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In an era of soaring executive compensation have come revelations about an even more insidious and probably illegal form of corporate kleptomania: options back-dating. Such rights to buy stock are often granted to a firm’s officers, directors and other employees. They give the recipients the ability to purchase shares in the future for a set price, which is typically fixed on the day the options are granted. But recent studies and disclosures have shown that many corporate officials have been clandestinely cherry-picking the exercise dates of their options by changing them from their grant dates to other points when the shares were trading at a lower value. Often this entailed simply back-dating the grants. But other times it appears to have involved even more sophisticated ways of gaming the system. Those include forward-dating the grant dates to take advantage of market swings and keeping them open so that the holders could pick the lowest point in the stock’s history to buy it. Although government attorneys are aggressively probing this matter, a better method for shareholders to redress their injuries is through a derivative suit. Since the affected corporations are the direct victims of these corrupt practices, they have legal claims against their dishonest officials for fraud and breach of fiduciary duty. Before shareholders can initiate a derivative action, however, they must exhaust their internal corporate remedies by making a demand upon the board to bring one, or they must show that such a demand would be futile. One case arising out of the options back-dating scandals demonstrates how boards can admirably cooperate here if they are serious about rooting out such sleazy behavior. Other legal actions, however, show how directors can shamefully seek to stymie these suits out of an apparent unwillingness to get to the bottom of the charges. Mercury Interactive cooperated When shareholders brought a derivative suit on behalf of Mercury Interactive Corp. alleging that three of its top executives had engaged in a pattern of options back-dating, the board took swift action against the culprits. It also appointed a special litigation committee to investigate the merits of the suit. The committee came back with a recommendation that the derivative suit should proceed against some of the defendants, and Mercury’s board followed its advice. I am quite familiar with that matter because I was retained as a consultant by the lawyers representing Mercury’s shareholders. In other such actions, however, stonewalling appears to be the order of the day. For instance, semiconductor giant Broadcom Corp. announced on Sept. 8 that it will have to restate its financials to account for $1.5 billion of additional compensation expense apparently owing to this misconduct. Yet the company has moved to dismiss a related derivative suit on the theory that the plaintiff failed to take the preliminary procedural step of demanding that the board initiate it. Broadcom says it can’t be presumed that such a demand would have been futile because a majority of its current directors came on the board after the alleged manipulations took place. Fair enough in theory, but recent disclosures by the company seem to indicate that its assertions about board independence are factually incorrect. Even still, the company’s board, as of yet, has failed to take any action to redress those alleged wrongs. Instead of moving to dismiss, the board should prove its bona fides by seeking only a short stay of the derivative suit and agreeing that the court review its actions at a later date to make sure that they have effectively remedied the problem. Two other high-tech firms that have admitted to options manipulation have likewise sought to have derivative suits dismissed because the plaintiffs did not make demand on the board. In one, Sycamore Networks Inc., the current directors were in office at the time of the alleged back-dating and so far have taken no action to remedy it by requiring disgorgement of the ill-gotten gain or even canceling wrongfully issued, but unexercised, options. Yet the company asserts in effect that a court shouldn’t doubt its board’s willingness to do justice. The other stonewalling company is Analog Devices Inc., whose chief executive officer, Jerald Fishman, allegedly took down more than $144 million in 2005 from a deferred-compensation plan in addition to his $4.3 million in salary, bonus and gains on options. Analog is playing “gotcha” by moving to dismiss its derivative suit on the grounds that Massachusetts requires that all such suits against its companies be preceded by a demand. It concedes, however, that the plaintiff probably just failed to follow that procedure because it believed the company was incorporated in Delaware, where demand can be excused when futile. Such motions keep lawyers busy and perhaps forestall the day of reckoning that these firms should face for the reprehensible practices they appear to have condoned. Rather than authorizing such tactics, it would be more appropriate if the directors took their fiduciary duties seriously by working with shareholders to provide meaningful remedies to this pervasive pattern of corporate looting. But, instead, these directors are selfishly spending their companies’ money to exonerate themselves rather than protecting the interests of their shareholders whom they are supposed to serve. Daniel J. Morrissey is a professor and former dean at Gonzaga University School of Law. He can be reached at [email protected].

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