Baruch Weiss - Legal Bisnow (DC) - Bisnow

Forward to a Friend  | April 12, 2007

Washington In-House Counsel

Do 40% of Public Companies
Have a Stock Option
Backdating Issue?

Baruch Weiss

That's what Baruch Weiss, a former Assistant US Attorney in the Southern District of New York and a Treasury Assistant General Counsel for Enforcement, says recent studies are showing. Weiss, now in practice at Arent Fox [a Bisnow on Business sponsor] says this includes not only the backdating of the grant, to make it appear that the option was granted at an earlier date and at a lower price, but also in some cases the date of the exercise, so as to start the required holding period for long term capital gains period treatment earlier.


The SEC is investigating 160 companies for possible regulatory proceedings and penalties; the DoJ and US Attorneys are considering criminal liability in particularly egregious instances, and shareholders are filing derivative suits.


Why would it be so widespread? Does that suggest rampant dishonesty in the corporate suites?


Weiss thinks the explanation is more subtle. He believe the practice proliferated because directors often serve on multiple boards and, as other commentators have noted, inadvertently carry "infected" habits with them. There is a natural tendency, he says, to assume that if other corporations are doing something, it must be okay.


It is even possible this may constitute a defense in some cases, he says—if, for example, officials observed expert attorneys conducting or condoning the practice.


Do all these cases raise the specter of severe financial punishment and even jail time?


Not necessarily, he says. The remedy for many companies with material discrepancies will likely be the need to re-state earnings under their reporting obligations to convey truthful information to the public markets. The SEC has wide latitude because of its variety of statutes that have different mental-state requirements associated with them. Individuals may have obligations to file amended personal income tax returns if the originals were based on the apparent grant date rather than the actual grant date. They may also have additional tax liabilities.


If you think you have a problem, what should you do? Weiss suggests a four step action plan:

  • First, assuming you don't know all the facts, you should conduct an internal investigation as soon as possible before the next major filing with the SEC, where any material past misstatement would need to be disclosed. If you know all the facts already and have a problem, you may need to disclose immediately.

  • Second, the investigation should be conducted by independent outside counsel, either because in-house counsel may have been involved in the administration of the option program, or simply to avoid a perception of conflict of interest in rendering a judgment about the behavior of executives who may be peers or superiors of the in-house counsel. Depending on the involvement of incumbent outside counsel in the design or administration of the program, it may be advisable to retain special outside counsel. A preliminary investigation can sometimes be conducted within two or so weeks. Depending on the severity and credibility of allegations, members of the Board or Audit Committee may need to be advised of the issue.

  • Third, the SEC has a policy of welcoming voluntary disclosure. Under certain circumstances, voluntary self-reporting may be credited in the government's determination not to take action with respect to the problems brought to its attention.

  • Finally, the so-called "McNulty Memo," promulgated by the Deputy Attorney General, provides guidelines to prosecutors on when matters are so egregious they should seek criminal liability on the part of a company rather than isolating actions to individuals. It too identifies voluntary disclosure as a factor that the government will weigh in favor of the company.




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