Option Backdating, Negligent Conduct And Spring Loaded Options

Last Friday, the SEC filed a settled civil action and a related administrative proceeding based on option backdating claims. The defendants are Analog Devices, Inc. of Massachusetts and its CEO Jerald Fishman. SEC v. Analog Devices, Inc., Civil Action No. 1:08-cv-00920 (D.D.C. May 30, 2008); In the Matter of Analog Devices, Inc., Adm. Proc. File No. 3-13050 (May 30, 2008).

The allegations of the civil action and the administrative proceeding differ little from other option backdating cases. According to the complaint, from 1998 through 2001 Mr. Fishman caused the company to backdate stock option grants, pricing them below the market price of the stock on the date they were actually approved. The in-the-money grants given to company officers and employees resulted in $30.7 million in compensation costs that the company did not properly record or disclose. The Commission’s papers do not state that a restatement of Analog Devices’ financial statements was necessary.

Two aspects of this matter are significant. First, although the charging documents state that Mr. Fishman is responsible for the option backdating, the claims against him are based on negligence. In the civil complaint, Mr. Fishman is charged in Count II with violating Sections 17(a)(2) & (3). In contrast, Count I against the company is based on a claimed violation of Section 10(b). That complaint was resolved with a consent by Mr. Fishman to pay disgorgement and prejudgment interest and a civil penalty equal to about the total of those two items. The company consented to the entry of an order requiring the payment of a $3 million civil penalty (three times that of Mr. Fishman).

To resolve the administrative proceeding, Mr. Fishman consented to the entry of a cease and desist order based on Sections 17(a)(2)&(3), again negligence. The company consented to a similar order, but based on Section 10(b). Both defendants entered into certain undertakings with regard to re-pricing unexercised options.

Analog is only the second option backdating case based on negligence. The first, filed against the former CEO of Maxim Integrated Products in SEC v. Maxim Integrated Products, Inc., filed in late December, is discussed here. Together, these actions may suggest that, as the Commission works through its inventory of option backdating cases, the prosecution standards will continue to shift from the initial focus on intentional fraudulent conduct to negligence.

The second aspect of Analog Devices of interest is what was not part of the complaint. A footnote in both the complaint and the Order for Proceedings states in part: “At some point during these earlier years, certain management and non-management Directors had obtained advice from Analog’s outside counsel that it was not inappropriate in the context of the company’s insider trading policies for the company to grant options on the basis of and prior to the release of favorable nonpublic financial information.” The company apparently issued “spring loaded” options, although the Commission’s papers make it clear that they are not the predicate for the charges here. Yet, the Commission does not state the reason this material is included in the complaint.

The use of spring loaded options (or the variant, bullet dodging options) is controversial. Some have argued that this conduct is insider trading. Others have claimed that since the company is the ultimate insider it cannot be insider trading. While the SEC has been aggressive in insider trading cases, based on Analog Devices it appears that the Commission will not will not prosecute spring loaded or bullet dodging options – at least where that conduct is based on a legal opinion.