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Stock Option Stock Option BackdatingBackdating
andandPractices ConferencePractices Conference
Presented by:Presented by:
Barry H. Genkin, Esquire Barry H. Genkin, Esquire [email protected]
September 21, 2006September 21, 2006
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IT’S THAT TIME AGAINIT’S THAT TIME AGAIN
Every several years “Corporate America” experiences an integrity gut check: Foreign Corrupt Practices Act Insider trading Enron, WorldCom, Adelphia Sarbanes-Oxley Act of 2002 *Option Backdating*
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The Harsh RealityThe Harsh Reality Governmental investigations of over 100
companies Average loss in market value of companies
implicated in scandal is 8%, or $500 million per company
Investors wary because of unanswered questions: major disruption (including possible delisting) restatement of financials cash overlays for taxes prospect of executives being forced out significant unknowns
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What is Option Backdating?What is Option Backdating?
Centers around timing of option grants Did grants occur on the dates stated, or
before or after? Was exercise price of stock options
retroactively set to correspond with market prices on date stock price was low, claiming these dates as the grant dates?
Do patterns suggest discrepancies between stated and actual grant dates?
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Types of Option BackdatingTypes of Option Backdating
Open and notorious backdating – (Intentional) Backdating with a reason Sloppy backdating Unintended backdating – (unanimous
consent) Lack of documentation Springloading (grant option in advance of
good news) Bullet dodging (delay grant because of
expected bad news)
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Was Backdating Intended Was Backdating Intended or Not?or Not?
Was there an intentional or unintentional incorrect recording of stock option grants (e.g. unanimous consent and “as of” dates)? In either case – result is
understatement of stock option expense in financial statements
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What are the Hallmarks What are the Hallmarks of Option Backdating?of Option Backdating?
Opportunity for SEC to flex its muscle 1,050,000 Google hits (and growing) Display poster children Shelf life
Commissioner Campos Speech (8/15/06) “How to be an Effective Board Member”
Option backdating matters are like icebergs Part above water
Change grant date of option to a date when stock trading at a low level
Part below water
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The Part Below the WaterThe Part Below the Water
Possible false financial statements (restatements) 9/19/06 letter from office of Chief Accountant of SEC
Possible adverse tax consequences Possible internal control weaknesses (404 of
SOX) SEC investigation U.S. Attorney investigation Incorrect Section 16 reports
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Inaccurate 34 Act disclosure – 10Qs and 8Ks (financials)
Current registration statements (33 Act) inaccurate
§11 and 12(a)
Violations of plan documentsPossible voiding of option grantsClass action suits
The Part Below the WaterThe Part Below the Water
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Scalps of officers/directors (who dropped the ball)
Governance failures Violate Exchange rules Rating agency (Moody’s and S&P)
downgrades CEO and CFO certifications problematic
302 certifications - financial statement accurately reflect financial condition
Investor confidence Stock price hit
The Part Below the WaterThe Part Below the Water
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DON’T ASK/DON’T TELL POLICY (put on the blinders)Wait for SEC to come knocking
OR Be proactive and make inquiry
Director oversight obligations (fiduciary duties) Climate demands it
If not, management must be proactive and raise issue with directors
Do You Have a Problem or Do You Have a Problem or Not?Not?
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Who Manages the Inquiry?Who Manages the Inquiry?
full board audit committee - preference governance committee compensation committee
Fact gathering role of officers what was role of existing inside and
outside counsel?
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Who Manages the Inquiry?Who Manages the Inquiry?
What was role of existing outside auditors? Tension between independent
auditors and management What is role of in-house/outside
counsel? What is role of outside auditors?
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What Gets Reviewed in What Gets Reviewed in Inquiry?Inquiry?
Match grant dates to stock price information
Review governing plan documents, employment agreements and option grant agreements providing for stock option grants
Board of committee minutes Unanimous consents and process Examine the grant process
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What Gets Reviewed in What Gets Reviewed in Inquiry?Inquiry?
Analysis of accounting treatment Analysis of tax treatment Review of Section 16 reports Review of communications to optionees Public disclosure Proxy statement disclosure
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What Gets Reviewed in What Gets Reviewed in Inquiry?Inquiry?
Interview management, board committee members and administrators
Preservation of documents Email review – Smoking Gun Identification of issues Securities law ramifications
FD issues – re: inquiries
Regulatory, tax and accounting ramifications Assess litigation risks Loan documents and debt instruments Director and Officer Policy - Restatement
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What You Do Depends Upon What You Do Depends Upon What You FindWhat You Find
Clean bill of health – nothing Report to Board
Still evaluate best practices –
(always room for improvement)
If find something: Analyze what went wrong and why – fix it
Adopt best practices (avoid future issues)
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What You Do Depends Upon What You Do Depends Upon What You FindWhat You Find
Focus on: Financials (restatement)
Item 4.02 of Form 8-K – Non–reliance on previously issued financial statements and press release
Corrective disclosure Amend 33 and 34 Act documents
Shelf and other registration statements, securities offerings
Tax return amendments Enhanced governance processes Internal controls enhancement Notification of regulators (SEC and Exchange) Revising practices
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Best PracticesBest Practices
Correctly date option grants Grant options at in person or telephonic
meetings, as opposed to by unanimous written consent
Consider granting options on a pre-established fixed grant date schedule (quarterly, annually, etc.)
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Best PracticesBest Practices
Avoid grant delegations Fully document all grants
contemporaneously with the actual grant
Do not grant “discounted” options that have an exercise price less than the fair market value of the underlying common stock
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Best PracticesBest Practices
Identify lines of responsibility among those involved in administering option grants – (Manual)
Consider designating one or two employees (in the finance area) with responsibility for overseeing and monitoring the documentation and grant process
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Best PracticesBest Practices
Know and adhere to the requirements of the option plans, board and committee charters, employment agreements and procedural requirements Avoid committees of one!
Keep current on the technical requirements applicable to options, including accounting, tax, disclosure, SEC and exchange rules
Full and complete disclosure – transparency - Key
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Final WordFinal Word
Take Ownership – Instill comfort that something like this will not happen again – Restore Confidence