by T. GormanPosted on Posted in SECActions

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.

by T. GormanPosted on Posted in SECActions

On August 2, 2006, ALJ Robert Mahony dismissed aiding and abetting charges against Paul Flynn, a former executive at CIBC, for allegedly assisting Security Trust, Samaritan Asset Management, and Canary Capital Partners in a scheme of late trading and market timing from 2001 to 2003. http://sec.gov/litigation/aljdec/2006/id316rgm.pdf Although finding that the market timing “strategies discussed above constituted a scheme and involved deceptive practices by STC and the Hedge Funds” and that Security Trust engaged in late trading, ALJ Mahony finally vindicated Mr. Flynn, holding that the record failed to show that Mr. Flynn participated in or was even “generally aware of playing any role” in the market timing or late trading. This ruling culminates a more than two year ordeal for Mr. Flynn.

That ordeal began in 2004 when N.Y. Attorney General Eliot Spitzer brought five felony charges against Mr. Flynn during his sweep of the mutual fund industry. Unlike others, Mr. Flynn refused to cut a deal. Spitzer’s office dropped the charges just before trial. Unfortunately, Mr. Flynn was also caught in the cross-hairs of the SEC, as the agency scrambled to keep pace with Spitzer’s mutual fund and headline grabbing task force. Compounding his legal troubles, the SEC brought an administrative proceeding against Mr. Flynn. Yet, market timing without additional facts is not illegal per se and the government’s late trading theory relies on an ambiguous phrase in Rule 22c-1 “NAV that it next computed.”

The basis for the government enforcement actions is recorded in the record of the SEC’s proceeding: While conducting due diligence for CIBC, Mr. Flynn visited Security Trust and learned information about how certain hedge funds intended to use a trading platform to market time and trade after hours. Mr. Flynn memorialized his findings in a memorandum that he later provided to the government. Because of overzealous investigators and a desire for large headlines, Mr. Flynn, who is no longer employed at CIBC, has spent the last two years fighting the government and trying to clear his name both of criminal and civil charges. One can only hope that the SEC staff will not appeal and will let Mr. Flynn’s ordeal end.