected just to rubber stamp a settlement to which the parties’ representatives have agreed. In order to get settlement approval, and avoid the suggestion of collusion, the parties will have to show certain key considerations: first, and at a minimum, that the plaintiff even has standing to represent the class and enter the settlement; second, that the settlement is proportionate to the injury to the corporation that the plaintiff has claimed; third, that the claimed values to the corporation are supported; and fourth, that the corporation is fairly compensated for its damages and its release of claims.

Even though Judge Alsup’s opinions technically have no precedential effect beyond the immediate cases themselves, the strength of the language he used, the seriousness of the concerns he noted, and the possibility of similar questions undermining other settlements could well have an in terrorem effect on other litigants in other cases. Certainly no litigant would want to take a chance that a court might suggest that their proposed settlement could be “collusive.” Even though many of the aspects of these opinions are a reflection of the particular circumstance involved, the opinions also bespeak more general principles that could have broad influence. In particular, Judge Alsup’s statement in the CNET Networks case that he could not even consider a proposed settlement until the plaintiff first establishes its right to enter a settlement and presents an adequate factual record and damages analysis suggests that cases must have progressed past a certain stage before the parties can even proffer a proposed settlement to the court.

There are several interrelated issues arising from Judge Alsup’s requirement for a damages analysis, his requirement that the settlement be proportionate to the alleged harm, and his obvious concern in the Zoran case that no cash was going to the corporation. The overall suggestion is that a few gestures and payment of some legal fees may not be enough. There may actually need to be some cash going to the corporation, proportionate to the alleged harm. Judge Alsup’s unwillingness to recognize significant value to the corporation for the corporate governance reforms may be particularly troublesome.

As I noted at the outset, many of the options backdating derivative cases that have been settled so far have been resolved on terms similar in many respects to the components of the Zoran settlement. The likely reason why there is no cash payment to the corporation in many of these cases is that D&O insurers balk at funding amounts they contend represent a disgorgement or a return of an ill-gotten gain. The individual defendants, for their part, resist making out of pocket payments for which insurance is unavailable. The parties thus perforce attempt to cobble together an agreement that resolves the case without any cash transfer other than the payment of plaintiffs’ counsel’s fees.

Judge Alsup’s opinion, particularly his repeated use of the word “collusive” and statement that the value to the corporation from the Zoran settlement was “illusory” could introduce a great deal of tension into this negotiation dynamic. Both insurance carriers and individuals could face heightened pressure to make cash contributions to the corporation to resolve these cases. Insurers will likely continue to resist any payment on their part, owing to policy exclusions for disgorgement and the return of ill-gotten gains.

Another important implication is that the parties must be prepared to substantiate their settlement, and that discovery, depositions, damages assessments and other procedures may be required to satisfy these requirements. These procedures could prove costly for all concerned – particularly for the D&O insurers, who not only will foot the bill for increased defense expense, but also ultimately could be called upon to pay the plaintiffs’ fees as well, as part of any eventual settlement.

Notwithstanding the foregoing, of the parties involved, the participants that may face the biggest problems if these cases become more difficult to resolve are the plaintiffs’ lawyers. There is a suggestion in both of these cases that the plaintiffs’ lawyers are starting to find the cases tiresome and just want them to go away. Indeed, one of the things that clearly seemed to be bothering Judge Alsup in these cases is that the plaintiffs’ lawyers were settling (too) cheap or walking away without even doing what the Judge at least believes to be minimally required. The plaintiffs’ lawyers piled into these kinds of cases with enthusiasm but they may now be repenting their involvement. The implication of Judge Alsup’s opinion may be that the plaintiffs’ lawyers may be challenged to extricate themselves.

According to my tally (which can be found here), there have been a total of 166 options backdating lawsuits filed. To date, only a small portion of these cases (less than a third) have been settled or otherwise resolved. The vast majority, well over one hundred, of these cases remain pending. Of course it remains to be seen, but I suspect that Judge Alsup’s opinions in these two cases will prove to have introduced significant challenges for parties trying to move these pending cases toward resolution.

Very special thanks to Zusha Elinson of The Recorder for providing me with copies of these opinions. Elinson’s April 24, 2008 article in The Recorder about the opinions entitled “Alsup Rejects Easy Options Deals” can be found here (Full disclosure: I was interviewed in connection with the article).

• Email This
• Print
• Comments (2)
• Trackbacks (1)
• Share Link

In two recent federal district court decisions, two options backdating-related securities class action lawsuits – one involving Witness Systems and one involving Jabil Circuit – were dismissed.

First, in the Witness Systems case, on March 31, 2008, Judge Clarence Cooper of the United States District Court for the Northern District of Georgia granted the defendants’ motion to dismiss, with prejudice. A copy of the Order can be found here. Background regarding the case can be found here.

The complaint alleged that seven options grants in 2000 and 2001 were backdated and that four grants in 2004 were springloaded. Oddly, the plaintiff alleged that he company’s financial statements during the period April 23, 2004 to August 11, 206 were misleading because of the 2000-2001 backdating. The allegedly misleading statements allegedly began earlier and continued through the class period.

Judge Cooper found that

Plaintiff has failed to allege sufficient, particularized facts to support a “cogent and compelling” inference of scienter as to Witness or as to each Individual Defendant. Although the [amended complaint] is lengthy, the details contained therein are simply insufficient to support a strong inference of scienter. Specifically, the allegations are in the nature of a theory that Defendants must have known that the 2004 and 2005 financial statements were misstated due to backdating that occurred in 2000 and 2001. The [amended complaint] never explains when, or how, any or all Defendants learned about the circumstances pertaining to any backdated option grants. (Citations omitted.)

Judge Cooper went on to observe that “nothing is alleged that would demonstrate that these individuals had any knowledge that disclosures during the class period might require further adjustments based on options grants made in 2000 and 2001.”

Judge Cooper further found that the defendants’ stock sales did not support an inference of scienter. Judge Cooper specifically found that the defendants’ “pattern of regular dispostions was inconsistent with allegations of scienter, and the two defendants who sold significant share percentages only joined the company as a result of a merger after the alleged backdating. Judge Cooper also found that the plaintiffs had not adequately pled loss causation.

In the Jabil Circuit case, on April 9, 2008, Judge Steven Merryday of the United States District Court for the Middle District of Florida granted defendants’ motion to dismiss, but with leave to amend. Plaintiffs have until May 12, 2008 to file an amended complaint. A copy of the April 9 order can be found here. Background regarding the Jabil Circuit case can be found here.

The Jabil Circuit case may be of some interest because the company was one of the several companies whose option grants were reflected in the charts that accompanied the  original March 18, 2006 Wall Street Journal article entitled “The Perfect Payday” (here) that launched the options backdating scandal.

The crux of Judge Merryday’s decision is his conclusion that the plaintiffs’ allegations failed to establish that any grant was backdated. Judge Merryday said:

Although the complaint specifies the offending statement and identifies when and where the defendants issued the statement, the complaint includes deficient allegations concerning the falsity of the statement. The plaintiffs purport to allege repeated instances of backdating by stating the dates of “suspiciously timed” option grants and the individual defendants who received the grants. However, the plaintiffs never allege the any specific grant of stock to any specific individual defendant was backdated. The issuance of suspiciously timed options fails to convert the [company’s compensation policy] representation into a false and misleading statement.

Having found that the complaint did not adequately allege backdating, Judge Merryday was able to dispose of plaintiffs’ allegations that the company had not properly accounted for the option grant or made misrepresentations when company officials later denied that there had been backdating.

Judge Merryday also found that the plaintiffs’ scienter allegations were insufficient because the complaints’ allegations of “knowledge of non-public information fails to raise an inference of scienter with respect to any defendant.” The insider trading allegations were insufficient because the complaint failed to allege the percentage of total shares sold or to compare the share sales to sales before and after the class period. The defendants’ alleged receipt of option grants was also found insufficient.

Judge Merryday also found that the complaint’s allegations of GAAP, IRS and SEC violations were insufficient “because the complaint fails to adequately allege a basis for the claim of backdating.” Similarly, with respect to the issue of loss causation, Judge Merryday found that “having failed to adequately allege the falsity of the backdating-related statements, the plaintiffs fail to sufficiently plead loss causation as to those statements.” Judge Merryday also rejected plaintiffs’ claims of proxy misstatements based on the plaintiffs’ failure to adequately allege backdating.

I have added these two dismissals to my table of options backdating lawsuit settlements, dismissals and denials, which can be accessed here. These two dismissals may be noteworthy because they appear to be the first options backdating securities lawsuit dismissals outside of the Ninth Circuit. They are also the first dismissals granted in an options backdating securities lawsuit in several months. But while some of these options backdating securities suits have now been resolved, many more remain pending.

As reflected on my running tally of the options backdating lawsuit filings (which can be found here), there were a total of 36 options backdating-related securities class action lawsuits filed. And as reflected in my table of options backdating lawsuit case dispositions (linked above), of these 36 cases, eight have settled, six have had their motions to dismiss denied, and five have been dismissed (albeit some with leave to amend). That leave 17 cases on which no action has yet been taken, and with the six dismissal denials, 23 cases that remain pending – not to mention the cases on which amended pleadings or appeals may give new life.

These cases appear to have a very long way to run yet. But the high degree of skepticism shown in these two opinions is striking, and would not bode well for these cases were this general view to become widespread.

Special thanks to an alert reader who prefer anonymity for providing copies of the two opinions.

Another Subprime-Related D&O Loss Estimate: On April 9, 2008, Fitch’s Ratings released a report entitled “Subprime Mortgage Exposure for Property/Casualty Insurers.” A link to the repor can be found in this Business Insurance article (here), but registration is required for access to the report.

The report repeats prior estimates of industry-wide insured subprime-related losses in the range of $3 to $4 billion (although also noting that estimates have ranged as high as $9 billion). The report states that “Fitch believes that the majority of these losses will be borne by the larges writers of primary and excess D&O.”

The report also states that “Fitch believes that the near-term impact from the subprime issues will have a stabilizing or modestly positive effect on professional liability rates, especially within the financial services sector, but are unlikely to result in broad hardening.” The report warns though that “if the credit contagion spreads into sectors not directly tied to the subprime mortgage market or if the weakening economy leads to increased bankruptcies, current loss estimates will prove to be inadequate and there could be adverse reserve development that could have a larger impact on rates going forward.”

Fitch’s estimates and comments are largely in line with prior D&O loss estimate, about which I previously commented here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Amidst all the subprime hoopla, it would be easy to forget that only a year ago, options backdating was the hot topic. Options backdating might now seem passé, but several considerations suggest that options backdating remains important and that we still have a long way to go before we can be sure we have seen all of the options backdating scandal fallout.

Accumulating Lawsuits: The first important consideration about options backdating in early 2008 is that the options backdating related lawsuits are still coming in. As I previously noted (here), last month shareholders filed an options-backdating related securities class action lawsuit against Teletech Holdings.

In addition, on February 6, 2008, plaintiffs' lawyers announced (here) that they had initiated a securities class action lawsuit in the United States District Court for the Northern District of California against Maxim Integrated Products and certain of its directors and officers. The lawsuit relates to Maxim's January 17, 2008 announcement (here) that, as a result of its Board's special committee's investigation of the company's stock option practices, the company would be restating its financial statements to record non-cash, pre-tax charges of between $550 and $650 million for additional stock-based compensation expense. The company also announced that investors should not rely on the company's financial statements for the fiscal years 1997 through 2005 and corresponding interim reporting periods through March 25, 2006.

The timing of Maxim's recent announcement is relevant here. The company had first announced its anticipated restatement nearly a year prior, in January 2007 (here), and the company's January 2008 announcement indicated that the company's review was not only not yet complete, but would have to be expanded backwards to include its 1995 and 1996 fiscal years. Maxim is surely not the only company that continues to struggle with the accounting clean-up from options backdating-related issues. There may well be additional options backdating related lawsuits filed in the months ahead.

But in any event, with the addition of the Maxim Integrated Products lawsuit to my running tally of options backdating related lawsuits (which can be found here), the current total number of options backdating related class action lawsuits now stands at 36. These 36 class action lawsuits are in addition to the 166 options backdating related derivative lawsuits that have also been filed.

Accumulating Settlements: The second important consideration about options backdating in early 2008 is that the settlements of the options backdating related cases are accumulating in a material way. Indeed, on February 8, 2008, HCC Insurance Holdings announced (here) that it had settled the options backdating-related securities class action lawsuit that had been filed against the company and certain of its directors and officers, for a payment of $10 million dollars (to be funded entirely by insurance). The company had previously announced on January 9, 2008 (here) that it had settled the options backdating related derivative lawsuit in which the company was involved, in exchange for an agreement to adopt certain governance reforms and the payment of $3 million of the plaintiffs' attorneys' fees.

As reflected in my table of options backdating-related lawsuits dismissals, denials and settlements (which can be accessed here), the HCC settlement represents the seventh of the options backdating-related securities class action lawsuits to settle. The aggregate amount of these seven settlements is $244.55 million. Three other options backdating-related securities class action lawsuits have also been dismissed, meaning that at this point, ten of the 36 options backdating related securities lawsuits have either settled or dismissed, with another 26 yet to be resolved.

As also reflected on my list of options backdating related case dispositions, there have also been a number of options backdating related derivative settlements. The value of some of these settlements has not publicly disclosed, but the value of the disclosed settlements - not counting the $900 million UnitedHealth Group derivative settlement - is over $61 million.
The sum of the value of these two categories of options backdating-related lawsuit settlements is over $300 million - and if the UnitedHealth Group settlement is included, the total value so far is over $1.3 billion. (It should be kept in mind that these figures do not reflect the derivative settlements that were not publicly disclosed). Of course, these figures do not include the costs the companies incurred to defend these cases, as well as to defend themselves and their senior officials against SEC investigations and other regulatory and criminal matters. And, perhaps most significantly here, there are many more of these cases yet to be resolved than have so far been settled or dismissed.

The Securities Litigation Watch blog has a more detailed analysis of the options backdating securities class action settlements here.

I have gone through this exercise to point out that when all is said and done, the options backdating scandal is going to have proven to have had a very significant event. While not all of the settlement and amounts and defense expenses represent covered loss (for example, the UnitedHealth Group would appear to be excluded from coverage under the typical D & O insurance policy), much of these amounts will be paid by D & O insurers.

As is clear from the fact that options backdating related lawsuits continue to emerge, and the fact that the vast majority of the options backdating-related cases are yet to be resolved, D & O insurers are going to continue to incur these losses for some time to come. And while it can certainly be hoped that the insurers' reserving practices fully anticipate future developments in these cases (and the cases yet to emerge), the possibility that options backdating might be a bigger deal than everyone has been assuming right now cannot be overlooked.

This analysis of the options backdating-related cases provides some significant context for the current rapidly unfolding subprime-related litigation wave. By any measure, the subprime wave represents a bigger threat than the options backdating related cases. There are going to be many more subprime-related securities class action lawsuits (right now, there are 43 subprime-related securities lawsuits vs. the 36 options backdating related securities lawsuits, and the subprime related lawsuits are going to be rolling in for the rest of this year and probably into the next); the subprime cases involve much more significant shareholder losses; the subprime cases will be very expensive to defend; and, due to their complexity, the subprime cases will take a long time to resolve.

Bottom line: the options backdating scandal and the subprime meltdown together represent adverse circumstances for D & O insurers - something you would never be able to discern from the current marketplace conditions.

Special thanks to Adam Savett of the Securities Litigation Watch for the link to the HCC settlement and for suggesting to me the aggregation of the options backdating related class action settlements.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

It has been such a while since a new options backdating securities lawsuit has appeared that it was with some surprise I noted the new case that has been filed against Teletech Holdings and certain of its directors and officers. According to the plaintiffs' counsel's January 25, 2008 press release (here), the lawsuit, filed in the Southern District of New York, relates to the company's November 8, 2007 press release (here), in which the company announced a "self-initiated review of accounting for equity-based compensation practices and likely restatement of prior period financial statements."

According to the company's filing on Form 8-K (here), also dated November 8, the company delayed the filing of its quarterly report for the quarter ending September 30, 2007, due to the company's Audit Committee's review of the company's "historical stock option and other equity-based compensation grant practices." The filing also states that based on the review completed to date, "management presently believes that it will be required to incur additional non-cash compensation charges for prior periods and that restatement of interim and annual financial statements for the periods 1999 through 2007 is likely." The filing also states that the company's interim and annual financial statements for the period 1999 through the second quarter of 2007 "should not be relied upon."

In light of the TeleTech lawsuit's allegations, I have, somewhat unexpectedly as this late date, amended my tally of options backdating-related lawsuits. The tally can be found here. With the addition of the TeleTech lawsuit, my count of options backdating-related securities lawsuits stands at 35.

Finding Orwell: I read with interest in the January 23, 2008 Wall Street Journal profile (here) of newly-appointed U.S. Attorney General Michael Mukasey that when he was a federal judge, Mukasey would require his new law clerks to read George Orwell's essay, "Politics and the English Language." Orwell's essay, which can be found here, is a declamation against the "vagueness and sheer incompetence" that Orwell believed to characterize contemporary prose, particularly political writing.

Orwell wrote that "the great enemy of clear language is insincerity. When there is a gap between one's real and one's declared aims, one turns to long words and exhausted idioms, like a cuttlefish spurting ink."

After providing many examples of bad writing, Orwell reduced his principles for clear writing to six rules, which undoubtedly are the reason Mukasey required his law clerks to read the essay. The six rules are:

1. Never use a metaphor, simile, or other figure of speech you are used to seeing in print.

2. Never use a long word where a short one will do.

3. If it is possible to cut a word out, always cut it out.

4. Never use the passive where you can use the active.

5. Never use a foreign phrase, a scientific word, or a jargon word if you can think of an everyday English equivalent.

6. Break any of these rules sooner than say anything barbaric.

The interior was dark and cool. The front room was crammed with wooden furniture. An empty teacup sat on the arm of an old planter's chair and the glass-fronted book cabinets were filled with old newspapers, their corners orange and crackling with age. Two grandfather clocks stood in opposite corners, each telling a different time.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In its January 24, 2008 quarterly earnings release (here), KLA-Tencor also announced that it had entered into an agreement to settle the options backdating-related securities class action lawsuit that had been pending against the company and certain of its directors and officers for $65 million.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

A shareholders' derivative lawsuit that generated the most prominent judicial pronouncements about options "springloading" has been settled. According to the company's January 18, 2008 press release (here) and its filing on Form 8-K of the same date (here), the parties have settled the consolidated shareholders' derivative lawsuit that has been been pending since 2005 against Tyson Foods, as nominal defendant, and certain present and former directors and officers of the company.

Under the terms of the settlement agreement (here), Don Tyson (the company's former CEO) and the Tyson Limited Partnership, the Company's largest shareholder are jointly and severally liable to pay the company $4.5 million. No other defendant will make any payments. The company also agreed to implement or continue certain governance measures, as detailed in the settlement agreement. The plaintiffs will be seeking a fee award of $3 million from the company, out of the $4.5 million to be paid under the settlement. The Company has said it will contest the fee award, but will not contest any award up to $1 million.

The derivative complaint contained a variety of allegations, only some of them relating to the timing of the company's stock option grants. Other allegations related to certain consulting contracts, as well as to executive compensation and related-party transactions involving Tyson and his family. But what has drawn notoriety to the case are the complaint's allegations concerning options "springloading" (that is, the award of options in anticipation of an event expected to trigger an increase in the company's stock price). The opinions in the case regarding springloading are undoubtedly represent the leading judicial commentary on the practice.

In opinions dated February 6, 2007 (here), and August 15, 2007 (here), Chancellor William B. Chandler III used memorably scathing language in denying the defendants' motions to dismiss the springloading allegations. Among other things, Chandler said that in the August 15 opinion that the company's proxy disclosure describing the options grants displayed "an uncanny parsimony with the truth" that "raise an inference that the directors engaged in later dissembling to hide earlier subterfuge."

Chancellor Chandler added that he "may further infer that grants of springloaded options were both inherently unfair to shareholders" and that "the long-term nature of the deceit involved suggests a scheme inherently beyond the bounds of business judgment." He added that the Court "may reasonably infer that a board of directors later concealed the true nature of a stock option," from which it may further infer that the options "were not granted consistent with a fiduciary's duty of utmost loyalty."

My prior more detailed discussion of Chandler's August 15 opinion can be found here.

The settlement is of course still subject to court approval, a condition that may be a relevant consideration in this case, given the seeming disparity between the flights of the Court's rhetoric and the scale of the settlement.

In any event, I have added the Tyson Foods settlement to my list of options backdating lawsuit settlements, dismissals and denials, which can be accessed here.

A January 21, 2008 CFO.com article further discussing the Tyson Foods settlement can be found here.

Supreme Court Rejects Enron Appeal: Less than a week after issuing the Stoneridge decision, the Supreme Court has denied (here) the petition for writ of certiorari in the case Enron investors had brought against a number of investment banks. News coverage of the denial can be found here and here.

As noted in the 10b-5 Daily blog (here), the Supreme Court also vacated and remanded to the Ninth Circuit the "scheme liability" case of Avis Budget Group v. California State Teachers Retirement, "for further consideration" in light of the Stoneridge decision.

While the Enron cert petition denial was probably inevitable after the Stoneridge decision, it is also dicey to read too much into the denial. For example, as the Conglomerate blog points out (here), the Enron case was in an odd procedural posture, having come up to the Supreme Court from the Fifth Circuit where it was on an interlocutory appeal after the denial of class certification. The Supreme Court does not have to explain itself when it declines to act. The lower courts will have to live with the Stoneridge decision and work out its meaning in the context of specific cases without further guidance from the Supreme Court, for now.

Professor Larry Ribstein has further thoughts about the meaning (and limitations on the meaning) of the Enron cert petition denial on his Ideoblog, here. The SEC Actions blog, here, finds greater significance to the Supreme Court's actions in the wake of Stoneridge. The WSJ.com Law Blog has more "post-game" analysis on the Enron cert petition denial, here.

More About the Subprime Litigation Wave: Way back in July 2007, when I declared (here) that subprime litigation was "this year's model" (that is, the hot litigation trend driving lawsuit activity), I noted that "subprime litigation is arising in an ever-increasing variety of additional forms" and that "as the concentric rings from asset valuation issues spread outward, an increasing array of companies will become engulfed in the litigation wave."

Sounding similar themes in a January 22, 2008 article entitled "If Everyone's Finger-Pointing, Who's To Blame?"(here), the New York Times observed that

a wave of lawsuits is beginning to wash over the troubled mortgage market and the rest of the financial world. Homeowners are suing mortgage lenders. Mortgage lenders are suing Wall Street banks. Wall Street banks are suing loan specialists And investors are suing everyone.

The article mentions a number of different cases, including in particular a case brought last week by the Maher family against Lehman Brothers Holdings. The lawsuit is described in greater detail in the a January 18, 2008 Bloomberg.com article entitled "Lehman Clients Demand $1.1 Billion on Auction Dispute" (here). The allegations have been brought by two brothers, Brian and Basil Mahan, in an arbitration complaint filed with the Financial Industry Regulatory Authority.

The complaint alleges that the brothers relied on Lehman to invest proceeds from the family's sale of its ship container company, claiming that the family's stated investment objectives were to preserve capital and provide liquidity. Lehman allegedly put the money in auction-rate securities, which lost value due to the turmoil in the credit markets. The brothers seek to require Lehman to buy the illiquid securities and pay treble damages of $857 million. The complaint accuses Lehman of negligence, deception, breach of contract, making unsuitable investments, and supervisory failures.

Thanks to the several readers who sent me copies of or links to the New York Times article.

Now This: The turbulence in the financial markets is scary enough in and of itself. Of perhaps even greater concern is what it may signify. George Soros, the Chairman of Soros Fund Management, suggests in a column in the January 23, 2007 Financial Times (here) that we now face "The Worst Market Crisis in 60 Years."

• Email This
• Print
• Comments
• Trackbacks
• Share Link

On December 6, 2007, UnitedHealth Group announced (here) that its Special Litigation Committee had concluded its review of claims relating to the company's option backdating practices that had been brought against certain of the company's directors and officers.

The company also announced that its former CEO William McGuire had agreed surrender certain rights and interests which, together with previous repricing of all stock options awarded to McGuire, have a value in excess of $600 million.

Certain other current and former officers also agreed to relinquish certain rights and repay other amounts, which in combination with the repricing of certain stock option, have a value of approximately $300 million.

According to the company's statement:

The SLC has valued the total amounts to be relinquished pursuant to these settlement agreements, together with the value previously and voluntarily relinquished by current and former executives, through the surrender and repricing of options, to be approximately $900 million.

A December 6, 2007 Bloomberg.com article (here) states that "if approved by a court, the settlement ...would be the largest ever in a 'derivative' suit...according to data compiled by Bloomberg."

Separately, the SEC announced on December 6, 2007 (here) that it had reached a $468 million enforcement action settlement with McGuire, which, the SEC said, includes the "largest penalty assessed against an individual in an options backdating case." The $468 million SEC settlement consists of "a $7 milllion civil penalty and reimbursement to the Minneapolis-based health care company for all incentive- and equity-based compensation he received from 2003 through 2006."

The SEC's press release also stated that the McGuire settlement "is the first with an individual under the 'clawback' provision (Section 304) of the Sarbanes-Oxley Act to deprive corporate executives of their stock sale profits and bonuses earned while their companies were misleading investors."

According to UnitedHealth's press release, McGuire's settlement consists of the following elements:

• Surrender to UnitedHealth Group certain stock options to acquire 9,223,360 shares of Company stock, which the SLC has valued at approximately $320 million;


• Surrender his interest in the Company's Supplemental Executive Retirement Plan, valued at approximately $91 million;


• Surrender to the Company approximately $8 million in his Executive Savings Plan Account; and


• Relinquish claims to other post-employment benefits under his Employment Agreement.

According to the company. these amounts, combined with a previous repricing of all stock options awarded to Dr. McGuire from 1994 to 2002, result in a total value to be relinquished by McGuire in excess of $600 million.

A copy of McGuire's settlement agreement with the company and the derivative plaintiffs can be found here.

The UnitedHealth press release described the settlement with the company's former General Counsel, David Lubben, as consisting of the surrender to UnitedHealth Group of his stock options to acquire 273,000 shares of Company stock, which the SLC valued in excess of $3 million; and the repayment to the Company $20.55 million of the compensation realized by him as a result of his March 2007 exercise of stock options.

According to the company, these amounts, combined with a previous repricing of stock options awarded to Lubben, result in a total value relinquished by Lubben of approximately $30 million.

A copy of the settlement agreement between Lubben and the company and the derivative plaintiffs' counsel can be found here.

The UnitedHealth press release also stated that under the settlement agreement that the company reached with its former director William Spears, "the fair settlement value of the Company's claims ... will be determined by binding arbitration."

According to the Bloomberg article, current United Health CEO Stephen J. Helmsley had agreed to repay $240 million, although the company apparently says he voluntarily did so months ago.

A copy of the UnitedHealth special litigation committee's December 6, 2007 report can be found here.

The Wall Street Journal's December 7, 2007 article discussing the settlement can be found here.

Special thanks to alert reader Kelly Reyher for sending alerting me to this story and sending along the Bloomberg link.

The magnitude of these settlements is obviously arresting. The scale of the settlements is proportionate to the scale of the backdating problems at UnitedHealth, which had forced the company to restate $1.13 billion in earnings over a 12-year period. The scale of these settlements could have a significant impact on at least some of the other pending options backdating derivative cases, particularly where the company has been forced to restate and where top company officials have personally benefited from the backdating.

Readers should note that the table I am maintaining of all options backdating related settlements, dismissals and denials can be accessed here.

From a D & O insurance perspective, it is noteworthy that all or virtually all of the amounts to be paid to the company or to the SEC may be characterized as disgorgement, return of ill-gotten gains, return of compensation to which the individual was not legally entitled, or fines and penalties. Assuming that these are in fact accurate characterizations of the settlement payments, these amounts would not constitute covered loss under the typical D & O insurance policy.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

As the options backdating cases flooded in a year ago, the standard explanation of the plaintiffs' lawyers preference for shareholders derivative lawsuits over securities class action lawsuits was that stock price declines rarely accompanied companies' options backdating disclosures. (A list showing the predominance of derivative lawsuits among options backdating cases can be found here.) Any doubts about the challenge that the absence of a stock price drop poses for erstwhile options backdating securities class action litigants should be put to rest by the November 14, 2007 opinion (here) dismissing the options backdating-related securities class action lawsuit pending against Apple and 14 of its current and former directors and officers. Background on the lawsuit can be found here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Defendants argue that Brooks has not adequately alleged loss causation because Brooks' stock price rose after the March 18, 2006 Wall Street Journal article and again after the July 31, 2006 publication of the Restatement. However, plaintiffs have alleged particular details regarding the decline in Brooks' stock price that occurred during the period from May 11, 2006, through May 22, 2006, when Brooks made several successive disclosures regarding investigations into its stock option practices.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

With the recent dismissals of the options backdating securities class actions filed against Hansen Natural (refer here) and Amkor Technology (refer here), it was beginning to seem that momentum might be building against these suits. But in an October 31, 2007 opinion (here), the court denied in significant part the motion to dismiss the options backdating securities class action lawsuit pending against Openwave Systems and certain of its present and former directors and officers. The portion of the ruling of Judge Denise Cote of the federal court in Manhattan denying the dismissal motion may provide other plaintiffs some grounds to hope that their complaints may also survive motions to dismiss.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

As various options backdating lawsuit settlements and dismissals have accumulated in recent days, I have received a variety of inquiries from readers about comparisons with prior dispositions or about the outcomes of various other specific cases. The absence of a single, all-inclusive resource to address these questions led me to put together a compiled list of options backdating lawsuit settlements, dismissals and denials, which can be found here.

The options backdating lawsuits dispositions list linked-to above is arranged in a series of seven tables, which provide the following information: options backdating securities class action lawsuit settlements and dismissals, as well as dismissal motion denials; options backdating shareholders derivative lawsuit settlements, dismissals and dismissal denials; and options backdatings lawsuits that were voluntarily dismissed. With respect to each listed item, I have tried to provide a link to the relevant court order or other source material.

I created the list using information from a variety of sources. While I am reasonably confident that the information is accurate, the list may be incomplete. The list captures most of the options backdating case dispositions that have attracted publicity, but there undoubtedly are others that were not as highly publicized and about which I am unaware. Readers are encouraged to please let me know of any omissions from the list; links or citations for any needed additions would be greatly appreciated. I will do my best to keep the list updated with future dispositions as well as any supplemental information that readers provide.

In addition, a blank in the "links" column indicates that I have not been able to locate a link to the relevant source document. It would be great of readers can provide the missing source links so that the document is more complete.

