Have You Checked Your Stock Options Lately?

Employee Benefits Alert

For the past several months, the media has been reporting allegations of backdating of stock options and other questionable option practices. The government’s expanding investigation into the backdating of stock options may lead to civil and criminal charges against individuals and corporate entities. Also, it has just been reported that the IRS has formed an options task force to determine whether corporations have been taking improper deductions and executives have been misreporting income.

Recently, the SEC and the Department of Justice provided a preview of what their charges could look like in the complaints filed against key executives of Brocade Communication Systems, Inc. The civil complaint (SEC v. Reyes et. al) alleges that Brocade’s CEO, CFO, and VP of Human Resources altered records, including committee minutes and personnel documents, to create the false impression that options had been granted at an earlier date (when the stock price was lower) than the actual grant. To conceal these acts, according to the complaint, the executives made fraudulent entries into the company’s financial records and made false and misleading statements to outside auditors.

The complaint advances eight claims for relief, all of which cite to either the Securities Act of 1933 or the Securities Exchange Act of 1934.

The criminal case (United States v. Reyes et. al) charges Brocade’s CEO and VP of Human Resources with securities fraud. While the government will face a heightened burden of proof and different discovery rules in the criminal case, the basic elements of proof and available defenses in the civil and criminal cases will be similar.

As the government investigations continue and widen, investigators will examine companies’ financial statements, tax returns, internal controls and corporate governance. The roles of compensation committees and external auditors will garner attention, as will companies’ responses to the announcement of the Brocade complaints. As the past several years have shown, companies will gain significant advantage by thoroughly investigating and reviewing option-related activity in advance of any government inquiry. Given the complexity of the issues involved and the fact-dependent nature of available defenses, public companies are well advised to get ahead of these issues before being contacted by government investigators. This is particularly important because these issues can arise inadvertently, and when that happens, it is critical for companies to be aware of the issues and be in a position to explain how they unintentionally arose.

Another reason to examine your option practices immediately is the SEC’s new proxy disclosure rules on executive compensation. These are intended to shed more light on a company’s granting and pricing policies to flush out "backdating," "spring-loading," and other abusive practices.

Proxy statements will now identify executive options authorized on a date other than the grant date or having exercise prices different from fair market value at the grant date. Companies will also need to explain in detail their granting policies, including whether option grants and pricing are coordinated with the release of good or bad news, the method by which exercise prices are determined, and the role of the board, compensation committee, and executives in the granting process. Companies adhering to “best practices” will now consider granting policies that ensure that exercise prices reflect all material non-public information.

Miller & Chevalier and Steven Hall & Partners have formed a collaborative relationship to assist clients in these matters. Steven Hall & Partners is an executive compensation consulting firm co-founded by Pearl Meyer, one of the leading experts in the field. Working together, we provide clients with an independent review of the practices and procedures associated with the grant and administration of stock options. Our compliance team is composed of experienced lawyers and consultants who specialize in

  • equity compensation awards and corporate governance,
  • taxation and accounting,
  • internal investigations, and
  • civil and criminal fraud.

This breadth of experience makes us eminently qualified to carry out these sensitive tasks. Together, we can assist you in determining whether your award practices comply with the underlying plan, grant agreement, and any related corporate governance requirements that you may impose on your optionees. In addition, our team is fully equipped to conduct internal investigations, deal with all tax and benefit issues and if necessary, defend the company or its executives in the event of a civil or criminal investigation.

As with so many business transactions, the award of stock options involves issues of knowledge, intent, and consequence. By virtue of our experience in the various disciplines implicated by stock option awards, Miller & Chevalier lawyers, and professionals at Steven Hall & Partners are especially qualified to provide advice and counsel on these crucial issues. Please contact us if we may be of assistance in these matters.

For more information, please contact any of the following lawyers:

Gary Quintiere, gquintiere@milchev.com, 202-626-1491

Richard Hibey, rhibey@milchev.com, 202-626-5888

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