The current SEC and DOJ investigations into the backdating of stock options may have, in part, been prodded by news articles, primarily those in the Wall Street Journal. In this regard, these investigations would not differ markedly from those into the so-called “market timing” and “late trading” practices at mutual funds, which were spurred in part by wide spread press coverage. In fact, both scandals share common threads. Backdating stock options is not in and of itself illegal as SEC Commissioner Paul Atkins noted in a July 2, 2006 speech. Similarly, market timing is not in and of itself a violation of the federal securities laws and late trading is, at best, only arguably a violation of those statutes. All of these practices may, however, violate the federal securities laws when combined with other activity such as non-disclosure or improper accounting in the case of backdating options or violation of specific representations in a prospectus or other disclosure documents in the case of market timing and late trading.
Now consider stock option spring-loading and bullet dodging. The former refers to timing the issuance of an option just before a company announces good news, while the latter is the opposite, timing the grant to avoid a downward movement in the stock price from bad news. Neither practice is considered a best practice in corporate governance. Rather, these practices may be forms of insider trading that differ from backdating. Insider trading is based on the theory that insiders should not use company information for their personal benefit. If, however, the company uses the information is there an abuse? Many would say no because the company is permitted to use its information as it sees fit. These points are discussed in a recent New York Times article. Despite recognition of the at best dubious legal theory on which spring-loading and bullet dodging may be based, the article ends by suggesting it would be regrettable if government prosecutors chose not to prosecute these cases.
Why? If these practices are not insider trading or if the basis of the legal theory is dubious at best, what would be regrettable is for the government to try and prosecute those cases. Government enforcement actions, whether civil when brought by the SEC, or criminal when brought by the DOJ, carry terrible consequences for those accused. That accusation can cause significant harm to a company and severely damage, if not end, the a career of an executive or professional. In many ways the power to charge is the authority to convict because the accusation whether proven or not never goes away – it lingers for years to sully what may have otherwise been a good reputation built over the years. So here is hoping that in this case publicity may not spur more action by government prosecutors and that great care is taken in bringing option enforcement actions.