Reaching a “quick and unanimous” decision and citing the weakness of the government’s case, a jury in the Southern District of New York delivered the government a decisive defeat on August 2, 2006, when they acquitted Robert A. Scavone, a former trader with Van Der Moolen Specialists USA LLC, of one count of securities fraud after only 45 minutes of deliberation. Mr. Scavone is one of fifteen NYSE specialists from five houses indicted for improper trading practices. Two other specialists were previously convicted on similar charges.

In a parallel case, the SEC instituted a civil enforcement action against Scavone, as well as 19 other former NYSE specialists, on April 12, 2005. The Commission’s complaint claims, in part, that the specialists fraudulently traded from their proprietary accounts by “interpositioning” and “trading ahead”, instead of pairing off available customer buy and sell orders directly with those of other customers. This allowed the specialists to make “guaranteed, riskless profits for their firm’s proprietary accounts,” to the detriment of customer orders. Mr. Scavone has not resolved this case. http://www.sec.gov/litigation/admin/33-8566.pdf

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In the latest stock option backdating case, criminal and civil actions were brought against three former officers of Comverse Technology, Inc., Jacob Alexander, former Chairman and EIC, William Sorin, former General Counsel, and David Kreinberg, former CFO. Both cases allege a long-term scheme in which options were improperly backdated. From court papers filed yesterday, it appears that the Board’s Compensation Committee approved most of the grants and typically had documents demonstrating that the options were being backdated and were “in the money.” On the other hand, in some instances, the court papers allege that the defendants actively deceived the Compensation Committee resulting in grants to phantom employees. Both cases detail defendants’ actions as to covering up their conduct. Additionally, Comverse allegedly failed to properly account for the options and will be required to restate several years of its financial statements. U.S. v. Alexander, No. M-06-817 (E.D.N.Y. Aug. 9, 2006), press release available at http://www.usdoj.gov/opa/pr/2006/August/06_odag_517.html; SEC v. Alexander, Litigation Release No. 19796, available at http://www.sec.gov/litigation/litreleases/2006/lr19796.htm.

Backdating options, in and of itself, is not necessarily a violation of the federal securities laws as SEC Commissioner Paul Atkins recently noted (See blog entry of July 20, 2006). Backdating options may, however, involve other actions that can result in violations such as failing to properly account for options or taking steps to hide improper back dating. Cover ups typically involve violations of the law. As the Martha Stewart case clearly demonstrated, “it’s not necessarily the crime, it’s the cover up.” In this respect the option backdating inquiries may turn out to be reminiscent of the now winding down market timing enforcement actions. In the market timing cases the core activity, market timing, in and of itself was not illegal but when coupled with disclosure problems, allegations of cover ups and other matters they frequently resulted in violations of the law. Yet often it was the market timing activity that generated the sensational headlines and spawned government action. No doubt some of the resulting enforcement actions were appropriate. Others, however, were not and yet they caused significant hardship for persons caught up in them.

In the Comverse cases, many of the grants appear to have been issued by the company’s Compensation Committee with the benefit of information indicating that the options were being backdated and under circumstances which at least suggest that the directors should have known that the grants would be “in the money”. The court papers also allege that the defendants deceived the Committee in some instances and tried to cover up their activities. The propiety of these actions will of course have to await a resolution of the court cases. With active and expanding criminal investigations on the East and West coasts and over 80 active SEC investigations at the moment all focused on option backdating one can only hope that the government is judicious this time in bringing cases, avoids criminalizing matters that are regulatory in nature, and is not over zealous in bringing civil enforcement actions or demanding sanctions in those cases.

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