Compensation

Indicted CFO: PwC Knew We Backdated

A former finance chief says that because his company shared information with its audit firm about misdated option grants, the feds have no case aga...
Sarah JohnsonJuly 5, 2007

Former executives caught up in the backdating scandal have either deflected blame onto other employees or claimed the practice of assigning an earlier date to a stock option grant is not illegal. Now, the ex-CFO of a defense contractor claims he shouldn’t be charged for fraudulently backdating options because his audit firm knew what the company was doing.

In a motion to dismiss the criminal case against Gary Gerhardt, the former CFO of Engineered Support Systems, his lawyers say the fact that PricewaterhouseCoopers accountants were aware that stock options had been granted “in the money” proves that Gerhardt hadn’t concealed the erroneous grant dates. Hence, “there was no attempt to avoid detection by the public, no attempt to deprive investors or the public of accurate information, and no attempt to defraud investors,” the lawyers wrote in the motion filed with a U.S. District Court in Missouri earlier this week.

The attorneys claim that since the executives shared information about the options dating with PwC, ESSI executives can’t be charged with trying to hide the backdating, as the indictment alleges. Further, because the grand jury was unaware that PwC knew that ESSI had backdated and repriced stock options, its indictment of Gerhardt is invalid, the lawyers added.

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The question of whether a company’s audit firm knew about backdating doesn’t matter if shareholders were still kept in the dark, according to investor advocates. “It’s got to be disclosed, it’s a material fact,” says Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware.

PwC was ESSI’s audit firm until the engineering company was acquired by DRS Technologies in 2006. The audit firm does not comment publicly on “client matters,” a PwC spokesman told CFO.com.

Gerhardt was indicted in March on 10 counts of securities fraud, including one count of falsifying documents and four counts of making false statements in regulatory filings. Federal prosecutors claim Gerhardt told his controller, Steven Landmann, to backdate stock options on eight occasions between December 1996 and August 2002.

The prosecutors accuse ESSI executives of trying to hide that fact by changing the dates on options award letters to make it seem as if they were mailed earlier. Gerhardt and other executives also allegedly did “double-backdating” by cancelling options that had been misdated and issuing new ones to take advantage of a new low in the stock’s exercise price. Gerhardt’s lawyer did not return CFO.com’s request for comment.

Earlier this year, Landmann pleaded guilty to one count of providing false statements to the Securities and Exchange Commission in an annual report. Facing a maximum sentence of five years, he is slated to be sentenced in September. He also settled similar charges from the SEC by agreeing to pay $886,557 in penalties. The regulator had accused him of personally gaining $518,972 in the backdating scheme.

Unlike Landmann — who is expected to testify against his former boss — Gerhardt still faces civil charges by the SEC. He allegedly gained $1.9 million for himself, while six other executives and directors also profited from the alleged backdating. The scheme resulted in overstatements of ESSI’s aggregated pretax operating income by $26 million, or 21 percent, according to the SEC.