The key question about the stock option backdating scandal is not if more cases will be brought, but rather what standard prosecutors will use when exercising their broad discretion to charge. To date there are at least 200 companies which have announced internal investigations into their option issuance practices. About 140 of those are under investigation by the SEC and some are the subject of criminal inquiries by various U.S. Attorney’s offices. The conduct engaged in by persons at these companies probably ranges from the bumbling to actual fraud. In-between there are varying shades of gray. Those companies, along with their directors and officers are holding their collective breath, wondering where in those shades of gray the line will fall between those charged and those not charged.
Today, the SEC gave some indication of where that line might fall. It brought a long awaited action based on its investigation into the backdating practices at Apple. Named as defendants in an enforcement action were Apple’s former GC of nine years, Nancy Heinen, and its former CFO and director, Fred Anderson. SEC v. Nancy R. Heinen and Fred D. Anderson, Case No. 07-2214-HRL (Lloyd) (N.D. Cal. filed April 24, 2007) http://sec.gov/litigation/litreleases/2007/lr20086.htm These are the two persons identified by internal investigators as having engaged in possible misconduct.
The SEC’s complaint follows what is becoming a familiar formula. It alleges instances of backdating and preparation of false documents and targets those persons who specifically participated in granting the options. The complaint focuses on two option grants, the first in January 2001 of 4.8 million options to Apple’s Executive Team and the second in October 2001 of 7.5 million options to Apple’s CEO Steve Jobs. According to the complaint, in both instances Ms. Heinen caused Apple to backdate the options and directed her staff to prepare documents to reflect the new date. For the October options, the SEC alleges that Ms. Heinen signed fictitious board minutes for a special meeting that did not occur. The complaint alleges that Mr. Anderson should have realized the implications of Ms. Heinen’s actions, failed to disclose key information to Apple’s auditors and neglected to ensure that the financial statements were accurate. While Ms. Heinen has vowed to fight, Mr. Anderson settled with the SEC without admitting or denying the allegations and will pay over $3 million in disgorgement, prejudgment interest, and fines. Anderson avoided an officer and director bar and disqualification from practicing before the Commission. Citing the company’s full cooperation, the SEC is not pursuing an action against the company. The SEC release does not state that its investigation is continuing as is typical, perhaps suggesting that its inquiry is at an end. The San Jose Mercury News reported earlier this week that Apple CEO and high tech rock star Steve Jobs who many think is Apple would not be charged criminally.
Putting this case together with the handful of earlier SEC actions in this area suggests the parameters of liability being used by the agency. In Apple, as in earlier cases, there are allegations of false documents and a cover-up – the kind of acts that support scienter. In Apple, as in earlier cases, the named defendants are alleged to have been directly involved in the issuance of the backdated options. In Apple, as in earlier cases, the company was not named nor were those outside the options issuance process.
Perhaps the only deviation from earlier cases is the negligence based allegations against Mr. Anderson claiming that he “should have known” the implications of what was going on. Not an unreasonable charge against a CFO but it is interesting that the SEC chose not to allege fraud. Equally interesting is the fact that the SEC did not seek an officer/director bar against Mr. Anderson as has become its customary practice, although he has retired. A press release issued by Mr. Anderson suggests that the SEC will also forgo its usual Rule 102(e) action to bar him from practicing before the agency which, given the consent decree he executed, is virtually automatic. Nevertheless, Mr. Anderson was the CFO of the company at the time, was involved in the transactions according to the complaint, and was identified by internal investors as possibly a culpable person. Thus, this case seems to fit within the pattern of earlier cases suggesting that in the future the SEC will focus on those directly involved in bringing options backdating cases where it finds clear evidence of scienter such as falsified documents and cover ups.