Stock Option Exercise Backdating: To date, the focus of the options timing scandal has been on the backdating of option grant date. But an October 30, 2006 New York Times article entitled “Dodging Taxes is a New Stock Option Scheme” (here, registration required) reveals that a new area of investigatory focus is the timing of the options exercise date.
Backdating the option exercise date can reduce the options holder’s tax burden. By reporting an exercise date when the share price was lower than it was on the actual exercise date, the option holder can understate his gains and lower his income taxes. It may also cause the company to take a lower tax deduction. The Times article discusses an example involving a former Symbol Technologies executive who, by reporting an exercise date when the share price was lower than the date he actually exercised his options, underreported his gains by nearly $1.5 million and underreported his taxes by nearly $600,000. The article also cites another example involving Mercury Interactive.
According to the Times article, the SEC is now interested in “several cases” where exercise backdating may have occurred. Because exercise backdating raises tax issues as well as disclosure and accounting issues, the SEC has also alerted the IRS. The article does note, however, that some lawyers who have been hired by companies to serve as outside investigators do not currently expect backdated exercises to become a widespread issue.
Options Backdating Litigation Update: The D & O Diary’s running tally of Options Backdating litigation (here) has been updated. With the addition of the recently filed case against Apollo Group (here), the number of companies sued in securities fraud actions stands at 21. The addition of several new options backdating related securities derivative actions brings the total number of derivative action to 99.
Spitzer Bars Employees’ Fees Payment: According to a November 2, 2006 Law.com article entitled “New York AG Presses Companies to Stop Paying Indicted Employees’ Legal Bills” (here), the office of New York Attorney General Eliot Spitzer has joined the practices of the United States Department of Justice in pressing companies that are the target of corporate criminal investigations to cut off the companies’ payment of the attorneys’ fees for the their employees that are also investigative targets. The issue has arisen in connection with Spitzer’s investigation of mutual fund market timing. Nine of the 17 settlements Spitzer has reached so far included “no indemnification” clauses. Under these agreements, the companies are prohibited from paying attorneys’ fees of “current or former directors, officers, employees or agents.” except where required by law or written agreement.
Under an agreement of this type, the Bank of America cut off the attorneys’ fees for an individual who had been indicted in connection with the market timing investigation, even though its by-laws require indemnification. The individual was forced to sue the company to have his fees paid; he was later acquitted of many charges and the prosecutor dropped the remaining charges.
The acquittal of the Bank of America employee is a reminder of the dangers of these heavy-handed prosecutorial tactics. The practice of forcing companies to cut off their employees’ attorneys’ fees have the effect of punishing individuals who have not been convicted of any crime – and who are entitled to a presumption of innocence. The U. S. Constitution is full of so many guarantees for criminal defendants because the founding fathers understood the powerlessness of an individual when targeted by the extensive police power of the state. (Indeed, similar concerns inform the opinion of Judge Kaplan in the KPMG case in which Judge Kaplan found the prosecutors conduct implementing the Thompson Memo to be unconstitutional. My prior post on the topic may be found here.) Prosecutorial efforts to compel companies to cut off payment of their employees’ attorneys’ fees not only threaten to deprive these individuals of their constitutional rights; they arguably are incompatible with the fundamental assumptions about our American system of justice.
An alert D & O Diary reader points out that given Spitzer’s actions and the similar actions of the DoJ, employees could be well advised to look to their indemnification rights, including ascertaining that their companies have the broadest rights available under applicable state law, and whenever possible obtain written indemnification agreements. The possibility of a corporate employer’s withholding of corporate indemnity also argues in favor of Broad Form Side A protection with advancement of defense cost and drop down protections.
Democratic Perspective on Securities Regulation Reform: In my prior posts discussing the Paulson Committee’s review of possible securities regulation reform (most recent post here), I have questioned whether a Democratic party take over of one or both houses of Congress might be a barrier to the Committee’s reform proposals. However, an article in the November 4, 2006 Wall Street Journal entitled “Democrat Nods to Wall Street” (here, subscription required) sheds an interesting light on this question. The Journal article contains an interview with Rep. Barney Frank, the Massachusetts Democrat who would take over the House Financial Services Committee if Democrats gain control of the House in the November 7 election. (The Committee is currently chaired by retiring Ohio Republican Rep. Michael Oxley.) Frank is reported to be opposed to “reopening the landmark Sarbanes-Oxley corporate accountability law, but would be willing to let regulatory agencies adjust their rules in light of business criticism.” This is an interesting comment, because the Paulson Committee has declared its intent to try to seek reform via regulation rather than legislation.
In addition to Frank’s comments, there were similar comments from New York Democratic Senator Charles Schumer in a November 1, 2006 Wall Street Journal op-ed column entitled “To Save New York, Learn From London” (here, subscription required) written Republican New York Mayor Michael Bloomberg. The column suggests that the Sarbanes-Oxley Act needs to be “re-examined” and that “it may be time to revisit the best way to reduce frivolous lawsuits without eliminating meritorious ones.”
These comments may suggest that even thought the Paulson Committee may not itself be bipartisan, there may nevertheless be some bipartisan consensus that some form of regulatory reform is needed to preserve the competitiveness of U. S. securities markets in the global economy.
PLUS International Conference: I will be in Chicago next week for the Professional Liability Underwriting Society (PLUS) International Conference (here). At lunch on Thursday, November 9, 2006, following a presentation by former Enron prosecutor John Heuston, I will be giving a speech on the topic of “Enron’s Legacies and D & O Risk.” I encourage D & O Diary readers to introduce themselves to me during the conference. I would welcome the chance to meet you and to hear your comments about the blog.