Readers should note that I have written prior blog posts about many of these case dispositions. I did not attempt to incorporate into the options backdating disposition list any links back to my prior blog posts, but readers interested in any specific case disposition should just type the case name in the search box on the upper left hand corner of the blog home page to find my blog posts relevant to specific cases.

I welcome any comments readers may have about the attached list, particularly if readers have concerns about the accuracy or completeness of any entry.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

For those keeping track, the options backdating-related securities class action lawsuit filed against Hansen Natural can be added to the list of options backdating-related securities class action dismissals. (Refer here regarding prior dismissals.) Hansen announced in its 8-K dated October 23, 3007 (here) that the court granted the defendants' motion to dismiss the plaintiff's complaint, without leave to amend.

In its October 16, 2007 opinion (here), the court granted the Hansen Natural defendants' motion on several grounds. The court found that the complaint failed to allege fraud with particularity, and that the complaint failed to allege facts sufficient to give rise to a strong inference that the defendants acted with scienter. In particular, the court found that none of the plaintiff's allegations of a backdating scheme, accounting fraud, lack of internal controls, corporate authority, or insider trading gave rise to a strong inference of scienter. The court also found that the plaintiff failed to sufficiently plead either materiality or loss causation.

The court clearly was not impressed with the plaintiff's argument, based upon a comparison of the company's stock price graph and the option grant dates, that the defendants "must have engaged in backdating." The court declined to draw any inferences from the plaintiff's analysis, which, as the court noted, "is no analysis at all, but simply a series of charts and graphs comparing Hansen's stock price on the date of each of the stock option grants with the stock price on the tenth day after the stock option grant day." The court noted that between 1997 and the end of 2005, Hansen's stock price increased about 15,000 percent, so "it is not surprising that Hansen's stock price would have risen following the twelve stock grants."

As readers will recall, there was a stir (refer here) as the options backdating story unfolded last year about the fact that many companies apparently were late in filing their Form-4s (as was detailed in a well-publicized Glass Lewis report). The notion at the time was that perhaps the late Form-4 filing indicated (or at least facilitated) backdating. The Hansen Natural court specifically considered and rejected this argument, in part because the Form-4s by themselves showed nothing other than they were late, and in part because the company's Special Committee had specifically found that the Form-4s did not support a finding of backdating.

The court's perspective on the case was clearly influenced by external events surrounding the backdating allegations, particularly the Special Committee's findings that there was no willful or intentional misconduct in connection with stock option grants; and that the company's outside auditor's conclusion that the needed options-related accounting adjustments were not material. The court took judicial notice of a wide variety of documents and materials outside the complaint. While the plaintiffs did not object to some of the items of which the court took judicial notice, the court's ultimate conclusions do have an air of factual determination about them. The Tellabs decision's requirement that courts weigh competing inferences puts them squarely in the business of making assessments. But reasonable minds might ask at what point the development and consideration of a voluminous record outside the complaint, supporting evaluations of factual allegations, is entirely consistent with the court's limited role at the motion to dismiss stage.

Nevertheless, the Hansen Natural court's categorical rejection of the plaintiff's complaint may foreshadow developments in other pending backdating cases that depend upon the plaintiffs' contention that there must have been backdating. For courts in the post-Tellabs business of weighing competing inferences, stock graphs overlain with option grant dates may simply not be enough to create a strong inference of scienter - as further corroborated below in the discussion of the Delta Petroleum options backdating-related shareholders' derivative case.

Two More Backdating Derivative Lawsuit Dismissals: In separate decisions, two courts recently granted motions to dismiss in options backdating related derivative lawsuits. There are some features of these two dismissals that are particularly noteworthy.

The first dismissal involves the shareholders derivative lawsuit brought against Delta Petroleum, as nominal defendant, and several of its directors and officers. The court's September 26, 2007 opinion dismissing the Delta Petroleum case can be found here. The second dismissal came in the derivative lawsuit filed against Glenayre Technologies, as nominal defendant, and several directors and officers. The court's October 9, 2007 dismissal opinion can be found here.

The two cases raised both raised allegations (pled derivatively) under both the federal securities laws and under applicable state law. The Delta Petroleum court dismissed the federal securities law allegations on the grounds that the plaintiffs had not stated a claim, because they had not made sufficient allegations that the options were, in fact, backdated. The plaintiffs relied on the standard litany of sources: the March 2006 Wall Street Journal article, the May 2006 research of the Center for Financial Research and Analysis, and the supposed suspicious timing of the stock options grants. The court found these references "insufficiently specific," noting that

• Email This
• Print
• Comments
• Trackbacks
• Share Link

On September 27, 2007, Amkor Technology announced (here) that the United States District Court for the District of Arizona had granted the defendants' motion to dismiss the securities class action lawsuit pending against the company and several of its directors and officers. As noted in a prior post (here), the initial complaint that the plaintiffs had filed in January 2005 did not contain options backdating allegations. After the company's revelation during 2006 of options backdating concerns, the plaintiffs amended their complaint to add the backdating allegations. The plaintiffs' second amended complaint can be found here.

In a September 25, 2007, U.S. District Judge Paul Rosenblatt granted the defendants' motion to dismiss the second amended complaint. A copy of the September 25 dismissal ruling can be found here. Judge Rosenblatt granted the motion with respect to the options backdating allegations on two grounds: first, that the plaintiffs had failed to adequately plead loss causation as required under the Dura Pharmaceuticals case; and second, that the plaintiffs had failed to adequately plead scienter.

In attempting to establish loss causation, the plaintiffs attempted to rely on the stock price drop following the Company's July 26, 2006 press release (here) in which the company both announced its second quarter 2006 operating results and also announced that it had voluntarily formed a Special Committee to examine options practices. Judge Rosenblatt, reviewing all of the allegations, considered that the price drop following the July 26 announcement was due to the company's second quarter results and weak third quarter forecast, rather than to the two sentence announcement of the Special Committee. In reaching this decision, Judge Rosenblatt considered the fact that at the time of the company's August 16, 2006 announcement (here) that it would be restating its prior financials and its October 6, 2006 announcement (here) of the Special Committee's findings, the company's stock price went up. Judge Rosenblatt said "the Plaintiffs have failed to link their losses to the alleged misrepresentations by showing the Amkor price dropped upon revelation of the true state of the facts. As noted by the Defendants, once a corrective disclosure was issued the stock price actually increased."

Judge Rosenblatt's finding that the plaintiffs had failed to adequately plead scienter is based on his conclusion that "other than general assertions about the Individual Defendants' roles and responsibilities and motivations, the Plaintiffs do not plead specific facts to support their allegations of scienter." Although Judge Rosenblatt mentions the Supreme Court's recent Tellabs opinion (about which refer here), the Tellabs decision is basically irrelevant to the scienter ruling.

The Amkor dismissal is interesting in and of itself , as the first dismissal of an options backdating related securities class action lawsuit of which I am aware. (Readers are encouraged to correct me on this point if I missed a prior options backdating securities lawsuit dismissal.)

UPDATE: Alert reader Avi Wagner points out that on July 30, 2007, Judge Fogel dismissed the Mercury Interactive options backdating securities lawsuit without prejudice. Judge Fogel's order may be found here. (I am embarrassed to admit that I actually had an item about this dismissal in an earlier post, here -- I should learn to rely on the blog rather than trusting my memory.)

In addition, alert reader John Orr points out that on September 14, 2007, the Court granted the defendants' motion to dismiss in the Verisign options backdating lawsuit, a case that combined both 10b-5 and derivative allegations. The Verisign dismissal order can be found here. The court granted the motion to dismiss the Section 10b-5 action based on the Tellabs case and the failure to allege sufficient facts to support a scienter finding and also failure to plead sufficient facts to establish loss causation. Similarly to the Amkor derivative case (as discussed below), the court granted to motion to dismiss the derivative allegations based on the platiniffs' failure to allege sufficient facts to establish demand futility and to establish that the plaintiffs had standing.

Another aspect of the dismissal is that it corroborates a view that was widely held at the time the options backdating scandal was unfolding a year ago as an explanation why there were relatively few options backdating securities lawsuits but a relatively large number of shareholder derivative lawsuits - that is, the view at the time is that the backdating revelations were not accompanied by stock price declines of the type necessary to support a securities claim. The plaintiffs in the Amkor lawsuit may have been unable to resist the temptation to try to upgrade their existing securities lawsuit by adding allegations relating to options backdating. But the absence of the ability to show causally related damages ultimately doomed their options backdating allegations. (It should also be noted that Judge Rosenblatt also dismissed the plaintiffs original unrelated allegations as well.)

None of this is to say that the plaintiffs' counsel who elected to file derivative lawsuits necessarily can be expected to fare better. Indeed, on August 28, 2007, Judge Rosenblatt also dismissed the separate options backdating related derivative complaint that had been filed against Amkor as nominal defendant as well as against several of its directors and officers. (Refer here for a copy of Judge Rosenblatt's dismissal opinion in the Amkor derivative lawsuit.) Judge Rosenblatt granted the dismissal motion on the ground that the plaintiff had failed to plead facts sufficient to establish demand futility. He also found that the plaintiff had failed to plead facts sufficient to show that he had the requisite share ownership for the requisite time period necessary to establish that he had standing to bring the claim.

The timing of the Amkor dismissal is interesting because is follows so closely after the recently announced $16 millions settlement in the Rambus options backdating securities lawsuit (about which refer here). While the Rambus settlement might have been (and may still prove to be) a precursor to further settlements, the Amkor dismissal may embolden some options backdating securities lawsuit defendants to continue to resist in the hopes of securing a dismissal, rather than attempting to reach an early compromise.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Rambus Settles Securities Lawsuit: In a September 7, 2007 press release (here), Rambus announced that it had settled the July 2006 options backdating-related securities class action lawsuit that had been filed against the company and certain of its directors and officers. Rambus has agreed to pay $18 million in exchange for a dismissal with prejudice of all claims against all defendants. The press release also stated that the settlement is subject to court approval and that the company "has been and will continue to be in discussions with its insurers concerning their contribution of a portion of the settlement amount."

In terms of market meltdowns and the degree of pain inflicted on the financial system, the subprime mortgage crisis has the potential to rival just about anything in recent financial history from the savings-and-loan crisis of the late 1980s to the post-Enron turndown at the beginning of this decade.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

On August 24, 2007, Rambus announced (here) that a Special Litigation Committee (SLC) of its board of directors had completed its review of "claims related to stock options practices that are asserted in derivative actions against a number of present and former directors and officers of the Company."

Rambus had previously announced (here) on October 19, 2006 that its Audit Committee had completed an independent investigation into stock options grants and had "determined that a significant number of the stock option grants were not correctly dated or accounted for," and that the company anticipated taking a $200 million charge. The Board also at that time formed the SLC to evaluate potential claims the company may have. The SLC consisted of two members of the company's board, J. Thomas Bentley, a Managing Director of SVB Alliant (the recently closed investment banking arm of Silicon Valley Bank), and Abraham Sofaer, a former U.S. District Judge who is also a law professor at Stanford.

According to the company's August 24 press release, the SLC determined, subject to the settlements described in the announcement, that "all claims should be terminated and dismissed against the named defendants in the derivative actions," with the exception of claims against one individual who served as the Vice President of Human Resources between 1996 and 1999, and Senior Vice President of Administration from 1999 to 2004. The SLC determined that the claims against the individual should proceed and that the SLC itself will "assert control over the litigation."

The announcement further disclosed that the SLC had "entered into settlement agreements with certain former officers of the Company." The aggregate value of the settlements, which are "conditioned upon the dismissal of the claims asserted against them in the derivative actions," exceeds $6.5 million in cash and cash equivalents "as well as additional value to the Company relating to the relinquishment of claims to over 2.7 million stock options." (The Company's January 4, 2007 press release announcing the company's former CEO's relinquishment of the stock options can be found here.)

The company's August 24 announcement is interesting by way of the contrast it provides to much of the litigation activity that has surrounded the options backdating scandal, where the battle lines typically have been drawn over the "demand futility" issue - that is, whether or not it would be futile to ask a company's board to investigate and prosecute the alleged wrongdoing. The evidence of the Rambus SLC's work presents an interesting counterpoint to the arguments that plaintiffs typically raise that it would be futile to demand that a board take responsibility for investigating alleged wrongdoing. There appears to have been nothing futile about the actions of Rambus's board or its appointed committee.

I have no knowledge of the details of Rambus's D&O coverage and I have no information beyond what appeared in the company's news release, but based on the available information and assuming the provisions of the typical policy, the outcome of the SLC's investigation could raise some potentially interesting coverage issues. To the extent that the amounts the individuals agreed to pay in settlement are in the nature of disgorgement or restitution, a D & O carrier would likely contend that it is not covered "loss." (Of course, the individuals are likely to contend that the amounts are not restitutionary or otherwise do constitute covered loss.)

In addition, the company may well seek to recover its own investigative costs and costs incurred in connection with the SLC. Indeed, issues surrounding coverage for these kinds of costs have been a great source of tension between D & O carriers and policyholders in connection with the options backdating claims. Attorney and D & O commentator Dan Bailey has a good summary of the coverage issues associated with these kinds of costs in a recent article, here.

The continuing claims against the remaining individual defendant also presents an interesting issue; since the ongoing action would be direct rather than derivative, the carrier may contend that the claim would no longer appear to fall within the derivative claim exception to the insured versus insured exclusion. The availability of insurance (or absence thereof) could have a significant effect on the likely future direction of the claim against the remaining individual defendant.

Bad News and D & O Claims: In prior posts (most recently here), I have commented on the fact that sometimes it is the way a company deals with bad news, rather than the bad news itself, that determines whether or not the company will also have to deal with a securities class action lawsuit. The allegations in the purported securities class action lawsuit that the Lerach Coughlin firm filed on August 24, 2007 against Advanced Medical Optics and several of its directors and officers appears to provide another example of this phenomenon. The press release regarding the new lawsuit can be found here, and the complaint can be found here.

Let me just say at the outset that I have no knowledge of the facts and circumstances other than what is alleged in the complaint, and I do not mean to suggest that the circumstances are as the plaintiffs' have alleged or that the claims are meritorious. For purposes of discussion, I have simply taken the plaintiffs' allegations as presented.

In the complaint, the plaintiffs allege that in November 2006, the Company announced a voluntary recall of CompleteMoisturePLUS ("Complete"), a bottled soft contact lens solution sold on a worldwide basis, because of bacterial contamination that compromised sterility. (The company's press release regarding the November recall can be found here) The complaint further alleges that the defendants "moved to assure the market that the problem was isolated to Asia and that the prospects for the Complete product were favorable."

The complaint cites a number of company statements that supposedly indicate that the Asian facilities had been sanitized, inspected and would be staged back into production, and that the company's sales for the Complete product were or would be fully restored. The complaint alleges that in April the Company announced favorable results, including rising sales of Complete. The complaint alleges that the defendants made favorable disclosures about Complete though they knew that there were problems and that a recall was "not just a future possibility but a significant likelihood." The complaint alleges that as a result of the company's reassurances, the company's stock performed well and the defendants were able to sell significant amounts of their personal holdings of the company's stock at a profit.

The complaint goes on to allege that in a May 25, 2007 press release, the company announced that in response to "information received today from the Center for Disease Control regarding eye infections," the company was immediately and voluntarily recalling its Complete contact lens solution. (A copy of the company's May 25 press release can be found here.) The complaint alleges that the company's stock price declined 14% on this news.

There are several interesting things about this complaint. The first is that the initial bad news (the November 2006 product recall) is not the basis of the securities lawsuit; indeed, the class period does not even purport to begin until January 2007, well after the initial product recall. It is rather the supposedly reassuring statements that the company allegedly provided between November and May that are the basis of the complaint. The events alleged (again, without taking a position whether or not they are true or that plaintiff's allegations correspond in any way to what actually happened) seem to illustrate the point, which I have previously observed here, that "partial, incomplete or overly optimistic disclosure can exacerbate damage from bad news disclosure and risk the creation of securities litigation exposure." As the allegations seek to show, it may be that the "calming" statement itself may be alleged to be misleading - in other words the securities litigation exposure results from the "damage control," not the underlying event.

The insider trading allegations also illustrate another important point for managing bad news disclosure (which point may or may not have been relevant to AMO's circumstances), which is that companies involved in bad news would be well advised to consider imposing a trading blackout until the problem is entirely contained. My prior essay presenting a more detailed program for managing bad news disclosure can be found here.

Another interesting thing about this lawsuit is the name of the company sued. Long ago, I noted the odd susceptibility to securities class action lawsuits of companies with the word "Advanced" as the first word in their name. The Stanford Law School Securities Class Action Clearinghouse index of securities lawsuits (here) identifies 12 different companies (including Advanced Medical Optics) that have been sued in class action lawsuits. I do not mean to engage in the much-derided confusion of correlation and causation, but I still do think that it is kind of weird that companies with the word "Advanced" in their name seem to get sued all the time.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In an August 15, 2007 opinion (here), Delaware Chancery Court Chancellor William B. Chandler III reexamined his February 6, 2007 refusal to dismiss plaintiffs' claim involving stock option springloading against directors and officers of Tyson Foods, Inc. In his earlier opinion (here), Chandler had held, in response to the defendants' motion to dismiss, that the board's authorization of springloaded options may, in certain circumstances, constitute a breach of a director's fiduciary duties.

In his August 15 opinion, Chandler considered defendants' motion for judgment on the pleadings, in which the defendants argued that the supposedly springloaded options were in fact authorized under the company's shareholder approved stock option plan.

The defendants probably sensed that their motion's prospects for success were dim when they read how Chandler characterized the circumstance that could be inferred from the consolidated complaint:

On three separate occasions between 2001 and 2003, defendants suspected that Tyson's share price would climb once the market learned what the board already knew. Armed with this knowledge, members of the Compensation Committee granted non-qualified stock options to select Tyson employees, ensuring that these options would shortly be in the money. When the option grants were later revealed to shareholders, however, defendants did not straightforwardly describe such strike-price prestidigitation. Rather, they provided minimal assurances to investors that these options rested within the limits of the shareholder-approved plan. The crux of defendants' argument is that a scheme that relies upon bare formalism concealed by a poverty of communication somehow sits within the scope of reasonable, good faith business judgment.

Loyalty. Good faith. Independence. Candor. These are words pregnant with obligation. The Supreme Court did not adorn them with half-hearted adjectives. Directors should not take a seat at the board table prepared to offer only conditional loyalty, tolerable good faith, reasonable disinterest or formalistic candor. It is against these standards, and in this spirit, that the alleged actions of spring-loading or backdating should be judged.

What the defendants here fail to confront is that their disclosures regarding the options under attack do nothing to rebut the pleading stage inference that the defendants intended to conceal a pattern of unfairly stocking up insiders' larders with option grants shortly before the announcement of events likely to increase the Company's stock price. In fact, the magnitude and timing of the grants, when accompanied with no disclosure of the reasons motivating the grants, is suggestive, at the pleading stage, of a purposeful subterfuge. Put simply, the pleadings support an inference not only that the defendants engaged in self-dealing, but that they attempted to hide their conduct from the stockholders.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In prior posts (most recently here), I described various attempts to shift the blame for alleged option grant manipulations to company gatekeepers. In the latest development, Vitesse Semiconductor announced on June 13, 2007 (here) that it has sued KPMG, its former auditing firm, seeking $100 million in damages and alleging that the firm failed to properly provide auditing and other services to the company.

On December 19, 2006, Vitesse announced (here) the results of a review conducted by a special committee of its board of directors that had been organized to look into allegations of possible options grant manipulations. The special committee "found evidence that members of Vitesse's former senior management team backdated and manipulated the grant dates of stock options issued over a number of years, utilized improper accounting practices primarily related to revenue recognition and inventory, and prepared or altered financial records to conceal those practices." The special committee estimated that the total additional expense to Vitesse from the stock grant manipulation is approximately $120 million since 1995.

The special committee identified a number of accounting issues, some of which "appear to have been used on certain occasions to manipulate revenues for accounting periods in consideration of Wall Street expectations." Among the practices identified were: the failure to properly account for returned inventory; use of false sales invoices to increase revenue; and improper revenue recognition practices, including channel stuffing and improper recognition of consignment sales.

The company's December 19, 2006 press release also stated that Vitesse's board had "dismissed KPMG LLP based on its lack of independence." However, in a December 22, 2006 press release (here), Vitesse clarified its prior statement about KPMG's dismissal, noting that "the dismissal was as a result of Vitesse's consideration of potential claims it may have with respect to KPMG, which would impair its independence, rather than any finding that KPMG lacked independence with respect to Vitesse prior to the date of the Special Committee's report." A CFO.com article regarding the clarifying press release can be found here.

The Vitesse lawsuit against KPMG follows the lawsuit that another former KPMG client recently filed against the firm. KPMG was named, along with PricewaterhouseCoopers, as a defendant in a lawsuit that Collins & Aikman Corp. filed against its former CEO, David Stockman, and other former company executives. The Collins & Aikman lawsuit (about which refer here) alleges that the accountants "turned a blind eye to accounting improprieties" at the company.

The Vitesse and Collins & Aikman lawsuits are only the most recent of KPMG's litigation woes. KPMG also was targeted in the Department of Justice's investigation of tax shelters KPMG developed and sold between 1996 and 2002 (refer here), in settlement of which KPMG agreed to make payments totaling $456 million.

Vitesse itself and several of its former directors and officers face securities class action litigation (here) based on allegations of stock option manipulations. At least one of the securities class action complaints filed against Vitesse (here) also named KPMG as a defendant.

Vitesse is not the first company having uncovered options backdating to sue its former auditor. As discussed in an earlier post (here), Micrel sued its former auditor, Deloitte and Touche, for allegedly faulty advice regarding the company's options practices. Deloitte settled the case for a payment of $15.5 million.

French Accent: "Vitesse" is of course the French word for "speed. " The D & O Diary associates the word with the French TGV trains ("train à grande vitesse") which SNCF, the French rail company, operates. The TGV Eurostar train goes through the Chunnel from Paris to London. On April 4, 2007 (refer here), a modified TGV train set the conventional train speed record, clocking in at 357.2 mph. (To my knowledge, Vitesse Semiconductor has nothing to do with the TGV.)

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The SEC's settlements of options backdating civil enforcement actions against Brocade Communications and Mercury Interactive received extensive coverage in the financial press last week (refer here and here). But there are several features of these settlements and the underlying civil actions that merit closer attention, particularly with respect to the Mercury Interactive action and settlement. The SEC's Mercury Interactive litigation release and complaint can be found here and here The SEC's Brocade Communications litigation release can be found here.

One aspect of the Mercury Interactive civil enforcement action that is particularly noteworthy is the sheer accumulation of numeric detail. The complaint alleges that all 45 of the company's stock option grants made to executives and employees during the period 1997 to April 2002 were backdated, some by as much as four months, causing "Mercury to fail to record over $258 million in compensation."

This apparently comprehensive program of options backdating stands in odd contrast to the option plan arrangement that Mercury's shareholders approved. According to the complaint, not only did the shareholder approved plan specifically require all options grants to be priced at 100% of fair market value at the date of the grant, but the shareholders had earlier rejected an option grant plan that would have permitted the stock options to be granted at less than fair market value. In order to create the appearance that the backdated grants (which were in the money when they were actually awarded) were priced at 100% of the fair market value, the Company's former general counsel allegedly created falsified written consents and meeting minutes, and other false reports to create the appearance that the approvals had taken place at the earlier date. (Law.com has a June 1, 2007 article entitled "SEC Says Former Mercury GC Falsified Records" (here) that examines in greater detail the SEC's specific allegations against the Mercury's former general counsel.)

But perhaps even more interesting that the options grant backdating allegations are the allegations in the complaint relating to options exercise backdating. Through this process, several corporate officials were able to report that they had exercised their options earlier than the actual exercise date. The company's stock was trading lower at the selected earlier date, which reduced the apparent spread between the strike price and the market value on the reported exercise date. Because the amount of this spread is taxed as ordinary income, the use of the earlier date with the lower market price permitted the officials to minimize the gain that would have to be reported as ordinary income. The underreporting reduced the tax deduction benefit to the company as well. The backdated exercise date also shortened the period the officials had to hold the stock in order for gain on any stock sales to be taxed at the lower capital gains rate.

One official's tax benefit from the exercise backdating was as much as $17.7 million, and another official's benefit was as much as $2.2 million. In some instances, these officials allegedly were backdating their exercise on backdated options. (Refer here for my prior post on exercise backdating.)

The complaint also contains other allegations not directly related to backdating. For example, the complaint also alleges that the defendants manipulated its revenue recognition in order to manage the company's reported earnings per share. The complaints also alleges that the defendants fraudulently structured loans for overseas employees' options exercises to conceal the loans' accounting consequences, causing the company to fail to report $24 million in related compensation expense.

All in all, it is difficult to disagree with the assessment of Peter Henning, the Wayne State law professor who maintains the White Collar Crime Prof blog, in the Law.com article (here), that the company had a "widespread culture of fraud."

Yet there are nevertheless a couple of things that trouble me. It had been discussed in the press for some time that the SEC Commissioners were struggling with the question whether or not to impose civil fines directly on the companies involved in the backdating scandal. (Refer here for a Bloomberg.com article discussing the Commission's debate about whether or not to approve the $7 million Brocade settlement). There is an awkward question about the imposition of civil penalties on corporations for past violations, since the financial burden falls on current shareholders.

The Mercury civil penalty put this question in sharp focus since Hewlett Packard acquired Mercury on November 8, 2006, and Mercury is now a non-trading subsidiary of HP. The burden of Mercury's civil penalty falls on HP's shareholders, who of course have nothing to do with what happened at Mercury. And while it may be surmised that the acquisition price that HP paid for Mercury was discounted due to the uncertainty surrounding the SEC's investigation, that does not eliminate the question surrounding the purpose of the corporate civil penalty.

With the Brocade and Mercury Interactive settlements, it is clear that the SEC has resolved its internal debate and is now committed to pursuing civil penalties against at least some of the companies involved in the options backdating scandal. The imposition of corporate civil penalties to be borne by current shareholders for past misconduct does raise questions about the punitive or deterrent value of the penalties; it is hard not to wonder whether the penalties are misplaced. And why was Mercury Interactive's settlement $28 million and Brocade's $7 million?

To be sure, the SEC's civil enforcement actions against the individual officials at Brocade and Mercury Interactive are continuing. It remains to be seen what penalties (if any) these individuals will face. Along those lines, however, one very interesting omission from the Mercury Interactive civil enforcement complaint is the absence of any reference in the civil complaint to Mercury's former outside directors. As Mercury disclosed prior to the HP merger (here), three individual Mercury Interactive outside directors had been served with Wells Notices in connection with the SEC's investigation. However, the only individuals named in the SEC's civil enforcement complaint were former Mercury officers; no former outside directors were named. UPDATE: Alert reader Uri Ronen points out that the SEC's press release (here)announcing the Mercury Interactive enforcement action specifically states that "The Commission's investigation is continuing." As the SEC Actions blog notes (here), the Brocade Communications release does not mention that the investigation is continuing. The statement in the Mercury Release about the continuing investigation suggests at least the possibility that there could be further actions brought in the future.

One final note-- the SEC, in its civil complaint, could not resist adding the following detail when describing Mercury's software business: "One of the product solutions [Mercury] sold was marketed as a means to implement best practices frameworks for Sarbanes-Oxley compliance."

Special thanks to alert reader Lauren Murphy Pringle for providing several links relating to the Mercury Interactive settlement.

Lerach Status: As I noted in a prior post (here), rumors continue to circulate about Bill Lerach's possible retirement from the Lerach Coughlin law firm and a possible link between his supposed impending retirement and developments in the Milberg Weiss criminal investigation. Perhaps the most provocative article the rumor mill has produced it the Los Angeles Times' June 1, 2007 article (here), relating to Lerach's possible retirement, entitled "Class-Action Lawyer Could Face Charges." The WSJ.com Law Blog has a good summary (here) of the various stories currently in circulation.

According to a separate WSJ.com Law Blog post (here), the Lerach Coughlin firm has issued a press release acknowledging that Lerach is "considering retirement." The release notes that the firm itself has never been the subject of the investigation - which by negative inference certainly suggests that developments in the investigation have something to do with Lerach's retirement considerations. (The complete text of the press release can be found on the Legal Pad blog, here.) The WSJ.com Law Blog post also notes that the prosecutors and criminal defendants filed a sealed agreement last week postponing all motions in the criminal case for two weeks, which is consistent with the notion that there are active plea negotiations underway.

There will clearly be some interesting developments in the story in the next few days.

401(k) Fee Suits: A May 31, 2007 Law.Com article entitled "401(k) Suits Over High Costs to Employees on the Rise" (here) takes a look at the growing number of lawsuits against companies, and in some cases their directors or 401(k) plan trustees, alleging that the defendants breached their fiduciary duties by allowing third parties to charge undisclosed or excessive fees to employees who participate in the plan. One law firm, St. Louis-based Schlichter, Bogard and Denton, has filed 13 of these cases, some of which have already survived preliminary motions to dismiss. However, other cases have been dismissed, including one case against Grumman that had named the Grumman board of directors as defendants.

The several plaintiffs' lawyers quoted in the article all indicate that they expect to be filing more of these excessive fees suits in the future. As one defense lawyer quoted in the article put it, the claims for excessive 401(k) fees are like the "new toy in the toy box" for plaintiffs' lawyers.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In an earlier post (here) entitled "Options Backdating: Sue the Gatekeeper," I discussed a recent case where a company had sued its former accountant for the accountant's options timing advice. It now appears, in addition to "sue the gatekeeper," that "blame the gatekeeper" has emerged as a part of options backdating litigation. A May 30, 2007 Law.com article entitled "On Judge's Advice, Brocade Drops Wilson Sonsini" (here) discusses a number of cases in which companies and individuals who are defending themselves against allegations of options-related misconduct have attempted to blame alleged improprieties on outside lawyers and accountants.

The case discussed most prominently is the article involves Brocade Communications, whose ex-CEO George Reyes is facing criminal charges related to backdating at the company. According to the article, Reyes blames Wilson Sonsini partner (and former Brocade director) Larry Sonsini "for recommending that Reyes be allowed to aware options with little oversight." In light of Reyes's defense, and apparently at the suggestion of the trial judge, Brocade has dropped Wilson Sonsini as its counsel on its own options-related lawsuit. According to a prior San Jose Business Journal article (here) discussing the hearing at which the judge questioned Wilson Sonsini's involvment in connection with the proposed settlement of the Brocade derivative case; the Business Journal article reports that the judge asked the Wilson Sonsini attorney at the hearing: "There is evidence out there that Mr. Sonsini was involved in the mechanism ... which officers utilized in granting backdated options. Is it appropriate for you as the law firm to negotiate the settlement?"

