Just when you thought it was safe, stock option scandals are back in the spotlight. While actual occurrences of option backdating are still few, charges and enforcement actions against former and current executives have started to pop up again. Officers from public companies have been recently charged by the SEC with backdating options.  Even though the biggest scandals broke earlier, latent concerns about backdating remain throughout the market, and companies and regulators are still buzzing about it.

As background, stock option backdating is the practice of giving stock options to employees that are priced at a historical date rather than the date the company actually granted the option such that there is an instant gain on the value of the stock. The practice isn’t illegal per se, but what is illegal is making improper disclosures to the SEC.  Stock options backdating raises issues as to disclosure requirements which prohibit making false statements, regulation and enforcement.

With disclosures of all flavors, extensive enforcement and even litigation recently erupting, backdating is still with us.  Though no longer the emergency it once was when it first leapt into the public eye, it’s clearly still under the SEC’s radar. Public companies and the SEC itself continue to comment on the practice and enforce the rules surrounding it.  These include numerous legal mechanisms, among them: securities laws, SEC rules requiring detailed reporting of stock options, the accounting requirements of the Sarbanes Oxley Act of 2002, and Section 409A of the Internal Revenue Code.

Disclosures abound. In order to avoid the appearance of impropriety, many companies attempting to practice good corporate governance make disclosures about stock option backdating. To be safe, some companies even make clear in their disclosures that they do not engage in the practice.  This group includes Sunair Services Corp., HSBC Finance Corp and Merck & Co. Inc. Along these lines, Macrovision Solutions Corp. emphasizes that its options are granted at fair market value on a fixed date. Visa Inc. goes one step further and discloses that it has adopted procedures to prohibit stock option backdating.

On the other hand, some companies which have been accused of option dating make disclosures about related litigation including Electronics For Imaging, Inc., Triquent Semiconductor, Inc. and McAfee, Inc., with the latter disclosing that its settlement related to option backdating charges had been granted court approval. Nonetheless, making baseless allegations in shareholder proposals of option backdating won’t be tolerated by the SEC. Consider, for example, Exelon Corp.’s recent No Action letter, in which the SEC notes that Exelon does not back date stock options and that language in the shareholder proposal which suggests otherwise degrades the character and integrity of the company, its officers and directors.

SEC efforts continue to focus on backdating and related enforcement. In addition to ensuring that companies meet their disclosure requirements, the SEC is also charged with enforcing rules and laws which prohibit stock option backdating. The SEC noted in October of 2008 that since February of that year, it had brought illegal stock options backdating charges against eight corporations and twenty-seven individuals including CEOs, CFOs and General Counsel. What is most shocking is the SEC’s discovery of the lengths people will go to try and get away with backdating.  The Commission has uncovered falsified documents, self-dealing, the maintenance of secret slush funds and lying to auditors.

Unfortunately for some, best practices and procedures are all too often ignored – which leads the SEC to take action. There have been numerous allegations of stock option backdating over the past year, with new charges being brought against HCC Insurance Holdings, Inc. and its former CEO and General Counsel and against Blue Coat Systems and its former CFO. One of the highest profile names associated with stock option backdating has been Apple, Inc., whose General Counsel, Nancy R. Heinen, settled options backdating charges for $2.2 million and was suspended from practicing before the commission for three years. All too aware of the costs associated with options backdating are executives from Research in Motion and UnitedHealth Group who both recently faced SEC charges.

Executives from Blackberry-maker Research in Motion faced new charges from regulatory authorities in Canada and in the U.S. related to stock options backdating. The SEC’s complaint alleged that the company’s former CFO Dennis Kavelman, former VP of Finance Angelo Loberto and Co-CEOs James Balsillie and Mike Lazardis made false and misleading statements in disclosures about how the company priced and accounted for options. The executives entered into a settlement agreement and are required to pay approximately $1.43 million in fines, disgorge the value of the backdated options and be permanently enjoined from performing certain duties with the company. You could say that U.S. regulators let these gentleman get of loosely, as the Ontario Securities Commission imposed more than $30 million in fines.

The previous allegations of backdating have recently come back to haunt UnitedHealth Group, Inc. and its former executives as well.  In December, the company settled charges with the SEC for violating reporting and internal controls provisions of the federal securities laws. In addition, the U.S. District Court for the District of Minnesota recently ordered the company’s former CEO, William M. McGuire, to disgorge all gains achieved through backdating, pay a $7 million civil penalty and reimburse UnitedHealth for up to $48 million in cash bonuses. McGuire was also permanently enjoined and barred from serving as an officer or director of a public company for ten years. Former General Counsel David J. Lubben, who allegedly created false or misleading records was also permanently enjoined by the Court and ordered to pay a $575, 000 civil penalty.  Furthermore, in February, Lubben was barred from appearing or practicing before the SEC for three years.

The SEC has sent clear signals that accurate and adequate disclosures are essential and violations will no longer acceptable. This is especially critical in terms of putting an end to options backdating as the practice is grounded in making untruthful disclosures. The culture of greed which led to years of stock option backdating is no longer going to be tolerated and be forewarned: the SEC has its eye on you. It’s likely that going forward we will see further disclosures about this offensive practice, additional offenders uncovered and stricter enforcement by the SEC in a concerted effort to continue prohibiting unearned stock option compensation.

Published: March 5, 2009