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As a director and lawyer for several companies suspected of illegally backdating stock options, Larry Sonsini has been under scrutiny the last six months for any role he may have played in option deals for employees. But a Recorder review of SEC documents suggests Sonsini’s involvement with suspiciously dated options wasn’t limited to those he approved for other people. Indeed, records filed by software maker Novell Inc. � which recently announced it has hired outside counsel to review past option grant practices � show that in 1999, Sonsini and the rest of the company’s board deviated from their normal compensation plan by awarding themselves 50,000 options apiece. That grant came on Oct. 26, when the stock was priced at a 17-month low. Over the next two months the share price would more than double, making the award worth more than $1 million on paper. The timing of the Novell grant raises the question of whether the options were actually doled out the day the company said they were, according to corporate governance experts. But that’s not the only issue raised by these options. Less than a month after the grant, Novell announced exceedingly rosy financial figures from the previous fiscal year. From a nadir of $16.69 on the grant date, the stock eventually hit $39.94 by the end of December. Ultimately, the options would become worthless before vesting due to the tech market crash. Nevertheless, the series of events makes experts wonder whether the grants were also “spring-loaded” � that is, intentionally issued just before positive disclosures that the board knew would impact share prices. The SEC does not seem to view spring-loading with nearly the same severity as it does backdating, but the practice still troubles many experts, especially in this case. “It doesn’t smell good,” said Boalt Hall School of Law professor Jesse Fried, an expert in corporate governance and insider trading. “This was at the annual low and was an off-cycle grant, and it’s highly likely that this was spring-loaded.” Neither Sonsini � who left the Novell board in 2002 � nor a spokeswoman from the firm he chairs, Wilson Sonsini Goodrich & Rosati, would comment for this story. On Aug. 29, though, Novell announced it was reviewing its option grant practices, and that the audit could lead to a restatement of past earnings under SEC rules governing executive pay. “It’s a comprehensive review,” said Novell spokesman Bruce Lowry. He wouldn’t comment on the ongoing work being done by lawyers at Morgan, Lewis & Bockius. Linda Griggs, a partner at the firm who is working on the probe, said Friday she was too busy to comment. However, Lowry did confirm that grants to board members would be included in the examination. “It is all grants that are being reviewed,” he said. Abnormal practices Novell’s disclosure came at the tail end of a long train of admissions by companies that their option grants raised suspicion. Since The Wall Street Journal first reported early this year on the apparently widespread practice of changing dates on stock options, more than 100 companies have come under scrutiny. At least six companies gave out suspiciously dated options at times when Sonsini sat on their boards. Two of them � Pixar and Novell � have publicly announced internal probes of past grants. Another, Brocade, has seen former executives indicted for past options practices. And three others, LSI Logic, Lattice Semiconductor Corp. and Echelon Corp, were identified by The Recorder in August as having suspiciously timed grants to top executives. Speaking privately because they are involved in stock option probes, several attorneys said questions about director grants have come up at a handful of companies being investigated by the SEC. But, they said, such cases are rare. At the majority of companies, board members only received options once a year at a pre-determined date outlined in a director compensation plan. Novell had just such a system to keep directors out of the awkward position of awarding options to themselves. Every spring, on the day of Novell’s annual shareholder meeting, each director would receive 15,000 options at the share price on the day of the meeting, in accordance with guidelines ratified by shareholders in 1996. “No person shall have any discretion to select which outside directors shall be granted options, or to determine the number of shares to be covered by options granted to outside directors,” the plan said. But Novell’s directors deviated from that policy three times between 1996 and 2001, granting themselves options at dates other than the annual meetings. On those occasions, the board cited a 1991 stock plan for the authority to make such grants. The fact that Novell had guidelines for option grants � and that directors strayed from them � is particularly disturbing, said lawyers and academics. “It should be an issue of shareholder concern whenever a board changes its own compensation,” said Kirk Hanson, the director of the Markkula Center for Applied Ethics at Santa Clara University and a former Stanford University business professor. While directors are generally permitted to award themselves whatever they want as long as it is publicly disclosed, Hanson said basic principles of corporate governance hold that they should avoid giving themselves pieces of the company just because they can. It’s not entirely clear from documents filed with the SEC how Novell’s board decided to make the out-of-cycle grants in 1997, 1999 and again in 2001. Besides Sonsini, two other ex-board members � former FCC Chairman Reed Hundt and Jack Messman, who was ousted as Novell CEO earlier this year � declined to explain. At the time of the 1999 grant, Hundt served on the company’s compensation committee, while Messman sat on both the compensation and corporate governance committees. “I think it is inappropriate for me to comment,” Messman said, especially given the terms of his severance agreement. “I’m in a contract that prevents me from talking.” Hundt, who is also a former Latham & Watkins partner, said he didn’t recall discussions about options grants in 1999, and that they wouldn’t have been of any importance to him because he didn’t exercise Novell options. Measuring the fallout When the company’s 1999 fiscal year ended Oct. 31, the stock options ostensibly awarded a week earlier already looked promising. The company had had a successful fourth quarter, capping off a good year. After sliding by nearly 50 percent over the previous three months, the company’s stock had begun climbing again. On Nov. 10 Messman and Hundt reported their options to the SEC. On Nov. 23 Novell announced that its 1999 financial results were extremely positive. Sonsini reported his options a few weeks later. “The options were awarded before good news was released, when they probably knew good news would be released,” said Fried, the Boalt professor, basing his opinion on a description of the events at Novell. As far as the dates on the grants go, “we don’t know if there was backdating, but if options were granted on a low like that, the probability the options would be granted on a low is very low.” None of the other out-of-cycle grants to Novell directors came at annual lows; the 2001 grant, for example, was awarded on Sept. 10 that year � hardly a good time to receive any stock. Ironically, that grant now is much more valuable than the questionable 1999 award. The 2001 option to buy 50,000 shares came at a strike price of $3.92. With Novell now trading at just over $6 a share, that grant was worth just over $110,000 as of last week. It is unclear whether Sonsini has ever exercised any of those options. It’s also unclear what � if any � consequences Novell’s directors could face if they’re found to have improperly handled options. First, the company will need to disclose the results of its internal investigation. And even if the Morgan, Lewis lawyers find wrongdoing, it may not be serious enough to warrant a significant financial restatement, or government interest. While spring-loading remains troubling to business ethicists, the SEC’s chief accountant, Conrad Hewitt, issued a letter Sept. 19 indicating that the SEC won’t consider the practice to have significant accounting ramifications. As far as criminal or civil liability goes, that’s less certain: Federal prosecutors and SEC enforcement agents haven’t said whether they’ll consider the behavior problematic, though white-collar defense lawyers say they don’t expect it to be a major issue. “Some may see it as unseemly or distasteful,” said one attorney speaking on condition of anonymity because he is conducting probes of several companies where spring-loading questions have come up. “However, if someone felt there was an ironclad theory of prosecution, you would have heard of it by now.” But that doesn’t make Fried feel any better. “The problem is with disclosure. They were giving themselves in-the-money options,” he said. “They were formally at-the-money, but they were really in the money.” And while the SEC might say it’s legal, “from a corporate governance perspective, they’re doing something improper, or they appear to have done it,” Fried said.

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