Part XIII: SEC Enforcement Trends And Priorities, 2008
Backdated options has been a key focus of the SEC and its enforcement division since at least late 2005 when academic studies on the subject were first were discussed in a Wall Street Journal article. Additional articles followed in the Journal as well as the New York Times in early 2006 detailing the findings of the studies: executives receiving stock option grants had abnormal returns which at least implied that the grants may have been backdated. While backdating option grants does not violate the law, if the accounting is not done correctly and/or proper disclosure is not made, the practice can adversely impact the financial statements and disclosure of the company and violate the law.
Within months the SEC, DOJ and others were actively investigating backdated options. At one point there were reportedly 140 companies under investigation related to backdated options. Over 200 companies disclosed that they were conducting internal investigations into option granting practices. A scandal had been born.
The initial cases were filed simultaneously by the SEC and DOJ following a joint press conference in San Francisco. SEC v. Reyes, Civil Action No. C-06-4435 (N.D. Cal. July 20, 2006); U.S. v. Reyes, Case No. CR06-556CRB (N.D. Cal). These cases were brought against the former CEO and human resources director of Brocade Communications. Both the SEC’s complaint and the criminal indictments alleged intentional wrong doing. Eventually, former CEO Reyes and former human resources director Jensen would be convicted on criminal charges.
Reyes was followed one month later with SEC and DOJ actions involving option grants at Comverse Technologies. Again, the cases alleged option backdating based on fraudulent, scienter-based conduct. SEC v. Alexander, Case No. 1:06-cv-03844 (E.D.N.Y. Aug. 9, 2006); U.S. v. Alexander, Case No. 1:06-cr-00628 (E.D.N.Y. Sept. 20, 2006). Mr. Alexander, the former CEO of Comverse, is currently a fugitive in Namibia and is fighting extradition.
Subsequent cases are keyed to fraudulent, scienter-based, conduct. Examples of those cases include:
? SEC v. Mercury Interactive, LLC, Case No. 07-2822 (N.D. Cal. May 31, 2007). The complaint named the company, its chairman and CEO, former CEO and former general counsel as defendants. The company settled by consenting to a statutory injunction and agreeing to pay a $28 million civil penalty.
? SEC v. Brocade Communications System, Inc., Case No. 0728-21 (N.D. Cal May 31, 2007). The company settled by consenting to a statutory injunction and agreeing to pay a civil penalty of $7 million.
? SEC v. Heinen, Case No. 07-2214 (N.D. Cal April 24, 2007). The complaint named as defendants the former general counsel of Apple and its former CFO. Mr. Anderson, the former CFO, settled by consenting to a statutory injunction and agreeing to pay $3 million in disgorgement, prejudgment interest and fines.
? SEC v. McGuire, Civil Action No. 07-CV-4779 (D. Min. Dec. 6, 2007). Defendant William W. McGuire, M.D. is the former chairman and CEO of United Healthcare Group. This is the first case to use a SOX Section 304 clawback. Dr. McGuire agreed to settle the action by consenting to a statutory injunction and a 10 year officer/director bar. In addition, he agreed to disgorge over $10 million and to pay prejudgment interest and a civil penalty of $7 million. The SEC announced the settlement as a huge $600 million deal. Most of the relief obtained however, was in the parallel class and derivative suits which settled in conjunction with the SEC suit.
Since 2006 the SEC has brought 24 cases based on backdated options. A number of companies have been given closing letters. A number of companies are still under investigation. The key question regarding those cases is the prosecution standards – will future cases be brought on scienter based conduct or a lesser standard?
Next: Prosecution standards in option backdating cases in the future