Read The Recorder‘s roundup of the stock-option backdating scandal. There won’t be a test later … but there might be a subpoena.
Board members “should make sure that when they approve the grants that, you know, the paperwork is correct and it’s all there,” said Richard Koppes, a corporate governance expert who is of counsel at Jones Day and previously served as the general counsel for the California Public Employees Retirement System. “They are responsible. That’s their job.”
In addition to Amylin, The Recorder found questionable timing of grants at Heartport Inc., which counted Gunderson Dettmer Stough Villeneuve Franklin & Hachigian’s Robert Gunderson as a board member, and at LSI Logic, Lattice Semiconductor Corp. and Echelon Corp., all three of which counted Wilson Sonsini Goodrich & Rosati’s Larry Sonsini as a board member [see "Sonsini Boards" below].
Sonsini served as a director at two more companies already known to be under scrutiny. One is Brocade Communications, whose former CEO and HR manager were indicted earlier this month. Another is Pixar, which has announced that it is investigating its past options practices.
Wilson Sonsini partner Mario Rosati is on the board at Sanmina-SCI Corp., which has likewise acknowledged an ongoing investigation.
Wilson Sonsini’s Mark Bertelsen sat on the board at Autodesk Inc., which has also disclosed an ongoing probe.
And Gaither was a director at Nvidia Corp., which has said it is investigating its past option grants.
“It’s understandable that companies would want their outside counsel on their boards, so there’s nothing, per se, wrong with that. I’ve got to say that,” said Richard Zitrin, a legal ethics expert and a partner at Zitrin & Mastromonaco in San Francisco. “But when a lawyer takes a company public, is a member of its board, is a member of the board that received the venture capital, and is receiving options or stock, it becomes virtually impossible for the lawyer to perform the fiduciary duty of loyalty to the company.”
Sonsini, Rosati and Bertelsen declined to comment through a spokeswoman. Gunderson didn’t return repeated phone calls and e-mails.
But white-collar defense lawyers say board members are supposed to be big-picture people and shouldn’t be punished for failing to spot sloppy paperwork.
John Coffee, a Columbia Law School professor and expert in securities law, likewise cautioned against pillorying board members today for something that simply wasn’t on the radar screen in the late 1990s. “Backdating is something no one was looking at.”
HITTING BOTTOM
Stock options have long been a preferred pay method for under-capitalized startups wanting to bring in top talent. Until accounting rules changed a few years ago, option grants didn’t have to be reported to the SEC until after the end of the fiscal year.
That’s how medical device maker Heartport handled it. On Jan. 31, 2000, when its shares traded at $6.56, the company told the SEC (.pdf) it had awarded CEO Casey Tansey and other executives the option to buy nearly 1 million shares back on July 29, 1999. On that day, the stock was at $1.88 � the lowest it had traded the whole year.
Other Heartport grants raise eyebrows, too. In 1998, all four options grants to executives came at a monthly dip in price.
And in 1999, a second grant to Tansey, while not at the annual low, came at a monthly low price of $2.19.
All told, the company granted options on seven dates between 1996 to 1999. Four came at quarterly lows. The probability of that happening is one in 385,000.
Johnson & Johnson, which bought out Heartport in 2001, declined to comment. Tansey did not return a call seeking comment.
CASHING IN
Corporate executives weren’t the only ones getting rich during the tech boom. Outside directors like Sonsini typically received options as compensation and handed most of those options on to their firms’ investment funds. That allowed them and the firms to profit greatly � at least on paper �from increases in the share price of client companies.
For example, in 1999, SEC filings show that on Aug. 20, Sonsini exercised an option to buy 974,848 shares of Brocade at 63 cents. On that date, Brocade was trading at $21.40, creating a paper profit of more than $20 million. A few months later, Sonsini sold 50,000 shares for $1,738,563.
The date of Sonsini’s grants were either set in advance, or were reported to the SEC within days, so it’s unlikely he received backdated options. But if the companies on whose boards he sat had improved balance sheets as a result of backdating � which is what prosecutors and the SEC allege occurred at Brocade � then he and other shareholders would have profited when selling shares at artificially inflated prices.
HARD TO CATCH
The scores of ongoing investigations into backdating have put hundreds of lawyers to work. Some are conducting internal investigations. Others are representing executives or board members in connection with probes by the SEC and federal prosecutors. Still others are representing investors and the companies in the dozens of shareholder suits filed thus far.
Pending the outcome of those investigations, it’s too early to tell whether or to what degree board members and outside lawyers will be held to account for their advice and oversight.
Clifford Hyatt, a former SEC enforcement lawyer who’s now a partner at Pillsbury Winthrop Shaw Pittman in Los Angeles, said he expects the backdating morass to be the first white-collar probe that casts suspicion over board members.
“This is a corporate practice that almost always involved the board,” he said, speaking generally about the issue and not specifically about any individual director. “This fact pattern will generate the most interest in outside directors.”
But another former SEC lawyer, Shartsis Friese partner Jahan Raissi, isn’t so sure. He’s conducting several internal investigations for companies concerned about their options practices, and is skeptical that board members � even those who were lawyers � really paid attention to the implications of options grants.
“In many instances, what’s going to be found is people who knew about the conflict and spotted it, but just whiffed on the issue,” he said. “They missed on catching the legal and accounting issue.”
Of course, an “oops” defense wouldn’t be very appealing for someone like Sonsini to have to invoke. He’s known in the Valley not only for his connections but for his expertise in corporate governance. He sits on the New York Stock Exchange’s Regulation, Enforcement and Listing Standards Committee, is the chairman of its Legal Advisory Committee, and has written a leading text on securities law.
Backdating may have been a pervasive practice during the late 1990s. But Lie doesn’t believe that will translate into widespread government charges.
“It’s going to be hard to catch a lot of companies because they chose from a small set of prices, they may not have chosen the lowest price � they might have chosen the second lowest � and they didn’t do it all the time,” he said.
The options grants at Heartport and the other four companies seem to fit this pattern. Questionable awards are interspersed among long strings of seemingly innocuous � and sometimes unfavorable � options.
William Lerach, the lead partner at Lerach, Coughlin, Stoia, Geller, Rudman & Robbins � a plaintiff firm that has filed dozens of lawsuits over backdating � said that at most companies, directors had a clear role when it came to awarding options: They were supposed to make sure grants were valued at the share price on the day they were given out.
“That doesn’t leave a hell of a lot to the imagination of what the board’s responsibility is,” Lerach said, adding that even when a board puts its compensation committee in charge of options, the entire board is still responsible for ensuring that things are done right.
“They’re allowed to delegate responsibility to committees, but that’s only an interim delegation. It’s not an abdication,” he said. “If a board wants to close their eyes and rubber-stamp what a committee does, then they’ll have to pay the consequences. Of course, in the real world, that’s what usually happens.”
