Backdating stock options is a crime? Go figure.

Elizabeth Nowicki —  8 August 2007

Yesterday, Former Brocade CEO Steve Reyes was convicted of all criminal charges brought against him in the Brocade backdating scandal.  (The ten charges included fraud, conspiracy, lying to the SEC, falsifying books, etc.)  I am thrilled.  Professor Larry Ribstein is not.

To remind you, backdating stock options basically means lying and maintaining that stock options were granted on a date that they were not.  Backdating stock options is a bad thing for many reasons, not the least of which is because it usually is contrary to the terms of the stock option plan at issue (the plan approved by stockholders).  Moreover, backdating stock options implies that the options are ultimately not accounted for correctly, such that investors are misled as to the true “cost” (paper or otherwise) of the options and the financial condition of the corporation.  While we could argue about the actual impact backdating has on a corporation’s financial picture, the upshot is that backdating options and accounting for them accordingly is deceitful.

Regarding the Reyes jury verdict, I am thrilled because the jury verdict makes clear to former CEO Reyes and, by example, senior management of corporations in general that lying to investors about matters relevant to their securities is not acceptable.  Moreover, the jury rejected Reyes’s argument that he did not commit fraud because he did not know that backdating was illegal (indeed, there was some speculation that Reyes’s attorney would call Larry Sonsini to the stand to try to point the finger at him for blessing the backdating).  That, to me, is a huge step in tagging corporate executives with the responsibility of actually knowing enough about accurate accounting to be able to actually accurately account.

But, as noted, Professor Larry Ribstein was not similarly elated.  Professor Ribstein opined that that “The thought of more of these misguided criminal prosecutions of backdating is disturbing, to put it mildly.”  Professor Ribstein went on to say “These problems with criminalization of backdating are especially striking in a case like Brocade, where the defendant was trying to maximize shareholder value by recruiting the best people, not line his pockets, and where it’s unlikely any misstatements hurt investors….”  Well, that’s a non sequitur.  Breaking the law is breaking the law.  Who *cares* whether Reyes was trying to benefit himself, the Pope, or the investors?  AAT&T v. Miller, loosely paraphrased:  “Don’t break the law, even if you are doing it to try to benefit the corporation.”  (What if Reyes hired prostitutes or gave out cocaine to entice the best possible people to come work for Brocade?  Would that be acceptable?  Of course not.)

After scary verdicts like these (“scary” meaning even mildly imposing accountability), the big law firms often send out memos to their corporate and management clients, explaining the legal impact or import.  Allow me to draft the memo to clients on this one:

Don’t lie to investors.  Don’t lie to the government.  Don’t lie to the corporate auditors/accountants.  Follow the rules.  Don’t break the law.

******Question for the fed courts wonks out there:  the 29 motion is still open, such that the judge could, in theory, set aside the verdict, yes?

5 responses to Backdating stock options is a crime? Go figure.

  1. 

    One thing that would be really helpful for all legal analysis of these matters is if they tried to understand the various aspects of cash vs non cash expenses. “tagging corporate executives with the responsibility of actually knowing enough about accurate accounting to be able to actually accurately account” – this will never be true for non cash expenses. EVER. And if it is- I can guarantee you one thing- that company/executive will be gone in a matter of years, because the tedious and non beneficial aspects of counting depreciation and stock options expenses has no material affect on that company, irrespective of whether or not these things are material to shareholders. It seems like many legal bloggers think CEOs do nothing but sit around and pick stock grant dates. Is that what you want Steve Jobs to focus on, because you seem to be advocating it. I doubt he is an accountant or non cash expense “hawk”.

  2. 

    “Don’t lie to investors. Don’t lie to the government. Don’t lie to the corporate auditors/accountants. Follow the rules. Don’t break the law.”

    I think this is a bit harsh. Breaking ‘the rules’ is frequently a good idea. I would end it as “Only break the rules if you aren’t breaking the law.”

  3. 
    Elizabeth Nowicki 9 August 2007 at 4:35 pm

    Jim and David, good comments.
    Jim, I wonder whether the government would ever go after Steve Jobs. As to investors, government, auditors, and accountants all knowing about the backdating, fortunately (for purposes of your query), they did not. Even if the auditors knew and even if the government suspected, the investors didn’t know as a practical matter b/c all they knew was that they voted on an option plan that did not allow for backdating. Right?
    Good thoughts, though.

  4. 

    My law, right or wrong! It is not clear to me wether or not backdating is still wrong if the the investors, government, auditors and accountants were all told that that is what was going on. Will Steve Jobs be found guilty too? Should there be a balance between legality and morality when they do not agree? Or should legality triumph over morality?

  5. 

    Yes on the Rule 29 – though that’s always the deal, right? The judge could set aside sua sponte – at least in the civil system that I know. I confess this is the criminal system that I don’t know.