Saturday, February 24, 2007
A sweeping investigation into the backdating of stock options at more than 100 companies has so far led to relatively few enforcement actions or resolutions.
Lawyers and executives at the companies under scrutiny have been waiting to see how investigations by the Securities and Exchange Commission, as well as those by United States attorneys, will play out.
In particular, they have been looking at one of the first cases, Brocade Communications. Yet while Brocade reached a $7 million settlement with staff lawyers from the S.E.C. regional office in San Francisco in July, the agency’s five commissioners have yet to sign off on it.
And that has put those looking to Brocade as a guide in limbo.
“An enormous market constituency is waiting to see how the government is going to assess these things,” said William R. McLucas, co-chairman of the securities practice at Wilmer Hale, who led an internal investigation of backdating problems at UnitedHealth.
Brocade was among the first companies to come under government scrutiny after backdating problems were disclosed, the result of an internal investigation prompted by the allegations of a fired employee. The company restated earnings from 1999 to 2004.
The S.E.C. commissioners are reportedly divided over penalties for the backdating of options.
A spokesman for the commission declined to comment on whether there was such a split, but the S.E.C. chairman, Christopher Cox, recently said that there was no disagreement among commissioners over penalties for backdating.
Speaking broadly about companies found to have improperly backdated options, Antonia Chion, associate director at the commission, said at a conference earlier this month that the S.E.C. was looking at the duration of misconduct, the number of instances of backdating and whether the company had restated earnings. This month, the commission has brought cases against former executives, including one against the former general counsel of Monster Worldwide Inc.
But these developments do little to help lawyers guide corporate directors, members of compensation committees and other senior officers, many of whom acted quickly to address these problems once they came to light.
Defense lawyers hope the S.E.C. will set a high bar.
“It should take extraordinary circumstances for the S.E.C. to assess a penalty against corporations in these cases,” said David Siegel of Irell & Manella in Los Angeles, who represents Broadcom, one of the companies being investigated by the S.E.C. “The vast majority of these companies have acted in a responsible manner by investigating and self-correcting any accounting errors.”
And some legal experts are not surprised that the commission has taken so long in vetting the Brocade settlement.
“The first settlement in these cases is the equivalent of the first free-agent signing in baseball; it clearly is going to set the market rate for what equivalent cases will settle for with the S.E.C.,” said Michael A. Perino, who teaches securities law at St. John’s School of Law. He suspects that the S.E.C. wants to get a sense of the landscape of cases before it makes any public pronouncements about penalties.
Backdating options is not necessarily illegal, but the practice can raise serious accounting, disclosure and tax issues.
In a separate but related action, the Brocade case has also resulted in the first criminal charges of securities fraud filed in the backdating investigation. Charged are Gregory L. Reyes, who was Brocade’s chief executive until January 2005, and Stephanie Jensen, vice president for human resources until 2004. The S.E.C. also filed a civil securities complaint against Mr. Reyes.
Federal prosecutors asked the judge overseeing the cases against Mr. Reyes to stay the S.E.C. case, in which Mr. Reyes can pursue broad discovery available in civil cases, until the criminal trial is concluded. Courts have typically granted such requests in the past.
“I really don’t appreciate the fundamental fairness of that approach,” Judge Breyer said at an October hearing.
Defense lawyers say his ruling is part of a trend to question the government’s approach to white-collar cases.
“The government ought not file a case and ruin someone’s reputation and cause embarrassment to their families and turn around and say we are not ready to proceed,” Mr. McLucas said. “It’s unacceptable, and Breyer is just saying put up or I’m going to dismiss the case.”
The ruling has caused further complications for the S.E.C. The agency is asking for more time to conduct discovery on the issue of “materiality” so that it can respond to Mr. Reyes’s summary judgment motion.
Its request notes that the San Francisco office is small and cannot match the defense lawyers “without jeopardizing the progress of other investigations and litigation.” The agency proposed a hearing on May 4 and asked for a halt to all other discovery until then.
Mr. Reyes’s lawyer, Richard Marmaro, a partner in the Los Angeles office of Skadden Arps Slate Meagher & Flom, called the request another attempt to stall or derail the progress of the civil case, and noted that the agency, after years of investigation, “can hardly raise its now-timid hand to the court and cry foul” about the vigor of the defense.