Stock Option Backdating and Practices Conference Presented by: Barry H. Genkin, Esquire...

Stock Option Stock Option BackdatingBackdating

andandPractices ConferencePractices Conference

Presented by:Presented by:

Barry H. Genkin, Esquire Barry H. Genkin, Esquire [email protected]

September 21, 2006September 21, 2006

mailto:[email protected]

IT’S THAT TIME AGAINIT’S THAT TIME AGAIN

Every several years “Corporate America” experiences an integrity gut check: Foreign Corrupt Practices Act Insider trading Enron, WorldCom, Adelphia Sarbanes-Oxley Act of 2002 *Option Backdating*

The Harsh RealityThe Harsh Reality Governmental investigations of over 100

companies Average loss in market value of companies

implicated in scandal is 8%, or $500 million per company

Investors wary because of unanswered questions: major disruption (including possible delisting) restatement of financials cash overlays for taxes prospect of executives being forced out significant unknowns

What is Option Backdating?What is Option Backdating?

Centers around timing of option grants Did grants occur on the dates stated, or

before or after? Was exercise price of stock options

retroactively set to correspond with market prices on date stock price was low, claiming these dates as the grant dates?

Do patterns suggest discrepancies between stated and actual grant dates?

Types of Option BackdatingTypes of Option Backdating

Open and notorious backdating – (Intentional) Backdating with a reason Sloppy backdating Unintended backdating – (unanimous

consent) Lack of documentation Springloading (grant option in advance of

good news) Bullet dodging (delay grant because of

expected bad news)

Was Backdating Intended Was Backdating Intended or Not?or Not?

Was there an intentional or unintentional incorrect recording of stock option grants (e.g. unanimous consent and “as of” dates)? In either case – result is

understatement of stock option expense in financial statements

What are the Hallmarks What are the Hallmarks of Option Backdating?of Option Backdating?

Opportunity for SEC to flex its muscle 1,050,000 Google hits (and growing) Display poster children Shelf life

Commissioner Campos Speech (8/15/06) “How to be an Effective Board Member”

Option backdating matters are like icebergs Part above water

Change grant date of option to a date when stock trading at a low level

Part below water

The Part Below the WaterThe Part Below the Water

Possible false financial statements (restatements) 9/19/06 letter from office of Chief Accountant of SEC

Possible adverse tax consequences Possible internal control weaknesses (404 of

SOX) SEC investigation U.S. Attorney investigation Incorrect Section 16 reports

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Inaccurate 34 Act disclosure – 10Qs and 8Ks (financials)

Current registration statements (33 Act) inaccurate

§11 and 12(a)

Violations of plan documentsPossible voiding of option grantsClass action suits


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Scalps of officers/directors (who dropped the ball)

Governance failures Violate Exchange rules Rating agency (Moody’s and S&P)

downgrades CEO and CFO certifications problematic

302 certifications - financial statement accurately reflect financial condition

Investor confidence Stock price hit


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DON’T ASK/DON’T TELL POLICY (put on the blinders)Wait for SEC to come knocking

OR Be proactive and make inquiry

Director oversight obligations (fiduciary duties) Climate demands it

If not, management must be proactive and raise issue with directors

Do You Have a Problem or Do You Have a Problem or Not?Not?

Who Manages the Inquiry?Who Manages the Inquiry?

full board audit committee - preference governance committee compensation committee

Fact gathering role of officers what was role of existing inside and

outside counsel?

Who Manages the Inquiry?Who Manages the Inquiry?

What was role of existing outside auditors? Tension between independent

auditors and management What is role of in-house/outside

counsel? What is role of outside auditors?

What Gets Reviewed in What Gets Reviewed in Inquiry?Inquiry?

Match grant dates to stock price information

Review governing plan documents, employment agreements and option grant agreements providing for stock option grants

Board of committee minutes Unanimous consents and process Examine the grant process


Analysis of accounting treatment Analysis of tax treatment Review of Section 16 reports Review of communications to optionees Public disclosure Proxy statement disclosure


Interview management, board committee members and administrators

Preservation of documents Email review – Smoking Gun Identification of issues Securities law ramifications

FD issues – re: inquiries

Regulatory, tax and accounting ramifications Assess litigation risks Loan documents and debt instruments Director and Officer Policy - Restatement

What You Do Depends Upon What You Do Depends Upon What You FindWhat You Find

Clean bill of health – nothing Report to Board

Still evaluate best practices –

(always room for improvement)

If find something: Analyze what went wrong and why – fix it

Adopt best practices (avoid future issues)

What You Do Depends Upon What You Do Depends Upon What You FindWhat You Find

Focus on: Financials (restatement)

Item 4.02 of Form 8-K – Non–reliance on previously issued financial statements and press release

Corrective disclosure Amend 33 and 34 Act documents

Shelf and other registration statements, securities offerings

Tax return amendments Enhanced governance processes Internal controls enhancement Notification of regulators (SEC and Exchange) Revising practices

Best PracticesBest Practices

Correctly date option grants Grant options at in person or telephonic

meetings, as opposed to by unanimous written consent

Consider granting options on a pre-established fixed grant date schedule (quarterly, annually, etc.)


Avoid grant delegations Fully document all grants

contemporaneously with the actual grant

Do not grant “discounted” options that have an exercise price less than the fair market value of the underlying common stock


Identify lines of responsibility among those involved in administering option grants – (Manual)

Consider designating one or two employees (in the finance area) with responsibility for overseeing and monitoring the documentation and grant process


Know and adhere to the requirements of the option plans, board and committee charters, employment agreements and procedural requirements Avoid committees of one!

Keep current on the technical requirements applicable to options, including accounting, tax, disclosure, SEC and exchange rules

Full and complete disclosure – transparency - Key

Final WordFinal Word

Take Ownership – Instill comfort that something like this will not happen again – Restore Confidence

Stock Option Backdating and Practices Conference Presented by: Barry H. Genkin, Esquire...

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Transcript of Stock Option Backdating and Practices Conference Presented by: Barry H. Genkin, Esquire...