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Companies Fire Back at Backdating Report

The Corporate Library takes heat from companies it ties to the stock-options scandal — and decides to add a clarification.
Sarah Johnson, CFO.com | US
October 27, 2006

Confronted with errors and criticized for unfairly implicating executives and companies in the stock-options scandal, officials at The Corporate Library are standing behind the firm's recently issued report, "The Spread of Backdating: A Closer Look at the Boards and Directors Involved," which purports to reveal that a web of board connections underlies the current wave of backdating misdeeds.

Some of the firms mentioned in the report, which found that companies entrenched in the backdating scandal are likely to share directors, say the governance-research firm's claim is flawed by incorrectly implying that the board members listed served simultaneously. That would have substantiated The Corporate Library's theory that "the practice of backdating stock options may have been spread by word of mouth, through the conduit of directors sitting on the boards of more than one company."

In fact, the tenure of the directors listed in the report varies from terms spent during the dates in question — the late 1990s through 2001 — to terms that began less than two years ago. Moreover, some of the people listed are not directors at all, but officers of their company.

The Corporate Library plans to clarify that not all of the people listed are directors of all the companies listed, the organization's co-founder Nell Minow wrote in an E-mail sent to the public relations firm representing Novellus Systems, one of the companies mentioned prominently in the report. Ninety-five percent of the people listed in the report are directors, estimates Paul Hodgson, The Corporate Library's senior research associate, who worked on the report with two other researchers.

Companies that are not being probed by the Securities and Exchange Commission or the Department of Justice told CFO.com that it is unfair to group them with organizations that have received formal inquiries from the SEC and the DoJ.

"The report seems to suffer from inaccuracies," Blue Coat Systems spokesman Steve Schick told CFO.com. The Corporate Library includes the technology company in its table of "51 linked scandal companies sorted by director" by showing that Blue Coat CFO Kevin Royal is a director of both his company and Novellus Systems.

In fact, Royal does not serve on either board. He was the CFO at Novellus from 2002 to April 2005, a period after the time that its practices of granting stock options have been questioned, Novellus said in a response to the study that the company E-mailed to CFO.com on October 25. While Royal joined the company in 1996 and held several financial positions before becoming the finance chief, he never served on the Novellus board. Royal declined to comment.

The authors of The Corporate Library study repeatedly use the word "director" in describing the kinds of individuals that are under discussion. Purporting to cover a group of companies with "a total of 1,440 directors," they discuss such things as "the level of interconnectedness between directors sitting on the boards of companies implicated in the scandal" and "directors who sit on more than one board in the group." A column in the report's tables refers to "Director name."

Yet Hodgson disagrees with the contention that the report's table implies that everyone listed is a director. The key point of the report is the connections between the high-level people involved in these alleged backdating cases, he asserts. "We tried to include all CEOs and CFOs in the survey, as in some cases where option backdating did occur it is the CFOs and CEOs who have been forced out, rather than any directors," he wrote in an E-mail to CFO.com. "The same goes for Kevin Royal. Controllers and corporate secretaries have also been implicated." The report, however, never uses the word "officer" when referring to any of the 120 companies it said were "implicated" in the backdating scandal.

Officials of Novellus and Blue Coat criticized The Corporate Library for including them in its list, arguing that regulators haven't accused them of wrongdoing related to backdating. "There's no implication, there's no third party," says Schick. "We've gone through a voluntary review, as many other companies have. Backdating was never anything that we stated as an issue or a problem."

Blue Coat's internal review of its stock-options practices showed that the actual measurement dates for some options differed from the recorded grant dates. As a result, the company announced in September that it will restate financial results for the 2000–2004 fiscal years and account for the changes as a noncash expense, according to a September press release.

Any time a company sets a stock-option grant to a prior award date, it's considered "backdating," says Charles Elson, director of the Weinberg Center for Corporate Governance. "Regardless of what you call it, it's the same issue from a disclosure standpoint and an accounting standpoint."

