New Wave of Options Lawsuits?: Regular readers know that The D & O Diary has been tracking options backdating lawsuits (here). A December 20, 2006 article on Law.com entitled “McAfee Employees’ Suit Reveals New Options Dynamic” (here) raised the question whether a breach of contract action brought by the employees of McAfee represents the opening salvo in a “new wave” of options backdating related litigation.
Seven McAfee employees have alleged they were “cheated” out of $2 million because the company did not permit them to exercise stock options that then expired during the company’s self-imposed blackout. The company imposed the blackout during a delay in the filing of its financial statements while it investigated possible options backdating. The blackout was imposed to prevent stock transactions that might later give rise to insider trading allegations. Employees whose shares expire during a blackout period are out of luck unless the company extends the expiration dates. McAfee apparently declined to extend the expiration date for plaintiffs’ options, all of whom had or have left the company. The plaintiffs allege that the company is “unfairly penalizing them for the accounting misdeeds of management.” The article quotes a plaintiffs’ lawyer who said that she “expects many suits similar to the McAfee action to be filed over the next few months.”
The breach of contract action is merely the latest options backdating related problem at McAfee. Press reports (here) recently suggested that Kent Roberts, McAfee’s former general counsel, may be indicted by federal prosecutors in coming weeks on charges relating to stock option grants.
Heard Melodies are Sweet, But Those Unheard are Sweeter; Therefore, Ye Soft Pipes, Play On: In a prior post (here), The D & O Diary took a look at the liability exposures for companies engaging in PIPE (Private Investment in Public Equity) transactions. (The prior post provides background about the nature and structure of these transactions.) Two recent SEC enforcement actions shed additional light on the issues and pitfalls that these transactions can sometimes present.
On December 12, 2006, the SEC announced (here) that it had filed a Complaint against Edwin “Bucky” Lyon, Gryphon Partners, and several Gryphon investment funds, in connection with thirty-five different PIPE transactions during the period from 2001 to 2004. The complaint alleges that after agreeing to invest in a PIPE transaction, the defendants sold the issuer’s stock short through “naked” short sales (that is, without owning shares to cover their short position) in Canada. Once the resale registration statement was effective, the defendants used the PIPE shares to cover their short position. The complaint also alleges that the defendants falsely represented to the PIPE issuers that they would not sell or transfer their shares other than in compliance with the securities laws. In addition, the complaint alleges that the defendants relied in inside information when they engaged in the short sales. The defendants are alleged to have realized more than $3.5 million in ill-gotten gains.
On December 20, 2006, the SEC announced (here), the filing of a separate settled complaint against broker-dealer Friedman, Billings, Ramsey & Co., its former Co-Chair and Co-CEO, and its former Director of Compliance. The complaint’s allegations relate to a 2001 PIPE transaction in which the Company acted as placement agent. The Company is alleged to have sold the issuer’s shares short while aware of material, nonpublic information prior to the public announcement of the PIPE transaction. The Company covered its short position with shares it bought from its own customers who had bought their shares in the PIPE offering. The Company’s total trading profits were under $450,000 (although its underwriting fee on the PIPE transaction was $1.764 mm), but it agreed to civil penalties of $3.756 mm, without admitting or denying the charges. The individual defendants, who also did not admit the charges, agree to lesser penalties and constraints on their ability to serve in similar roles. The company’s press release about the settlement may be found here. An interesting discussion of the case on the SEC Actions blog can be found here.
While these cases illustrate some of the pitfalls of PIPE transactions, it is significant that they do not involve charges against the issuer companies – as I pointed out in my prior post, most of the enforcement proceedings relating to PIPEs transactions involve the broker dealers or the investors, but not the issuing company. There is nothing about these two new actions that changes my prior statement that issuer companies involved in these transactions should not be treated as suspect merely because the engaged in a PIPE financing. Both of these cases also relate back to the 2001 time frame, which, as my prior post pointed out, was a period when these transactions were less structured and involved greater perils. Nevertheless, it is clear that the SEC is taking a look at these transactions.
The quotation in the caption of this item (about “soft pipes,” and which admittedly has nothing to do with the item itself) is of course from “Ode to a Grecian Urn” written in 1820 by John Keats after viewing an exhibit of Greek artifacts accompanying the Elgin Marbles at the British Museum. The Elgin marbles are the remnants of marble sculpures removed from the Parthenon. Their removal to England has been a controversy since Lord Byron wrote his “Childe Harold’s Pilgimage” (“Curst be the hour when from their isle they roved”).
Holiday Interlude: The D & O Diary will be slowing down over the next few days. Readers can look forward to the resumption of the normal publication schedule after the New Year. Happy Holidays to all.