Another company mentioned in the Law.com article is KLA Tencor, for whom Sonsini also apparently acted as outside counsel. The article quotes a November 1998 email from KLA Tencor's general counsel to Sonsini, in which the general counsel tells Sonsini that PricewaterhouseCoopers accountants had approved a process by which the company's stock options committee could meet "during the 30 days following August 31 and set the price for repricing at that time in order to maximize the value for employees." KLA Tencor apparently has acknowledged that the August grant was backdated and has repriced those options.

The article suggests that the difficulty and complexity of relevant options accounting rules put management in a position where they had to rely on outside lawyers and accountants for guidance. The defendants will argue that that their interactions with lawyer and accountants show that they did not intend to commit a crime. The difficulty for defendants trying to use this as a defense is that they will have to show that the attorneys or accountants were explicitly informed of the defendants' behavior. Moreover, as Mark Fagel, the head of enforcement in the SEC's San Francisco office, puts it in the article, "I'm skeptical of the claim that someone didn't understand that there was an accounting issue when they created a false document."

In an earlier post (here) entitled "Is Backdating Criminal?" I discuss an op-ed piece written by Reyes's criminal defense lawyers in which they contend that "most backdating cases" are "not fraud, but books and records errors." In the post, I contend that the "authors' theme that backdating is essentially innocent gets weaker the more a particular set of circumstances involves personal benefit, document falsification, and the greater the impact the activity had on the company's reported financial condition."

To Woo Rather Than Scourge: When he was New York's Attorney General, Eliot Spitzer made his name, and paved his way to the New York governor's mansion, by taking on Wall Street and major insurance companies. Now that he is governor, he has decided to try New York financial services companies now need his help in order to remain competitive in the global market place.

In a May 29, 2007 Executive Order (here), Spitzer formed the New York Commission to Modernize the Regulation of Financial Services. A press release accompanying the order (here) states that the purpose of the Commission will be to "identify ways in which regulatory powers could be integrated, rationalize and changed in order to promote economic innovation and protect the consumer."

Spitzer's Executive Order follows the recent tradition established by other leading New York politicians in their release of the Bloomberg-Schumer report (here), also designed to suggest ways to address the competitiveness of the New York financial markets. According to a May 30, 2007 New York Times article entitiled "Now, Spitzer Is Warming to Wall St." (here), the Bloomberg/Schumer report "focused on the patchwork of federal and state regulation," whereas Spitzer's Commission will be "focused, at least initially, on trying to rationalize outdated state regulations."

New York currently has four departments responsible for regulating financial service in New York. The Commission will seek to rationalize the structure. The Commission will produce a report by the end of June 2008, but will try to put changes into place before then, including in particular a new principles-based system of insurance regulation.

The Commission will be chaired by Eric Dinallo, the New York State Insurance Commissioner, and will include leaders from Insurance, Securities, Banking, Business, Law and Government. The full list of Commission members can be found here.

This story brims with irony, particularly in the fact that among the insurance leaders that Spitzer has appointed to the Commission is AIG CEO Martin Sullivan. I am sure that most readers will recall that on March 15, 2005 (refer here), Sullivan's predecessor, Maurice "Hank" Greenberg, resigned under pressure from Spitzer while Spitzer was New York Attorney General. As summarized in Wikipedia (here), Spitzer later filed a complaint against Greenberg and others alleging fraudulent business practices, securities fraud, common law fraud, and other violations. All criminal charges were later dropped and Greenberg was not held responsible for any crimes. Some civil charges remain (refer here). An interesting commentary on Spitzer's criminal nonprosecution of Greenberg can be found here.

Spitzer appears to have decided that his current political interests are better served by ingratiating himself with business leaders, rather than suing them (which served him so well in the past). I think most of us would understand if it took Sullivan a while to get comfortable in his new Commission seat.

I wonder, is it an inate human instinct to suspect zealous converts, particularly where the conversion is still recent and has an unmistakable air of calculation about it?

Hat tip to the FEI Financial Reporting Blog (here) for the link to the Executive Order and the Press Release.

Is Lerach Going to Retire?: According to a post yesterday on the Legal Pad blog (here), Bill Lerach of the Lerach Couglin law firm may be getting ready to retire:

The nation's preeminent class action lawyer, Bill Lerach, 61, informed at least one major client this week that he would be retiring imminently from his firm, Fortune has learned.

There have been multiple hearsay accounts all day to the effect that Lerach also informed his partners at San Diego-based Lerach Coughlin Stoia Geller Rudman & Robbins at a meeting last night, but Fortune has been unable to confirm those accounts with any one actually present.

Special thanks to a loyal reader for the link to the Legal Pad blog.

At the same time, there are also rumors circulating (refer here) that former Milberg Weiss partner David Bershad is in plea talks in connection with the ongoing Milberg Weiss criminal investigation and prosecution.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In an earlier post (here), I reported on the voluntary dismissal of the options backdating related derivative lawsuit that had been filed against Novellus Systems (as nominal defendant) and certain of its directors and offices. The May 7, 2007 press release (here) issued by Novellus' defense firm, Morrison Foerster, referring to the voluntary dismissal, announced "there goes one case you can strike from the options backdating scorecard." Referring to the case as "one of the few outright wins by a company accused of backdating stock options," the press release quotes MoFo partner Daryl Rains as saying that "it's not often you get a plaintiff to give up and walk away. I'm pleased that Lerach Coughlin was willing to take a hard look at the facts and see the case had no merit."

It appears that plaintiffs' lawyers willingness to "give up and walk away" is even less common that Mr. Rains thought. According to a May 25, 2007 San Jose Mercury News article (here), "less than three weeks after its attorney declared victory in a stock-option case, Novellus Systems was hit with harsher allegations...in a lawsuit filed by the same plaintiff." The new lawsuit, filed on May 24, 2007 in San Jose federal court, accuses 14 past and present Novellus officers and directors of enriching themselves through stock option manipulations, including backdating, springloading, and bullet dodging. The new lawsuit alleges that the defendants received more than $125 million as a result of options manipulations and seeks the return of the gains and additional damages. A copy of the new complaint can be found here.

The plaintiffs' counsel, Darren Robbins of the Lerach Coughlin firm, is quoted in the Mercury News article as saying that he was "baffled" by earlier press release, which he said was "false and misleading." Robbins cited the fact that the March 23, 2007 lawsuit dismissal had been without prejudice and allowed the plaintiffs the opportunity to amend their complaint, which the plaintiffs apparently intended to do even though their counsel voluntarily withdrew the lawsuit on May 2nd.

I can't help but wonder whether the Lerach Coughlin firm would have refiled the lawsuit if the defense firm had not issued the press release, or issued one that was a little more, well, restrained.

Hat tip to the WSJ.com Law Blog (here) for the link to the press release and the new complaint.
Another Insufficient Demand Futility Allegations Dismissal: On May 17, 2007, U.S. District Judge Susan Illston granted the defendants' motion to dismiss the options backdating derivative lawsuit that had been filed against Openwave Systems as nominal defendant and 18 of its current and former directors and officers. The court found that he plaintiffs' allegations did not satisfy the requirements under Delaware law (applicable to Openwave, a Delaware corporation, under Federal Rule of Civil Procedure 23.1) to show that a demand on the company's board to pursue the lawsuit directly would have been futile. A copy of the opinion can be found here. (Special thanks to Adam Savett at the Securities Litigation Watch (here) for the link to the Openwave opinion.)

Significantly, the court distinguished the Ryan v. Gifford case (involving Maxim Integrated Products, discussed here), which it said was "analogous." The court found that the Openwave plaintiffs' allegations did not "allege facts sufficient to support an inference of backdating" and in fact the pattern alleged was "consistent with a random selection of stock option grant dates, as with a pattern of backdating." The court found that "plaintiffs complaint fails to plead sufficient facts to avoid Rule 23.1 demand requirements," but allowed granted leave to amend "to allow plaintiffs the opportunity to conduct and present a more comprehensive statistical analysis, or other allegations supporting an inference of backdating."

It will of course remain to be seen whether plaintiffs can amend their complaints sufficiently to overcome the pleading deficiency. In the meantime, it is worth noting that the Openwave dismissal joins a growing line of cases that have been dismissed on the ground of insufficient demand futility allegations, including CNET (here), CSC (here) and Bed Bath and Beyond (here). In addition, the Openwave decision also cited a prior dismissal in the Linear Technology Corp. case, a decision of which I was not previously aware.

Early on in the whole options backdating scandal, I asked (here) the rhetorical question, with respect to growing number of options backdating related derivative lawsuits, "Yes, but WHY are they filing derivative lawsuits," based on the observation that derivative lawsuits face many defenses including in particular the demand futility requirement. When the Maxim Integrated Products decision came down in February 2007, it appeared that my concerns might have been misplaced, since the Delaware Chancery Court's rejected the defenses so enthusiastically in that case. But as time has gone by, the evidence is starting to mount that, at least in jurisdictions other than Delaware (even in cases to which Delaware law otherwise applies), the substantial hurdles that derivative action plaintiffs face may make many of these cases far less rewarding than the plaintiffs' lawyers may have hoped.

Meade Instruments Settles Options Backdating Cases: According to a May 24, 2007 remark by Meade Instruments President and CEO Steve Muellner in the company's quarterly earnings conference call (here), the company has reached a settlement in principle in the class action and shareholder derivative suits" that had been filed against he company with respect to options backdating. Muellner noted that both settlements are contingent upon court approval. Neither Muellner or the company released the details of the settlement.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for links to the Openwave decision and the Meade Instruments conference call statement.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In prior posts, I have tracked options backdating lawsuit dismissals (refer here) and settlements (refer here). Over the last few days, a number of additional backdating-related lawsuit dismissals and a settlement have surfaced.

Here are the dismissals:

Computer Sciences Corp.: On March 26, 2007, the United States District Court for the Central District of California dismissed the backdating-related derivative complaint that had been filed against certain of Computer Sciences Corp.'s directors, as well as against CSC as nominal defendant. The Court found that because four of the six director defendants had neither approved nor received the allegedly backdated options, the plaintiffs had failed to allege facts to show that a majority of CSC's board faced a substantial likelihood of liability. The Court dismissed the plaintiffs' complaint for failure to establish demand futility. The CSC dismissal is described in a May 8, 2007 memorandum by the Bingham McCutchen law firm, here. (The CNET dismissal that is also described in the linked document was previously discussed in The D & O Diary, here.)

Novellus: As disclosed in Novellus' May 10, 2007 filing on Form 10-Q (here), on March 23, 2007, the Court dismissed the options backdating shareholders' derivative lawsuit that had been filed against certain members of the Novellus board, as well as against the company itself as nominal defendant. The dismissal gave the plaintiffs until May 3, 2007 to seek to amend the complaint. On May 2, 2007, according to the 10-Q, "the plaintiffs voluntarily dismissed the case without prejudice." According to Novellus' defense counsel (quoted here), the Lerach Coughlin firm dropped the lawsuit because they "had nothing" to build a case on.

Xilinx: According to Xilinx's February 2, 2007 10-Q (here), on January 8, 2007, the U.S. District Court for the Northern District of California dismissed with prejudice the consolidated shareholder derivative lawsuit that had been filed against members of the company's board and certain of the company's officers. The Xilinx dismissal was also a voluntary dismissal.

The Xilinx and Novellus dimissals are discussed in a May 15, 2007 Marketwatch article entitled "Why The Lawsuits Over Options Backdating Are Failing" (here).

The options backdating lawsuit settlement that recently surfaced related to federal and state court shareholders' derivative lawsuits that had been filed against certain directrors and officers of J2 Global Communications, as well as against the company itself as nominal defendant. According to J2's May 9, 2007 filing on Form 10-Q (here), on March 19, 2007, the parties to both the federal and state derivative actions "entered into a settlement agreement that provides for dismissal of the four derivative cases and a release of all current and potential claims relating to our stock option granting practices." The 10-Q does not describe the terms of the settlement, but according to reliable sources, the settlement involved corporate governance changes and the payment of plaintiffs' attorneys' fees of $625,000.

UPDATE: In response to this post, readers brought a couple of additional options backdating-related derivative settlements to my attention:

Dean Foods: In its May 10, 2007 filing on Form 10-Q (here), Dean Foods disclosed that it had settled the two options backdating related shareholders derivative lawsuits against certain current and former directors and officers. The company said in its 10-Q that "the derivative actions were settled in the first quarter of 2007. The settlement resolves all claims and includes no finding of wrongdoing on the part of any of the defendants and no cash payment other than attorneys' fees. The Company has agreed to adoption and implementation of stock option grant procedures that reflect developing best practices. The district court approved the settlement and the actions were dismissed." A newspaper article discussing the Dean Foods settlement can be found here.

Molex: In its April 30, 2007 filing on Form 10-Q (here), Molex disclosed that the settlement of the shareholders derivative lawsuit that had been amended to include allegations of options backdating. In its 10-Q, Molex said that following about the amended lawsuit and the settlement: "In November 2006, plaintiffs filed a further amended complaint that added allegations that stock options were priced and issued improperly. The parties reached a settlement in principle of this action in February 2007. The settlement received final approval by the court on April 20, 2007. The settlement included an award of attorneys' fees funded by insurance proceeds and the Board's commitment to maintain certain corporate governance measures."

Special thanks to a loyal reader for the information about the J2 settlement. Thanks to yet another alert reader for the links to the Molex and Dean Foods settlements.

Tyco Settlement Observations: Tyco's May 15, 2007 announcement (here) of its massive $2.975 billion securities class action settlement has garnered extensive media attention. The Wall Street Journal's article about the settlement can be found here (subscription required) and the New York Times' article about the settlement can be found here.

I was struck by a couple of things that were not mentioned either in Tyco's announcement or in the press coverage. First, there is no reference in any of the discussion of the settlement to Tyco's D & O insurance. To the contrary, Tyco's press release states that "the company will incur a charge of $2.975 billion in the current quarter." This certainly suggests that the company expects to eat the whole thing. It is entirely possible that the D & O coverage has been exhausted by litigation expense and the resolution of other matters, but it is striking that apparently none of the securities class action settlement will be covered by insurance.

Second, by contrast to the WorldCom and Enron settlements, the Tyco settlement does not, at least according to the publicly available information, seem to involve any payment by Tyco's outside directors. To be sure, claims against criminally convicted former CEO Dennis Kozlowski and former CFO Mark Swartz will go forward, as will claims against former director Frank Walsh, who received a secret $20 million payment for helping arrange a merger and pleaded guilty to securities fraud. But the other former Tyco directors do not appear to have been required to contribute toward the class action settlement, unlike the Enron and WorldCom outside directors who had to contribute to settlement without recourse to insurance or indemnity.

It will be interesting to see if investors choose to participate in the class settlement or instead choose to opt out of the class and pursue individual claims. After all the publicity attending the improved percentage of investment loss that the opt outs from the Time Warner settlement recovered over what they would have recovered by remaining in the class (refer here), investors may well consider whether to pursue opt out claims rather than participate in the Tyco settlement.

The 10b-5 Daily's post about the Tyco settlement can be found here.

The Cardinal Health Settlement: The Tyco settlement comes close on the heels of another massive settlement, the $600 million Cardinal Health settlement (refer here). According to Cardinal Health's May 8, 2007 filing on Form 10-Q (here), on May 2, 2007, the company's board approved a memorandum of understanding regarding the settlement, subject to approval by the plaintiffs' class representatives and the Court. Cardinal previously established a $600 million reserve to cover the cost of the settlement. But Cardinal's 10-Q also discloses that it is involved in litigation with its insurance carrier, in which the carrier disputes coverage for the securities class action lawsuit as well as for related shareholders' derivative and ERISA lawsuits. Cardinal says in its 10-Q with respect to the insurance coverage litigation that "the Company currently believes that there will be some insurance coverage available under the Company's insurance policies."

The Cardinal Health settlement stands out, because unlike Tyco, Enron and WorldCom settlements, the underlying case was not really a part of the massive wave of corporate fraud that followed the stock market collapse in the early part of this decade. The Cardinal Health securities lawsuit was not filed until 2004, well after the enactment of the Sarbanes Oxley Act, and relates to accounting allegations specific to that company (refer here for a description of the Cardinal Health securities lawsuit). The Cardinal Health settlement may suggest that the higher level of securities class action severity is not exclusively an attribute of the cases arising out of a narrow set of pre-SOX corporate scandals, but rather may reflect higher overall severity levels. Certainly, the average severity for 2007 settlements will remain at elevated levels as a result of these settlements.

Hat tip to The 10b-Daily (here) for the Cardinal Health settlment links.

2006 PwC Securities Litigation Study: In a prior post (here), I reported on the 2006 PricewaterhouseCoopers 2006 Securities Litigation Study. At the time I created that post there was no link available for the Study, but the Study is now available online (here). I discussed the 2006 PwC Study in my prior post.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Newpark Resources has announced (here) a $9.85 million settlement of a securities class action lawsuit that, as amended, was based in part on allegations of stock options backdating.

The lawsuit against Newpark Resources and several of its directors and officers arose following the company's April 17, 2006 press release (here) in which it disclosed that the company's board's audit committee had "commissioned an internal investigation regarding potential irregularities involving the processing and payment of invoices by Soloco Texas, LP, one of the company's smaller subsidiaries, and other possible violations." The company also announced that it had placed three officials on administrative leave. The company's share price declined, and plaintiff shareholders initiated a securities class action lawsuit (here).

On June 29, 2006, Newpark Resources announced (here) that it had completed its initial investigation, and that it would be restating its financial statements for fiscal years 2001 through 2005, and for fiscal quarters in 2004 and 2005. The investigation concluded that certain of the Soloco Texas transactions had not been properly accounted for. The company also announced that during the investigation, "the Audit Committee had also requested a review of the company's past practices regarding stock options." The "preliminary findings" of the stock options investigation were "that a portion of the stock options granted prior to June 2003 were dated on a date other than the date their issuance was approved and the exercise price of such options were determined in advance of their approval by the appropriate board committee, all in contravention of the company's stock option plan." Newpark Resources also announced that the Board had terminated its former CEO and current Chairman of one if the company's subsidiaries, as well as the company's CFO.

On November 9, 2006, the plaintiffs filed their consolidated amended complaint (here) against Newpark Resources and present and former Newpark directors and officers. The amended complaint contains (at paragraphs 53 through 76) detailed options backdating related allegations. A summary regarding the Newpark Resources securities class action lawsuit can be found here.

On April 13, 2007, Newpark Resources announced (here) that it had settled the securities class action lawsuit as well as a related derivative lawsuit. The company announced that it would pay $1,550,000 toward the settlement, and its directors and officers liability insurer would pay an additional $8,300,000. The company announced that it was settling liabilities related to the Soloco Texas transactions as well as "alleged improper granting, recording, and accounting of backdated grants of stock options to executives." The company also announced that it had also been notified by the SEC that it had opened "a formal investigation into Newpark's restatement of earnings."

The lead plaintiffs in the case are Plumbers and Pipefitters Local 51 Pension Fund and and co-lead plainiffs law firms in the case are the Lerach Coughlin firm and Glancy Binkow and Goldberg.

The D & O Diary notes that while it had duly recorded, in our running tally of options backdating related lawsuits (here), that Newpark Resources had been named as a nominal defendant in an options backdating related derivative lawsuit, we had not picked up that the Newpark Resources securities class action lawsuit had been amended to add options backdating related allegations. The D & O Diary's options backdating related litigation tally will be amended to add the Newpark Resources lawsuit to the securities class action tally, with a link back to this post.

With respect to a prior partial settlement of a derivative options backdating lawsuit involving SafeNet, refer here.

Special thanks to a loyal reader (who prefers anonymity) for the link to the Newpark Resources settlement.

Another Interesting Class Action Settlement: On April 30, 2007, Doral Financial announced (here) the settlement of a pending securities class action lawsuit, as well as a related derivative lawsuit. The lawsuits related to Doral's April 19, 2005 restatement (here) of its financial statements for the period 2000 to 2004. As part of the settlement, the Company and its insurers will pay an aggregate of $129 million, of which the insurers will pay approximately $34 million. A summary of the class action lawsuit may be found here. The Lerach Coughlin firm acted as lead plaintiff firm, on behalf of the West Virginia Investment Management Board.

There are several interesting things about this settlement, the first of which is the significant amount by which the aggregate settlement amount exceeds the amount of available insurance. The company is responsible for a very significant portion of this settlement (but see below about the company's funding for the settlement). It used to be that the available insurance limits defined the outer limits of the potential settlement. There are more occasions now where the settlements exceed the insurance limits.

Second, in addition to the company's and its insurers joint payment, "one or more individual defendants will pay an aggregate of $1 million (in cash or Doral Financial stock)." This statement is odd for its careful imprecision -- one or more individuals? Cash or stock? Doesn't it seem unlikely at this point that they don't know who is going to pay and what form the payment will take? Or is something else going on? In any event, it seems to be a more common occurence for individuals to be called upon to fund a portion of the settlement. The reference to the possibility of payment in the form of company stock also seems to suggest that the individual (or is it individuals?) will be paying the settlement out of their own assets.

Third, the company also announced that its "payment obligations under the settlement agreement are subject to the closing and funding of one or more transactions through which the Company obtains outside financing during 2007 to meet its liquidity and capital needs, including the repayment of the Company's $625 million senior notes due on July 20, 2007, payment of the amounts due under the settlement agreement and certain other working capital and contractual needs." This sentence is hard to parse, but it apears that the company must borrow or otherwise raise the funds to finance the settlement. The company's press release goes on to say "either side may terminate the settlement agreement if the Company has not raised the necessary funding by September 30, 2007 or if the settlement has not been fully funded within 30 days from the receipt of such funding." Certainly seems like the company has to try to come up with the money somehow. I wonder where that leaves the plaintiffs if the company can't come up with the money?

In any event, Doral's other news today is that it is exploring selling itself to a private equity firm, according to news reports (here).

Hat tip to an alert reader (who prefer anonymity) for the link to the Doral Financial settlement.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

On April 11, 2007, Judge William Alsup of the San Francisco federal court granted the defendants' motion to dismiss the consolidated shareholders' derivative complaint filed in the connection with alleged options backdating at CNET Networks, based on plaintiffs' failure "to plead with particularity that demand on the board was excused as futile."

The plaintiffs' complaint, as amended, asserted four derivative claims based on federal securities laws, against thirteen individuals and against CNET itself as nominal defendants. Six of the thirteen individuals were board members at the time that the plaintiffs' filed the initial complaint. In order for plaintiffs to pursue their claim, the plaintiffs are required under Rule 23.1 of the Federal Rules of Civil Procedure to plead the steps they have taken to "obtain the action the plaintiff desires from the directors or comparable authority" or alternatively to show the reasons for not making this effort. The CNET plaintiffs alleged they did not make any demand on CNET's board because they contend demand would have been futile. In assessing the plaintiffs' demand futility allegations, Judge Alsop relied on Delaware law because CNET is a Delaware corporation.

In order to support their allegation that demand was futile, the plaintiffs allege that the six individual defendants who were directors when the complaint was filed received backdated options and that they had "ratified" the backdated options grants.

Judge Alsup had "failed to plead with particularity that a majority of the board was not disinterested or independent or did not exercise business judgment in making decisions." Judge Alsup examined the plaintiffs' options grant allegations, and found with respect to board recipients of the few options grants the plaintiffs successfully allged to have been backdated, only one board member recipient was still on the board when the complaint was initially filed. So the plaintiffs' allegtions that the board members had received the backdated options failed to establish demand futility. Judge Alsup also found that the plaintiffs' allegations that the board members "ratified" the allegedly backdated options grants was conclusory and insufficiently particularized to support demand futility allegations.

In reaching the conclusion that the plaintiffs had not adequately plead demand futility, Judge Alsup expressly distinguished Chancellor Chandler's recent finding of demand futility in the Maxim Integrated Products case (here), where, Judge Alsop noted, the plaintiffs "had pleaded particularized facts" supporting demand futility, including allegations of knowing approval of backdated option grants, along with alleged intentional failure to disclose the backdated options. (My prior post regarding the Maxim Integrated Products case can be found here.)

The amended complaint on which Judge Alsup granted the dismissal motion was the CNET plaintiffs' fourth iteration, due to which Judge Alsup said that he was "inclined to deny further leave to amend." However, he withheld his final determination on whether or not to grant leave to amend. He asked the parties to provide additional submissions on the question whether he had authority to allow the plaintiffs limited discovery about the possible "taint" to two of the directors defendants' service on the CNET board's compensation committee.

As noted in the April 16, 2007 Law.com article entitled "Federal Judge Axes CNET Stock Option Claims" (here), the CNET decision shows "how difficult it may be for plaintiffs to succeed in numerous similar claims related to stock-options backdating." It does show that plaintiffs will have to allege more than merely that options grant dates differed from the measurement date, or even that the members of the board received allegedly backdated options.

Judge Alsup's opinion also show that the Delaware Chancery Court decision in the Maxim Integrated Products case is not necessarily determinative of the demand futility question in other backdating cases, even other cases to which Delaware law applies. Judge Alsup's particularized inquiry based on the plaintiffs' specific allegations suggests that these issues will be determined on a case by case basis. Judge Alsup's insistence on particularized allegations and his unwillingness to accept unsupported inferences as a basis for demand futility suggests that it could prove challenging for demand futility allegations in other options backdating lawsuits to survive dismissal motions.

UPDATE: According to the CorporateCounselNet.com blog (here), Judge Alsup has ruled to allow the plaintiffs to amend, and is considering whether to stay the case while permitting limited discovery.

An interesting and helpful memo on the CNET case by the Fenwick & West law firm can be found here.
Options Backdating Litigation Update: With the addition of the new derivative complaint filed against Lehman Brothers Holdings (here), The D & O Diary's current tally (here) of the number of companies sued as nominal defendants in shareholders' derivative complaints based on options backdating allegations stands at 157. The number of securities class action lawsuits stands at 29. In addition, as a result of the ERISA suit filed against KB Homes (here), the number of ERISA or 401(k) options backdating lawsuits now totals 5.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

As the list of options backdating lawsuits has grown ever longer (refer here), one question has been: where will it all lead? Sooner or later, these cases will all have to be resolved, but so far it has remained unclear what the resolution might look like. A recent settlement in the derivative cases filed against two former executives of SafeNet provides at least a suggestion of where at least some of the cases could be headed.

In an April 3, 2007 filing on SEC Form 8-K, SafeNet announced (here) that it had reached settlements with former Chairman and CEO Anthony Caputo and former President, COO and acting CFO Carole Argo, both of whom had previously resigned following a review of the company's stock option practices. Caputo agreed to put $1.5 million in escrow, and Argo agreed to put $100,000 in escrow, pending the approval of the courts presiding over the derivative actions against the two individuals. (The 8-K also describes the procedures to be followed in the event of shareholder objections to the settlements, or in the event the court does not approve the settlements.) The settlement agreements also provide that certain of Caputo's and Argo's stock option grants will be canceled and the other option grants will be repriced.

The company's 8-K disclosure does not specify which courts' approval is required. The disclosure also leaves a number of other questions unanswered. For example, the disclosure is silent about the impact of these settlements on the derivative claims filed against SafeNet's board. It simply isn't clear from the disclosure the extent to which the settlements represent something less than complete resolution of the derivative actions.

However, at least some of SafeNet's backdating related litigation does now seem to have been resolved, beyond the settlements with Caputo and Argo. Regular readers will recall my prior post (here) describing the lawsuit that one of SafeNet's investors had brought alleging that some SafeNet directors had agreed to a low ball sale of the company in an effort to avoid potential liability for backdating stock options. According to an April 4, 2007 Baltimore Sun article (here), the investor that brought the suit had notified the court in which the case was pending that it had reached an "agreement in principle."

Brocade Criminal Case Tests Prosecutors: An April 4, 2007 San Jose Mercury article entitled "Brocade to Test Prosecution of Backdated Options" (here) describes the "complexities and challenges of bringing criminal charges against executives implicated in the murky legal landscape of backdated stock options."

While prosecutors targeted two Brocade executives to demonstrate the government's resolve to prosecute stock options manipulations, prosecutors could have, according to the article, "picked a more egregious case for the first criminal charges." Instead, prosecutors must make a case where neither of the defendants benefited personally from the alleged wrongdoing, making the case less intuitively appealing. On the other hand, the government's case does involve "basic document falsification and false statements."

The criminal case is scheduled to go to trial in June 2007. The outcome of the case could have an enormous impact on the course and extent of future prosecutions in other options backdating related cases.

My prior post on the question whether backdating is criminal, including specifically a discussion of the criminal case against former Brocade CEO Gregory Reyes, can be found here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Way back in 2003, long before any of the rest of us had ever heard of options backdating, Micrel sued its former auditor, Deloitte and Touche, alleging that the accounting firm had given the company faulty advice regarding its options grant practices. In its recently filed 2006 10-K (here), Micrel dislosed that on February 23, 2007, it settled the lawsuit, the first of its kind against an outside professional of which The D & O Diary is aware.

Micrel first disclosed its lawsuit against Deloitte in an April 23, 2003 8-K filing (here). The lawsuit didn't attract much attention at the time, but it gained notoriety after the options backdating scandal broke almost exactly a year ago. On June 19, 2006, the New York Times ran an article about the case entitled "Inquiry Into Stock Options Pricing Casts a Wide Net" (here). The article can also be found on the International Herald Tribune's website (here).

According to the Times article, Micrel was having a problem in the mid-90's due to the volatility of its share price. It was providing new hires with stock option grants, with the exercise price set at the closing price on the new employee's first day. Because the exercise price was so variable, a "fairness problem" emerged. Micrel wanted to make its option grants "a little more equitable."

According to the allegations in the subsequent lawsuit, Deloitte proposed that Micrel set the exercise price at the lowest point in the 30-day period from when the grant was approved. The lawsuit also alleged that Deloitte advised Micrel that this 30-day pricing method followed the rules and would not have adverse accounting consequences. The 30-day pricing method was originally used for just new employees, but was subsequently extended across the company. According to the Times article, "Morrison and Foerster, the San Francisco law firm hired as Micrel's outside counsel, affirmed the terms of the plan in an opinion letter." Senior management also signed off on the plan, as did three members of the board.

In December 2001, Deloitte decided to reverse its view regarding the 30-day pricing method. (According to the Legal Pad blog, here, Deloitte's reversal came when a new audit partner replaced the audit partner who approved the plan.) According to the Times, Deloitte urged Micrel to restate its prior financial reports. Micrel subsequently restated its financial statements for 1998, 1999, 2000 and the first three quarters of 2001 (refer here). Micrel claimed that the total cost to the company of the flawed options plan was $58.6 million. In its 2003 lawsuit, Micrel sought to recover, among other things, the additional professional fees incurred to "address the impact on Micrel's financial statements and other effects"; changes to earnings that would not have occurred but for the advice; and liability and potential liability for taxes that would not have been due but for the advice.

