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As lawsuits and government investigations against companies with suspect stock-options backdating practices pile up, some plaintiffs’ lawyers are eyeing corporate law firms that advised companies as a new class of defendants. Several plaintiffs’ firms say that their corporate law firm brethren will be on the hook if they knew about fraudulent options practices, and they’re gearing up to scout for wrongdoing as they prep for discovery. With Vinson & Elkins’ $30 million settlement in June with Enron Corp.’s bankruptcy estate to avoid litigation still reverberating through the legal community, plaintiffs’ lawyers are wondering how much corporate lawyers knew about their clients’ questionable stock-options backdating practices. Stock-options backdating, or changing the date of a stock-option grant to a date when the stock’s price reached a market low, is legal. But the practice-which typically balloons executive compensation by increasing the spread between the option price and a stock’s eventual sale price-mandates that companies notify shareholders and reflect the financial calculations in earnings and tax filings. Suspicions about fraudulent options backdating activity have sparked about 80 investigations by the U.S. Securities and Exchange Commission (SEC) and more than 40 U.S. Department of Justice probes so far, and plaintiffs’ law firms are mulling the civil side of the equation. In the Silicon Valley epicenter of the stock-options scandal, Wilson Sonsini Goodrich & Rosati of Palo Alto, Calif., is at the eye of the hurricane. The firm’s corporate client list includes nearly half of the 32 area companies implicated in stock-options backdating, according to The Recorder, an affiliate of The National Law Journal. “Consistent with our ethical responsibilities to our clients, we will not provide comment on client-specific matters,” said spokeswoman Courtney Dorman. Building claims against firms could take months, or years. But plaintiffs’ law firms such as Boston-based Berman DeValerio Pease Tabacco Burt & Pucillo are carefully examining law firms’ roles in advising corporations sued for stock-options backdating. Executive departures in stock-options cases have already affected general counsel, including software security company McAfee Inc.’s termination of its general counsel in May. So it’s worth examining the role-played by outside lawyers, said Berman DeValerio partner Peter Pease. “If they’ve been drafting the stock-option plans and proxy statements knowing that the company has year by year by year been backdating its options to fraudulently reward its executives in contravention of terms of the stock-option plan, I think they’ve got a problem,” Pease said.
Clock’s been ticking, but from when? Pamela A. MacLean/Staff reporter With the flurry of federal subpoenas hitting dozens of companies in stock-options backdating probes around the country, prosecutors have embarked on choppy legal waters.One of the critical issues for both sides will be calculating when the five-year clock started running on the statute of limitations for alleged frauds: at the award of backdated options, or the exercise of those options, or the point that executives withheld from public filings the true option costs from investors. Just when the legal clock starts running may be key to the fate of many of the current investigations. It is likely to be the subject of backroom negotiating with prosecutors and failing that the object of pretrial litigation. “I don’t know if anyone knows for sure when it starts, or if any court has acted on it,” said one East Coast securities lawyer who asked not to be identified because his firm is advising clients about the ramifications of backdating. He pointed to the public accessibility of the options backdating information available to the academics generally cited as bringing the issue to public attention earlier this year. “The fact that it was available suggests the clock started back when the options were granted,” the lawyer said. One more hurdle In addition, treating stock options as an expense was not “a hard and fast rule until 2005,” something that will make the government’s ability to prove intent to defraud shareholders more difficult, the lawyer said. “These will not be easy cases for the government,” he said. Securities lawyers on the West Coast echoed his perspective. They also declined to put their names to discussions of the legal pitfalls facing the government because of client sensitivity to public airing of the issue while subpoenas are still flying. Typically, when allegedly illegal conduct is partly beyond the statute of limitations, the government will try to expand the definition of what constitutes a violation because the last act in violation of the law starts the clock running, said Andrew Genser, a white-collar defense specialist in Kirkland & Ellis’ New York office and former assistant U.S. attorney in Brooklyn, N.Y. For the current investigations, Genser said he expects the government “will look for any statements, filings or documents that constitute false statements.” This may have serious consequences for companies on the defensive because granting options was a popular activity in the high-tech industry boom period of the 1990s.”Once [prosecutors] can show a continuous scheme into the limitations period they can capture all the acts that lead up to that scheme,” he said. “You only have to catch the tail to capture all that lead up to the scheme,” he said. Even so, San Francisco-based U.S. Attorney Kevin Ryan acknowledged the government has statute of limitations concerns in the backdating inquiries. “There is an issue�much of the conduct was in the late 1990s. It is an issue and we’re looking at it,” Ryan said during the announcement of the first-in-the-nation criminal charge against a company stemming from an estimated 30 backdating investigations in San Francisco, Manhattan, Brooklyn and Boston. Ryan’s office filed a single-count securities fraud complaint and the SEC leveled civil charges against Gregory L. Reyes, the former CEO of Brocade Communications Systems Inc. and two others on July 20. Reyes is accused of backdating options to benefit hundreds of company employees while reporting to the SEC, and in Brocade’s annual reports between 2000 and 2003, that options always equaled the strike price, according to the SEC complaint. SEC v. Reyes, No. C06-4435PVT. Reyes’ attorney, Richard Marmaro of Skadden, Arps, Slate, Meagher & Flom’s Los Angeles office, did not return a call for comment, but did issue a statement: “Greg Reyes is innocent, and if necessary, we will prove his innocence in a court of law. Financial gain is always the motive in securities fraud cases, and here there was none.”

