Friday February 9, Commissioner Paul Atkins suggested to attendees at the annual SEC Speaks program presented by the Practicing Law Institute in Washington, D.C., that the SEC’s process for approving waivers should be revisited. “It’s time that we review our processes and procedures,” Atkins told reporters after his speech. The same week Karen J. Mathis, President of the ABA, sent a letter to SEC Chairman Cox proposing revisions to the Commission’s policies regarding requesting privilege and other waivers. Specifically, the proposal advocates dropping a footnote to criteria 11 in the SEC’s Seaboard Report. Presently note 3 to that part of the Seaboard Report states that companies may chose not to assert the attorney client privilege and work product doctrine as part of their efforts to cooperate with the SEC. The ABA proposal would add an addendum to criteria 11 stating that “a company shall not be required to take any of the forgoing actions to the extent that it would result in a waiver of the attorney-client privilege or work product doctrine.” Based on Commissioner Atkins’ remarks and the increased attention to the issue in light of the DOJ’s McNulty Memorandum and other groups such as the ABA, it will be interesting to see when, if, and how the SEC reacts to continued calls for policy revisions.
The SEC filed two stock option backdating cases yesterday, both arising out of the same six year scheme involving the options of Engineered Support Systems, Inc. http://www.sec.gov/litigation/litreleases/2007/lr19990.htm In complaints against Gary C. Gerhardt, the former Chief Financial Officer, and Steven J. Landmann, the former Controller, the SEC detailed a scheme in which the two caused the company to grant undisclosed, in-the-money stock options to themselves and other officers, employees and directors. Backdating options violated company policy according to the complaints. In two instances options were “double backdated” because shortly after the initial backdated options were granted the market price dropped, requiring that they be backdated again so they would be in the money. The complaints allege that company employees received about $20 million in unauthorized compensation as a result of the scheme. The two defendants allegedly profited by about $1.9 million.
Former controller Landmann settled by consenting to a statutory injunction, an officer director bar and agreeing to pay disgorgement of $518,972, prejudgment interest of $108,099 and a penalty of $259,486. Mr. Landmann also consented to a permanent suspension of his right to appear and practice before the SEC as an accountant. Mr. Gerhardt has not entered into a settlement with the SEC. Although no action has been brought against the company, the SEC Release does not indicate that the company cooperated with the investigation. It does, however, state that the Commission’s investigation is on-going.
These complaints in these two cases differ from those in the earlier Brocade and Comverse cases. All of the cases involve securities fraud claims based on backdating and the failure to disclose. The two complaints filed yesterday, however, focus primarily on the failure to disclose the scheme. The complaints also detail the fact that the options could be exercised immediately, thus giving the recipients an instant profit. This contrasts with most cases where the options vest over a period of time. Likewise, earlier cases involved elaborate allegations of cover-up, falsification of documents, and even in some instances the issuance of options to fictitious employees. While Messrs. Gerhardt and Landmann concealed their fraud from others at the company, they also kept notes detailing their wrongful conduct. Not only has the company not been charged as in earlier cases, but also no criminal cases were announced and the SEC press releases does not reference any coordination with the U.S. Attorney’s Office or the Department of Justice in contrast to Brocade and Comverse.
The Gerhardt and Landmann complaints may indicate that the SEC is moving forward more aggressively with actions in the options backdating area, although it is difficult to draw conclusions from the few cases that have been filed. At the same time, because the SEC has upwards of 140 companies under investigation there is little doubt that this is not the end of the option backdating scandal.