According to Micrel's 2006 10-K (here, refer to footnote 15 of the financial statements), "Deloitte agreed to pay Micrel a settlement amount of $15.5 million." The Company expects to record the settlement as other income during the first quarter of 2007.

Micrel was not the only company with which Deloitte was entangled over the 30-day pricing method. According to a June 16, 2006 Wall Street Journal article entitled "During 1990's, Microsoft Practiced a Variation of Options Backdating" (here, subscription required), Microsoft also awarded options at monthly lows, each July, from 1992 to 1999. During that period, Microsoft issued options "covering what would now amount to about three billion shares, adjusting for stock splits," according to the Journal. The article also states that the July-low practice was "approved by Microsoft's longtime auditor - Deloitte and Touche."

Microsoft voluntarily stopped the practice, and on July 19, 1999, announced that it was ending the practice and took a $217 million charge. According to the Journal article, "Microsoft and Deloitte consulted about the practice before making the 1999 change."

All of this makes me wonder a couple of things: why did it take Deloitte more than two years after Microsoft had taken a $217 million charge to earnings to discontinue the practice at Micrel? And were Micrel and Microsoft the only two companies who received Deloitte's counsel regarding this specific options grant practice?

More generally, the sequence of events involving these two companies make me wonder whether outside gatekeepers may have spread these and other kinds of options grant practices among companies?

And finally, I wonder whether we will be seeing more lawsuits against outside professionals for their options grant related advice, or for negligent oversight regarding options backdating?

The Legal Pad blog discusses these issues further, here. Special thanks to a loyal reader (who prefers anonymity) for the link regarding this settlement.

The D & O Diary's prior post about the Micrel case can be found here.

Now This: Before you fly, read these important messages (here).

• Email This
• Print
• Comments
• Trackbacks
• Share Link

A shareholder of SafeNet has filed a shareholders derivative lawsuit in Delaware Chancery Court, claiming that the SafeNet directors agreed to sell the company to a private equity firm to avoid potential options backdating related liabilities. On March 5, 2007, SafeNet announced (here) that it had agreed to be acquired by Vector Capital for $634 million, which represented a 1.6% premium over the prior trading day's closing price. According to a March 9, 2007 Baltimore Sun article entitled "Suit Claims SafeNet Being Sold to Shield Directors," (here), the lawsuit seeks to stop the sale to Vector, order directors to account for "special benefits" tied to the deal, and award unspecified damages. The news article quotes a spokesperson for the plaintiff as asserting that the buyout is designed to protect the directors from their liability for wrongdoing associated with options backdating; "Why else would the director-defendants cause the company to agree to a low-ball offer with virtually no premium?"

SafeNet announced in July 2006 (here) that it would be revising several years' financial statements. In addition, as a result of the Company's review of its options grant practices, the company's Chairman and CEO and its President and Chief Operating officers resigned (here) It has delayed filing its periodic reports with the SEC (here), struggled to maintain its NASDAQ listing (here), and also had its creditors claim that its delayed SEC filing violated debt covenants (here). Current and former directors and offercers have also been sued (refer here) along with the company as a nominal defendant in a separate shareholders derivative lawsuit alleging breaches of fiduciary duty and unjust enrichment in connection with options grant manipulations.

The D & O Diary has no basis on which to judge the merits of the new lawsuit's claim that the directors are selling the company to avoid liability or as an alternative to trying to tidy up the various problems arising from options backdating issues. The WSJ Deal Journal blog (here) notes that companies that have announced options backdating woes do have a way of getting acquired; the Deal Journal notes that the SafeNet acquisition "swells the ranks of those that have disclosed backdating issues and later gone on to find suitors to at least 10." The Deal Journal also identifies five other companies that are mired in the backdating scandal that it speculates might also be takeover targets. Whether or not that is a coincidence, it it true that, for example, Mercury Interactive, as well as other companies, have successfully had previously filed derivative lawsuits dismissed after the company was acquired (regarding the Mercury Interactive dismissal, refer here).

However, The D & O Diary also notes that in addition to the shareholders derivative lawsuit, SafeNet and its directors and officers have also been sued in a securities class action lawsuit (here). The sale of the company would have no effect on this pending securities fraud lawsuit, which will go forward without respect to the pending acquisition.

Options Backdating Litigation Tally: The filing of a new securities fraud lawsuit against HCC Insurance Holdings and certain of its directors and officers (here) brings the number of options backdating related securities lawsuits to 27, as reflected on The D & O Diary's running tally of options backdating related lawsuits (here). The number of companies named as nominal defendants in options backdating related shareholders derivative lawsuits stands at 152. Readers may also be interested to know that the Securities Litigation Watch is also maintaining a list of options backdating related securities fraud lawsuits, here. Fortunately, the two tallies agree.

Competitiveness of U.S. Capital Markets: According a March 10, 2007 Wall Street Journal article entitled "Business Leaders, Washington Aim to Fix Wall Street's Ailment" (here, subscription required), the U.S. Chamber of Commerce and the U.S. Treasury Department will both be hosting daylong conference this upcoming week to discuss the competitiveness of the U.S. financial markets in the global economy. The Treasury Department will go first on Tuesday March 13, with a meeting that is expected to include Alan Greenspan and Warren Buffett in addition to Treasury Secretary Henry Paulson. (The full list of speakers and schedule can be found here.) The U.S. Chamber of Commerce will follow on Wednesday March 14 with the "First Annual Capital Markets Summit" and will be heavy on politicians, including Senator Chris Dodd and Representative Barney Frank. The agenda for the Chamber's conference can be found here. The Chamber is also releasing a report on Monday. The early signals are that the report will emphasize the things that businesses themselves can do, for example, by eliminating quarterly guidance as a way to reduce the focus on short term results. (The D & O Diary has previously commented on the virtues of eliminating quarterly earning guidance, here.)

Campos on Capital Markets Competition: While the upcoming conferences and reports undoubtedly will repeat the conventional wisdom the culprit for the decline in U.S. competitiveness is regulation and litigation, a March 8, 2007 speech (here) by SEC Commissioner Roel C. Campos (pictured above) had a different perspective. Campos commented on the various calls that have arise to adjust the U.S regulatory approach to enable it financial markets to be more competitive. He started by disagreeing that the U.S markets are in fact in decline, citing the recent Thompson Financial study (about which The D & O Diary recently commented, here). He added that, even were it true that U.S markets were declining, "the evidence does not support the claim that regulation is to blame." He cited a recent Goldman Sachs study, which states that "growth of the capital markets outside the U.S. is a natural consequence of economic growth and market maturation elsewhere," and that "regulation is not the problem." (For a more detailed discussion of the Goldman Sachs study, refer to the With Vigor and Zeal blog, here).

Campos went on to note that many of the would-be reformers and their supporters "have a broad ideological agenda," but the bottom line is that "most capital and investment will go to jurisdictions that have a high level of protection" and "if a jurisdiction promotes itself as having lower standards, it risks driving capital away to other markets where capital is perceived to be better protected."

Campos apparently also caused a flap by making a comment comparing the London Stock Exchange's Alternative Investment Market to a "casino" because, he claimed, 30 percent of new listing are "gone within a year." Campos apparently later retracted that statement. (The With Vigor and Zeal blog has a detailed discussion of the Campos casino comment flap, here.)

It may have been impolitic (not to mention bad manners) for Campos to refer to the AIM as a casino. But as The D & O Diary previously noted (here), a recent study did show that 52 percent of the companies that listed on the AIM during the three year period ending December 31, 2006 are "either trading at or below their issue price or have had their shares suspended."

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In an earlier post (here), The D & O Diary commented on the research published by Lucian Bebchuk of Harvard Law School and two colleagues, in which they examined over 19,000 options grant awards between 1996 and 2005, finding a disproportionately higher number of grants on the date during the month with the lowest share price. In an article in the March/April 2007 issue of Harvard Magazine entitled "'Insider Luck': How Stock-Option Grants Were Gamed - And What to Do About It" (here), Bebchuk elaborates and comments upon his research.

A portion of the magazine article summarizes Bebchuk's previously released study, in which the researchers found that 12% of all CEO options grants were "lucky grants," defined as grants awarded on days on which the stock price was at its monthly low. (The research findings are summarized in my prior post, linked above.) The magazine article adds the further research finding that "opportunistic timing has not been limited to executive' grants; rather it has been present to a significant degree in outside directors' grants as well." The research showed that about 9% of the grants to outside directors were "'lucky' events taking place on dates with stock prices at monthly lows." Bebchuk reports that the opportunistic timing was spread over about 460 companies, and that "in companies in which opportunistic timing of options awards took place, luck tended to lift the boats of both executives and outside directors."

Bebchuk emphasizes that the research showed that "most companies have not engaged in such timing in awarding options," but that certain factors were associated with a higher likelihood of lucky grants. The option grants were more likely to be "lucky" when the potential payoffs were relatively high, and opportunistic timing was "correlated with increased influence of the CEO on the company's internal pay-setting and decision-making process."

Bebchuk goes on to note that the "fact that many outside directors were themselves recipients of lucky grants reinforces the view that opportunistic stock-options awards were produced by governance failures, not business decisions made rationally and in good faith to serve shareholder interests." Bebchuk concludes by commenting that "even though significant backdating may belong to the past, its underlying causes are problems with which the corporate governance system must continue to wrestle."

Bebchuk's research and commentary are interesting. But I have begun to be a little suspicious of research studies showing that backdating took place at a very large number of companies, far greater than the number that have announced backdating problems so far. We are now nearly a year beyond the first wave of media attention surrounding the backdating issue. How many more companies can there be out there yet to divulge options grant manipulations? If Bebchuk's numeric research conclusions are not ultimately borne out, are his other conclusions and comments adequately supported? To be sure, there may yet be many companies about to reveal options timing problems, and Bebchuk's research could be validated by forthcoming disclosure events. At this point, I have become a little skeptical that there are as many companies yet to reveal options timing problems as Bebchuk's research would suggest.

Losing AIM?: In prior posts (most recently here), I have suggested that global financial markets are evolving, and that factors that may have made London's Alternative Investment Market (AIM) more attractive than U.S securities markets in the last few years may be changing on their own. A February 22, 2007 article in the U.K.-based LegalWeek.com entitled "Losing AIM - Three Years of Market Boom Has Come to an End" (here) confirms that "the twin shadows of market indigestion and long-simmering concerns regarding the quality of companies floating has finally called a halt to the AIM express."

The article notes that the recent headlines regarding Torex Retail (see my prior post, here) "have taken their toll, though regulatory concerns have been brewing for months." Although the article optimistic about the prospects for renewed future prosperity on the AIM, it does acknowledge that right now, the market is going through a "necessary correction." As one commentator quoted in the article says, "we are paying the price for the number of deals done in 2005 for companies of questionable quality."

Contrary to the arguments of would-be reformers, the AIM experience is not bearing out the need for U.S securities markets to loosen their regulatory standards in order to compete in the global marketplace. To the contrary, the AIM experience increasingly is substantiating the need for markets to maintain their regulatory discipline in order to preserve investor confidence. Moreover, it appears that some of the differences in the global financial marketplace that have been driving competition in recent years are turning out to be transient, and are evolving. As The D & O Diary has frequently noted (most recently here), we should be very cautious about relying on transient phenomena as a basis for compromising the U.S. securities markets' regulatory integrity.

Hat tip to Werner Kranenburg of the With Vigor and Zeal blog for the link to the LegalWeek.com article.

Practice, Practice, Practice? How you really get to Carnegie Hall -- refer here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

As the Wall Street Journal noted in its February 16, 2007 article entitled "Probes of Backdating Move to Faster Track" (here, subscription required), the various options backdating investigations may be moving more rapidly now. Within the last weeks, there have been guilty pleas entered in connection with the Take-Two (here) and Monster Worldwide (here) investigations, and the Journal article also suggested that criminal charges may be forthcoming in the Broadcom investigation.

The reason that the pace of activity seems to be picking up may be due to a looming deadline. According to a February 20, 2007 San Jose Mercury article entitled "Clock Ticking on Prosecuting Backdating Options" (here), investigators are "bumping up against a legal deadline" - the five year statute of limitations for securities fraud. According to the article, the window may be closing because stock options misdating largely ended in 2002 because of Sarbanes-Oxley options reporting requirements. The article suggests that the looming deadline may force prosecutors to allege lesser related charges, such as conspiracy or lying to prosecutors, because they are not yet ready to press criminal securities charges. Prosecutors may also seek waivers from potential defendants, but defendants may have little incentive to agree to a waiver. Prosecutors may also seek to allege that until recent disclosures and restatements, the options timing practices were concealed, and therefore the running of the statute should be tolled - but obviously prosecutors would rather avoid taking the chance that a court might not agree that the statute was tolled.

In determining whether or not to bring charges, prosecutors are, according to the Journal article linked above, looking for "plus factors" that can increase prosecutors' "promise of success" - these factors include "written indications of deliberate backdating; falsified documents; efforts to hide manipulation from auditors or investigators; or indications that top executives gave themselves backdated options." (These factors are similar to those I cited in my earlier post, Is Backdating Criminal?, here.)

Prosecutors undoubtedly will be, among other things, reviewing company email traffic pertaining to options grants, as the Wall Street Journal's February 20, 2007 article entitled "Emails Reveal Backdating Scheme" (here, subscription required) suggests. Certainly, email references (such as those the Journal reports to have appeared in emails at Mercury Interactive) to "magic backdating ink" are not helpful for individuals hoping to avoid investigators' attention.

The Ultimate Solution to Investment Fraud: According to news reports (here), a Chinese businessman has been sentenced to death for a fraudulent $385 million investment scheme. Wang Zhendong promised investors returns of 60 percent on investments in an ant-breeding scheme. (Ants apparently are used in traditional Chinese medicinal remedies; refer here for background) The scheme drew over 10,000 investors between 2002 and 2005. The investment arrangement was really a pyramid scheme, and most investors lost their entire investment. The Intermediate People's Court in Yingkou sentenced Wang to death.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The options backdating scandal has engendered a flood of shareholders' derivative lawsuits (146 as of the last count, here). The D & O Diary has previously questioned (here) plaintiffs' lawyers' apparent enthusiasm for these suits given the numerous potential defenses these cases present, including, among others, statute of limitations, demand failure, and the business judgment rule. However, two February 6, 2007 opinions by Chancellor William B. Chandler III (pictured above) of the Delaware Court of Chancery, rejected defendants' dismissal motions on these grounds, and is permitting the options manipulation cases to go forward.

The two opinions were issued in connection with an options backdating case in which Maxim Integrated Products is named as a nominal defendant (Ryan v. Gifford), and with respect to the option springloading allegations in the Tyson Foods Consolidated Shareholder Litigation. The Maxim opinion can be found here and the Tyson Foods opinion can be found here.

The Maxim case is only one of several derivative lawsuits that shareholder plaintiffs have filed alleging options backdating at the company, and the Delaware case was not even the first filed. There are other cases pending in California federal and state court. The Chancellor nevertheless declined to stay the Delaware action because the case presents questions of "great import to the law of corporations." Because Delaware courts have not addressed these "fundamental issues" and because Delaware law controls many of the backdating cases, the Chancellor found that Delaware courts have "an overwhelming interest in resolving questions of first impression under Delaware law."

The Maxim defendants moved to dismiss on grounds of demand failure, the business judgment rule, and the statute of limitations. Chancellor Chandler rejected the Maxim defendants' motion to dismiss the complaint for failure of the plaintiffs to demand that the board take up the allegations. The plaintiffs allege that the board's compensation committee (composing half of the board) had approved backdating options in contravention of the written and shareholder approved plan. The Chancellor said that that "a board's knowing and intentional decision to exceed the shareholders' grant of express (but limited) authority raises doubt regarding whether such decision is a valid exercise of business judgment and is sufficient to excuse a failure to make demand." In reaching his conclusion that the alleged approval of the option grants exceeded that plan, the Chancellor reviewed the backdating allegations and concluded that the "timing, by my judgment and by support of empirical data, seems too fortuitous to be mere coincidence."

Chancellor Chandler also rejected defendants' motion to dismiss based on the business judgment rule. The plaintiffs' argued that the defendants were not entitled to rely on the business judgment rule because the board acted intentionally or in bad faith. The Chancellor denied the defendants' motion to dismiss, saying "I am unable to fathom a situation where the deliberate violation of a shareholder approved stock option plan and false disclosures, obviously intended to mislead shareholders into thinking that the directors complied honestly with the shareholder approved options plan, is anything but an act of bad faith."

The Chancellor also rejected defendants' motion to dismiss based on the three-year statute of limitations, finding that the statute was tolled as a result of fraudulent concealment: "Inaccurate public representations as to whether directors are in compliance with the shareholder-approved stock option plan constituted fraudulent concealment of wrongdoing sufficient to toll the statute of limitations."

The Chancellor did hold that the particular plaintiff in the Maxim case lacked standing to assert claims of alleged options backdating that occurred before plaintiff acquired his Maxim stock when Maxim took over a predecessor company in which the plaintiff owned shares. In other words, to have standing, a plaintiff must have owned his or her shares at the time the alleged backdating took place.

The Tyson case involves a multitude of allegations and supposed misconduct, including in particular four alleged instances of "springloading," in which the defendants supposedly made stock options grants immediately in advance of the release of positive news (which in every instance led to a stock price hike). Chancellor Chandler rejected the statute of limitations defense based on the "doctrines of equitable tolling and fraudulent concealment." The option grants themselves were disclosed but not that they were made while the defendants possessed material nonpublic information: "Such partial, selective disclosure - if not itself a lie, certainly exceptional parsimony of the truth - constitutes an 'actual artifice' that satisfies the requirements of the doctrine of fraudulent concealment." He found that the "equitable tolling" doctrine also tolls the statute: "It is difficult to conceive of an instance, consistent with the concept of loyalty and good faith, in which the fiduciary may declare that an option is granted at 'market rate' and simultaneously withhold that both the fiduciary and the recipient knew at the time that these options would quickly be worth more."

The Chancellor also rejected the Tyson defendants' motion to dismiss based on the business judgment rule. Acknowledging that allegations of "options springloading" implicate a "much more subtle deception" than options backdating, Chancellor Chandler said that it is not a question whether the practice is a form of insider trading; rather the question is:

whether a director acts in bad faith by authorizing options with a market-value price, as he is required to do by a shareholder-approved incentive option plan, at a time when he knows those shares to be actually worth more than the exercise price. A director who intentionally uses inside knowledge not available to shareholders in order to enrich employees while avoiding shareholder imposed requirements cannot, in my opinion, be said to be acting loyally and in good faith as a fiduciary.

The Chancellor emphasized that in order to make this allegation, the plaintiff "must allege that options were issued according to a shareholder-approved employee compensation plan."

Chancellor Chandler's opinions in these two cases could have a significant impact on the many pending options backdating cases. As the Chancellor himself noted in deciding not to stay the Maxim case, "an answer regarding the legality of these practices pursuant to Delaware law plainly will affect not only the parties to this action, but also parties in civil and criminal proceedings where Delaware law controls or applies." In other words, the Chancellor's opinions reflect his awareness and his intent that his rulings will affect other proceedings - significantly, including even criminal proceedings.

In light of Chandler's awareness that his rulings will carry influential, persuasive, and even precedential power, perhaps even beyond cases controlled by Delaware law, his censorious, even outraged tone is striking. It is clear that he takes a dark view of the alleged options manipulations, particularly where shareholders have been told that the options would be granted according to a plan that they have approved. Chandler had little trouble rejecting defenses the might otherwise protect the alleged misconduct. The potential impact on the many other pending cases could be substantial. Plaintiffs' briefs in the other cases will now be replete with lengthy quotations from Chandler's opinions, and defendants will be forced to try to distinguish the cases, even if Delaware law is not controlling, at least where the companies had shareholder approved options plans in place at the time the alleged options grant manipulations. Chandler's ruling that options springloading (and, his opinion also suggest, options bullet dodging) might violate fiduciary duties could also have a very significant impact.

The Maxim opinion is discussed in a February 8, 2007 Wall Street Journal article entitled "Maxim Ruling Opens Door for Backdating Cases" (here, subscrition required). A more scholarly discussion of the Maxim opinion can be found on Professor Bainbridge's Business Associations blog (here).

Special thanks to Broc Romanek of the CorporateCounsel.net blog (here) for providing me with copies of the opinions, thanks to Adam Savett of the Lies, Damned Lies blog (here) for forwarding me links to the opinion, and hat tip to Francis Pileggi of the Delaware Corporate and Commercial Litigation blog (here) for maintaining links to the opinions on his site.

SEC Files New Options Backdating Enforcement Proceeding: On February 6, 2007, the SEC filed a new civil enforcement proceeding against two former officers of Engineered Support Systems, based on the officials' participation in an alleged six-year options backdating scheme. The SEC's press release can be found here. The scheme was somewhat unusual because it involved the occurence of "double backdating" where backdated options that had fallen out-of-the-money were backdated a second time. This new action is the first options backdating action since the SEC filed its earlier actions against Comverse Technology and Brocade Communications last summer. It may have taken the SEC a while to get around to this most recent action, but it surely will not be the last that the SEC files. An interesting discussion of the new action, including important differences between this action and the earlier Comverse and Brocade actions, can be found on the SEC Actions blog, here. The case is also discussed on the AAO Weblog, here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

While 144 different companies have been named as nominal defendants in options backdating related derivative lawsuits (see The D & O Diary's running tally of options backdating related lawsuits here), a new lawsuit filed in federal court in Houston on Thursday will be of particular interest to The D & O Diary's readers, both because of the company involved and because of one of the individual defendants involved. According to a February 2, 2007 Houston Chronicle article (here), HCC Insurance Holdings has been sued as a nominal defendant in a shareholders derivative lawsuit, along with twenty of its former present and former directors and officers. The suit alleges that the defendants backdated stock option grants and caused the company to file false and misleading statements with the SEC between 1995 and 2006; diverted "hundreds of millions of dollars of corporate assets" to HCC senior executives; and subjected HCC to potential liability from regulators.

Among the individual defendants is Marvin Bush, President George W. Bush's youngest brother. Bush was an HCC director from 1999 to 2002, until he became an advisory director. Bush is alleged to have sold 93,000 HCC shares for $2.2 million while supposedly in possession of material nonpublic information.

The lawsuit follows the company's November 17, 2006 release (here) of the results of its internal investigation, in which it reported that "the company used incorrect measurement dates for certain stock option grants covering a significant number of employees," from 1995 to 2006. HCC's internal investigation was conducted by the Skadden Arps law firm. In connection with the release of the internal investigation report, company founder and CEO Stephen Way resigned. The company has also said that it is cooperating with an informal SEC investigation.

Penalties Debate Stalling Options Enforcement Cases?: Even though the SEC reportedly is investigating over 100 companies, it has charged only a handful of individuals at two technology companies - Brocade Communications Systems and Comverse Technology. According to a January 31, 2007 Blooomberg.com article entitled "SEC's Cox Stalls Options Crackdown By Delaying Vote" (here), the SEC's probe of over 100 companies in connection with the options backdating scandal has stalled while SEC Chairman Christopher Cox determines how to penalize the companies involved. According to the article, Brocade has been waiting since July 2006 for approval of a proposed $7 million settlement. The Commission apparently is split along party lines on whether companies should be penalized, with the two republicans opposing fines as harmful to shareholders and the two democrats supporting the practice as a deterrent and as a means to recover ill-gotten gains. Later news accounts (here) reported Cox's denial that the decision is stalled.

Will Outside Directors Become Involved in Options Backdating Charges?: Since three outside directors received Wells Notices in connection with the Mercury Interactive stock options investigation (refer here), there has been a unanswered question surrounding the stock options scandal: to what extent will outside directors get dragged into enforcement actions and claims involving options backdating? In a January 23, 2007 speech (here), SEC Commissioner Roel C. Campos added fuel to the speculative fire when he stated, in connection with his comments on the SEC's options backdating investigation, that so far "we have charged only officers" but that "if the specific facts are present, it wouldn't surprise me to see charges brought against outside directors."

Welcome Back: The D & O Diary is delighted to see the Lies, Damned Lies blog back on the blogging circuit again after a brief hiatus. Apparently the current active phase will be brief, as Adam Savett, the blog's author, will soon be reinvigorating the dormant Securities Litigation Watch blog. In the meantime, Adam has put the Lies, Damned Lies blog up for "adoption." (here). The D & O Diary will be interested to see how this anticipated double brain transplant works out.

Now This: The D & O Diary was surprised to learn from Wikipedia (here) that Marvin Bush is a 1979 graduate of the University of Virginia, founded by Thomas Jefferson and also the alma mater of The D & O Diary's author (B.A. 1978). According to Wikipedia, Bush was a member of the St. Elmo Hall fraternity, known at the time for its preppy athletes. Although we overlapped for three years at UVa, I did not know Bush; my fraternity down the street from Bush's drew from a different demographic and enjoyed a somewhat different reputation. Readers may be interested to know that Katie Couric was also at UVa at the same time. I don't believe that Katie attended too many parties at my fraternity...

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Regular D & O Diary readers know that I have been maintaining a running tally of options backdating related litigation (here). According to the most recent count, so far there have been 23 securities class action lawsuits raising allegations of options grant manipulations. (The Stanford Law School Securities Class Action Clearinghouse maintains its own tally on its home page, here, that agrees with my count.)

My running tally includes cases that did not originally involve (or feature prominently) allegations related to stock grant manipulations, but that were later amended to include or emphasize options backdating allegations. Because I have already made the decision to incorporate in my tally cases that included options backdating allegations by amendment, I feel compelled to revise my tally to include the Amkor Technology case.

The initial complaints in the Amkor Technology case, filed in January 2006, may be found here. The initial complaints did not contain options backdating allegations. In an Amended and Consolidated Complaint filed in the Amkor Technology case on August 14, 2006, the allegations in that lawsuit were significantly augmented to include detailed allegations of supposed options backdating, complete with the now standard stock price graphs showing arrows superimposed on stock price troughs when options allegedly were granted. (Links to the Amended and Consolidated Complaint are unavailable, but the Amended Consolidated Complaint in Amkor is available on PACER; anyone who wants a copy of the pleading but lacks a PACER subscription should drop me a note and I will email a copy).

I only became aware of the Amkor Amended and Consolidated Complaint by accident while I was looking for something else. I am concerned that there may be other pending securities fraud cases that did not contain options backdating allegations when initially filed that have been amended to include them. It would be extraordinarily helpful if D & O Diary readers who are aware of securities fraud lawsuits that have been amended to add options backdating allegations could let me know, so that I could adjust the options litigation tally accordingly.

With the addition of the Amkor Technology case, the tally of securities fraud lawsuits raising options grant manipulation allegations stands at 24.

As also noted in my running tally, the number of companies that have been named as nominal defendants in shareholders derivative lawsuits stands at 141. This count has been substantially revised this week thanks to information supplied by alert D & O Diary readers Bill Ballowe and Ben Eng. Hat tip to these gentlemen for their helpful information.

UPDATE: My request for help from readers has already yielded results. The list of securities fraud lawsuits involving options grant manipulations has been amended to include the lawsuit pending against Quest Software. The lead plaintiff's counsel's press release regarding the Quest Software case may be found here. With the addition of this case, the tally of securities fraud lawsuits now stands at 25. Hat tip to Adam Savett of the Lies, Damned Lies blog for the link to the press release.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

According to a January 20, 2007 Wall Street Journal article entitled "Executives Get Bonuses As Firms Reprice Options" (here, subscription required), some of the companies ensnared in the options backdating scandal are paying cash bonuses to executives whose options are being repriced, as the option exercise price is shifted to the actual grant date from the backdated date. According to the article, these bonuses are going to executives who weren't involved in options wrongdoing, and who would otherwise see the overall value of their paid compensation shrink as a result of the repricing.

Although the repricing is designed to make the executives' compensation whole, some executives could wind up better off as a result of the cash bonuses, because they are "swapping unrealized, potential profit" (since the share price could decline) for cash. In the examples cited in the article, the cash bonuses involve payments of hundreds of thousands of dollars.

Some companies are going even further and paying the 20% excise tax payable under IRS Section 409A on "discount" options whose exercise price is below the level of the stock on the day the option is granted.

The article does point out that there are a number of companies that have concluded that the problem "should be fixed without taking more out of shareholders' pockets" and have accordingly declined to pay additional amounts to affected executives.

What are we to make of all this? On the one hand, as Professor Larry Ribstein points out on his Ideoblog (here), the executives receiving the cash bonuses weren't involved in the backdating: "If they didn't do anything wrong, why punish them by taking away some of their agreed compensation?"

While I see Professor Ribstein's point, it is a struggle for me to see that the right thing for companies to do here is make a cash payment to the executives. The point of options compensation is to align corporate managers' interests with those of shareholders by providing that managers only do well if shareholders do well. By converting that investment risk into fixed cash, the element of shared interest is eliminated. To the contrary, it converts the shared interest into exclusive service of executives' interests at shareholders' expense.

The reality of shareholders expense leads to another concern. The executives receiving the cash bonus may have been cleared of wrongdoing, but for the backdating to have taken place there had to have been some missing internal controls. Even if the executives were uninvolved in the wrongdoing, they were present when the errors occurred. As between the executives and investors, who ought to absorb the compensaion consequences involved with cleaning up the mess? Shareholders already are absorbing all of the costs of accountants' and attorneys' services required to clear up accounts. Why should shareholders also have to absorb additional costs for cash compensation to senior executives who were "on the bridge" when the malfunctions occurred?

There are also a couple of very serious atmospheric problems with the cash payments at this particular point in time. First, by communicating that the incremental additional value of the backdating options represents compensation to which the executives were entitled, the companies are inferentially suggesting that the backdating was an intended part of their compensation scheme. (This is a conclusion that Professor Ribstein overtly draws.) Whatever the theoretical debate might be about the propriety of backdating, now is a particularly poor time for companies to suggest that backdating was a calculated part of their intended compensation scheme.

Finally, with all of the scrutiny on executive compensation in general right now, providing executives with immediate cash payment for flawed variable compensation sends a very provocative message - particularly as at least some of the companies involved, according to the Journal article, have not yet determined how they will treat backdated options by nonexecutive employees.

These and other concerns are obviously the reason why many other companies are declining to reimburse executives for repriced options. The fact that many companies have declined to make these cash payments certainly puts the companies that are making the payments in a conspicuous spot - the front page of the Wall Street Journal, for starters.