In May, Novellus protested being named in a Merrill Lynch report about options pricing and stated that two legal firms, internal and external auditors, and its board have "reviewed its process of granting options and did not find any irregularities."


Corporate Library officials do not find in those protests reason enough to exclude Novellus from its list of scandal companies. "Whether the SEC finds a problem or a company finds it during their own investigation, it's still the same problem," Minow told CFO.com. "I would hope that as soon as the backdating issue arose out of that academic report or UnitedHealth [another company named in the survey] case, that every company started an investigation," she said. "If they've been exonerated, we'll remove them from the list."

In her E-mail to Novellus's PR firm, Minow said that The Corporate Library stands by its report. "A self-report from a company exonerating itself from backdating will not remove them from our list (or any of the other lists we have seen of companies with backdating concerns) as long as there is pending litigation," she wrote.

Hodgson says his group included all companies that have reported they are conducting internal investigations, have faced scrutiny from the SEC or DoJ, or are facing a shareholder derivative lawsuit. "We looked at the entire universe of companies that were implicated in one way or another," he says.

The study also rarely makes a distinction concerning the dates that the directors sat on the boards. For instance, the report shows that, as a director, Neil Bonke serves as a link between the Novellus and Sanmina-SCI boards. However, he did not join the Novellus board until 2004, a fact that is noted in the report. That is at least three years after the period generally acknowledged to be the time when the wave of backdating occurred.

The study, the authors say, "looked at all present-day connections among the 120 companies implicated at some point in the past in the practice of backdating of stock option grants. Of the companies implicated in the options backdating scandal, some 51 of their boards are linked to at least one other of the 120 'scandal' boards via a director presently or recently serving on both boards."

That approach hasn't sat well with Novellus. The firm sent a list of corrections of the report's "factual inaccuracies" to The Corporate Library and media outlets, including CFO.com. The Corporate Library report says Novellus CFO William Kurtz is one of two directors who connect the most boards in its list of "scandal companies" and lists him as serving on boards for Novellus, PMC Sierra, and Redback Networks.

Declaring that it "strongly disagrees with the premise and findings of the report," Novellus noted that Kurtz, its CFO since September 2005, does not sit on the Novellus board but does chair the audit committees of Redback and PMC Sierra. "He is not on the compensation committees of either of these companies, and therefore is not responsible for oversight of the compensation practices at these companies," Novellus said in the E-mail.

"As a result of concerns expressed earlier this year by several analysts, Mr. Kurtz, as audit committee chair, led an independent investigation of stock option practices at both companies. The results of the independent investigation concluded that there was no evidence of stock option backdating at either [Redback or PMC Sierra]."

Following academic reports released last year that studied option-grant timing, the SEC and the U.S. Attorney for the Northern District of California requested information on Redback's practices. According to Redback spokesman Doug Wills, who has not seen The Corporate Library report and did not want to comment on it directly, Redback determined it was implicated in a study by University of Iowa professor Erik Lie because of a mathematical error.

Redback looked at every stock option granted over its 10-year history through internal and independent investigations, says Wills. "We found no evidence of backdating and no evidence of fraudulent activity. We reported these findings during our second-quarter filing in July and gave a more detailed summary of the investigation's finding in our 10-K, which was filed in August. We consider the matter done, closed."

PMC Sierra's audit committee has found incorrect measurement dates for certain stock-option grants awarded between 1998 and 2001. The mistakes "were not the product of any deliberate misconduct by the company's executives, staff, or members of its board of directors," it said in an August press release. PMC Sierra and Sanmina did not return CFO.com's phone calls for comment.

In the case of Comverse, which has been much in the news in recent months as one of only two companies that have actually seen criminal charges result from backdating, the report lists former Comverse CFO David Kreinberg, former CEO Jacob Alexander, and former general counsel William Sorin as "key connectors" in the scandal. The report, which was concluded in September, says the three served on the Verint Systems, Ulticom, and Comverse boards before 2002, but incorrectly asserts that they "continue to serve on these boards to the present."

