Special Investigations Practice - Why You Need to Check Your Options Dates
The announcements of the ouster of top officials at UnitedHealth, Altera, McAfee,
and Cnet are only the latest chapter in the options backdating saga which is turning out
to be not just the hot topic of the summer, but the key corporate issue of the year.
According to USA Today, 142 companies have opened internal investigations into their
option backdating practices. More importantly, the SEC is currently investigating 91
companies while the Department of Justice is investigating 55. Class action lawyers
have filed numerous shareholder derivative actions. Clearly, a bull’s-eye has been
painted on any company that grants options to its executives.
What is Options Backdating?
Generally, backdating concern arises when the record date of granting the option
is earlier than the date on which all actions necessary to grant the aware occurred (the
“measurement” or award date). The purpose of backdating is to provide a more
favorable strike price than the price of the stock on the award date. Often this is
accomplished by leaving the grant date uncertain until a later date, or by retroactively
changing the grant date to one earlier than the award date. When options are granted
upon hiring, backdating appears when the record date of the grant is earlier than the
employee’s start date. There are circumstances when backdating appearing in
company records is not intentional, as when the options are offered to an employee on
one date but authorization and award do not occur until later.
Although backdating has received most of the press coverage, companies may
risk violations by springloading options. Springloading occurs when a company issues
or records an option grant immediately before the release of news that causes the value
of the company’s shares to rise, or immediately after the release of negative news.
While backdating raises tax, accounting, and fraud issues, among others, springloading
can lead to charges of insider information abuse.
What are the risks?
The SEC and the IRS can initiate investigations and impose civil penalties,
including disgorgement. In many instances, the Department of Justice may also initiate
prosecutions for income tax invasion or fraud resulting in possible criminal sanctions.
Additionally evidence of backdating may raise concerns about the adequacy of a
company’s internal controls under Sarbanes-Oxley, which could lead to further
investigations or shareholder suits.
A company found to have backdated options may face disclosure issues if it
failed to disclose option backdating in its description of its compensation plan in SEC
filings.
A finding of option backdating may require a company to restate its
compensation expense and corresponding income tax deductions and may subject the
employee to increased tax liability. This is because option backdating can be
characterized as constituting current income to the employee and a current expense to
the company, much like “in the money” options.
Backdating may also lead to the suspension of a listing from trading until the
company provides restated financial documentation to the relevant exchange further
harming the company.
And of course, backdated options and the attendant fallout could negatively
impact the market price of the company’s stock. In the current environment, this
inevitably leads to class actions from shareholders, which can have a serious effects on
the company.
What should you do?
Companies should determine whether options granted before 2004 were set at
the price on the award date. Where options award and grant dates are different, it is
more true than ever that an ounce of prevention is worth a pound of cure.
Companies should also thoroughly review both their procedures and their
practices for awarding options. Identifying risks of backdating and springloading, and
taking proactive measures to limit them will stand as firm evidence of effective
compliance if authorities later question the company’s handling of options.
We’re Here to Help
Troutman Sanders' Special Investigations Practice Group offers skilled
lawyers with extensive experience in all phases of regulatory and punitive concern,
including: compliance programs; document retention; threatened investigations; active
federal, state and congressional investigations; voluntary cooperation; grand jury
investigations; trials; and public relations. Whether the matters involve complicated
securities, tax and other fraud, the Group's service to clients provides a comprehensive
understanding to inform and support prudent and timely judgments in the face of the
significant risks created by backdating options.
The Troutman Sanders Securities Litigation Practice Group is comprised of
result-oriented litigators with a reputation for providing the highest quality service to our
clients in an efficient and cost-effective manner. Our attorneys have significant trial
experience and are capable of trying the most complex issues to judges, juries, and
arbitrators. However, from the outset of every engagement, we look for early solutions,
whether by settlement or pre-trial proceedings.
The Troutman Sanders Tax Practice Group offers seasoned tax lawyers with
years of experience representing clients before the IRS in audits, investigations,
administrative proceedings and litigation. Our tax lawyers have significant expertise in
the federal income taxation of employee qualified and non-qualified stock options,
including valuation issues, timing and character of income issues, as well back-dating
issues. These lawyers can work closely with our client’s counsel, accountants and
outside auditors to spot back-dating issues and develop a tailored strategy for resolving
any income tax issues with the I.R.S.
Class Action and Derivative Litigation:
Our attorneys defend public companies, individual directors and officers,
underwriters, and auditors in securities fraud class actions, shareholder derivative suits,
and other securities-related litigation.
Key Representative Engagements
- Defended international manufacturer and distributor of equipment and its officers
and directors in related shareholder class actions alleging securities fraud in violation
of Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934, and Rule
10b-5 for alleged materially false and misleading statements regarding the client's
financial results during the class period. - Represented one of the nation’s largest mutual fund companies in the SEC,
NASD, and various state attorney general’s investigations into market timing issues. - Representation of company in (i) litigation against a former officer and director
and former consultant alleging breach of fiduciary duties and violations of
confidentiality agreements, and (ii) books and records litigation filed by shareholder
seeking access to corporate documents under Section 220 of the Delaware General
Corporation Law. - Representation of director of Fortune 100 company in criminal and civil
proceedings following its multi-billion dollar collapse. No charges; satisfactory
settlements. - Representation of national accounting firm in connection with federal grand jury
and administrative agency investigation of alleged improper accounting procedures
used prior to merger of major corporations. - Internal investigation for a large electric utility of issues arising from Enron
practices and the California energy crisis. Materials and information gathered
immediately and analyzed; government demands for information satisfied. - Internal investigation for a publicly traded communications company resulting in
discovery of multi-million dollar kickback scheme conduct-ed by senior manager.
Assistance to the company in isolating the risk and maintaining its position as only a
witness.
This e-mail alert is intended to provide general legal information and does not render legal advice or legal opinion. Such advice may only be given when related to actual fact situations.