Stock-Option Backdating: Don't Push the Panic Button
from
March/April 2007
by Peter J. Anderson
The boardroom fallout from the backdating of stock options does appear to be grim. At the end of last year, more than 130 companies were under investigation by federal authorities; the Securities and Exchange Commission had brought its first criminal charges in the matter; and then came the news that some executives might have used backdating to dodge taxes. But let’s remember, most of the difficulties now coming to the fore occurred prior to 2001. Today the SEC requires companies to disclose how they put executives’ compensation packages together, which should help prevent any repeats.
The best lesson to be learned from the backdating saga may be the importance of treating stock options properly in the future rather than overreacting to the past. Directors should note that attempting to pin outdated practices on a few individuals, without strong evidence that they’ve done anything fraudulent, is not in the best interests of shareholders.
Many stock-option investigations tell a less sinister story than the headlines suggest. The board member’s duty is to take a prudent businessperson’s approach in determining whether action is needed. As boards review the results of internal investigations, the most important questions to ask are:
• Who received stock options?
• How many options were granted and why?
• Were stock-option policies and practices applied equally?
A policy that applied to all qualified recipients and may have allowed for backdating is very different from an instance in which one person appears to have repeatedly backdated his or her options for personal gain.
Board members need not be dismayed if an employee claims that he or she does not recall why options were treated in a particular manner—this by itself does not mean a witness is being untruthful. Difficulty remembering is a common frailty when events are viewed through a five- to 10-year prism.
The bottom line is that the results many boards will receive from internal investigations will not be clear-cut. For example, an investigating law firm may conclude that option backdating did occur but no one remembers who decided why particular grants were priced when they were, and that if someone is to be held responsible it should be the CEO. Before the CEO is shown the door, though, the board should think about whether this is in the interests of the shareholders, especially when there have been no prior ethical breaches and the company is performing well. If board members, exercising their sound business judgment, decide to stand behind the CEO, they can protect themselves by documenting their reasons for doing so and specifying why they concluded the investigation.
Punishing a few individuals without adequate evidence of intentional wrongdoing is bad for business and bad for shareholders, and has a significant human impact. Overreaction by the financial markets to the news of internal option investigations has doubtless hurt shareholder equity far more than the financial impact of all repriced options. So far, few companies have issued restatements, but a number have reported charges to historical retained earnings and have repriced previously granted options. In addition, boards should pay attention to the SEC compensation-disclosure rules, which require companies to report the total compensation of the CEO, the CFO, and the three other highest-paid executives.
In short, the best news about stock-option backdating is that it is ancient history. Boards should not forget that.
Peter Anderson is a senior partner with Sutherland Asbill & Brennan LLP in Atlanta and heads the firm’s securities-enforcement and regulatory practice.
