Light At the End of the Tunnel for Companies in the Options Scandal?

Last week the SEC brought a long awaited action based on its investigation into the backdating practices at Apple.  SEC v. Nancy R. Heinen and Fred D. Anderson, Case No. 07-2214-HRL (Lloyd) (N.D. Cal. filed April 24, 2007)  (see blog post of 4/25/07).  As discussed earlier here, the case added some definition to what standard prosecutors may use when exercising their broad discretion to charge.  Those cases suggest that future cases will focus on allegations of false documents and a cover-up – the kind of acts that support scienter – and situations where defendants have been directly involved in the issuance of the backdated options.  The company and those outside the options issuance process do not appear to be the focus of the inquiries.   

Yet, while most struggle to grasp where the SEC is headed with its options investigations, yesterday the Financial Times reported a new wrinkle that raises concerns for companies and their executives caught up in the on-going options saga.  Guerrera, Masters and Pimlott, “Threat to US Backdating Scandal Companies,” FT (Apr. 30, 2007).  The article reports that during a time when “cash-rich hedge funds and private equity groups are scouring the market for takeover targets” more than 40 companies are exposed to takeover bids because they have not filed financials with the SEC nor had a shareholder meeting for 13 months.  Under certain state laws, including Delaware, if a company does not hold a shareholder meeting for 13 months, investors can ask a court to call one.  Companies however are prohibited from issuing proxy documents if they have not produced up-to-date financial statements.  This inability to communicate with shareholders paves the way for activist investors to make proposals, such as removing directors, and the company would be unable fully to respond.  The article noted that Comverse asked the SEC to waive the ban on shareholder communications if the circling hedge fund succeeds in calling a meeting.  The SEC declined to comment.  Again, the question is where will the SEC take the option scandal on this issue.   

Curiously, this is not the first time that the media has reported new studies which may have contributed to the contour of the option scandal.  The current SEC and DOJ investigations into the backdating of stock options began with news articles, primarily those in the Wall Street Journal, which recently won awards for its coverage.  This year news articles have continued and more studies have been completed regarding the breadth of the option issue, including a study suggesting  that interlocking boards contributed to the backdating practice.  See Bizjak , John M., Lemmon, Michael L. and Whitby, Ryan J., “Option Backdating and Board Interlocks” (November 2006). Available at SSRN:  A discussion of the report is contained in the New York Times, January 21, 2007 at BU-5 (see post of 1/22/07).  Sometimes its difficult to determine if the regulators or the investigating media are driving this scandal.  (see post of 10/10/06). 

Now however the final chapter may be about to unfold taking another turn as it does so.  Last week Reuters reported that SEC Chairman Christopher Cox expects to wrap up many of its stock options dating cases within weeks. “We are working on procedures to move many of the cases very quickly,” Cox said, adding their resolution would be within “weeks.”  Rueters reported that Mr. Cox gave no indication of whether the options cases would be resolved through settlements, lawsuits or a combination of both.  Mr. Cox added that the SEC would like to put the option backdating scandal behind them, noting that such conduct will not likely continue in today’s environment.   Mr. Cox did not elaborate on what process the SEC is likely to use. 

The statements of Chairman Cox in the context of over 140 on-going investigations and the handful of cases that have been brought are curious at best.  While the scandal seems to ebb and turn in various directions, this newest wrinkle is perhaps the most intriguing.  On the one hand the Chairman’s remarks, read in the context of the cases brought to date could suggest that only a relative few of the 140 open investigations contain the kind of scienter laden allegations the SEC is looking for as the predicate for an enforcement action.  That would clearly be good news for many companies, their directors and executives.  On the other hand, the FT story may not be good news for the forty or so companies caught in that dilemma.  Yet, it is hard to imagine an enforcement agency like the SEC, which has been proceeding at an ever-increasingly slow pace, resolving 140 investigations in a matter of weeks.  Absent a new turn in the scandal, however, the Chairman’s comments do offer a view of the light at the end of the tunnel for many companies.