Both Alexander, whom the government is trying to extradite from Namibia to face 32 charges, and Kreinberg resigned from the boards of Comverse and its subsidiaries in May. Sorin has not served on the Ulticom board for three years, according to company spokesman Chris Tunnard. (Kreinberg pleaded guilty on October 24 to charges of securities fraud and agreed to settle civil charges with the SEC regarding the backdating case. Sorin has been discussing a plea deal with prosecutors, according to Bloomberg. Verint did not return CFO.com's request for comment.)


Hodgson acknowledges that the mistake concerning Kreinberg, Alexander, and Sorin should have been caught, and adds that the matter of who serves on the board currently is not an issue, since the backdating problems happened several years ago.

Minow says The Corporate Library's research is pulled from its database of SEC filings. "If they're not updated, then our information is not updated," she says.

The Corporate Library lists Comverse and its two subsidiaries as having six directors who sit on more than one implicated board, although not all six have served together at the same time, according to Tunnard.

Besides the former Comverse board members, the report lists Juniper Networks CEO Scott Kriens and VeriSign CEO Stratton Sclavos as key connectors, and shows links between their respective companies and Equinix (Kriens) and Intuit (Sclavos).

VeriSign spokesman Brian O'Shaughnessy disputes the report's findings. "Neither one of these CEOs [Sclavos and Kriens] serves on an audit committee or compensation committee," he told CFO.com. "I fail to see how they draw their conclusions. Their contention is specious." The report says VeriSign has five directors sitting on the boards of other implicated companies; however, it lists only four: Kriens, Sclavos, Roger Moore, and Gregory Reyes. Reyes is no longer on the board, O'Shaughnessy says.

A spokesman for Juniper says The Corporate Library's claim is irrelevant since Kriens doesn't serve on the audit or compensation committee of those boards. Intuit spokeswoman Diani Carlini says she did not notice any inaccuracies in the report. After Intuit announced this past summer that a special committee investigating its past options-granting practices had uncovered no evidence of fraud or intentional wrongdoing, the company decided not to comment further on the issue, she adds.

The Corporate Library researchers drew their conclusions when they noticed during their work on another backdating report that a higher level of interconnectedness exists among directors than they would have expected from a randomly selected sample, they wrote. The report, available on The Corporate Library's Website for $1,100, includes simple tables and graphs outlining the web of the directors and executives' relationships and notes that certain people are the key connectors substantiating their hypothesis.

The researchers say that although the findings cannot "definitively" prove the judgment that directors serving on more than one board spread the practice of backdating, current social-networking theories could support it. Yet Catherine Bromilow, a partner with PricewaterhouseCoopers, wonders if there's more to be seen in the fact that most of these companies are in technology. The idea of backdating could have spread among common service providers as easily as it could have spread among common directors, she suggests.

Still, common board members or another link "could just be simply a coincidence," says Bromilow. She stresses that she hasn't seen The Corporate Library's entire report.

The Corporate Library alludes to the high-tech connection by highlighting that many of the companies accused of backdating in Silicon Valley have used the law firm Wilson Sonsini Goodrich & Rosati for initial public offerings and ongoing legal services. (The firm did not return a call requesting comment.) Tech businesses have been known to use more stock options as compensation than others, and "some would argue technology companies have been less stringent on the formalities of standard governance procedures over more established companies," says Elson.

The issues raised in the report are important for weighing the effectiveness of boards and individual directors, Minow contends. "We are tracking relationships, and relationships are important historically," she says. "We are talking about things that happened in the past."

The researchers intended to show a link between the common, high-level people involved in backdating investigations, according to Hodgson. "We were trying to communicate as quickly and clearly as possible the links between a director who serves on one board with an employee of another company."




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