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Q: What kind of legal charges could companies face?
It depends on the individual circumstances. But in general, backdating a stock option (without communicating this to shareholders) could run afoul of tax laws, securities regulations and laws prohibiting fraud.
The Securities and Exchange Commission, the U.S. Attorney's office in San Francisco, and the U.S. Attorney's office in New York have been conducting parallel investigations.
Q: Would the IRS get involved?
Paul Caron, a visiting professor at the University of San Diego School of Law and author of the TaxProf blog, outlined two possible tax law violations in an e-mail to CNET News.com.
Stock option backdating
Some Bay Area companies have announced that they've been contacted by the U.S. Attorney's office in northern California. Typically the contact comes in the form of a grand jury subpoena. They include:
Altera
Applied Micro Circuits
Asyst Technologies
CNET Networks
Equinix
Foundry Networks
Intuit
Linear Technology
Marvell Technology Group
Maxim Integrated Products
Openwave Systems
Power Integrations
Redback Networks
VeriSign
Zoran
Source: Wall Street Journal database
One consideration, Caron said: Did the companies take the backdating into account when calculating how much they owed under the tax code, which limits a public company's deduction of employee compensation to $1 million? Second, do the backdated options constitute "nonqualified deferred compensation," in which case the companies may be liable for excise taxes?
Q: Why are companies restating earnings?
If they had stock options that were backdated and not disclosed, that essentially provides executives (or other employees, but typically executives) with extra compensation. That's an expense that must be disclosed to shareholders.
Q: What's going on with Brocade Communications Systems?
Federal officials held a press conference on July 21 in San Francisco to announce civil and criminal charges relating to allegations of stock option backdating by former top executives of the networking-gear manufacturer.
Gregory Reyes, Brocade's chief executive until 2005, and Stephanie Jensen, the company's vice president of human resources from 1999 to 2004, are facing civil and criminal charges. In addition, Antonio Canova, Brocade's former chief financial officer, is facing civil charges.
Q: What are the allegations against Reyes?
The FBI has not alleged that Reyes backdated stock options for his own financial benefit. Rather, he's accused of backdating stock options to lure an unnamed employee to take a "high-level sales position." An FBI affidavit says Reyes told Jensen to backdate an offer letter by more than two months to benefit from a more favorable share price in late 2001.
Reyes' attorney has defended his client as wrongly accused, saying "financial gain is always the motive in securities fraud cases, and here there was none. There is not even an allegation of self-enrichment, or self-dealing."
Q: That's backdating. What's "spring-loading?"
It's almost the opposite of backdating. The stock options are awarded just before news, usually positive, is announced. The shares increase in value and--presto--the options are worth more. It works like this: If a CEO expects to make a new product announcement, he could allocate himself options when the stock is valued at $20. Then, after the announcement boosts the share price to $25, each option would be worth $5.
In a conference call on July 13 to announce a federal stock option task force, U.S. Attorney Kevin Ryan said the task force will be investigating spring-loading as well. "Then you have both insider trading and you have an accounting issue," Ryan said. "An old-fashioned cooking-the-books fraud."
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San Francisco Gate
Options scandal grew out of 1990s strategy
Many Silicon Valley businesses offered the incentives to attract
and retain their top employees in a competitive market
- Carolyn Said, Chronicle Staff Writer
Sunday, July 30, 2006
Stock options were the crack cocaine of the late 1990s.
"It's the new American dream, getting rich off your company's
stock," Forbes magazine gushed in 1998. "And it's a dream
that's becoming ever more real.
"Were those who backdated stock options out to steal from the
company and shareholders?
Some experts say, in many cases, the explanation is more
benign. Sloppiness and ignorance rather than perfidy underlay
the practice at many companies.
"Because of the very rapid growth (in granting of stock options),
the infrastructure for administering and dealing with it didn't
grow as quickly," said Corey Rosen, executive director of the
National Center for Employee Ownership.
"To put it simply, you had a lot of amateurs. Professional
advisers were giving advice that may not have been very good
and stock plan administrators made mistakes."
Bottano said the software commonly used in the 1990s to
administer options grants made it easy to change records,
facilitating backdating. "You could make an edit, the program
didn't ask for any verification," he said. "It was more a tool than
an auditing mechanism. The systems weren't very advanced
because options weren't."
Some tweaking of options grants may have been inspired by a
sense of fairness.
From 1992 through 1999, Microsoft Corp. awarded employees
options that were retroactively keyed to its stock's monthly lows.
Annual awards were given in July, at that month's low point.
Awards to new employees were given at the lowest closing price
during the month after they were hired.
Microsoft disclosed and ended the practice in 1999, taking a
$217 million charge. The revelation raised nary an eyebrow.
"When Microsoft said it had to restate its earnings for
backdating, the reaction of the market was ho-hum," Koenen
said.
Microsoft's motivation appeared innocent, Rosen said.
Evening out the rewards "They were saying, 'Well, look,
someone comes to work here and the stock is $17 and someone
comes two days later and it's $24. They both do the same job
and get the same number of options. Let's try to even this out
and we'll just give everybody who comes that month the lowest
price of the month.' "
Last month, Microsoft said in a statement that its practice "did
not involve 'backdating' as we understand that term is being
used in current reports of investigations of other companies"
and said it believed its approach was legal.
Several tech insiders said Microsoft's scheme was common
knowledge and may have inspired other companies to follow
suit.