Growing corporate scandal has implicated
over 100 public companies

• Over claims that option grant dates were retroactively set to coincide with a prior low in the company's stock price

• Effect was to put options in the money from the outset
• Likened to betting on a horse race after it's started

• Facts can vary widely
• In some cases, company had policy of picking lowest stock price in the prior month for all employee grants
• In others, backdating went back months to favor just a few executives with options that were deep in the money

• Investigations have mostly focused on option grants
  in the late 1990s up until 2002

• SEC rules were changed in 2002 to require filing of Form 4 to report option grants within two days of grant
• Makes backdating more difficult, given the public record

• SEC is now expanding its probe to cover spring-loading

• Where grant date is purposely picked to immediately precede announcement of favorable company news
• Effect is to put options in the money right after grant
• CFO article  6.21.06

• See Affects on Companies and Company Scorecard below

Granting in the money options isn't per se illegal

• But practice can violate accounting and tax rules that are premised on options being granted at the money
• Companies may also have made misleading disclosures

Accounting issues

• Prior to the recent adoption of FASB 123R, companies could grant options without incurring compensation expense

• To qualify for this favorable treatment, option grants had to be at the money (per old rules - APB 25)

• See Equity Compensation Accounting

• Thus, under old rules, if options were backdated to be
  in the money they wouldn't comply with APB 25

• To fix this, a company would need to recognize additional compensation expense for the relevant prior periods
• If material, this additional compensation expense can trigger financial restatements for these prior periods

Tax issues

• Many of the options at issue were intended to qualify for favorable tax treatment under rules that required they not be in the money at the time of grant
• If options were backdated to be in the money a company and the holder have significant tax consequences

• Morrison & Foerster commentary  June 2006
• SEC Congressional testimony  9.06.06

• Tax issues can include IRC §409A

• Brocade made a tender offer to affected employees to address IRC §409A issues
• Brocade tender offer

Disclosure issues

• At a minimum, the holder of a backdated option received undisclosed compensation
• In some case, disclosure violations and changes to corporate records have given rise to criminal liability

For detail see below

• Affects on Companies
• Company Scorecard

Scandal has been stirred by news media and others

• Naming names of those suspected of backdating options
• Based on their analysis of public filings which show option grant dates suspiciously coinciding with low points in the stock's trading

• Wall Street Journal has published several articles
  naming names

• Started with an academic study by Erik Lie

• Business professor at the University of Iowa
• On the Timing of CEO Stock Option Awards
  Management Science May 2005
• Didn't name names, but put bullets in the gun
• As study identified abnormal patterns and suggested that grants were being timed retroactively

• See also SEC Spotlight On: Stock Options Backdating

SEC Chief Accountant issues a Letter to the Industry

• See accounting practices

Senate Banking Committee hearings

• Held 9.06.06
• Committee webpage
• SEC Chairman testimony

Criminal charges brought against Comverse execs

• See criminal charges

PCAOB issues audit practice alert

• See audit practices

Criminal charges brought against Brocade CEO and VP

• See criminal charges

Northern California US Attorney launches task force

• Press release  7.13.06 

• Dedicates resources to investigate
  Silicon Valley fraud cases

SEC expanded its probe to cover spring loading

• See spring loading below

CalPers 

• Asks 25 companies to respond to questions
  about backdating
• Press release  6.09.06
• Form letter

Moodys may lower its credit ratings

• For companies that backdated options
• Even when direct financial impact isn't material

• CFO article  6.06.06

D&O insurers take notice

• Press accounts report insurance companies concern
• Could lead to exclusions and higher premiums

Council of Institutional Investors

• Sends letter to 1500 companies asking whether they're under investigation
• Form letter  6.12.06

Grant date is purposely picked to immediately precede announcement of favorable company news

• Effect is to put options in the money right after grant

SEC has expanding its probe to cover spring-loading

• See Analog Devices, Cyberonics and Tyson Foods
  under Company Scorecard below
• CFO article  6.21.06

Impropriety of spring-loading is not as clear as backdating

• May not raise tax and accounting issues

• As options aren't in the money at the time of grant

• But may raise disclosure issues

SEC Commissioner warns of overreaction

• See SEC Commissioner speech  7.06.06

• "We need to distinguish scenarios that are black-and-white fraud from legitimate practices that are being attacked ..."
• Defends spring-loading

Comverse Technology executives

• Former CEO, CFO and General Counsel

• Claims that false documentation was routinely used to give "in-the-money" options
• Benefited executives personally

• SEC brings civil securities fraud charges

• SEC press release  8.09.06
• Litigation release
• SEC complaint

Brocade CEO and VP

• Claims that false documentation was routinely used to give employees "in-the-money" options
• Joint DOJ - SEC press release  7.20.06

• Criminal charges against former CEO and HR head
• SEC also charges new CFO for failing to notify Board

• DOJ (ND CA) brings criminal charges

• Criminal complaint

• SEC brings civil securities fraud charges

• Litigation release
• SEC complaint
• SEC Chairman comments

• Commentary

• Wachtell Lipton  7.27.06

Symbol Technologies general counsel (Leonard Goldner)

• Manipulated stock option exercise dates and
  backdated transactional documents

• Criminally convicted, including for income tax violations
• Barred from practice before SEC

• Litigation release  3.02.06
• C&D order  2.27.06

• Form 10-K disclosure 3.03.06

• Government Investigations at page 30
• Securities Litigations at page 31

• SEC brings charges

• SEC press release  6.03.04

Many companies have initiated their own
 internal investigations

• Often in response to articles and studies that have named the company as a suspect
• Often using a board committee and outside counsel

• See Internal under Company Scorecard below

Many have been targets of SEC and DOJ inquiry

• To date, SEC has largely been conducting informal investigations
• But several have progressed beyond this initial stage

• See SEC under Company Scorecard below

• DOJ has been issuing subpoenas

• Especially through Northern District of California and
  New York's Southern and Eastern Districts
• See DOJ under Company Scorecard below

Many have had to delay their periodic reports

• Pending the results of these investigations
• Delayed periodic reports in turn have triggered Nasdaq delisting process for many companies

• See Late under Company Scorecard below

Some companies have already restated their financials

• To recognize additional compensation expense for the affected periods

• See Rstmt under Company Scorecard below

Some companies have dismissed executives

• Including at least three general counsel
• At least one general counsel has been criminally convicted

• See Mgmt under Company Scorecard below

Many companies have been hit with shareholder lawsuits

• Factual claims are easy to develop
• News stories

• See Suit under Company Scorecard below