Tax Man Takes Aim at Mercury Ex-CFO

In one of the earliest backdating cases, IRS files criminal complaint against Sharlene Abrams.
Stephen TaubApril 21, 2008

The former CFO of Mercury Interactive was hit with an Internal Revenue Service criminal complaint accusing her of tax evasion in one of the first cases in the stock-option backdating scandal.

The IRS said that in 2001, Sharlene Abrams tried “to evade and defeat a large part of the income tax due” when she and her husband reported joint taxable income of $898,361, and taxes due of $520,388. The complaint, filed in U.S. District Court in northern California, also accused Abrams of helping former Mercury CEO Amnon Landan and former Chief Operating Officer Kenneth Klein file false returns.

The difference between the stock’s fair market value and the exercise price is included in alternative-minimum-tax (AMT) income, which may trigger the imposition of the AMT, according to the IRS. Thus, if a person exercises non-qualified stock options, purchasing stock at a lower price than the fair market value on a certain date, the difference between the purchase and fair-market price is taxed as ordinary income.

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“In April and May 2001, Abrams orchestrated the backdating of stock option exercise dates for herself, Landan, and Klein in order to reduce the income taxes due on the gains realized by the exercises,” the IRS complaint said. According to the Associated Press, no indictment has yet been filed. But the IRS complaint called on the government to file criminal charges against Abrams for filing a false tax return and aiding and assisting in the preparation of false tax returns.

Abrams’ attorney, Douglas Young, a partner with Farella Braun and Martel, said the defense team was not commenting at this time.

An IRS spokeswoman told the AP that the case is the first of its kind in northern California connected to stock-option backdating.

Last May, the Securities and Exchange Commission settled civil fraud charges with Mercury, which was acquired by Hewlett-Packard two years ago for $4.9 billion. The settlement included a $28 million fine for Mercury. Last October, the company agreed to pay $117.5 million to settle a number of lawsuits, according to the AP.

The SEC also had charged four former senior officers of Mercury: Abrams, Landan, CFO Douglas Smith, and general counsel Susan Skaer.

In August 2006, as part of a settlement of charges involving his role in stock-options manipulation, Landan agreed not to exercise a large number of options he had received three years earlier.

The commission had alleged that Mercury and the former executives “perpetrated a fraudulent and deceptive scheme” from 1997 to 2005 to award themselves and other employees undisclosed, secret compensation by backdating stock-option grants, failing to record hundreds of millions of dollars of compensation expense, and falsifying documents to further this scheme. Through Landan and at times Abrams, Smith, or Skaer, the SEC alleged, Mercury also made fraudulent disclosures concerning Mercury’s “backlog” of sales revenues to manage its reported earnings, and structured fraudulent loans for option exercises by overseas employees to avoid recording expenses.

The SEC further had alleged that the company backdated 45 different stock-option grants to executives and employees, representing every grant made by the company to executives and employees from 1997 to April 2002. It accused Skaer or others at her direction of preparing false documentation for the grants, including false written consents and meeting minutes. The complaint alleged that Landan, Abrams, Smith, and Skaer each personally benefited from in-the-money backdated stock options, in the aggregate collecting millions of dollars through the fraudulent scheme.

The SEC complaint had said that from 1998 through 2001 Mercury, acting through Landan, Abrams, and Skaer, fraudulently backdated the date of option exercises of certain senior Mercury officers. Through Landan, Abrams, and others, the SEC said, Mercury “secretly managed” the company’s reported earnings per share to meet or exceed financial analyst expectations by manipulating the recognition of revenue and making fraudulent disclosures concerning its sales orders. According to the complaint, Mercury stopped the shipment of its products once revenue targets for a period had been achieved, pushing the recognition of the revenue into subsequent periods.

The SEC also said that from 1999 through 2005, Abrams, Skaer, and others participated in fraudulent structuring of loans for stock-option exercises by overseas employees, concealing the accounting consequences of those transactions and causing the company to fail to report about $24 million in required compensation expenses, which “materially overstated” the company’s reported pre-tax earnings during this period.

Landan, Abrams, Smith, and Skaer were accused by the SEC of violating or aiding and abetting violations of the antifraud, record-keeping, financial reporting, internal controls, equity transaction reporting, and proxy provisions of the federal securities laws. It was alleged that Landan and Smith violated a Sarbanes-Oxley provision when they signed certifications that were false and misleading concerning Mercury’s 2002 through 2005 periodic reports.

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