A recent federal appeals court case boosts the potential legal exposure for third parties involved in fraudulent schemes, lawyers say. Examining the role of outside law firms is on Federman & Sherwood’s agenda as the Oklahoma City-based firm builds backdating cases. The issue is what firms should have known, not just what they knew, said Federman name partner William Federman. “If the law firm was not aware the company was backdating, it was not participating, but how negligent not to at least annually get some type of report or do due diligence,” said Federman. On the surface, law firms review stock-options plans when they file opinion letters with companies’ S-8 stock-options plan registration filings with the SEC. But some plaintiffs’ firms say that they’ll delve deeper into law firm involvement once they enter discovery on fraud cases they have filed. Stock-options cases are in their infancy, so it’s unclear whether boards or executives misrepresented their actions to lawyers. But class action firm Scott + Scott of Colchester, Conn., is also taking the possibility seriously, said managing partner David Scott. “It clearly is an avenue that is worth being investigated,” Scott said. The firm is involved in about 10 stock-options cases, including a case against United Health Group Inc. of Minnetonka, Minn., and Vitesse Semiconductor Corp. of Camarillo, Calif. The idea of seeking to hold law firms liable in options backdating cases has occurred to Philadelphia’s Spector Roseman & Kodrof, according to name partner Robert Roseman, who acknowledged that the firm is “researching that issue.” However, other plaintiffs’ firms, such as New York-based Grant & Eisenhofer, say that holding third parties legally responsible in corporate wrongdoing is a thorny process, which may discourage suits against law firms that played an advisory role in stock-options matters. “Factually, I’m not aware of anything in particular that would give rise to potential liability,” said managing partner Jay Eisenhofer. “Legally, it’s extremely difficult even if the facts support some claim of law firm involvement.” Attorneys agree that a recent 9th U.S. Circuit Court of Appeals ruling and similar federal decisions may increase the potential for new third-party claims against law firms, yet some believe the barriers are still too high to clear. In T. Jeffrey Simpson v. AOL Time Warner Inc., No. 04-55665, known as the “Homestores case,” the 9th Circuit remanded a suit back to district court to consider whether third-party vendors Time Warner Inc. and Cendant Corp., both of New York, had primary liability in a scheme to overstate Homestores’ revenue. That decision, which allowed the plaintiffs to file a new brief with more details about the third parties’ allegedly fraudulent actions, and a handful of other recent federal decisions implicating third parties, show how third-party defendants could be liable as primary violators, Pease said. “It’s a pretty good roadmap how one could be held accountable for false drafting or scheme liability,” he said. A narrow opening Other plaintiffs’ lawyers, including Eisenhofer, say that the opening for third-party liability created by “Homestores” and a half-dozen similar cases is still too narrow to be practical. “[Homestores] recognizes there are circumstances when you can do it, but the circumstances are so restrictive it’s still extremely difficult,” Eisenhofer said. Yet even corporate law firms acknowledge that SEC charges and plaintiffs’ lawsuits against law firms wouldn’t come as a surprise. White-collar and securities defense lawyer James Sanders of McDermott, Will & Emery’s Los Angeles office said that the SEC is likely to put law firms’ advice under the microscope. “To the degree someone at the company says I got legal advice [on stock options], SEC will look at whether that advice is appropriate,” Sanders said. “The SEC has looked into a lot of situations recently, and examined the role of lawyers in more detail than they might have done in the past.” Lawyers are not immune to being named as defendants by plaintiffs’ law firms, added Mark Biros, a Washington attorney with New York’s Proskauer Rose. “The law firm, depending on the advice it gives, can get ensnared in the potential illegal activities of the client,” Biros said. He is part of Proskauer’s team of 25 corporate, executive-compensation, tax and benefit and white-collar defense lawyers advising clients with stock-options backdating troubles. Biros doesn’t expect that law firms were specifically advising their clients to act illegally, but he said firms may have been aware of specific client actions as they waded through the complicated maze of options-disclosure and reporting requirements.

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