H-P CEO Claims He Was Not "Bullet Dodging": On January 19, 2007, the House Committee on Energy and Commerce forwarded to the SEC a letter that H-P CEO Mark Hurd sent to the Committee in response to the Committee's questions about his exercising of H-P options shortly before the H-P pretexting scandal broke last fall. A copy of the Committee's letter, to which Hurd's letter is attached, can be found here. In his letter, Hurd defended the stock transactions, which took place two weeks before the pretexting scandal broke, and the same day as he was questioned by H-P's outside counsel in connection with the internal investigation surrounding the abrupt resignation of former H-P board member Tom Perkins.

Hurd specifically wrote that "My August trade was not a case of bullet dodging." Hurd stated that the trade was part of his regularly scheduled trading plan, established on the advice of his financial planner and broker, and consistent with the legal opinion he received from H-P's counsel in advance of the trades. He also states that he began the process to execute the trades before anyone had asked to interview him. He also pointed out that the options exercised were granted, and the exercise price was set, long before the exercise date.

While the letter is interesting and its release has generated press attention (for example, this January 20, 2007 San Jose Mercury News article, here) this may all be much ado about nothing. As the While Collar Crime Prof blog points out (here), "while the timing is suspicious ... the company's stock price increased after Hurd's sale," so that rather than dodging a bullet, "he may actually have taken one instead."

Oh, Behave: Some great quotes about behaving comme il faut (or not), here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

On January 16, 2007, the Lerach Coughlin firm filed a purported securities class action lawsuit in federal court in the District of Columbia against Sunrise Senior Living and several of its directors and officers. A copy of the law firm's press release can be found here and a copy of the complaint can be found here. The complaint raises a variety of different allegations but also contains allegations that the defendants manipulated the company's stock option program by backdating or springloading option grants.

The Complaint alleges that the "top insiders of Sunrise took advantage of the artificial inflation in Sunrise's shares to bail out of the stock, unloading almost a million shares of the stock." What is interesting about the plaintiffs' insider trading allegation is their assertion that the defendants stock sales were triggered "in early 2006, as widespread revelations of a stock option backdating scandal began to sweep corporate America." The allegedly backdated or springloaded options were awarded during the period 1997 to 2001.

The plaintiffs do not specify why the unfolding scandal supposedly motivated the defendants to sell their shares; the suggested inference, I suppose, is that defendants sold their shares because they knew when the marketplace found out about the backdating in the company's options, the company's share price would drop. But in fact, the company's share price declined in value as a result of its announcement (here) that it would be restating its financial statements for the years 2003 through 2005, not because of disclosures relating to options backdating.

Apparently in anticipation of the defendants' likely arguments that their share sales were made pursuant to Rule 10b5-1 trading plans, the plaintiffs raise a number of interesting allegations. The plaintiffs not only contend that the plan terms "did not comply with regulatory requirements" but also that when the defendants put the plans in place, they knew "that they were already pursuing a scheme to defraud and falsify Sunrise's reported financial results" hoping that the plans "would give them protection from the legal liability they knew they would otherwise face." In other words, the plaintiffs are trying to argue that the Rule 10b5-1 plans themselves were part of the scheme to defraud.

Updated Options Backdating Litigation Tally: The initiation of the lawsuit against Sunrise brings the total number of options backdating related securities class action lawsuits to 23. The number of companies named as nominal defendants in shareholders' derivative lawsuits based on options backdating allegations now stands at 131. The D & O Diary's running tally of the options backdating related lawsuits can be found here.

Courts Reject SOX Whistleblower's Claim: Employees of public companies who believe they have been retaliated against because they engaged in "protected" whistleblowing activity may assert a claim against their employer under Section 806 of the Sarbanes-Oxley Act. The burden is on the employee to show that the protected activity was a contributing factor in the adverse employment action. The D & O Diary's prior post about the difficulty employees are having obtaining relief under the SOX Whistleblower provisions can be found here.

There is still relatively little case authority establishing what constitutes "protected activity." A recent federal court decision from Michigan examined how direct the causal connection has to be between the allegedly protected activity and the job action.

In the case (Sussman v. K-Mart Holding Corp.) the plaintiff (Sussman) alleged that he had sent the company's President a letter alleging that his supervisor was accepting kickbacks from vendors. K-Mart investigated the supervisor, but before the investigation was complete, the supervisor was terminated for unrelated reasons. Five months later, Sussman's performance came under criticism, and he received a warning. Sussman asked his (new) supervisor whether the warning was related to his complaints about his prior supervisor. After additional performance shortcomings, Sussman was terminated.

In SOX whistleblower case that Sussman filed against K-Mart, the court held that Sussman had failed to establish a causal link between the job action and the activity he claimed was protected. The court did observe that Sussman was not engaging in protected activity when he raised with his new supervisor that he had blown the whistle on his prior supervisor's kickbacks. The court found that his comments about his previous supervisor's actions could not be related to protecting shareholders from fraud because his prior supervisor was fired for unrelated reasons five months before he made the remarks to his new supervisor.

A detailed summary of the decision, as well as a brief overview of the "protected activity" case law, can be found a memorandum by the Sutherland, Asbill & Brennan law firm, here.

The Ultimate Team Building Video: This YouTube video is for anyone who has ever felt like a team of one. The video takes about a minute to watch, but rewards a complete viewing.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In a January 10, 2007 Wall Street Journal op-ed piece provocatively entitled "Should Steve Jobs Go to Jail?" (here, subscription required) the attorneys for Gregory Reyes, the former CEO Brocade Communications who faces criminal charges in connection with stock option activity at Brocade, present their view that "most options backdating cases" are "not fraud, but books and records errors." They recite that Steve Jobs, the CEO of Apple who faces his own set of questions about options grants at his company, like their client, is a "non- accountant who didn't personally benefit one cent from the options grants at issue." They go on to state that the "problem with the government's theory is that it "conflates books and records violations with criminal securities fraud." The government thus "untethers securities fraud from the legal elements that safeguard executives from conviction from inadvertent accounting violations resulting in little or no harm to companies or investors." The authors go on to assert that "there is no proof of deceit or concealment in alleged backdating cases," and that the backdating was "actually undertaken in good faith" arising from the high volume of options grants that led to "paperwork errors."

While the authors' essay is most directly intended to exonerate their client, their arguments join a chorus of other voices that have contending that options backdating in general is not illegal and the current proecutorial zeal to prosecute backdating is a combination of government (and media) overreaction and failure to understand the practical and legal ramifications of backdating. This view is most persuasively presented on Professor Larry Ribstein's Ideoblog (here) and in Holman Jenkins columns in the Wall Street Journal (most recently, here).

There is absolutely no doubt that what has happened with the options backdating story is what usually happens when there is a contagion event across many companies. The media has jumped on the story, looking for scapegoats and all too eager to see this story as one more example of "greedy" corporate executives enriching themselves (supposedly) at shareholder expense. There is no doubt that some of the media coverage has swept with too broad a brush, and lumped together many companies and many kinds of activities as if the activity and the companies were all equivalent and equally culpable. But while not every company executive whose name has been associated with the backdating story is criminally culpable, neither is every one of them completely innocent, as the authors of the Journal op-ed piece seem to come close to suggesting.

It is undoubtedly the case, as the op-ed authors contend, that a number of different things have gotten "conflated" in the whole options backdating scandal. First and foremost, there is an unfortunate tendency for too many commentators to sweep together a whole range of conduct under the heading "options backdating." As The D & O Diary has taken great pains to emphasize in discussing the options backdating scandal, what is commonly referred to as options backdating actually includes a wide variety of options related activities, including not just backdating itself, but options springloading (here and here), employee related options backdating (here), bullet-dodging (here), and even options exercise backdating (here). Each of these kinds of activities is different, each involves different actions, and each arguably involves varying levels of culpability, both potential, and in some cases, actual. More to the point, there varying aspects of each of these different sorts of activities that make the activities more or less arguably criminal.

The variables that potentially might make options related activities more arguably criminal can be seen best in an extreme example. As chance would have it, the same day as the op-ed piece appeared in the Journal, an extreme example arose in the case of William Savin, the ex-General Counsel of Comverse Technology. On January 10, 2007, Sorin settled the enforcement proceeding that had been brought against him by the SEC in connection with options backdating allegations. The SEC's press release about the settlement can be found here. The SEC had charged Sorin, along with former Comverse CEO Kobi Alexander and David Kreinberg, Comverse's former CFO, of engaging in a scheme to backdate Comverse options grants from 1991 to 2001. The SEC's complaint against the three former officials can be found here. Their scheme is alleged to have resulted in the restatement of income because of the understatement of Comverse's compensation expense. Sorin himself was alleged to have realized more than $14 million from the sale of stock underlying the exercises of backdated option that were granted during the 1991 to 2001 period. Sorin was specifically alleged to have played a critical role in the scheme by drafting grand documents with false grant dates. Sorin is also alleged to have facilitated a similar backdating scheme at Ulticom, a Comverse subsidiary, by creating false company records.

In settling the fraud charges, Sorin neither admitted or denied the allegations. (However, on November 2, 2006, Sorin pled guilty to a single count of conspiracy to commit securities fraud, mail fraud, and wire fraud.) As part of the SEC settlement, Sorin consented to be enjoined from further securities laws violations; to pay $1.6 million in dosgorgement, of which $1 million "represented the 'in-the-money" benefit from the exercises of backdated options grants; $800,000 in prejudgment interest; and a civil fine of $600,000. The total value of the amounts Sorin agreed to pay is more than $3 million.

Even though Sorin neither admitted or denied the allegations against him, the allegations provide an interesting context to assess the op-ed authors' assertion that backdating is no more than a mere scrivener's error. By contrast to the benign picture the op-ed authors conjure, Sorin was alleged to have personally benefited; he was alledged to have falsified documents, both at Comverse and at Ulticom; and Comverse investors were alleged to have been deceived because income was overstated by the understatement of expense.

Using these elements as a framework to assess potential culpability, it seems to me that the op-ed authors' theme that backdating is essentially innocent gets weaker the more a particular set of circumstances involves personal benefit, document falsification, and the greater the impact the activity had on the company's reported financial condition. As they correctly contend, cases without these elements lack indicia of securities fraud. But as the allegations against Sorin suggest, there may be cases where these allegations of personal benefit and deception are present and where the shareholder harm was great.

Whether any particular case involved culpable behavior depends on what actually happened, and this is where the distinction between the different kinds of options grant activity matters most. As The D & O Diary pointed out when the criminal complaint was first filed against Gregory Reyes (here), the employee related options grant activity of which Reyes is accused seems to be different in kind and character from other alleged options backdating activity, precisely because it lacked the element of self-interest and self-benefit that may be involved in other kinds of options grant activities. So the differences between the kinds of activity matter. (A copy of the criminal complaint against Reyes may be found here.)

What these kinds of distinctions may mean for Steven Jobs is still an open question. As I have pointed out (here), the grant related practices under scrutiny at Apple involve both options springloading as well as options backdating. Moreover, one critical element - whether or not Jobs personally benefited from the options practices--is the subject of heated debate. For example, a January 11, 2007 Washington Post article entitled "Apple Chief Benefited From Options Dating, Records Indicate" (here, registration required) presents a perspective that the options he was granted in December 2001 and that were backdated to October 2001 personally benefited him when he later traded the options for registered shares he subsequently sold at a profit. By contrast, Professor Ribstein contends (here) that the same options grant involved no culpable activity and that the grant date was reasonably fixed at a date certain so that the exercise price could be fixed while Jobs continued his negotiations with the company over the size of the grant.

Without having the benefit of complete information, it is hard to tell what the government ultimately may do in connection with the options backdating at Apple, or for that matter at any of the other companies that are under investigation. But just as the op-ed authors argue that prosecutors ought not to conflate books and records violations with securities fraud, so too should distinctions be carefully drawn about the specific kind of activity involved, because different activities will involve different degrees of the elements that potentially could support allegations of culpability: self-benefiting activity, deceit, and shareholder harm. As the Comverse allegations illustrate, there are going to be at least some cases where these elements arguably support allegations of criminality. It seems to me that by "conflating" conduct that might be sufficiently self-interested and deceptive to constitute fraud with mere good faith paperwork errors, the op-ed authors seek to extend the justifiable excuse of the innocent to cover even the conduct of the culpable. Ironically, I happen to think that the lack of self-interest involved in the employee-related options backdating allegations against their client puts his client at the less culpable end of the spectrum.

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

In their Consolidated Amended Shareholder Derivative Complaint filed December 18, 2006 in the federal court in San Jose, the plaintiff in the Apple Computer shareholders derivative action have zeroed in on alleged options springloading practices. A January 3, 2007 Los Angeles Times article entitled "At Apple, Timing Led to Overnight Windfalls" (here) describes the allegations.

The Amended Complaint alleges that three Apple executives received a windfall on August 5, 1997 when they were granted options to buy over 2 million shares, the day before Apple CEO Steven Jobs announced during a keynote speech at the MacWorld conference that Microsoft would invest $150 million in Apple and share patented technologies. Apple's agreement to put Microsoft's Internet Explorer on Macintosh computers sent Apple's share price up 48 percent in two days. The options vested in installments over a three year period, during which Apple's share price tripled. The three Apple executives who received the shares were Chief Financial Officer Fred Anderson, Controller Robert Calderoni and Senior Vice President Jonathan Rubinstein.

The Amended Complaint also alleges that Jobs himself received two backdated options grants in 2000 and 2001, but that in March 2003, Apple canceled the options in exchange for 5 million shares of restricted stock. Jobs sold the restricted stock the day they vested, March 19, 2006, the day after the Wall Street Journal ran its front page article entitled "The Perfect Payday" (here) that launched the whole backdating firestorm.

Apple's Backdating Disclosures: The Dance of the Seven Veils? In its December 29, 2006 press release (here), Apple announced the completion of its internal investigation of its stock options practices. The release contained a joint statement from the chair of the board's special investigative committee, former Vice President Al Gore, and the audit committee chair, Jerome York, stating, among other things, that Apple's board "has complete confidence in Steve Jobs and the senior management team." In its 10-Q filed he same day (here), Apple detailed the results of its investigation, stating:

Based on a review of the totality of evidence and the applicable law, the Special Committee found no misconduct by current management. The Special Committee's investigation identified a number of grants for which grant dates were intentionally selected in order to obtain favorable exercise prices. The terms of these and certain other grants, as discussed below, were finalized after the originally assigned grant dates. The Special Committee concluded that the procedures for granting, accounting for, and reporting stock option grants did not include sufficient safeguards to prevent manipulation. Although the investigation found that CEO Steve Jobs was aware or recommended the selection of some favorable grant dates, he did not receive or financially benefit from these grants or appreciate the accounting implications. The Special Committee also found that the investigation had raised serious concerns regarding the actions of two former officers in connection with the accounting, recording and reporting of stock option grants.

The report does not identify the two officers, but press reports (here) suggest that they are Fred Anderson (who resigned as Apple's CFO in 2004 and left Apple's Board in September 2006) and former general counsel and corporate secretary Nancy Heinen, who resigned in May 2006.

In an earlier SEC filing, Jobs expressed his contrition for these practices. In Apple's October 4, 2006 8-K (here), Jobs stated "I apologize to Apple's shareholders and employees for these problems, which happened on my watch."

Apple's board exoneration of Jobs has drawn harsh criticism. A January 5, 2007 San Jose Mercury News article entitled "Apple is Giving Jobs a Free Pass, Critics Say" (here) quotes Lynn Turner, a managing director of shareholder advisory firm Glass Lewis and the former SEC chief accountant, as saying "Apple's board derserves an 'F' for how it handled its backdating investigation." A January 4, 2007 BusinessWeek.com article entitled "Is Steve Jobs Untouchable?" (here) suggests that Apple's board and investors alike may prefer a go-softly approach with Jobs because of his iconic status and his franchise value to the company.

But while Apple's board may prefer that Jobs is given a pass, there may be too many questions for Jobs to escape further scrutiny. In a January 6, 2007 Wall Street Journal op-ed piece entitled "Inside Jobs" (here, subscription required) Harvard Law School professor Lucien Bebchuk raises a host of concerns about the troubling unanswered questions in Apple's board's special investigation report.

And there are still the governments investigations (here). The SEC and the U.S. Attorney's office are both investigating Apple's options practices, and they undoubtedly will insist on answers to the unanswered questions. In addition, some commentators have suggested that government investigators may also be interested in Apple's disclosures about its options practices. The BusinessWeek.com article linked above contains the comment that

Some lawyers say government investigators may be troubled that Jobs's role in the backdating has appeared to grow with each of the four filings since Apple first reported last June, and could cause them to question the reliability of Apple's findings. "One of the factors the SEC looks to is [whether there is] full and complete public disclosure, not the dance of the seven veils," says one highly regarded securities lawyer.

With all of these questions, it is understandable that, according to today's Wall Street Journal (here, subscription required), "When he hops onto the stage to kick off the MacWorld conference in San Francisco Tuesday, Apple Computer Inc. Chief Executive Steve Jobs will seek to return the spotlight to innovative gadgets and away from a stock-option backdating mess at the company that has nabbed headlines for months." The D & O Diary suspects that this year, there won't be a massive award of stock options to Apple executives the day before the MacWorld conference.

Special thanks to a loyal D & O Diary reader who prefers anonymity for the link to the Los Angeles Times article.

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

Shareholders suing Cablevision Systems over its backdated options have amended their complaint to add the company's former compensation consultant as a defendant. According to news reports (here), the allegations against Lyons Benenson & Co., the company's former compensation consultant, are the first in the nation to accuse a compensation advisor of taking part in a backdating scheme.

Cablevision's options granting practices gained a certain macbre notoriety for their involvement of the first known instance of "Sixth Sense" options grants ("I pay dead people" - hat tip to Patrick McGurn at the ISS Corporate Governance Blog, here, for that great one-liner). In its 2Q06 10-K (here), Cablevision reported that its internal options investigation uncovered that the company had awarded options to a vice chairman after his 1999 death, but backdated them, making it appear that the grant was awarded when he was still alive. As Columbia Law School professor John Coffee dryly commented (here), "Trying to incentivize a corpse suggests they were not complying with the spirit of shareholder-approved stock-option plans."

Cablevision's filing also disclosed that its internal investigation had discovered that options had also been awarded to its compensation consultant, but that the options award had been accounted for as if the consultant were an employee. The filing reported that the award had been canceled in 2003. The filing also noted that the company's "relationship with the company...terminated" more than a year before the options investigation began.

The company also restated its earnings for 2003 through 2005 and the first quarter of 2006 to adjust for the impact of improper options practices, which reportedly took place during the period 1997 through 2002. The company has announced that it is under investigation by the SEC as well as the U.S. Attorney's office. The company has also received a grant jury subpoena.

The shareholder action naming Lyons Benenson as a defendant was filed by Grant & Eisenhofer on behalf of plaintiff shareholder the Teachers Retirement System of Louisiana. The complaint alleges that Lyons Benenson attended compensation meetings during which backdated options were granted in violation of the company's employee option plan. The complaint also alleges that the consultant provided the committee with advice and documentation to facilitate the grants. The complaint also contains allegations about the options awareded to the consultant; the complaint does not allege that the options were illegal or backdated, but that they were "unusual and inappropriate" given that they came from an option account designated for Cablevision employees.

Cablevision has also been in the news lately based upon the offer by the Dolan family, which controls the company, to buy out the company's public shareholders in a deal that values the company at about $7.9 billion. The D & O Diary previously commented on the buy out offer here. As noted in the Wall Street Journal article (here, subscription required) reporting on the Dolan's buy out offer, the company's recent history has been "turbulent," as detailed further in the article.

While the Cablevision shareholders' claim against Lyons Benenson may be the first against a company's compensation consultant arising out of the backdating scandal, there may be many more claims against the outside advisers to companies caught up in the backdating scandal. Attorneys, auditors and others undoubtedly will also be drawn in as the story continues to unfold. (See more details below about options backdating litigation.)

What Can EDGAR Tell Us About Lyons Benenson?: The D & O Diary had not previously heard of Cablevision's erstwhile compensation consultant, so this seemed like a good opportunity to test out the new full-text search capabilities of EDGAR, on the SEC website. (See the SEC's November 14, 2006 press release about the new full-text search capabilities, here.) A full-text EDGAR search on the name Lyons Benenson revealed several instances associating the firm or one of its principals with various public companies. (It should be noted that the searchable text is limited only to the last four years.)

The 2002 10-K of ACTV, Inc. (here) revealed that the company had hired Lyons Benenson as a compensation consultant in 1999.

The December 22, 2003 proxy statement of DRS Technologies (here) disclosed that the company previously had retained Lyons Benenson to "assist in the design, assessment, and implementation" of the company's compensation system, but at the end of the most recent fiscal year had replaced the consultant with another firm.

The April 7, 2006 Proxy Statement of CKX, Inc. (here) disclosed that the company had retained Lyons Benenson as a compensation consultant "to assist the Committee in fulfilling its responsibilities and to provide advice with respect to all matters relating to executive compensation and the compensation practices of similar companies. The consultant is engaged by, and reports directly to, the Compensation Committee. Harvey Benenson generally attends all meetings of the Compensation Committee on behalf of Lyons, Benenson & Company Inc."

In addition, according to 2005 10-K of Penn Octane (here), Harvey L. Benenson, who is described in the filing as a "Managing Director, Chariman and Chief Executive Officer" of Lyons Benenson, served as a director of the company since his election in August 2000. Benenson also served on the company's audit and compensation committees. However, according to news reports (here), Benenson resigned from the Penn Octane board in October 2006.

Options Backdating Litigation Update: As a result of the latest additions to The D & O Diary's running tally of options backdating litigation (which may be found here), the total number of companies named as nominal defendants in options backdating related shareholder's derivative lawsuits now total 117. The number of companies sued in options backdating related securities fraud lawsuits stands at 21.

OK, But They Don't Get Any Stock Options Awards: From the IMdb website (here), which touts itself as the "Earth's Biggest Movie Database":

Cole Sear: I see dead people.

Malcolm Crowe: In your dreams? [Cole shakes his head no]

Malcolm Crowe: While you're awake? [Cole nods]

Malcolm Crowe: Dead people like, in graves? In coffins?

Cole Sear: Walking around like regular people. They don't see each other. They only see what they want to see. They don't know they're dead.

Malcolm Crowe: How often do you see them?

Cole Sear: All the time. They're everywhere.

Cole's perception is familiar to those (including your faithful correspondent) who have worked in certain office environments.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Lucky CEOs: A new study by three leading academics claims to establish a link between governance practices and questionably timed stock options to chief executives. A November 16, 2006 study entitled "Lucky CEOs" (here) by Lucian Bebchuk of Harvard Law School, Yaniv Grinstein of Cornell, and Urs Peyer of INSEAD, examined 19,036 option grants between 1996 and 2005, involving about 6,000 companies and about 8,000 CEOs. The authors looked at the distribution of grant prices within the grant month and found a disproportionately higher numbers of grants on the date during the month with the lowest share price (and a disproportionately lower number of grants on the date with the highest share price). The authors found that these "lucky" grants were likeliest to occur at companies that did not have a majority of independent directors. The authors also found that this luck was persistent; CEOs that had lucky grants tended to have multiple lucky grants.

The authors also found that about 43% of lucky grants were "super lucky," because they fell on the date with the lowest share price for the quarter.

Among the authors more interesting findings is their conclusion that the lucky grants were not concentrated amongst high tech companies. The authors found that a majority of the lucky grants as well as the super lucky grants were awarded at "old economy" firms.

The authors estimated (using probabilistic techniques) that about half of the lucky grants were due to manipulation rather than chance. They also estimated that about 850 CEOs at about 750 companies received or provided lucky grants produced by opportunistic timing.

The authors also found that lucky grants were likeliest to occur at companies that had CEOs with longer tenure. The authors estimated that the average gain to CEOs from the lucky grants that were backdated exceeded 20% of the reported grants and increased the CEOs total reported compensation for the year by 10%.

News reports describing the study may be found here and here. A brief commentary critical of the study can be found on Professor Larry Ribstein's Ideoblog, here.

Stock Option Grant Givebacks: On November 15, 2006, EMCORE announced (here) that two top executives will return gains from exercising stock options that a voluntary internal investigation had concluded were the result of improper practices. EMCORE's CEO voluntarily agreed to return $147,775 and its chief legal officer agreed to repay $97,000. The company said these amounts represented "the entire benefit received from the misdated grants they exercised." The company's CFO, who had not exercised any of the misdated stock option grants, voluntarily surrendered his rights to the grants. The company's internal investigation was "unable to concluded that the company or anyone involved in the stock option granting process engaged in willful misconduct."

A CFO.com article discussing the EMCORE stock option investigation can be found here.

As The D & O Diary previously noted (here), executives at Molex agreed to repay the company $685,000 to cover gains they realized on misdated options.

These somewhat isolated incidents pale by comparison to the givebacks involving UnitedHealth Group's options investigation. UnitedHealth Group's outgoing CEO William McGuire and his successor Stephen Helmsley collectively forfeit $390 million in gains from previously exercised options, and their unexercised stock options were repriced to eliminate paper gains from due to options timing. See the Wall Street Journal's November 9, 2006 article, here, registration required. UnitedHealth Group's November 8 press release can be found here.

UPDATE: The November 20, 2006 Wall Street Journal has a front page article entitled "Companies Discover It's Hard to Reclaim Pay from Executives" (here, subscription required) discussing difficulties companies have had trying to recover past compensation to which executives were not entitled.

Options Backdating Lawsuit Update: With the recent addition of new lawsuits that have been filed against Flowserve, Biomet and Black Box, The D & O Diary's running tally (here) of companies named as nominal defendants in shareholders derivative lawsuits raising options timing allegations now stands at 113. The number of companies sued in securities fraud lawsuits remains at 21.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

One of the standard features of most articles discussing the options backdating scandal has been the obligatory statement that backdating largely disappeared after the 2002 passage of the Sarbanes-Oxley Act, as a result of the Act's requirement (in Section 403(a)(2)) that all transactions in the company's shares involving directors or officers must be documented to the SEC "before the end of the second business day following the day" on which the transaction took place. But a new report entitled "The Backdating Scandal's Second Act?," shareholder advisory firm Glass Lewis raises doubt about whether Sarbanes-Oxley eliminated the practice after all, and suggests that there may be a whole new round of options timing revelations ahead.

According to news reports (here and here), Glass Lewis found that many companies have not been complying with the timing requirements for filing options related paperwork on SEC Form 4. The report found that the SEC rarely cracks down on companies for filing their paperwork late, which allows the opportunity to change the actual date the stock options were granted to a day when the stock was trading at a lower price. The firm reviewed hundreds of thousands of Form 4 filings from January 2004 to June 2006 and pinpointed some 6,000 questionably timed stock-options grants that were dislosed late to investors. Glass Lewis found that in several instances the price of company shares increased materially between the purported grant date and the date of the filing.

One of the companies Glass Lewis identified in the report is Silicon Image. According to news reports (here), Glass Lewis found that several Silicon Image officers were late filing Form 4s in connection with options grants during 2004, 2005 and 2006. In 11 out of 12 grants during that period, Silicon Image's stock price increased between the grant date and the (late) filing date. According to an October 31, 2006 San Jose Mercury News article (here), Silicon Image has launched an internal review of its option practices. The Glass Lewis Report cited eight other companies whose Form 4 filings showed a similar jump in share price between the grant date and the filing date.

Based on this analysis, Glass Lewis questioned whether the options timing scandal might be about to enter a "second act," involving potentially "hundreds" of companies that may have backdated options grants even after the 2002 Sarbanes-Oxley reforms. The report also notes that even where the company's Form 4 filing were unintentionally or inadvertently filed late, the company's regulatory filing practices still raise concerns about the company's internal controls.

It is too early to tell whether or not the Glass Lewis "second act" analysis really does portend a significant new phase in the options timing scandal. It is worth noting that the original trigger for the initial round of options backdating investigations was a similar academic analysis of options practices. And even though there are as yet no claims based on these kind of "second act" allegations, the possibility of these kinds of claims does pose a new challenge for D & O underwriters. The underwriters must now consider whether claims might yet arise based on allegations about post-2002 late Form 4 filings and stock price increases between the grant date and the filing date. Well-advised companies will take steps now to able during their D & O insurance renewal to substantiate the timeliness of their Form 4 filings, or in general to be able to respond to questions about their regulatory filing practices.

Update: A November 9, 2006 article in the Minneapolis Tribune (here) describes a lawsuit that has been filed against Digital River, raising options backdating allegations. The allegations are based in part on Digital River's habit of being late with its Form 4 filings relating to options grants. Digital River is one of the nine companies named in the Glass Lewis study.

Options Backdating Litigation Update: The D & O Diary's running tally of litigation arising from options timing allegations (here) was updated today. According to the current tally, 95 companies have been sued as nominal defendants in shareholders derivative lawsuits based on options timing allegations. The number of options timing securities fraud lawsuits stands at 20.

Inside the Milberg Weiss Indictment: Readers who can't get enough of the details surrounding the indictment of the Milberg Weiss firm and two of its partners will definitely want to read the October 31, 2006 Fortune article entitled "The Law Firm of Hubris, Hypocrisy & Greed"(here). The article is written by Peter Elkind, co-author of The Smartest Guys in the Room, the standard volume on Enron's demise. The article contains detailed descriptions of the firm's interaction with the "paid plaintiffs" identified in the indictment.

The article also has a fascinating account of the reaction of the key players to the criminal investigation, including in particular Mel Weiss. According to the account, as the possibility of indictment moved closer and as the firm's negotiations with prosecutors to avoid indictment fell apart, Weiss "repeatedly assured the partnership that it faced no danger." He refused to bring in an outside firm to investigate. He also refused to turn over decisions about the investigation to nontargeted partners. And in the final stages before the indictment, the firm remained controlled by "people in the crosshairs" (including Weiss) and so refused to meet prosecutors' demands that might have averted the firm's indictment. In other words, he was conducting himself as he has so often alleged that entrenched public company management behaves when management's interests conflict with those of shareholders. Pretty ironic.

The Fortune article makes for some pretty interesting reading, and includes a more detailed account of the facts and circumstances surrounding the Cooperman painting insurance fraud scam and its connection to the Milberg indictment, about which I previously wrote here (my prior post includes pictures of the now infamous Cooperman paintings).

And Under No Circumstances Should You Read This Story: Read the story, here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

According to news reports (here), Glass Lewis has released an analysis estimating that the options backdating scandal now involves 152 companies and has cost those companies collectively about $10.3 billion. A breakdown of the 152 companies can be found here.

CFO.com reports here that so far over 60 companies have announced accounting restatements in connection with options timing issues, totaling $5.2 billion in accounting charges. Another 24 companies have announced they will have to restate earnings, but have not yet announced the amount of any charges.

The scandal has also cost over 40 executives their jobs. The WSJ.com has a separate page (here) where they are keeping an updated list of the executives' ousters resulting from the backdating scandal.

