Jail time for backdaters

Larry Ribstein —  9 November 2010

I’ve blogged fairly extensively about backdating, including serious questions about whether and when it was wrong at all, and even more serious questions about whether it should be criminalized.  Among the specific issues are whether any misrepresentations were material to investors.  And then there’s the epidemic of prosecutorial misconduct that has occurred in these cases.

One cases in which prosecutorial misconduct was alleged was the Bruce Karatz/KB  Homes case. The case has nevertheless gone to trial and conviction, and now comes down to sentencing, as discussed in today’s WSJ.  

The question right now is whether Karatz should go to jail for 6.5 years as the U.S. Attorney’s office has argued or get probation and home confinement as the U.S. Probation Office has recommended. The jail recommendation is based on Karatz’s $11 million of supposed gains, supposedly at KB Home’s expense.  The Probation Office found no loss.  (The article also notes that of the 11 individuals convicted in this supposed nationwide crime wave only five have received prison sentences, none more than two years.)

The article suggests the real argument for long sentences isn’t the supposed investor losses but that “swindlers shouldn’t be treated better than dope dealers. Public outrage over scandals, such as Enron Corp., also played a role.”

I’m all for ending draconian sentencing of dope dealers too, and maybe even broad legalization.  But in the meantime my subject is corporate crime. 

Whatever one thinks of criminalizing agency costs in general, for all the reasons I’ve been writing over the last several years, backdating is the most egregious example. One reason is that it’s not clear anybody’s been hurt.  These cases are based on violations of economically illogical accounting rules.  Financial markets look through the accounting to the firm’s pro forma disclosures. 

Even if there is some possibility of investor loss, justice demands certainty before taking away a man’s liberty.  Doesn’t sound like that’s the case for Bruce Karatz.  Injustice to drug dealers doesn’t justify injustice to backdaters.

Update:  The judge sided with the Probation Office.

Larry Ribstein

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Professor of Law, University of Illinois College of Law

2 responses to Jail time for backdaters

  1. 
    north fork investor 9 November 2010 at 9:54 am

    The economic harm of backdating is that the company gives/sell (in lieu of other compensation) options with a lower exercise price than they would have without backdating. The loss from “selling” the options at a lower price is to the corporation. The calculation of the loss is the simple difference between two Black Scholes estimates of the options values–one at the backdated exercise price and one at the real date of grant.

    The only way there would be no economic loss to the corporation is if you assumed the Corporation was otherwise made whole by reducing other forms of executive compensation. But there is absolutely no proof of that.

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