TheCorporateCounsel.net

This week, I am taking a walk down memory lane and offering up some of the key lessons that I have learned over the course of my career. Today, I turn our attention to the mid-2000s options backdating fiasco, which I witnessed from my perch as Chief Counsel of the Division of Corporation Finance at the SEC.

For those who did not experience the events first-hand, the options backdating fiasco was a sprawling scandal that affected many public companies at a time when we were just trying to get past the crisis in confidence brought about by the major corporate scandals that I talked about yesterday. The conduct underlying the fiasco was simple enough – executives falsified corporate documents by selecting an option grant date when the stock price was at its lowest, locking in an immediate boost in value and achieving favorable tax outcomes. In addition to straight-up options backdating, there were other nefarious practices prevalent at the time, including “bullet dodging” and “spring loading” by timing option grants relative to the release of material nonpublic information, which remains a topic of great interest to the SEC even to this day.

What was particularly notable about this fiasco was the extraordinary impact on companies and shareholders of this seemingly innocuous act of selecting favorable grant dates. Many companies were forced to restate several years of their financial statements, and those restatements took extended periods of time as the investigations unfolded. Many talented executives from very high profile companies lost their jobs and were implicated personally in SEC actions. I gleaned some valuable lessons for the options backdating fiasco, including:

1. If it Sounds Too Good to Be True, It Probably Is: The fact that so many companies and executives were implicated in options backdating cases demonstrates how a practice can become endemic when no one steps up and says: “Isn’t this too good to be true?” Some healthy skepticism about conduct that did not even seem to pass the smell test might have gone a long way to avoid a situation where a great deal of shareholder value was destroyed and careers were ruined.

2. The Little Things Matter: While board and committee minutes, resolutions and consents are admittedly one of the more boring things that we do, it is critically important that they accurately reflect the proceedings and not be subject to manipulation. Whenever someone wants to “fudge” a date in a resolution, I always think back to the parade of horribles that emerged from the options backdating fiasco.

3. Creativity is Not Always Good: Lawyers and other professionals are always seeking to come up with creative solutions to the problems that clients face, which I think is generally a good thing, but those professionals need to always think about how a proposed “creative” approach to a problem could ultimately be viewed by regulators, criminal authorities, auditors, plaintiffs’ lawyers, academia and the media before advising companies to go down that creative path. In other words, there can sometimes be a fine line between being creative and committing fraud.

4. A Protracted Restatement is a Very Rough Ride: The sheer scope of options backdating issues meant that the internal investigations and restatement efforts at affected companies were very complicated and protracted, meaning that companies were slogging through the restatement process for many months before they could file restated financial statements. This often meant that companies could not hold their annual meeting (because they could not provided the financial information for the annual report that accompanies the proxy statement), could not raise capital in public markets (because they had to shut their registration statements down) and could not even offer equity compensation to employees in some circumstances (because their Form S-8 registration statement was no longer available). These were very difficult waters to navigate, and not any place that a company wants to find itself.

I am grateful to have had the opportunity to share my lessons learned with you this week!

– Dave Lynn