The D & O Diary's list of options backdating lawsuits (here) has been updated today. The number of options timing related shareholders' derivative suits now stands at 92. The number of options timing related securities fraud lawsuits remains at 20. The Stanford Securities Class Action Clearinghouse has added a box to its home page (here) in which it is also tracking the number of options timing related securities class action lawsuits; its tally also stands at 20.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The options backdating story has unfolded in successive stages. First, there was the March 18, 2006 Wall Street Journal article (here, registration required) that drew attention to the issue and set off the media frenzy. Then there were the waves of announcements from companies stating that they or regulators were investigating their options practices. (According to the WSJ.com "Options Scorecard," here, there are 115 companies under investigation one way or the other.)

The current stage seems to involve the slow but steady defenestration of numerous senior company officials.

An October 17, 2006 Philadephia Inquirer article entitled "Backdating -Who Has Been Ousted" (here), attempted to list all of the executives who have lost their jobs so far. Even thought the Inquirer list is only a couple of days old, it is already out of date, because it omits the recent departures from KLA-Tencor (here and here), Altera (here), Sapient (here) and SafeNet (here). By my count, more than 40 executives have lost their jobs so far.

More departures undoubtedly are on the way. These circumstances have to be uncomfortable for executives at companies undergoing options timing investigations. Both investors and the individuals themselves have to be wondering about the executives' continued tenure. For example, the San Jose Mercury News ran an October 17, 2006 article entitled "Is Steve Jobs Safe?" (here, registration required) (short version: not enough information yet). Times have to be rough even for executives whose names are not in the papers every day.

There is a certain inevitability to this ritual bloodletting. The companies are, of course, taking great pains to repair their public image and to restore investor confidence. Companies also face pressure under the Thompson Memo to show full cooperation with regulators in order to avoid corporate criminal prosecution, which adds a particularly sharp edge of necessity for companies to cut individuals loose.

Given the number of companies that have not yet completed their investigations, the steady drumbeat of executive departures is likely to continue for some time.

There is some peculiarly American necessity to scapegoat and assign blame when dramatic, unexpected events occur, and consistent with that tradition it is to be expected that these company officials are being made to walk the plank. Perhaps few will shed tears for William McGuire, United Health Group's recently departed CEO, who ended last year with $1.78 billion in unexercised stock options. But SafeNet's October 18 announcement (here) of the resignation of two of its officials (including one of its founders) has a downright elegiac tone. The D & O Diary questions whether this forced exodus of the senior officials at so many companies is really in investors' best interests --or in anyone's best interest. This concern will only grow as the list of ousted officials lengthens in the weeks and months ahead.

Finally, if the current stage in the unfolding backdating story is the outster of senior officials, what is the next stage? Possibilties include additional criminal and regulatory enforecement actions and resolution of the pending civil litigation, undoubtedly followed by coverage disputes. Regardless of what lies ahead, this story has a very long way to go yet. We are still only in the opening chapters.

Options Backdating Litigation Update: Along with the steady stream of executive departures has been the continuing influx of new options backdating lawsuits. According to The D & O Diary's latest tally (here), there have 20 securities fraud lawsuits and 89 shareholders' derivative lawsuits based on allegations of options timing misconduct.

Harvey Pitt Interview: In an interview published in the San Jose Mercury News on October 17, 2006 (here, registration required), former SEC Chairman Harvey Pitt had a number of interesting observations about the unfolding options backdating story:

This may be just my own inherent bias, but I have very little sympathy for the companies that were engaged in real backdating. If you look at the Brocade and Comverse indictments, that conduct was raw. I grew up in Brooklyn, and we had a word for that. We called it fraud....

On the other hand, there are cases where people made mistakes, maybe cases where people did things inadvertently, maybe cases where companies backdated option grants but had poor procedures. That's where the tension comes into play. It places a heavy premium on regulators and prosecutors to be balanced in their judgments. Just because there was backdating doesn't mean it was a hanging offense. But if it was backdating with false documents and that sort of thing, I do think it's a hanging offense....

Then you also need to look at what the company is doing -- how does the company rectify the situation? If what you want is for companies to be law-abiding, then you have to give them credit when they take steps to bring themselves into compliance.

The SEC is showing a great amount of balance in how it approaches these issues. It's not rushing to make headlines. It's proceeding in a way that is thoughtful and appropriate. That is the hallmark of good regulation and good enforcement.

Pitt is right that a distinction needs to be drawn between companies that falsified documents and companies that made inadvertent mistakes due to poor procedures. All too frequently the media tar both kinds of companies with the same brush. I also hope he is right that the reason the SEC has been moving deliberately in its investigations of options backdating is that it is attempting to draw these kinds of distinctions.

Word Czech: While the word "defenestration" is generally meant to refer to the act of throwing someone out of the window, historically the word was meant to suggest politicial dissent.

The historical reference derives from the "defenestrations of Prague," particularly the Second Defenestration of Prague, which took place in 1618, during the Thirty Years War. Protestant aristocrats, angered by Catholic Church attempts to claim certain contested land rights, convicted several officials for violating the rights of religious expression and threw the officials from the windows of the Bohemian Chancellery. According to tradition, the officials landed in a pile of manure-- and survived. With that historical background, readers may judge for themselves whether it is accurate to refer to the backdating-related ouster of corporate executives as defenestration.

According to Merriam-Webster (here), "defenestration" was one of their dictionary's users' favorite words of the year in 2004. By the way, the 2004 Word of the Year was "blog." Now you know.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The D & O Diary's running tally of options backdating lawsuits (which can be found here) has been updated to include new securities lawsuits that have been filed against Meade Instruments and Michaels Stores; a new ERISA action against Home Depot; and several new shareholders' derivative actions.

With the addition of the new actions, the count of options timing-related securities fraud lawsuits now stands at 19, and new cases are still continuing to arise. Even though the cases are coming in gradually rather than all at once, the total volume is starting to accumulate toward the point where collectively they are starting to look like a more serious problem for the D & O insurance industry. The number of options timing related derivative lawsuits, which now stands at 79, also represents a frequency concern. The count of ERISA related lawsuits stands at 6.

Thanks to alert reader Paul Curley for the Home Depot and Michaels Stores links.

Merck/Vioxx Case Study: A very detailed post on the LawReader.com blog entitled "Merck Insurance Carriers Jump Ship Over Vioxx Diasaster" (here) reviews the enormous burden that Merck faces as a result of the flood of litigation involving its now withdrawn Vioxx drug. The post quotes at length from Merck's SEC filings regarding the litigation, including, for example, the note that during 2005 Merck spent $285 million (!) defending the various lawsuits, including shareholder lawsuits relating to Merck's Vioxx disclosures. The post also reviews the various insurance coverages that Merck potentially has available to respond to the litigation, including its directors and officers liability insurance program. The post reports, however, that all of Merck's insurance may not be available due to disputes that have already arisen with its insurance carriers. The post quotes Merck's August 7, 2006 SEC filing that "[a]t this time, the Company believes that its insurance coverage with respect to the Vioxx lawsuits will not be adequate to cover its defense costs and any losses."

The article is quite detailed and very interesting. Thanks to Adam Savett of the Lies, Damn Lies blog for the link to the LawReader.com post.

Options Backdating Seminar: On October 13, 2006, I will be participating on a panel entitled "Directors and Officers Insurance Policies and Coverage for Options Claims," at the"Stock Options Practices" seminar, to be held at the Marriott Financial Center in New York. The seminar is sponsored by HarrisMartin. Further information about the seminar may be found here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In recent days, there has been extensive media attention (here and here) focused on the fact that plaintiffs' lawyers seeking to exploit the options backdating scandal are filing shareholders' derivative suits in preference to securities fraud class action lawsuits. Indeed, The D & O Diary's running tally of options backdating lawsuits (here) shows that only 16 companies have been named in securities fraud lawsuits, but over 70 companies have been named as nominal defendants in shareholders' derivative lawsuits. But while the observation that plaintiffs' lawyers are preferring shareholders' derivative lawsuits appears to be valid, this observation does not explain why plaintiffs' lawyers are so eager to file derivative lawsuits. Traditionally, derivative lawsuits have not been nearly as lucrative for plaintiffs' lawyers as securities fraud suits. So why are plaintiffs' lawyers preferring derivative lawsuits in connection with the options backdating scandal?

It may be supposed that recent trends in other recent derivative lawsuits' recoveries makes these suits more attractive to plaintiffs' lawyers now than perhaps they were in the past. The derivative lawsuit filed against the Hollinger board resulted in a $50 million settlement (here) - funded entirely by D & O insurance - and the Oracle derivative settlement resulted in Larry Ellison's payment of $100 million to charity, as well as his payment of the company's $22 million attorneys' fees. In addition, the existence of a derivative lawsuit was a "substantial factor" in the payment of $200 million in settlement of various litigation against AOL Time Warner. But there need to be numerous caveats around the purported value of the AOL Time Warner derivative settlement (see the prior D & O Diary post concerning the AOL Time Warner settlement here) and the Oracle settlement with its payment to charity rather than to the company requires a very big asterisk (and is probably a worthy topic of a separate post). The Hollinger settlement may be more apposite, but it may also represent an extreme case.

Whether or not these other settlements represent a trend that might be increaing plaintiffs' lawyers interest in filing shareholder derivative suits, the derivative lawsuits brought in connection with options timing allegations appear subject to numerous defenses or other practical limitations. To name but a few of the defenses and limitations:

Standing: For many of the companies involved in the backdating scandal, the period during which the alleged misdating took place covers a large swath of time, in some cases going back to the early or mid 90's. In order to have sufficient standing to pursue the derivative suit, a shareholder plaintiff will have to show continuous share ownership, at the time of the alleged wrongdoing as well as the at the time of the lawsuit. Some putative plaintiffs may satisfy this requirement, but not many, and most of the plaintiffs in whose name the options lawsuits have been brought lack the requisite standing (and for an additional comment about standing, see the note below about the Mercury Interactive shareholders' derivative lawsuit);

Statute of Limitations: The statute of limitations under Delaware law for shareholder derivative suits is three years. Shareholders' claims for alleged options timing misconduct more than three years' prior to the spring or summer 2006 (when most of the lawsuits were filed) may well be time barred. Plaintiffs' lawyers undoubtedly will seek to circumvent this bar by alleging concealment or some other excuse to stay of the limitations bar, but the whole point of a limitations statute is to avoid trying events from the distant past. The limitations period may well prove a substantial bar to many of the plaintiffs' claims.

Demand Requirement: In the race to the courthouse that followed the media frenzy surrounding the options backdating scandal, many of the plaintiffs' lawyers disregarded the derivative lawsuit filing prerequisite that the plaintiffs first demand that the board pursue the lawsuit on the corporations' behalf or present allegations to show why demand would be futile. The demand requirement is substantial and cannot be circumvented by mere conclusory allegations of futility; the plaintiff must plead with particularity why a majority of the board lack sufficient disinterest to consider the demand. This should be a particular burden in the many cases where the directors did not themselves benefit from the options timing. Moreover, where (as in most cases) the plaintiffs filed their suits without first pursuing a books and records request to obtain requisite factual information as a basis for their claim, a
dismissal based a failure to meet the demand requirement will be with prejudice;

Exculpatory Clause: Most corporations have adopted an exculpatory clause in their corporate charter, as permitted under Delaware law, precluding liability against the directors for breach of fiduciary duty except upon a showing of bad faith or disloyalty. Liability for mere breaches of the duty of care is waived under these exculpatory provisions. In most cases, the boards of directors of companies caught up in the backdating scandal were simply unaware of the backdating, and therefore allegations of wrongdoing amount to no more than alleged breached of the duty of care, the liability for which is precluded under the exculpatory clause.

To be sure, there are some companies with respect to which more substantial or active wrongdoing is alleged, and with to respect to which the derivative claim may be more substantial and perhaps potentially more lucrative for the plaintiffs' lawyers. But these claims amount to no more than a very small handful; almost all of the derivative complaints that have been filed are subject to the above defenses and other substantial defenses and limitations. It remains to be seen whether the flood of derivative lawsuits raising options timing allegations produces substantial value for the corporations on whose behalf the lawsuits have been filed, or for the plaintiffs' lawyers who filed the lawsuits. But the number and strength of the potential defenses makes the D & O Diary wonder: why are the plaintiffs lawyers filing all these derivative suits?

The D & O Diary is interested in readers' comments about the potential merits of the shareholders' derivative options backdating lawsuits.

Unique Standing Defenses in the Mercury Interactive Derivative Lawsuit: Among the companies involved in the options backdating scandal is Mercury Interactive, which also was named as the nominal defendant in a shareholders' derivative lawsuit brought by the Lerach Couglin firm. On July 25, 2006, while the derivative lawsuit was pending, Mercury Interative announced its acquisition by Hewlett-Packard. According to a September 11, 2006 story on Law.com entitled "H-P Deal May Kill Mercury Suit" (here), one of the individual defendants (who is represented by the Wilson Sonsini firm) has filed a motion to dismiss based on the argument under Delaware law that as a result of the H-P acquisition, the plaintiffs lack standing to assert the claim against the individual defendants. The only way the case can continue is if H-P decides to take it up on its own. The story has a definite "clash of the titans" feel to it, because the Lerach firm's response to the motion to dismiss is to contend that because of the Wilson Sonsini's firm's alleged involvement in the H-P board's brouhaha about its own Board investigation, Wilson Sonsini is or ought to be precluded from being involved in the Mercury Interactive lawsuit. Lerach's arguments based on the Wilson Sonsini firm's role with H-P probably indicates nothing so much as that the motion to dismiss is almost certainly meritorious, as mergers of this type generally divest plaintiffs of standing under Delaware law.

Thanks to Adam Savett of the Lies, Damn Lies blog (here) for the link to the Law.com article. (The comments about the case are strictly my own.)

Options Backdating Litigation Tally Update: The D & O Diary has updated its options backdating litigation tally (here) to add the new securities fraud class action lawsuit that has been brought against Aspen Technology (here). The addition of the Aspen Technology lawsuit brings the number of securities fraud lawsuits based on options timing allegations to 16. In addition, the number of companies sued in shareholders' derivative lawsuits is now stands at 71, with the addition to the lawsuit against Home Depot (here), THQ (here), and Witness Systems (here).

Request for Information: As previously noted on The D & O Diary (here), Lynn Turner, the former Chief Accountant at the SEC and now a managing director at Glass Lewis, testified on Capitol Hill on September 6, 2006. As part of his written testimony (here), Turner attached an appendix that listed the companies involved in the options backdating investigations. A column on the appendix purported to identify the companies that have been named in options backdating shareholder suits (but not differentiating between securities fraud suits and shareholders' derivative suits). There were some companies that were not identified in Turner's exhibit as having shareholder suits that have in fact been sued (e.g., Mattel), and there were others identified as having been sued that The D & O Diary simply cannot independently corroborate as having been sued. The companies that Turner lists as having been sued for which The D & O Diary can find no corroboration are: Amkor, Blue Coat, Boston Communications, Dot Hill, Molex, and Newpark Resoureces. Most if not all of these six companies have shown up on various plaintiffs' law firms' press releases as being "under investigation" but as far as I have been able to determine they have not actually been sued. The D & O Diary would greatly appreciate it if its readers could provide any further corroboration about the existence of lawsuits against these companies -- or any others that do not appear on The D & O Diary's list of options backdating lawsuits.

Special thanks to Michael Miraglia for a link to the Turner testimonial exhibit and to Bill Ballowe for his help in locating options backdating lawsuits.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The unfolding options backdating story may have hit its high water mark (or its low point, depending on your perspective) on September 6, 2006, when the Senate Committee on Banking, Housing and Urban Affairs and the Senate Finance Committee both held hearings concerning options backdating. The hearings involved the testimony of numerous regulators, academics and other pundits, and included the testimony of SEC Chariman Christopher Cox (testimony here), which was noteworthy for its identification of Internal Revenue Code Section 162(m) as the culprit in the scandal. Among other things, Cox said:

...one of the most significant reasons that non-salary forms of compensation have ballooned since the early 1990s is the $1 million legislative caps on salaries for certain top public company executives that was added to the Internal Revenue Code in 1993. As a Member of Congress at the time, I well remember that the stated purpose was to control the rate of growth of CEO pay. With complete hindsight, we can all agree that this purpose was not achieved. Indeed this tax law change deserves pride of place in the Museum of Unintended Consequences...The million-dollar cap on tax deductibility of executive compensation...doesn't apply to options granted at fair market value. So for companies that wanted or needed to pay compensation in excess of $1 million per year, the tax code outlawed deducting it if it was paid in a straightforward way through salary, but permitted a deduction if the compensation was paid through at-the-money options.

So the tax law encouraged at-the-money options, which in turn encouraged creative actions to maximize the return under the options.

Linda Thomsen, Director of the SEC Enforcement Division, also testified (here) about the tax incentives that provide context for options backdating.

Cox's and Thomsen's testimony also make interesting reading for the history they provide about the SEC's enforcement activity in connection with the options timing investigations, and in particular the enforcement activity that preceded the media attention that was drawn to the issue earlier this year. Cox's testimony reviews the 2003 enforcement proceedings the SEC brought against Peregrine Systems, and the 2004 action against Symbol Technologies. (Thomsen's testimony also discusses the Symbol Technologies action in detail.) Peregrine Systems was charged with financial fraud for failing to record any expense for compensation when it issued incentive stock options. The Symbol Technologies case involved manipulation not of options grant dates but of exercise dates, to ensure that the exercise date was the most advantageous to the grant recipient during a 30-day lookback period. The Symbol Technolgies complaint, which alleged numerous allegely misleading activites, was settled with a payment of $37 million.

Cox's stated that the SEC's Enforcement Division is "currently investigating over 100 companies concerning possible fraudulent reporting of stock option grants." Cox added that while not all of these investigations will result in enforcement proceedings, "we have to expect that other enforcement proceedings will be forthcoming in the future."

The written testimony of all of the witnesses who appeared before the Senate Banking Committee can be found here. The written testimony of all the witnesses who appeared before the Senate Finance Committee can be found here. The Wall Street Journal's September 7, 2006 article describing the hearings can be found here (subscription required).

Options Timing Hot Seats Multiply: Senate Finance Committee Chair Charles Grassley (R. Iowa), in his closing remarks at the hearing (which can be found here) declared his intentions to target "all the actors" involved in the options backdating scandals. That includes accountants, lawyers, and compensation consultants who advised executives to backdate options, and board members who "blessed it or looked the other way." Sen. Grassley apparently is going to lead a campaign to request materials from companies involved in the backdating investigation, including board minutes regarding the decision to backdate "as well as any and all materials from advisors...who assisted in these efforts." Grassley also said that he is considering legislation to address the tax issues that Cox and other identified.

More about Options Springloading: The testimony on Capitol Hill reflected the continuing debate surrounding options springloading (granting options now in anticipation of good news later that it is anticipated will increase the company's share price). As The D & O Diary has previously noted (here), options springloading seems categorically different from options backdating, among other reasons the value of the options at the time of the grant cannot be locked in as with options backdating, since there is no way to be sure how the market will react to the impending news. In addition, some commentators, including SEC Commissioner Paul Atkins (remarks here), have publicly stated that they see nothing wrong with springloading. But in his testimony before the Senate Banking Committee (testimony here) Lynn Turner, the former chief accountant at the SEC, came down in strong disagreement "with those who say it's not illegal or a problem." Turner clearly equates springloading with trading on inside information, and therefore unlawful. He also cites numerous ways in which the failure to disclose springloading would make proxies and other disclosures misleading. He concludes his thoughts about springloading by saying "I believe that disclosures made in the past regarding springloaded options grants will be found in all too many instances to have been false and misleading, violating the securities laws and regulations." Turner also asks rhetorically with respect the options practices that have come to light"Where were the gatekeepers, including legal counsel and independent auditors?"

The Cost of Backdating: Three University of Michigan professors have written an article entitled "The Economic Impact of Backdating of Executive Options," (here) which attempts to determine the financial impact of options timing. The authors analyzed thousands of stock option grants between 2000 and 2004 at 48 companies who had announced prior to July 1, 2006 that they were under investigation in connection with stock options practices. The authors measured the maximum possible gains for executives if they backdated every option grant during that period. The authors also measured the drop in market capitalization of the 48 companies by comparing the companies' share prices in the ten days before and the ten days after the news of the backdating inquiry was released. The authors found that while the average executive's pay would have been increased about 1.25 percent, the average decline in market value per company when the news of the options investigation was announced was an average of eight percent.

The D & O Diary notes that while the cost of options backdating to the companies and their shareholders clearly is greater than the benefit to the executives, the eight percent market cap decline that the authors' determined is consistent with The D & O Diary's ongoing theory on why this scandal has not produced more securities fraud litigation. (According to the D & O Diary's tally, here, there have only been 15 companies sued in securities class action lawsuits so far.) A stock price drop of that magnitude is just not sufficient to attract the attention of the plaintiffs' lawyers. Indeed, in a September 5, 2006 New York Times article (here, registration required), Melvin Weiss of the Milberg Weiss firm is quoted as saying in explanation for why there is not more securities fraud litigation in connection with the options timing scandal, "A lot of these companies aren't reacting with big drops in price, or, if they dropped initially, they come back over a short period of time."

The D & O Diary also has an observation about the authors' presentation of their research. While their paper is now available on line, it states on its face that it will appear in the June 2007 issue of the Michigan Law Review. The article is timely and topical now, but by next summer it is going to be completely out of date. Almost all of the footnotes will have been superseded by intervening events, and many of the legal issues that the authors conjecture about will have been addressed in actual proceedings. The lag time almost guarantees that the article, while relevant today, will be completely irrelevant by the time it appears in a traditional publication form. All of this is by way of observation that the Internet may be making traditional forms of legal scholarship obsolete. Perhaps Internet weblogs are the rightful successors to more traditional law journals in an Internet age.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

SEC Options Backdating Investigations List: Directorship.com has posted on its website a hotlinked list of companies (here) that have been contacted by the SEC, revealed a probe by the SEC, or have been subpoenaed by a U.S. attorney, in connection with the options timing investigations. The Wall Street Journal's Options Scorecard list of companies involved in the options backdating investigation (here) is more complete, in that the Journal's list also includes companies that have announced their own internal investigations. But the Directorship.com list zeroes in on the companies that have SEC or U.S. Attorney's office inquiries and investigations, and is hotlinked to provide information about the authorities' investigations.

The D & O Diary is also maintaining a list (here) of companies that have been sued in civil lawsuits involving options timing issues. The D & O Diary's list was most recently updated on August 31, 2006, to include the new shareholders' derivative lawsuit that has been filed against Family Dollar(here). The addition of the Family Dollar lawsuit brings the number of companies sued in shareholders' derivative lawsuits (of which The D & O Diary is aware) to 60. The number of companies sued in securities class action lawsuits currently stands at 15.

Why so Many Options Backdating Derivative Suits? The D & O Diary has previously speculated (here) that the reason so few of the companies involved with the options backdating investigation have been sued in securities fraud class action is that for many of the companies, their announcement of options timing issues was not accompanied by the kind of stock price drop that would support a securities fraud lawsuit. But that still doesn't explain why plaintiffs' lawyers are so interested in filing shareholders derivative lawsuits, especially because the cases usually settle with the companies agreeing to a few corporate therapeutics and the payment of modest plaintiffs' attorneys' fees.

An August 31, 2006 article in the International Herald Tribune entitled "In the Hunt for Heftier Awards, Lawyers Seek Backdating Suits," (here) takes a look at the reasons why plaintiffs' lawyers might be more interested in the derivative suits, even though the payday for the plaintiffs' lawyers would probably be lower in a derivative suit than a securities fraud class action lawsuit. The article quotes Columbia University Professor John Coffee that "You can often bribe the plaintiffs attorney with a non-pecuniary settlement coupled with high attorney fees." The article also reports that the amount of derivative settlements has increased in recent months. Full disclosure: I was interviewed in connection with the article.

Welcome: The D & O Diary extends a hearty welcome to a great new weblog that Directorship.com has launched, the Corporate Governance News blog (here). The CGN has numerous posts throughout the day with items from around the web relating to corporate governance issues. Even though CGN has only been live a short time, The D & O Diary has already found it an indispensable resource for keeping track of governance related news and information. The D & O Diary also notes that Janice Brand, who runs the CGN blog, has a really cool title : Online Editor-in-Chief. However, the D & O Diary is still holding out for a preferred title: The Big Kahuna.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The D & O Diary's list of options backdating litigation (here) has been updated to include the action (here) filed on August 23, 2006 against Zoran Corporation and ten of its past or present directors and officers. The Zoran complaint presents an interesting variation in the options backdating litigation, because it focuses on allegedly improper or misleading solicitation of shareholder proxies and consent. The complaint alleges that between July 1998 and September 2001, senior Zoran executives were granted unlawfully backdated stock options at the expense of Zoran shareholders, in violation of GAAP and the Internal Revenue Code. The complaint alleges that the defendants' grant of the backdated options and subsequent solicitation of shareholder proxies, consent or authorization violated the Exchange Act.

The complaint is filed on behalf of a purported class of shareholders who received Zoran proxy statements between April 30, 1999 and May 1, 2006. The class period covers this longer period even though the allegedly improper grants took place between 1998 and 2001 because each of the allegedly improper grants were for a term of ten years, so the first date at which the grants expire has not yet occurred, while the Company has continued to issue proxy statements allegedly containing misleading information about the grants.

Under Section 14 of the Securities Exchange Act of 1934 and its corresponding rules, whenever shareholders must approve a compensation plan, the issuer must accurately disclose the material elements of the proposed plan. With respect to stock options, the compensation disclosure must include the grant date, the exercise price, and grant and exercise tax consequences for the issuer and the recipient. If the issue is soliciting proxies in connection with the grant of stock options having a below-market exercise price, the issuer must disclose the option exercise price and the market price on the grant date, as well as the value of the options at the market price on the grant date.

If the company does not apply the proper tax treatment for below market options grants, the proxy disclosures may inaccurately reflect the tax consequences for grant and exercise. Because the difference between the grant and market prices for backdated options represents income to the recipient, the recipient must pay tax and withholding on the difference. The issuer could be liable for income and FICA tax it failed to withhold upon exercise, as well as interest and penalties. In addition, because the difference between the exercise price and the market price represents compensation, it counts toward the $1 million maximum for each executive's compensation deductibility under Internal Revenue Code Section 162(m). If the issuer did not allow for this compensation in connection with deduction for the executive's compensation, the issuer could owe additional taxes, interest and penalties.

Even if we assume that the plaintiffs' allegations are true, the value of the remedies the Zoran plaintiffs' seek is uncertain. The complaint seeks to void the election of directors based on the allegedly improper proxies, which seems like a perhaps principled but not very financially valuable remedy at this late date (unless you assume for the sake of discussion that shareholders are better off without any of the current directors involved with Zoran in any way). The complaint also seeks unspecified damages. Whether the plaintiffs can demonstrate damages that are not simply speculative or fraught with causation questions seems debatable, at best.

Bruce Vanyo and Michael Weisman of the Katten Muchin Rosenman firm have written an interesting paper entitled "Backdating Stock Options: An Overview" (here) that examines these proxy solicitation and income tax issues, as well as other legal issues surrounding option backdating, in much greater depth.

Special thanks to Adam Savett of the Lies, Damned Lies blog for the link to the Vanyo paper.

The Securities Litigation Watch blog is also maintaining a list of securities class action lawsuits relating to options backdating, which may be found here.

The Fugitive: Kobi Alexander, the former CEO of Comverse Technology and a fugitive from criminal allegations filed against him in connection with the options backdating investigation at the company, has been found in Sri Lanka, according to news reports. An intersting legal commentary on the prospects for Alexander's extradition from Sri Lanka can be found on the White Collar Crime prof blog, here. A more entertaining discussion of Alexander's choice of Sri Lanka as his hideout appears on the DealBreaker.com blog, here. The DealBreaker.com also had an earlier, amusing discussion (here) of the issues a fugitive faces in attempting to flee overseas.

Now This: While many astronomers (and bloggers) still hope for signs of intelligent life on planet Earth, signs of another sort abound (here). Caution: Viewer discretion advised, may not be appropriate for all audiences.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Earlier in the summer, it was a seemingly daily occurrence for one or more public companies to announce that they were launching internal probes of their options practices. (These announcements were accompanied, and no doubt encouraged, by numerous simultaneous announcements of SEC probes, U.S. Attorney's subpoenas, and the like.) Now as the summer has, alas, started to wane, the wave of new investigation announcements seems to have been replaced by a growing number of companies' announcements that they have completed their internal investigations and found no evidence of options fraud or timing manipulations.

Just in the last week, Intuit, Xilink, Equinix and Redback have each announced that they have completed internal investigations without finding intentional or fraudulent misconduct. The companies also announced that they have so advised governmental authorities. Several of these companies did announce that they were taking accounting charges, without restating, because their probes had found that some options were dated earlier than the actual grant date, due to administrative or processing delays.

In addition, on August 21, 2006, the Corporate Library announced (here) the results of a study of the stock options granted over the past decade by a dozen financial institutions. The study looked at stock option awards to executives at the nation's five largest banks, and at several other financial companies that made use of options. The study found no evidence of backdating of options issued to the executives at the institutions whose options were analyzed.

The AAO Weblog has an interesting August 21, 2006 post about Intuit's announcement, including a discussion of the factors that will affect how long these kinds of internal investigations are likely to take to complete.

Milberg Weiss Indictment Fall Out Continues: The WSJ Law Blog has an August 21, 2006 post reporting that four more partners have left the Milberg Weiss firm. At this rate, it may wind to be a moot point whether or not the prosecutors actually prove their allegations against the firm. In the meantime, Saxena and White, formed of attorneys from Milberg's Boca Raton office (including Chris Jones, the author of the PSLRA Nugget blog), has surfaced with an announcement of the filing of a securities class action complaint, as discussed here in the Lies, Damned Lies blog.

As The D & O Diary has previously noted (here and here), it is hard to say what the final consequential effect of the Milberg Weiss indictment will be, but the firm's slow dissolution and the setting up of competitor (successor) firms will each have their own impact, as will the perhaps opportunistic attraction to the securities litigation arena of plaintiffs' firms best known for their prominence in asbestos and tobacco litigation.

