The Securities and Exchange Commission filed civil lawsuits on Tuesday against Gary C. Gerhardt, the former chief financial officer of Engineered Support Systems Inc., and Steven J. Landmann, the company’s former controller. The SEC is charging that the duo participated in six years of fraudulent options backdating, in which they granted undisclosed, “in-the-money” stock options to themselves and to other Engineered Support officers, employees, and directors.
According to the complaints, employees and directors received approximately $20 million in unauthorized compensation as a result of the backdating, $15 million of which was received by top executives and directors. Gerhardt and Landmann personally gained $1,906,300 and $518,972 respectively, stated the SEC in a press release.
The SEC charges also alleged that Gerhardt and Landmann caused Engineered Support to file with the SEC materially misstated annual and quarterly financial reports, and that the company not recognize compensation expense for the company’s stock option grants, as required by generally accepted accounting principles. As a result, Engineered Support overstated its aggregate pretax operating income by approximately $26 million, or 21 percent, for years 1997 through 2002.
Defense contractor Engineered Support is a holding company based in St. Louis that was purchased by another military contractor, DRS Technology, in January of 2006. Engineered Support’s largest operating unit, Systems & Electronics, generates about $119 million in revenues annually.
Landmann, the former controller, settled the civil suit with the SEC by consenting to a permanent injunction and an officer-and-director bar, and by agreeing to pay disgorgement of $518,972, prejudgment interest of $108,099, and a civil penalty of $259,486. As part of the settlement, Landmann also agreed to a permanent suspension from appearing or practicing before SEC as an accountant.
As of Tuesday evening, Gerhardt’s attorney, Eugene Goldman, told CFO.com that he had not yet read the complaint, and therefore would not comment on the allegations.
In recent weeks, the SEC has stepped up its efforts to identify and take action against companies and executives that engage in backdating—which is the improper timing of stock grants to give the options immediate value. Last week, while speaking with reporters, SEC Chairman Christopher Cox sent a harsh warning to companies suspected of engaging backdating. He said the commission is vigorously proceeding with probes at more than 100 public companies and that it is working closely with federal prosecutors, reported the Associated Press. “This is a very aggressive program,” Cox reportedly asserted.
Critics have maintained that federal prosecutors and the SEC have been slow to begin criminal and civil proceedings, noting that so far they have charged only a handful of individuals at two technology companies, Brocade Communications Systems and Comverse Technology. The current suits against the Gerhardt and Landmann may signal that the commission will be launching other actions in the near future.
The SEC is alleges that the two former finance executives improperly increased their compensation without notifying shareholders, and the situation was “exacerbated by the fact that the company’s options vested immediately,” noted Merri Jo Gillette, director of the Commission’s Midwest Regional Office. Gerhardt and Landmann undermined the company’s stated goal of using stock options to tie management’s compensation to shareholder return. “They granted themselves and others instant compensation that was entirely unrelated to the future performance of the company’s stock,” added Gillette.
In the Engineered Support complaints, the SEc alleges that from 1997 through 2002, Gerhardt instructed Landmann to backdate company stock option grants to coincide with historically low closing prices of Engineered Support’s common stock. The company’s stock options vested at the time of grant, allowing the option recipients to obtain immediate cash gains, according to the suit. In addition, the complaints charges that, on at least two occasions, Gerhardt ordered Landmann to cancel previously issued stock options that had fallen out-of-the-money and to reissue them with new backdated grant dates and exercise prices, to bring them back in-the-money, said the SEC in a press statement.
The lawsuits also claim that Gerhardt directed Landmann to issue additional Engineered Support stock options to non-employee directors in excess of authorized amounts. Reportedly, the directors received a total gain of about $6 million from the backdated options.
The SEC also noted that the Engineered Support investigation has not yet been completed.