Backdating investigation


Fifty-two companies currently under criminal investigation. Moreover, the company avoids having to expense the options as current compensation, thus increasing earnings in the near term. As a consequence, the option is immediately profitable, or “in the money,” to the option holder.The backdating problem was first highlighted by Professor Erik Lie of the University of Iowa, who published his initial study in 2004.Professor Lie concluded that the robust profitability of so many options was statistically impossible absent some artificial influence such as backdating.“I do think it was a real wake-up call for the industry, just given the number of people caught up in improper conduct,” said Marc Fagel, regional director for the SEC in San Francisco.Backdating became a big issue in Silicon Valley in 2006, when authorities began investigating scores of companies here and around the United States.Hoping to spare her client from prison, an attorney for former Brocade executive Stephanie Jensen stood before a federal judge this month and argued that the furor over stock-option backdating was a “so-called scandal” that never amounted to much.

Legal experts say the issues raised by backdating are more complex than in cases of theft or embezzlement, and it can be difficult to convince jurors that executives had criminal intent. “It’s not surprising that more of these were handled civilly,” said Joseph Grundfest, a law professor and co-director of the Rock Center on Corporate Governance at Stanford.These led to numerous civil and criminal enforcement actions that helped change those practices, they say, despite some high-profile stumbles by prosecutors in recent months.At its height, the backdating scandal touched dozens of local companies that came under federal investigation or launched their own accounting reviews, which led in some cases to firings, earnings restatements and shareholder lawsuits.Reyes’ attorneys, for example, have argued he never profited personally from backdating and that he relied on accounting advice from senior executives and company auditors. “In a criminal case, you have to prove wrongdoing beyond a reasonable doubt, and in many of these situations you would have trouble demonstrating that a CEO knew he was in engaged in a criminal violation.” That doesn’t mean no harm was done, argues Harvard law professor Jesse Fried, another expert on corporate governance.A jury found Reyes guilty on 10 counts of securities fraud, but an appellate court ruled the trial was tainted by a prosecutor’s improper statements in court. He said the practice artificially inflated company earnings and stock values, in many cases “enabling executives to reap larger cash bonuses and sell their stock at a higher price.” The government’s investigations, as well as changes in accounting rules, have made companies more sensitive to legal requirements around backdating, added Grundfest.Five of those received prison sentences, as opposed to probation or fines.

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