Freddie Mac Settles ERISA Lawsuit: Freddie Mac announced (here) on August 21, 2006 that it had agreed to pay $4.65 million to settle a class-action lawsuit that had been brought under ERISA following the company's restatement of financial results for the years 2000 through 2002. The company had been accused of overstating its earnings, inflating the value of its shares. Some of the allegely inflated stock was held in employee retirement plans. The company announced that the settlement was fully covered by insurance.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In an August 15, 2006 speech entitled "How to be an Effective Board Member" (here), SEC Commissioner Roel Campos made a number of interesting comments about the potential liability of corporate board members, and for that reason the entire speech merits reading. Of particular interest to The D & O Diary are Commissioner Campos' remarks about the options backdating cases:

Finally, let me discuss briefly stock option backdating cases. So far, the SEC has brought two cases, against Brocade and Comverse, and we're likely to bring more in the future. As yet, we have charged only officers in option backdating cases. However, if the facts permit -- and I want to emphasize that all of our Enforcement cases are very fact specific -- it wouldn't surprise me to see charges brought against outside directors.

I also think that the backdating cases can provide a few lessons in terms of "do's and don'ts" for directors. In my opinion, the two big "don'ts" are: (1) don't use "as of" dates unless you have carefully thought about the consequences and have explicit approval from legal counsel that it is acceptable to use an "as of" date; and (2) don't assign critical board functions to "committees of one," unless you're extremely careful to adopt procedures to ensure that there are appropriate checks and balances in place. In terms of "do's", let me highlight one: do pay attention to procedures and processes -- such as properly signing and dating Actions by Unanimous Written Consent -- because simple logistics can get you into trouble.

The D & O Diary finds a couple of points of interest in these remarks. First, the Commissioner is discrete about the possibility that outside directors might face exposure to SEC enforcement actions in connection with options backdating, saying only that he wouldn't be surprised if it happened, but The D & O Diary reads that to mean that it probably will happen. Indeed, the Commissioner seems to overlook that "Wells notices" already have been served on three outside directors of Mercury Interactive. (A prior D & O Diary post discussing the Mercury Interactive Wells notices may be found here.)

Second, the Commissioner may not have anything in particular in mind in his reference to the Committee of One, but The D & O Diary believes that this could be a reference to the situation at Brocade Communication, where Silicon Valley legal giant Larry Sonsini, who was an outside director of Brocade, for a time allegedly operated as a Brocade board compensation committee of one. A prior D & O Diary post commenting on the circumstances at Brocade may be found here. A WSJ Lawblog post commenting on Sonsini's service as a committe of one may be found here. The Commissioner's further remarks with respect to Committees of One are interesting in light of the situation at Brocade:

I think my advice to "don't assign critical decisions to committees of one" is fairly self-explanatory, but apparently it's advice that's also been ignored. Again, I'm not suggesting that committees of one are per se wrong -- Delaware law permits it, after all. However, at best, it's far from being a "best practice" in good corporate governance. And at worst, it's a signal to the company's officers that directors are not taking their obligations as a director seriously and are willing to let expediency guide their decision-making.

Comment on ABA's Thompson Memo Resolution: In a prior post, The D & O Diary commented on the American Bar Association's recent resolution calling for revision of policies embodied the Thompson Memo. An August 14, 2006 post in the SEC Actions blog has the following interesting comment on the ABA's action:

In view of the continued actions by the government that are eroding fundamental rights in the name of effective law enforcement, the ABA positions represent a good start, yet more is necessary. What is needed here is a recognition by the government - both DOJ and the SEC - that it cannot effectively enforce the law by eroding it. In fact, eroding fundamental rights disrespects the law. Rather, both DOJ and the SEC need to reform their standards for evaluating cooperation to focus on what they need: the basic facts involved and reasonable assurances that the questionable activity has been halted and will not reoccur. If good prosecutors are satisfied on these points they should have what they need in most cases to evaluate cooperation and make whatever prosecutorial decisions are necessary without eroding fundamental rights of the company and its employees.

The D & O Diary couldn't agree more.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

According to August 10, 2006 press reports, Brocade Communications settled the derivative lawsuit that shareholders had filed in federal court in San Francisco in connection with Brocade's options-award timing miscues, in exchange for an agreement to adopt certain therapeutic governance measures and the payment of $525,000 in legal fees. The settlement also involves contributions to the legal fees of the defendant directors and officers (amount undisclosed).

Fifteen current and former Brocade Directors and Officers reportedly participated in today's settlement (including former Brocade director and Wilson Sonsini partner Larry Sonsini.) KPMG, Brodcade's auditor, also reportedly settled. Gregory Reyes, Brocade's former CEO, who faces criminal charge in connection with options timing problems at Brocade, did not take part in the settlement. Other shareholder lawsuits, including shareholder fraud lawsuits, remain pending. A hearing on the stipulation of settlement is scheduled for August 18.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In this prior post, the D & O Diary noted the recent resurgence of the 70's vintage statute, the Foreign Corrupt Practices Act. Recent developments in the Comverse Technology options timing investigation underscore the increasing importance of the FCPA, particularly as the options backdating scandal continues to unfold.

On August 9, 2006, the SEC filed a civil enforcement complaint against three former officers of Comverse Technology. (The Affidavit filed in conjunction with the criminal complaint filed against the three individuals can be found here, even though the document says on its face that it is to be filed under seal.) The SEC Complaint alleges "a fraudulent scheme" by the three defendants "to grant undisclosed, in-the-money options to themselves and others by backdating stock option grants from 1991 through 2001 to coincide with historically low closing prices for the Company's stock." The SEC Complaint alleges a variety of securities laws violations, including specifically violations of the books and records provisions of the FCPA, which are codified as amendments to the Securities Exchange Act of 1934. The FCPA allegations are that the defendants "knowingly violated ...internal controls" and "falsified books, records or accounts."

These same kinds of allegations are likely to be a recurring part of future enforcement actions arising out of the options backdating investigations. Indeed, according to press reports, the criminal indictment entered on August 10, 2006 against former officials of Brocade Communications also contained "books and records" allegations.

The D & O Diary's prior post about the FCPA noted that one of the dangers from an FCPA enforcement proceeding is the possibility of follow-on litigation. A recent securities fraud lawsuit settlement provides a glimpse of the way FCPA violations can spawn follow-on litigation, including specifically follow-on securities fraud lawsuits.

On August 9, 2006, Willbros Group, Inc. announced that it had settled the 2005 class action lawsuit that had been filed against the Company and several of its directors and officers. The Complaint alleged that the company had been the subject of numerous of numerous investigations "because the Company engaged in a campaign of illegal and illicit bribery of foreign government officials in Bolivia, Nigeria and Ecuador to successfully obtain construction projects." The Complaint alleged that the company was forced to restate several years of financial statements and to establish a reserve to accrue for possible fines and penalties for FCPA violations. The Complaint alleged that as a result of these violations, the Company had misrepresented its true financial condition. The Complaint alleged that the company's share price declined 31% when these matters were disclosed.

In its August 9 press release, the Company did not disclose the amount of the securities class action settlement, but the press release did state that the amount of the settlement would be funded by the company's insurance carrier.

The Willbros settlement illustrates the growing D & O risk that increased FCPA enforcement activity could represent. The threat is not so much from the underlying FCPA enforcement action itself; any FCPA fines and penalties likely would not be covered under most D & O policies. Rather, the threat is from the potential liability that could arise in any follow-on civil action, including any follow-on securities fraud lawsuit like the one filed against Willbros Group. Any settlement or judgments incurred in a follow-on action, as well as defense expenses, would usually be covered under the typical D & O policy.

As FCPA enforcement actions grow in number and magnitude, this exposure could pose an increasingly greater D & O risk.

An August 10, 2006 CFO.com article discussing the Willbros settlement, as well as the simultaneous resignation of the company's CFO (who had been a defendant in the securities fraud action), may be found here.

Two particularly interesting articles discussing the Comverse Technology criminal complaint may be found at the White Collar Crime Prof blog, and at the Securities Litigation Watch blog.

A particularly provocative contrarian view of the Comverse Technology criminal complaint and of the whole options backdating morass may be found on this post on Professor Ribstein's Ideoblog.

Big Numbers: An August 10, 2006 post on Bloomberg.com reports that

The number of companies with stock options grants under scrutiny passed 100...At least 105 companies have disclosed internal or federal probes, according to data compiled by Bloomberg News. Nineteen people have lost their jobs, five face criminal charges and one of them -- Comverse Inc. founder Jacob Alexander -- didn't show up for his arraignment yesterday.

A separate article on Bloomberg.com, also dated August 10, reports that:

UnitedHealth Group Inc. Chairman William McGuire sparked outrage among some stockholders over his $1.8 billion in potential stock-option gains. Turns out, the board of directors that granted those options got a share of the wealth, too. UnitedHealth's 10 non-executive directors held $230 million in stock as of March 21, according to the health insurer's most recent proxy...``You have to ask yourself, are these people paying attention to the mission of the corporation, or are they being distracted by the amount they're getting themselves?'' says Minnesota Attorney General Mike Hatch, who is investigating Minnetonka-based UnitedHealth along with federal authorities...A board committee is reviewing 45,000 separate option grants made to 15,000 people over 13 years, the company said in a statement.

And a Japanese man was arrested this week after making 37,760 silent calls to directory inquiries because he wanted to listen to the "kind" voices of female telephone operators, according to news reports.

Sudden Complications: United Airlines' aviation war risk insurance is up for renewal on August 31, 2006. Read the story here.

Yet Another Globalization Downside: The U.S. economy is trading factory workers for real estate agents. Take a look at this uncanny chart here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Molex Execs Repay Pay: In one of the more interesting (and speediest) resolutions by a company of options timing concerns, 12 executives of Molex, Inc. agreed to repay the company a total of $685,000 to cover gains they realized on misdated options. The executives also agreed to have the prices raised on their unexercised options, reducing the options' value and ensuring that the executives would not benefit in the future from the misdating. The Company's press release states that the misdating was due to clerical error that in some instances had the effect of diminishing the value of certain options awards to the executives. The August 3, 2006 Wall Street Journal article describing the company's action points out that no other company involved in the options backdating investigations has ordered a repayment from the executives who profited.

The D & O Diary notes that D & O insurers would likely contend that the Molex executives' payments, which represent a return to the company of compensation overpayment, would not be covered under the typical D & O policy, because it would not constitute covered "loss." Interestingly, the "personal profit" exclusion typically found in most D & O policies would not appear to preclude coverage for the payments even if the payments were otherwise covered "loss," because the payments were not made pursuant to an "adjudication" that the executives were not legally entitled to the excess payments. (To be sure, many policies allow insurers to trigger the exclusion by obtaining a judicial declaration that amounts paid represented "remuneration" to which insured persons were not legally entitled.)

Hat Tip to Adam Savett of the Lies, Damned Lies blog for the Molex link.

Yet Another Variant of Options Timing Manipulations? As The D & O Diary has noted in prior posts, the current options timing scandal encompasses several different types of options timing practices: options backdating, which involves the retroactive setting of the grant date to an earlier date when the company's share price was lower; options springloading, where the grant date is set ahead of the release of positive news expected to raise the company's share price: and hiring-related options grants, which can involve setting options award dates at a time prior to an employee's hiring, or simply at a false hiring date, to increase the value of the new hires' options.

A July 20, 2006 article in The Economist (subscription required) identifies yet another variant of options timing: "bullet-dodging," which involves delaying an option grant until after the bad news is announced. The value of an award made prior to the bad news announcement would diminish if shares declined in reaction to the news; waiting until after the bad news to make the award averts the decline and increases the award recipients profits if the company's share price later rebounds.

The D & O Diary believes that it is important to distinguish these distinct options practices, as each involves different sets of issues and its own sets of concerns. For example, the profits for backdated options are locked in; profits from springloading or bullet dodging are far less certain. By the same token, hiring-related options practices lack the element of self-dealing that may characterize the other options timing practices. These differences are significant and potentially could substantially affect investigative outcomes, as well as the resolution of any civil litigation based on allegations of options timing manipulations.

One further note about hiring-related stock options: the August 9, 2006 criminal complaint is entered against three former Comverse Technology officials alleges an interesting variant of the hiring-related options timing manipulations. The complaint alleges that the defendants created a slush fund of backdated options granted to fictitious employees and later used these options to recruit and retain key personnel. One of the ficticious names allegedly used was "I.M. Fanton."

Options Investigations and Company Share Prices: Notwithstanding the media barrage surrounding the options backdating scandal, relatively few of the companies involved in the various investigations have been sued in securities fraud lawsuits - to date, only 11 companies. (The D & O Diary is tracking Options Backdating related litigation here.) One possible reason why the plaintiffs' bar may be shying away from suing more companies is the lack of share price decline for companies involved in the investigations.

An August 7, 2006 Forbes article reports its analysis of stock prices of 65 firms that announced financial restatement or government investigations related to their options-granting practices. Though some companies saw dramatic share price declines, the group as a whole saw no abnormal drop compared to the wider market. The companies' share prices fell an average of 7.4% since the announcements (most of which have taken place in the last three months) compared to a 9.4% decline in the NASDAQ Composite Index since May 1. The article does note important difference; for example, companies that have lost senior executives have suffered more than others. The companies with the most significant price declines are listed here.
The absence of significant share price declines for most of the companies involved in the scandal supports The D & O Diary's view that the scandal will not be a "severity event" for the D & O insurance industry.

Hat tip to the Vangal blog for the Forbes link.

Cooperman Paintings: For those D & O Diary readers who were interested in my prior post about the Cooperman Paintings heist and its impact on the Milberg Weiss indictment, you may want to visit the post again. I have added images of the paintings.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

With all of the media attention focused on the first options backdating criminal complaint, filed July 20, 2006 against two former officials of Brocade Communications Systems, and with published reports suggesting (for example in the July 21, 2006 front page article of the Wall Street Journal , subscription required) that prosecutors are investigating "over 80 companies" for options timing manipulations, it would be easy to conclude that the tide of federal white collar criminal prosecutions is mounting. And indeed with the options backdating story just beginning, it may well be that we are at the leading edge of a growing prosecutorial crackdown on corporate fraud.

But a July 18, 2006 Legal Times article entitled "Has the Wave of White-Collar Prosecutions Crested?" raises the question whether the crackdown on corporate criminals is in fact on the decline as a result of changing prosecutorial priorities. Citing the United States' Attorneys' Annual Statstical Report for Fiscal 2005, which can be found here, the article notes that "there was a 30 percent drop in the number of defendants charged with corporate fraud in 2005 over the previous year and a more than 50 percent decline in the number of corporate fraud investigations opened by federal prosecutors last year." The 2005 figures were the lowest for any year since the 2002 post-Enron crackdown on corporate crime. The Legal Times article quotes a number of sources for the proposition that the decline in new prosecutions is due to a continued shift in resources toward terrorism investigation and public corruption. However, factors such as the options backdating scandal may yet relieve what could prove to be an otherwise temporary stall.

A Closer Look at the First Options Backdating Criminal Case: Wayne State University Law School Professor Peter Henning in a thoughtful July 21, 2006 post on his White Collar Crime Prof blog raises some interesting questions about the criminal complaint filed against the former Brocade Communications officials. First, he questions why the prosecutors chose to "proceed by criminal complaint rather than seeking a grand jury indictment," and speculates that there may be plea agreements or statute of limitations concerns that motivated prosecutors to use a criminal complaint, but that there could be "an indictment in the next few weeks that may well contain more charges, perhaps including books-and-records accounting." Professor Henning also raises questions about the merits of the criminal complaint:

While the charges allege numerous instances of options grants involving backdated documents, it remains unclear what constitutes the securities fraud....[I]t is not clear what constituted the fraudulent scheme when the employees received the proper amount of options while their additional paper gains were not "taken" from the company. To the extent that fraud is a type of larceny, it is not easy to see the company as a victim of the deception, and [defendant] Reyes did not gain from the transactions, at least not directly. Not all lies are frauds, and the government's case may be a difficult one, at least on a securities fraud charge.

The D & O Diary notes that while the SEC filed a parallel civil complaint against three former Brocade Communications executives, thus far other Brocade officials, including Brocade's outside directors, have not been named. The non-involvement of Brocade's outside directors stands by interesting contrast to the Mercury Interactive investigation, where three former outside directors of Mercury have been served with "Wells" notices. As has been noted on prior this D &O Diary post, Brocade's former outside directors include Larry Sonsini, of the Wilson Sonsini Goodrich & Rosati law firm and one of the most prominent lawyers in Silicon Valley. The WSJ.com law blog has an interesting post discussing the fact that Wilson Sonsini has represented over half of the more than 30 Silicon Valley companies that have been named in connection with the options backdating investigation. A July 22, 2006 New York Times article discussing the significance of options backdating in Silicon Valley during the dot-com boom and afterwards, and the role of the Wilson Sonsini firm, can be found here. A cool feature of the Times article is an interactive map showing the geographic location of Silicon Valley firms involved in the options backdating investigation.

Finally, The D & O Diary notes that the Brocade Communications options timing scandal presents an example of hiring-related options timing, which as discussed on this prior D & O Diary post, involves important differences from options backdating and options springloading. The most important difference that is that hiring-related options timing may not involve self-dealing or personal enrichment. According to this WSJ.com law blog post, the absence of self-dealing or personal benefit is precisely the basis on which the defense attorney for Gregory Reyes, Brocade's former CEO, is raising in Mr. Reyes' criminal defense.

More Statistical Analysis of Options Backdating: Graef Crystal has an interesting July 20, 2006 article on Bloomberg.com analyzing opportunistic option timing. Crystal looked 16,211 options grants made to chief executive officers between 1992 and 2005. He analyzed the actual and expected option exercise prices compared to the share prices in the 180-days before and after the date of the awards. The expectation would be that the exercise price would fall at the mid point of the price range. But instead the exercise price was consistently lower than the share price following the award. Interestingly, Crystal's analysis shows that the statistically unexpected rise in share price after the award has continued even after the enactment of the Sarbanes Oxley Act. (Crystal estimates the probability of this outcome as a result of chance as "way less than 1-in-100 trillion.") His analysis suggests even after Sarbanes Oxley made it more difficult for CEOs to backdate options, they have continued to springload options grants.

Not Your Average Blogger: Attentive readers may have noticed that I have added my photograph to this blog. I am feeling defensive about my blogger identity as a result of Pew Internet & American Life Project survey of bloggers, which may be found here and is discussed in this July 20, 2006 Washington Post (registration required) article. According one source quoted in the Post article, "the average blogger is a 14-year old girl writing about her cat." My newly added picture is your assurance that I am, let us say, well over 14 years old and that posts about my cats (I have two of them, actually) will never appear on this blog. Disappointed cat lovers are directed here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The information in this post was last updated on September 10, 2008

The purpose of this blog post is to track options backdating related litigation. All of the companies that have been sued -- and of which the The D & O Diary is aware -- have been listed below. The D & O Diary will update this information as additional companies are sued, or as loyal readers advise The D & O Diary of any omissions. The D & O Diary will note at the top and bottom of this post the date on which the information was most recently updated, and will indicate in red which information has been most recently added. Readers interested in keeping up to date on the number of lawsuits will want to check back frequently. The running tallies below are meant to include a listing of any company that has been sued based on allegations of options timing manipulations, regardless whether the allegations are based on options backdating, options springloading, or hiring-related options timing.

Securities Fraud Class Actions (Total as of latest update = 39):

1. American Tower
2. Amkor Technology (see discussion of this case here)
3. Apple Computer
4. Apollo Group
5. Aspen Technology
6. Broadcom
7. Brocade Communications
8. Brooks Automation
9. Comverse Technology
10. Cyberonics
11. Hansen Natural Corporation
12. HCC Insurance Holdings
13. Jabil Circuit
14. Juniper Networks
15. KLA-Tencor
16. Marvell Technology Group
17. Maxim Integrated Products
18. Meade Instruments
19. Mercury Interactive
20. Michaels Stores
21. Monster Worldwide

22. MRV Communications
22. Newpark Resources (see discussion of this case here)
24. Openwave Systems
25. PainCare Holdings (see discussion of this case here).
26. Quest Software
27. Rambus
28. SafeNet
29. Semtech
30. Sonic Solutions
31. Sunrise Senior Living
32. TeleTech Holdings
33. The Children's Place Retail Stores
34. Vitesse Semiconductor
35. United Health Group
36. UTStarcom
37. Wireless Facilities
38. Witness Systems
39. Zoran (see discussion of this case here).

 Shareholders Derivative Lawsuits (current total as of latest update = 168)

1. Actel
2. Activision
3. Adobe Systems
4. Affiliated Computer Service
5. Affymetrix
6. Agile Software
7. Alkermes
8. Altera
9. American Tower
10. Amkor
11. Analog Devices
12. Apollo Group
13. Apple
14. Applied Micro Circuits
15. Arthrocare
16. Aspen Technology
17. Asyst
18. Atmel
19. Autodesk
20. Barnes and Noble
21. BEA Systems
22. Bed Bath and Beyond
23. Biomet
24. Black Box
25. Blue Coat
26. Boston Communications Group
27. Broadcom
28. Brocade Communications
29. Brooks Automation
30. CA, Inc.
31. Cable Vision Systems
32. Cardinal Health
33. Caremark Rx

34. Ceradyne
35. Cheesecake Factory
36. Children's Place Retail Stores
37. Chordiant Software
38. Cirrus Logic
39. Cisco Systems
40. Citrix Systems
41. Clorox
42. CNET Networks
43. Coherent
44. Computer Sciences Corp.
45. Comverse Technology
46. Corinthian College
47. Countrywide Financial Corp.

48. Costco Wholesale Corp.
49. Crown Castle International
50.Cyberonics
51. Delta Petroleum
52. Dean Foods
53. Digital River
54. Ditech Networks
55. Eclipsys
56. Electronic Arts

57. Electronics for Imaging
58. Embarcadero Technologies
59. EMCORE

60. Epiq Systems
61. ePLUS
62. Equinix
63. F5 Networks
64. Family Dollar
65. Finisar
66. Flir Systems
67. Flowserve
68. Fossil
69. Foundry Networks
70. Getty Images
71. Glenayre Technologies
72. Hain Celestial Group
73. HCC Insurance Holding
74. Home Depot
75 Hansen Natural Corp.
76. Hot Topic
77. Hovnanian Enterprises
78. i2 Technologies
79. Basis
80. Infosonics
81. Insight Enterprises
82. Integrated Silicon Solutions
83. Intuit
84. J2 Global Communications
85. Jabil Circuit
86. Juniper Networks
87. Jupitermedia Corp.
88. KB Homes
89. Keithley Instruments
90. KLA-Tencor
91. Kopin Corp.
92. KV Pharmaceutical
93. L-3 Communications Holding
94. Lehman Brothers Holdings
95. Linear Technology
96. M-Systems (see note below)
97. Marvell Technology
98. Mattel
99. Maxim Integrated
100. McAfee
101. Meade Instruments
102. Medarex
103. MercuryInteractive
104. Michael's Stores
105. Microtune
106. MIPS Technologies
107. Molex
108. Monster.com
109. MSC Industrial Direct
110. Nabors Industries
111. Network Appliance
112. Newpark Resources
113. Novell
114. Novellus
115. Nvidia
116. Nyfix
117. Openwave
118. Par Pharmaceuticals
119. Pediatrix
120. Peet's Coffee & Tea
121. Pool Corp.
122. PMC Sierra
123. Power Integrations
124. Progress Software
125. Quest Software
126. QuickLogic
127. Redback Networks
128. Rambus
129. Research in Motion
130. RSA Security
131. Safenet
132. Sanmina-SCI
133. Sapient
134. ScanSource
135. SecureLogic Corp.
136. Semtech
137. Sepracor
138. Sharper Image
139. Sigma Designs
140. Silicon Storage Tech
141. Sonic Solutions
142. Sonus Networks
143. SPSS
144. Staples
145. Sunrise Senior Living
146. Superior Industries International
147. Sycamore Networks
148. Take-Two Interactive
149. Tetra Tech
150. The First American Corp.
151. THQ
152. Trident Microsystems
153. TriQuint Semiconductor
154. Tyson Foods
155. Ultratech
156. Ulticom
157. United Healthcare
158. UTStarcom
159. Valeant
160. Verisign
161. Vitesse Semiconductor
162. Waste Connections
163. Western Digital Corp.
164. Westwood One
165. Wind River Systems
166. Witness Systems
167. Xilinx
168. Zoran Corp

 

ERISA or 401(k) Litigation (Total as of latest update = 5):

1. United Health Group

 

2. Affiliated Computer Services
3. Analog Devices
4. KB Homes
5. The Home Depot

In addition to these lawsuits, SanDisk Corporation has been sued in connection with its proposed acquisition of M-Systems. The defendants include not only SanDisk, but M-Systems and certain directors and officers of M-Systems. The lawsuits allege that the terms of the deal are not fair to M-Systems shareholders. In addition, the plaintiffs allege that the M-Systems officers and directors breached their fiduciary duty to M-Systems shareholders by backdating stock options and sought to further their own interests by approving the merger. A description of the lawsuit may be found here. Special thanks to Adam Savett of the Lies, Damned Lies blog for bringing this lawsuit to the attention of The D & O Diary.

Also, Sycamore Networks has been named in a lawsuit brought by a former employee, in which the former employee alleges that his employment contract was terminated because he complained about the company's stock option practices. A Wall Street Journal article (subscription required) describing the lawsuit can be found here.


The information in this post was last updated on: August 4,  2008.

 

 

• Email This
• Print
• Comments (2)
• Trackbacks
• Share Link

Erik Lie, the University of Iowa Business School professor whose research is widely credited with unlocking the emerging options backdating scandal, has published a new research paper concluding that practice of options backdating was far more widespread than current media reports suggest. According to Lie's July 14, 2006 paper, written with Associate Professor Randall Heron of the University of Indiana Business School, "the alleged incidents of backdating that have surfaced in the media appear to represent merely the tip of the iceberg."

The paper's authors examined a sample of 39,888 stock option grants made to 7,774 companies' CEOs, Presidents and Chairmen of the Board, using information from the Thompson Financial Insider Filing database and insider transactions reported to the SEC. The study analyzed whether or not there were "abnormal [investment] returns around option grants." The authors' assumption is that, without manipulation, half the returns should be positive and half should be negative, but in fact the distribution was shifted upward. The authors used this analysis to infer the number of grants that were backdated or otherwise manipulated.

According to the authors, 13.6% of the grants studied were backdated or manipulated. Because grants that are scheduled to take place at the same time every year are more difficult to backdate or otherwise manipulate, the authors focused their attention on unscheduled grants that were in-the-money or at-the money. (Grants that were out-of-the-money, that is, with the exercise price below the share price on the grant date, presumptively were not the subject of manipulation.). The authors concluded that 18.9% of the unscheduled, in-the-money or at-the money option grants were backdated or otherwise manipulated. The authors also concluded that the practice was more widespread before August 29,2002, when the SEC implemented new rules requiring option grants to be filed within two days. The authors concluded that 23% of the unscheduled at-the-money grants between January 1, 1996 and August 29, 2002, and 10% of the unscheduled grants after August 29, 2002, were backdated or otherwise manipulated.

The number of backdated or otherwise manipulated grants is different from the number of firms that engaged in backdating. The authors compared expected and average actual options returns for the 7,774 companies in their data population to estimate that 29.2% of companies (or 2,270 companies) engaged in backdating or similar manipulation of grants to top executives at some point between 1996 and 2002. The authors also estimate that 16.1% of companies in the study engaged in backdating between August 29, 2002 and December 1, 2005.

The authors' finding of continued backdating after the SEC's August 29, 2002 implementation of the new filing rule may be partially understood by some companies' apparent disregard for the new filing rules. The authors found that while 10% of the unscheduled at-the-money grants after August 29, 2002 were backdated or otherwise manipulated, the incidence was 19.9% for companies that filed their grants late, but only 7% for companies that filed within the required two business days.

The study also found that the incidence of unscheduled at-the-money grants that are backdated or otherwise manipulated is 20.1% among low tech firms but 32% among high tech firms; 23.1% among small firms (market capitalization within 20 days before the grant < $100 million), 27% among medium-sized firms ($100 million $1 billion); and 13.6% among the firms with the lowest one-third of share price volatility, 26.2% among the firms with the middle third level of share price volatility, and 29% among firms with the one-third highest level of volatility.

The study also concludes that smaller auditors (i.e., those other than the big five) are associated with more companies that backdated after August 29, 2002. Among the big five firms, PwC and KPMG are associated with less backdating before August 29, 2002, and PwC with less after August 29, 2002. However, the authors note that care should be taken in interpreting the backdating differences among the auditors, as the differences might reflect characteristics of the audited companies.

The New York Times July 17, 2005 article reporting on the new study quotes Professor Lie as saying that the widespread nature of options backdating is "pretty scary and quite surprising to me." The Times article also reports that Professor Lie said the findings were so surprising that he asked several colleagues to check his numbers, and they concluded that the numbers probably erred on the low side.

The D & O Diary notes that because the study is limited to analysis of grants made to the most senior company officials, the study necessarily omits companies that engaged in options timing practices for grants to other persons. For example, another option timing practice that has been the subject of scrutiny is the award of hiring-related options grants, whereby new hires or potential new hires were offered grants backdated to a date prior to their hire date, when the company's share price was trading at a higher price. The backdating potentially made the options grant more attractive to potential new hires. Hiring-related options grants was the subject of a prior D & O Diary post, which may be found here.

Professor Lie's Options Backdating website may be found here.

Options Backdating Criminal Charges Coming? An article in the July 14, 2006 issue of The Recorder predicts that Gregory Reyes, the ex-CEO of Brocade Communcations may be the first executive indicted in the options backdating scandal. Brocade was one of the first companies implicated in the scandal, as it restated its financials due to options related issues in January 2005. According to this February 13, 2006 Business Week article, Reyes blames one of the most prominent lawyers in Silicon Valley, Larry Sonsini of the Wilson Sonsini Goodrich & Rosati firm and a former member of Brocade's board, for the company's options problems. According to Reyes, Sonsini suggested a compensation structure in which Reyes sat as a "committee of one" and those could aware stock options at will. When stock options questions arose, Reyes said, Sonsini argued for him to resign. Sonsini is named as a defendant in the Consolidated Amended Complaint filed in the civil securites fraud class actions that has been filed against Brocade Communications. A WSJ.Com Law Blog post on the anticipated indictment can be found here.

According to a July 17, 2006 article on Bloomberg.com, after the first indictment, which is anticpated this week, "at least 12 more cases will probably follow." The Bloomberg.com article also quotes sources as saying that in the enforcement action this week, the SEC will probably file a civil case in tandem with criminal charges by the Justice Department. The Bloomberg.com article also notes that the June 2003 criminal complaint filed against Peregrine Systems encompassed a wide variety of charges including stock-option violations. The SEC's June 2003 complaint against Peregrine Systems can be found here (the stock options allegations are in paragraph 29).

Jupiter Networks Sued in Options Backdating Securities Class Action: According to a July 17, 2006 press release, Jupiter Networks has been named in a securities class action lawsuit based on allegations of improper options backdating. This brings the number of companies sued in securities class action lawsuit based on allegations of improper options backdating to nine. Prior D & O Diary post tallying the other eight lawsuits and identifying the companies previously sued can be found here and here and here.

Options Backdating Link: Readers interested in more regular servings of options backdating news may want to check out the Vangal blog, which may be found here. Tip of the hat to Adam Savett at the Lies, Damn Lies blog for the Vangal link. The Vangal blog apparently is affiliated with Vangal Strategy and Business Consulting, whose website describes the company as "the leading strategy consulting firm for high-velocity companies who are facing a crisis with Stock Options Backdating [and] and Spring-loading grants." A June 24, 2006 article in the San Jose Mercury News describing Vangal and other blogs discussing options backdating can be found here.

Tags: Options Backdating

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Options Backdating Securities Litigation: On June 29, 2006, a putative securities fraud class action was initiated against KLA-Tencor. This brings the number the number of companies sued in securities fraud class action lawsuits based on options timing allegations to eight. Background on the other seven companies previously named can be found on prior D & O Diary posts here and here. In addition, Apple Computers announced on July 5, 2006 that it had been sued in two derivative action based upon its awarding of stock option grants.

Mercury Interactive Restatement: A sense of the magnitude of the problems that options backdating can cause can be found in Mercury Interactive's July 3, 2006 release of its restated financials. Among other things, the company reported that as a result of problems surrounding its options practices it would restate its earnings before taxes for the period 1992 through 2004 downward by $566.7 million. All told, the company's special investigative committee found 55 instances in which "the exercise price of stock options was established based on a stated grant date that was different from the actual grant date." Jack Cielski has a detailed review of Mercury's options practices and the resulting accounting mess in a July 6, 2006 post on the AAO Weblog.

Mercury Interactive also announced that on June 23, 2006, the SEC staff provided three of the company's outside directors with "Wells" notices, signifying the staff's intent to pursue charges against the individuals. A July 6, 2006 post on the ISS Securities Litigation Watch blog points out that it is "quite unusual" for the SEC to pursue outside directors in connection with financial problems at the company on whose board they serve, but that appears to be the direction the SEC is headed in connection with the Mercury Interactive mess. (The SEC also served Wells notices on outside directors of the Hollinger Corporation, as discussed here.) The July 5, 2006 Wall Street Journal (subscription required) article describing Mercury Interactive's restatement and its directors receipt of Wells notices may be found here.

In a related development, on July 5, 2006, Opsware announced that its CFO had received a "Wells" notice pertaining to her prior service as Mecury Interactive's CFO.

Ken Lay's Death and the Resurrection of D & O Coverage? It may be an idle question on my part, but a July 5, 2006 note on Professor Peter Henning's White Collar Crime Prof blog has left me wondering about the D & O insurance implications arising from the legal effects of Ken Lay's death. Professor Henning reports that under established Fifth Circuit precedent, a criminal defendant's death during the pendency of an appeal "abates, ab initio, the entire criminal proceeding." Under United States v. Estate of Parsons, 367 F.3d 409) (5th Cir. 2004), "the appeal does not just disappear....Instead, everything associated with the case is extinguished, leaving the defendant as if he had never been indicted or convicted." Now, it may well be that the available D & O insurance was exhausted long ago, and it may be that the applicable policy language differs in a way that avoids this whole line of analysis. But assume for the sake of discussion that the applicable policy had the standard "after adjudication" language in the criminal conduct exclusion, pursuant to which the exclusion precludes coverage only upon final adjudication of criminality. There is no question that a jury of 12 persons good and true found Ken Lay guilty of multiple criminal acts. But if his death operates to leave him "as if he had never been indicted or convicted," does the exclusion apply? Or would his death resurrect coverage, or rather remove the obstacle to coverage? The entire question may be moot due to the exhaustion of coverage, and because the lead plaintiff in the pending civil securities action against Lay (as quoted in the July 6, 2006 Times of London), has stated publicly that it does not expect to pursue the case against Mr. Lay's estate. But it is still an interesting question, albeit based upon a fact pattern that presumably will not frequently recur...

A July 7, 2006 Wall Street Journal (subscription required) article discussing the legal effects of Ken Lay's death, as well as the financial condition of his estate, can be found here.

• Email This
• Print
• Comments (2)
• Trackbacks
• Share Link

Options Backdating Litigation Update: On June 19, 2006, the Kaplan Fox & Kilsheimer law firm initiated a new securities fraud class action lawsuit against Brooks Automation and several of its directors and officers, based on options backdating allegations. With the addition of the Brooks Automation lawsuit, the number of companies named in securities fraud class action lawsuits since the Wall Street Journal's (subscription required) March 18, 2006 article brought widespread attention to options backdating is now up to five. (The four companies previously named are Comverse Technology, United Health Group, Vitesse Semiconductor, and American Tower. The four prior lawsuits were discussed in this previous D & O Diary post.)

In addition to these five, the Consolidated Amended Complaint filed against Brocade Communications alleges misconduct (including backdating) in connection with hiring-related stock option grants. The Brocade Communications complaint was previously discussed in this D & O Diary post.

Thus, according to the D & O Diary's tally, and counting the Brocade Communications lawsuit, the number of companies sued in securities fraud class action lawsuits based on allegations of improper stock options grant timing now stands at six. The D & O Diary is interested in hearing from readers who are aware of any other lawsuits that this post may have overlooked.

Update: An alert D & O Diary reader has referred me to the securities fraud lawsuit pending against Mercury Interactive. The initial D & O Diary post about options backdating referenced the case pending against Mercury Interactive. The initial securities complaint filed in August 2005 against Mercury Interactive did not emphasize the options backdating allegations, but subsequent events, including in particular, the November 2, 2005 resignation of the company's top three executives because of improper timing practices involving employee stock options, suggest that the centerpiece of the Consolidated Amended Complaint, when filed, will be the options backdating allegations. The Order granting leave to file the Amended Complaint was entered on June 7, 2006, and the Amended Complaint must be filed by the later of 60 days from the Order's date or 21 days after Mecury Interactive files its restated financial statements, but in no event more than 90 days from the Order. Clearly, the securities fraud class action filed against Mercury Interactive involves options backdating allegations, so that case should be "counted" -- which brings the total number of companies sued in securities fraud cases involving options timing to seven, rather than six as previously stated.

In addition to securities fraud class action lawsuits, companies involved in the options backdating investigations are also being named in shareholders' derivative lawsuits. Derivative lawsuits are harder to track because the plaintiffs' lawyers do not always issue a press release when they file derivative lawsuits. The Weiss & Lurie law firm cast modesty aside in issuing its June 12, 2006 press release about the new shareholders' derivative lawsuit it has filed against KLA-Tencor. The firm not only announced the new derivative lawsuit, but stated further that it has been retained to investigate possible additional lawsuits against 48 other companies (which companies it identifies in the press release by name and ticker symbol). Not to be outdone, the law firm of Stull, Stull & Brody, in announcing the shareholders' derivative action that it initiated against Computer Sciences Corporation, claims that it is investigating "over 50" companies.

Sarbanes-Oxley Whistleblower Update: As discussed in this prior D & O Diary post, one of the most important legacies of the Enron era may be the Sarbanes-Oxley Whistleblower protection. Two recent developments increase the likelihood that this statutory provision may become increasingly significant.

On June 9, 2006, in a closely watched case involving the first worker to win protection as a whistleblower under the Sarbanes-Oxley Act, the U.S. Department of Labor Administrative Review Board held that the whistleblower's employer must reinstate him to the position he held before he was fired for criticizing the employer's accounting practices. The decision may be found here. A Washington Post article (registration required) describing the decision can be found here.

Update: CFO.com has a June 28, 2006 post in which it reports that Cardinal Bancshares (the defendant in the whistleblower case described above) has "decided once again to refuse a Department of Labor judge's recommended order to reinstate the bank's former CFO....Instead, the bank holding company plans to wwait and see whether the DoL or [the plaintiff] brings an action against the company in U.S. District Court."

The U.S. Supreme Court's June 22, 2006 decision in a Title VII case could further strengthen the Sarbanes-Oxley Act's whistleblower protection. The Court held that any adverse actions by an employer - whether in or out of the workplace, and even if they fall short of dismissal or demotion - can be illegal if they would dissuade a "reasonable" employee from filing a discrimination complaint. According to the Wall Street Journal's (subscription required) June 23, 2006 article discussing the decision, "[w]hile the ruling was in a discrimination complaint, employment lawyers said it is likely to influence retaliation cases of all sorts, including age bias and whistleblower claims under the Sarbanes Oxley law."

Outside Director Liability: After outside directors of Enron and WorldCom were forced to contribute to the class action settlements out of their own assets without recourse to insurance or indemnity, a great debate ensued about whether the settlements represented a trend or were mere artifacts of unique cases. A scholarly overview of outside director liability by Michael Klausner of the Stanford Law School summarized in the June 2006 issue of the PLUS Journal (registration required) statistically examines the historical evidence and concludes that outside directors personal exposure is limited to "very narrow exceptions." The Enron and WorldCom settlements may, according to Professor Klausner, be understood as the outcomes of "exceptional scenarios." He further comments that to protect themselves from their remote exposure to liability, outside directors should be sure that their companies have a "state-of-the-art D & O Policy with appropriate severability, bankruptcy and other protections."

• Email This
• Print
• Comments
• Trackbacks
• Share Link

D & O insurers, concerned about lawsuits that have already have been filed and troubled by the possibility of an unknown number of lawsuits yet to come, have begun to respond to the options backdating investigation. On June 20, 2006, the Wall Street Journal (subscription required) carried an article entitled "Options Timing Raises Concern Among Insurers" discussing the response of the D & O insurance marketplace to the options backdating investigations. The D & O Diary's author's views on the topic of options backdating and D & O insurance may be found here, in an article entitled "The Options Backdating Scandal and the D & O Insurance Marketplace." This article provides background on options backdating, and discusses the kinds of problems that companies involved in the investigations are facing. The article also examines the ways that the D & O marketplace is responding to the investigations and suggests practical steps for companies to take in connection with their purchase of D & O insurance under the circumstances.

Erik Lie's website: As anyone who has followed the options backdating story knows, the existence of options backdating was first established by University of Iowa business school professor Erik Lie. Those interested in a deeper understanding of options backdating will want to visit Professor Lie's website, which is remarkably readable and informative.

Options Springloading: As described in the June 11, 2006 post on The D & O Diary, "options springloading" refers to the practice of timing option grants to take place before expected good news. (Professor Lie's website has a detailed discussion of options springloading). The June 20, 2006 issue of the Los Angeles Times (registration required) carried an interesting article quoting SEC Chairman Christopher Cox as saying that the SEC is "very interested" in options springloading and stating that the forthcoming SEC executive compensation rules will contain provisions designed to address options springloading.

Cost of Being Public: The cost of being public declined slightly in 2005, according to one law firm's annual report of the costs associated with corporate governance reform. But while overall costs are declining, audit costs are continuing to climb, especially for the smallest companies. Foley & Lardner released its fourth annual study report on June 15, 2006. The firm prepared the study using a statistical analysis of proxy statement data and survey responses from 114 public companies.

The study found that the overall costs to a compnay of being public (including, among other things, legal fees, audit fees, D & O insurance, and board compensation) declined 16% for companies with under $1 billion in annual revenue and 6% for companies with revenues over $1 billion. But according to the firm's analysis of 850 public companies' proxy statements, audit fees increased 22% for S & P small cap companies, 6% for mid-cap companies, and 4% for S & P 500 companies. These data are somewhat inconsistent with some published reports suggesting that audit fees declined in 2005.

The study includes a number of other interesting findings, including the finding that the average cost of compliance for companies with under $ 1 billion in annual revenue has increased from approximately $1.1 million in 2001, the year prior to Sarbanes Oxley's enactment, to approximately $2.9 million in 2005, an increase of 174%. Not too surprisingly, one in five survey respondents (21%) is considering going private as a result of corporate governance and public disclosure requirements.

While the law firm's 2005 study report is interesting, and while the study is on solid ground where it relies on the statistical analysis of proxy statements of a large group of public companies, the study's reliance on a limited set of survey data undermines some of its other conclusions. For example, of the 114 public company survey responses, only 33 came from companies with annual revenues of over $1 billion. These 33 companies reported an average D & O insurance premium that was 35% greater than the average D & O insurance premium reported in the 2004 study with respect to companies with revenues over $1 billion. This of course does not mean that premiums went up 35% between 2004 and 2005 for companies in that category. It does not even mean that the 33 companies in that category that responded to the 2005 survey saw their D & O insurance premium rise 35% between 2004 and 2005. It simply means that the companies in that category that responded to the 2005 survey reported premiums that averaged 35% higher than the different companies in that category that responded to the 2004 survey.

That is the problem with attempting to draw conclusions by comparing two small but different sets of data. Small differences can produce results that appear significant but that may be misleading, due to the different composition of the two sets of data. The study's authors may be faulted for not doing a reality check before issuing their report - any D & O insurance professional could have told them that D & O insurance premiums did not increase 35% between 2004 and 2005 for any category of companies.

But this shortcoming notwithstanding, the study report still merits attention, at least with respect to the portion of the report pertaining to statistical analysis of proxy data.

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

The recent media coverage surrounding stock option practices primarily has been focused on options backdating, and to a lesser extent on options springloading. A new wave of media attention has drawn scrutiny of another options compensation practice - the allegedly improper use of stock options grants in connection with hiring and recruiting of new personnel.

The June 19, 2006 New York Times carries a detailed article examining stock option related hiring practices at Micrel. Micrel's volatile stock prices created a situation where new hires' stock option strike price (set on the date of hire) could differ significantly from the strike price on options granted to others whose date of hire was only a few days before or after. With the alleged blessing of its auditor, Deloitte & Touche, Micrel set the strike price on new hires' stock option grants at the lowest point in the 30 days from when the new hires' stock option grant was approved. According to the Times article, the practice also had the blessing of Micrel's outside counsel, Morrison & Foerster. Five years later, Deloitte "reversed its opinion and urged Micrel to restate its financial reports." The company restated earnings downward and subsequently sued Deloitte claiming that the cost to Micrel from the flawed option plan could reach $58.6 million.

Deloitte is also the long standing auditor of Microsoft. According to a June 16, 2006 article in the Wall Street Journal, between 1992 and 1999, Microsoft "routinely issued options to new employees at the stock's lowest closing price in the 30 days after they joined."

Hiring-related stock options practices are at the heart of the securities class action lawsuit pending against Brocade Communications. The lawsuit was first filed against Brocade in May 2005. The Amended Complaint, filed April 14, 2006, alleges a variety of hiring related stock options practices designed to provide potential new hires the most potentially lucrative stock options grants. These practices allegedly took place because of the fierce competition for qualified job applicants during the tech bubble in the late 1990s. The hiring practices allegedly included giving new hires false start dates or backdating offer letters or even stock option grant dates to give new employees the advantage of lower stock option strike prices; and signing a new hire on as a current employee and then immediately placing him or her on a leave of absence (even thought the employee was still working at another company) so that Brocade could grant the new employee options at the earliest possible date and the lowest possible exercise price. The Amended Complaint alleges that these and other practices resulted in a misrepresentation of Brocade's actual compensation expense and true financial condition. After an internal investigation, Brocade restated its financials, and, according to Brocade's 1Q06 10-Q subsequently offered to enter a settlement with the SEC. The plaintiffs have sued not only Brocade, and its directors and officers (including Larry Sonsini of the Wilson, Sonsini Goodrich and Rosati firm), and Brocade's auditors, KMPG.

These hiring related stock options grants are in a different category from the options grants involved in the options backdating investigation - most of the options grants at the center of the options backdating investigation involve options that company officials granted themselves, as opposed to new hires. While the self-dealing allegedly involved in the options backdating investigation seems more inherently objectionable, the class action lawsuit and the SEC investigation involving Brocade shows that questions associated with hiring-related options grants can still cause companies a lot of problems. The lawsuits against the Micrel's and Brocade's auditors suggests the possibility that problems surrounding stock option grants could ensnare a wide variety of professionals, not merely the company officials involved in the stock options grants. The more interesting question is how potentially widespread the problems from hiring-related options grants may be. Given the popularity of stock option related compensation practices in the 1990s and early part of this decade, the problems arising from hiring-related options practices could prove to be even more widespread than the options backdating practices that have dominated the recent media coverage.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Earlier this week several publications carried reports that pension funds in the United States, Europe and Australia had retained the Lerach Coughlin law firm to sue "dozens of companies" over the timing of stock options grants to their top executives. A June 13, 2006 article in the San Jose Mercury quoted Lerach Coughlin partner Darren Robbins as stating that the pension funds are "completely beside themselves and outraged over the self-dealing that has gone on." A June 14, 2006 article in Red Herring quotes Robbins as saying that the pension funds seek to terminate jobs of executives who diverted assets to their own pockets; the replacement of boards who permitted backdating; and the substitution of shareholder-nominated directors. The pension funds will also seek to "recover funds that were diverted from the corporate till." In addition, he also said that the pension funds will seek recovery of damages, which, he estimates, "total in the billions of dollars." The Red Herring article states that Robbins "has been directed to take action in 34 cases from 350 to 400 pension funds." Five companies are identified by name in the article: American Tower, Mercury Interactive, McAfee, Juniper Networks, and United Health Group. The article is unclear whether the actions that Robbins has or will file are or will be in the form of shareholders' derivative actions (which would be consistent with the stated goal of seeking management and board reform) or of a securities fraud action for damages (which would be consistent with the stated goal of recovery alleged shareholder losses).

The D & O Diary will update this post as further information about these alleged pension fund lawsuit becomes available.

Statutes of Limitations Defenses?: One interesting question that any actions for damages under the federal securities laws will present is whether the statute of limitations bars some or all of plaintiffs' claims. In many instances, the alleged options backdating goes back into the 1990s. For example, according to the April 17, 2006 Wall Street Journal article (subscription required) discussing questions surrounding options grants at United Health Group, the specifc grants that are under investigation took place between 1994 and 2002. Section 804 of the Sarbanes-Oxley Act of 2002 extended the statute of limitations for federal securities fraud actions at the earlier of two years after discovery of "facts constituting the violation" or "five years after such violation." (Previously, the limitations periods had been one year and three years, respectively). The Sarbanes-Oxley Act's statute of limitations period raises a number of interesting questions: does it apply retroactively to options grants that took place before it was enacted in 2002, or does the shorter limitations period apply? Even if the longer period does apply, does the longer limitations period bar claims based on grants that took place more that five years ago? Or are the options backdating practices (and the alleged misreporting of the practices and accompanying accounting and tax mispresentations) part of a continuing course of conduct that brings the "violation" within the five year period? What is the "violation" that triggers the running of the statute? None of these questions are clear, but if plaintiffs' lawyers are as committed to pursuing these actions as they claim, we will be hearing more on these issues as the cases go forward.

The D & O Diary is interested hearing readers' comments on these statute of limitations questions.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In the last couple of months, there has been widespread media coverage (including several prior posts on The D & O Diary) discussing the growing investigation into options backdating. New allegations have surfaced that may evidence options "springloading."

Options backdating involves retroactively dating the grant and exercise price of an options issue to a time preceding a rally in the price of the underlying shares, which maximizes the profits for the grant recipients. Options springloading, according to this June 7, 2006 Reuters article, involves looking forward to set the grant date and exercise price ahead of the release of positive news expected to raise share values, also boosting option profits.

Analog Devices Inc.'s November 15, 2005 tentative settlement with the SEC regarding the company's stock option practices involve allegations of practices that, although not using the term "options springloading," present the circumstances that phrase describes. The company's announcement stated that the settlement addressed

ADI's disclosure regarding grants of options to employees and directors prior to the release of favorable financial results....The SEC settlement would conclude that ADI should have made disclosures in its proxy filings to the effect that ADI priced these stock options prior to releasing favorable financial results.

Under the settlement Analog Devices agreed to pay a civil money penalty of $3 million, and certain of the grants to officers and directors were repriced.

Options springloading may be involved in the circumstances described in a June 9, 2006 New York Times article about options practices at Cyberonics. According to the article, the company's Board approved stock option grants for top executives one evening in June 2004, a few hours after the company received positive news about the regulatory prospects for a promising product. When trading began the next day, Cyberonics share price soared, along with the value of the options. The option grant gave the Company's chairman and CEO instant paper profits of $2.3 million, and lesser amounts of paper profits for the other two executives who received options in the grant. The company has publicly challenged the notion that there was anything wrong with the grant, saying that the options grant was immediately reported, and noting that none of the grant recipients has yet exercised any of options. The securities analyst whose recent report first questioned the Cyberonics option grant noted that while the grant did not involve options backdating, "the effect is exactly the same." The analyst also noted that options are supposed to align executives' financial interests with those of investors, but because these options were granted before investors were able to trade on the good news, the grant operated as a reward rather than an incentive. He also contends that because the options were priced below the market value fully loaded for the good news that was known to the company when the grant was made, the grant should have been counted as compensation in the quarter in which the grant was made.

The Reuters article cited above also contained a report that the SEC is looking at whether auditors have culpability in connection with the options backdating investigation. According to the article, the SEC is looking into whether auditors knew about the questionable practices and whether the auditors may have signed off on improper options backdating and springloading.

Article Plug: The D & O Diary recommends the recent law review article by Sean Fitzpatrick appearing in the Fordham Law Review. This article, entitled "The Small Laws: Eliot Spitzer and the Way to Insurance Market Reform," argues that while Eliot Spitzer's campaign against contingent commissions purportedly sought to eliminate anticompetitive behavior in the insurance brokerage industry, the ironic effect of Spitzer's efforts is that smaller brokers may be harmed, as a result of which there may be further consolidation in the insurance broker industry, resulting in less rather than more competition. The article's author recommends simpler, less draconian solutions for reform. The article may be found here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

On May 30, 2006, American Tower Corporation became the fourth company to be named in a securities class action lawsuit connected with the options backdating probe. (As noted in this prior post on The D & O Diary, the three companies previously named in securities class action lawsuits related to options backdating are Vitesse Semiconductor, Comverse Technology, and United Health Group.) American Tower also reported that it had been named in a shareholders' derivative lawsuit in Massachusetts state court.

In an even more ominous development on the options backdating litigation front, on May 30, 2006, the plaintiffs' firm of Kahn Gauthier Swick LLC issued a press release announcing "the creation of the nation's first privately funded Independent Options Pricing Investigations Division," which reportedly was formed to invesitgate options backdating at U.S. companies. The press release names five companies the firm is currently investigating (Altera Corp., Brocade Communications, Broadcom Corp., Brooks Automation and CNet Networks), and urges shareholders of these companies to contact the firm "to discuss your legal rights." According to Kahn Gauthier's website, the firm was founded by tobacco litigation plaintiffs' attorney Wendall Gauthier.

Thompson Memo Update: In a prior post, the D & O Diary commented on the enormous burden the so-called Thompson Memo places on business organizations facing criminal investigations. Among other things, the firms can find themselves forced to withhold payment of their individual employees' attorneys' fees, or even to waive the attorney client privilege, in a bid for leniency in a criminal prosecution. The May 31, 2006 issue of USA Today carries a lengthy story discussing these issues in greater detail. Accompanying the article is a spiffy chart listing the 21 companies that have been forced to waive their attorney client privilege in connection with criminal investigations. The chart lists the wide variety of types of criminal matters in which the issue has arisen. According the WSJ.com law blog, the government's decision to indict the Milberg Weiss law firm has drawn together a variety of different organizations who object to the prosecutorial action of forcing firms to waive the privilege or cut off employees' attorneys' fees or face the death penalty of corporate criminal indictment. Among the groups joining together to voice their concern are the US Chamber of Commerce, corporate counsel groups and corporate defense lawyers.

Coming Soon to a Courtroom Near You?: You may have missed it over the long holiday weekend, but on Saturday, May 27, 2006, the Wall Street Journal carried an article (subscription required) entitled "Scandals Seem Bad Now? Just Wait," speculating on the corporate scandals to come now that the grandaddy of them all from the last wave of corporate scandals -- the Enron criminal prosecution -- has been to the jury. The article conjectures that the credit boom of the last few years will generate several waves of scandals, including issues arising from: "proprietary trading at investment banks"; "scandalously incompetent lending" -- the prediction is that future blow ups will "expose those in the hedge fund world and elsewhere who've taken on excessive risk in pursuit of quick returns"; securitized loans, such as collateralized debt obligations, which the article comments is "an area rich in conflicts of interests, hazy pricing, excessive leverage and opportunities for self-dealing." Other fruitful areas for "tomorrow's accounting outrages" include excessive executive compensation, hedge funds' excessive management fees, and dual-share stock structures that enable founders or insiders to maintain corporate control to the detriment of other shareholders.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In the latest development in the evolving options backdating story, the May 19,2006 issue of the Wall Street Journal contains a report (via wsj.com, subscription required) that federal prosecutors have launched criminal probes of at least five companies involved in potential stock-option backdating abuses. The article reports that Caremark RX, SafeNet, Affiliated Computer Services, Vitesse Semiconductor and United Health Group have received subpoenas from the U.S. Attorney from the Southern District of New York. Caremark and SafeNet also reported that they received informal SEC inquiries. United Health group also announced that it had received a request from the Internal Revenue Service for documents from 2003 to the present relating to stock options and other compensation for company executives.

Affliliated Computer Services has publicly taken the position that its processes legally involved backdating. In a May 10, 2006 Form 12b-25 filing with the SEC, the company presented a detailed explanation of its stock option practices, explaining that options were granted as a specified date after all compensation committee members' consent were obtained, often after the specified grant date.

An increasing number of companies are announcing the formation of special litigation committees to look into options grant practices. For example, American Tower today announced that a special committee of independent directors will be conducting a review of the company's stock option practices. The company's announcement also reported that it had received a document request from the SEC.

The media are definitely taking this story and running with it, and it is not just the Wall Street Journal pursuing the story. On May 14, 2006, the St. Louis Post-Dispatch carried a story examining in great detail the stock options practices of Engineered Support Systems. (Most of Engineered Support's top management retired after the company was sold in January to DRS Technologies for nearly $2 billion.) Engineered Support is separately under SEC investigation in connection with alleged insider trading.

The May 19 Journal article also reported that five pension funds had filed a lawsuit against United Health Group on May 18, 2006 in federal Court in Minneapolis, seeking to prevent the company's two top executives from exercising about $1.5 billion in options.

wsj.com is now maintinaing a detailed, company-specific ledger of the key companies involved in the options probe and the status with respect to each company. The posting identifies 13 companies by name. (The list does not include American Tower or Engineered Support Systems.)

Update: On Monday May 22, 2006, the Wall Street Journal ran another front page article (via wsj.com, subscription required) naming five additional companies whose option grant dates and stock price graphs seem to suggest the existence of options backdating. The five additional companies were identified using the same analytical technique used to identify the companies named in the Journal's original March 16, 2006 article about options backdating. The May 22 article notes that the phenomenon of options backdating seems to have disappeared after mid-2002, following the enactment of the Sarbanes-Oxley Act.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Well, it didn't take long for my prediction in yesterday's post -- that we would be hearing more about options backdating -- to be proven correct. Today's Wall Street Journal has a front page article (via wsj.com, subscription required) reporting that United Health Group has warned that it may need to restate three years of financials because of "significant deficiencies" in how the company administered options grants. The article also reports that Brooks Automation will restate seven years of financial statements because it believes it recognized too little compensation expense for options granted to executives. The article is accompanied by a graphic entitled "Key Companies in Options Probes" describing options inquiries at seven companies. The article also states that the SEC has "ramped up its investigation" of options grants and that the SEC is "now conducting reviews of about 20 companies."

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Every day seems to bring fresh media outrage on the topic of executive compensation. Yesteday, the New York Times ran this article questioning executives' personal use of corporate aircraft. (See a useful discussion of this article on the CorporateCounsel.net blog).

Among the more interesting media analyses on the topic of executive compensation is the series of articles that the Wall Street Journal has published on the topic of options backdating. The first article (via wsj.com, subscription required) in the series, entitled "The Perfect Payday," appeared on March 18, 2006. The article reported an apparent (but statistically unlikely) pattern at several companies of options grants to senior executives dated just before a sharp rise in the share price, and at or near the bottom of a steep dip.

In a subsequent article (via wsj.com, subscription required) on May 6, 2006, the Journal reported that a number of the companies named in the original article have had (or will have) to restate prior year's financials as a result of options backdating. The restatements were required because the restating companies have to record "additional noncash charges," because accounting rules require companies to report an expense for grants of "in the money" options. The article also explained that companies that backdated options may face bills for unpaid income taxes because backdated options wouldn't qualify for compensation-related tax deductions that may have already been taken.

This recent media attention follows an SEC inquiry looking into alleged options backdating that has been proceeding since November 2004 and that according to some media reports has involved more than a dozen companies. The SEC investigation has resulted in Analog Devices agreeing to pay a civil money penalty of $3 million in November 2005 . In addition, three senior officers at Mercury Interactive resigned in November 2005 and the company was delisted from NASDAQ after the SEC investigation uncovered backdated options grants.

Perhaps inevitably following the front page publicity of the issue in the Journal , the securities class action lawsuits raising option backdating allegations have begun to arrive. Since the March 18 Journal article, three of the seven companies identified by name in the Journal series of articles have been named in separate securities class action lawsuits raising allegations pertaining to alleged options backdating. The three companies named so far are Comverse Technology, Vitesse Semiconductor and United Health Group. In addition to these purported shareholder class actions, United Heath Group has also been sued in a separate purported class action raising substantially similar allegations on behalf of United Health Group employees in connection with their 401(k) plan. A detailed discussion of Comverse Technology's recent woes, including separate shareholder derivative litigation that recently has been filed against the company in connection with these issues, appears at this post. (In addition to these three lawsuits, Mercury Interactive was named in an August 2005 securities class action complaint, but the complaint does not contain options backdating allegations.)

The alacrity with which the plaintiffs' lawyers have jumped on this issue makes me wonder if the plainitffs' bar will try to turn the options backdating story into"this year's model", along the lines of the successive litigation onslaughts we saw in the recent past following, for example, the bursting of the Internet bubble, the IPO laddering conflagration, the telecom industry collapse, the energy industry implosion, etc.

As the quotation below may suggest, the alleged practice of backdating options may not have been widespread. We can, however, be certain that we are going to be hearing a lot more from the media about executive compensation issues -- and I expect that we will also be hearing more about options backdating. Whether or not additional companies will be named in shareholder lawsuits raising options backdating allegations of course remains to be seen.

Quotation of Note:

In the May 6 Journal article, commenting on how widespread options backdating may be, David Aboody, an associate professior at the Anderson School of Management at UCLA, said "It's like stealing money. How many CEO's steal money from their company?"

• Email This
• Print
• Comments
• Trackbacks
• Share Link