Risk Management

Backdating Not Sufficient to Prove Fraud

Federal judge's ruling is good news for the more than 200 companies that have looked into their stock-option practices.
Dave Cook and Stephen TaubApril 16, 2007

A federal judge in San Francisco has dismissed most of a shareholder derivative lawsuit against Cnet Networks regarding backdated stock-option grants, according to The Recorder.

Late last week, reported the legal publication, Judge William Alsup of U.S. District Court for the Northern District of California ruled that it is not sufficient for the plaintiffs to state simply that since backdating occurred, a fraud has also occurred.

“If a shareholder wishes to bring a lawsuit on the corporation’s behalf, the shareholder should have to plead that the board could not have made a disinterested and independent decision to do so itself before proceeding,” wrote Alsup, according to The Recorder. “The inference that fraud still occurred…is improper absent other facts indicating fraud. Â… Had plaintiffs pled other facts in support of this theory, perhaps such an inference would have been proper. Here, it is not.”

Alsup reportedly also noted that a special committee of the online media company’s board found no wrongdoing by current or recently resigned directors or executives.

The ruling is good news for the more than 200 companies that have undertaken internal investigations into possibly backdated stock options.

“The courts are going to analyze the facts of each case individually and are not going to fall into a trap of assuming that merely because option dates are moving that that means there must’ve been some sort of misconduct,” Fenwick & West partner Kevin Muck told The Recorder. “I think that a lot of times plaintiffs’ lawyers want to infer the worst from particular fact patterns, and it’s not always warranted. Sometimes there are more innocuous and less interesting explanations for what happened.”

The publication stressed that Alsup did not completely dismiss the lawsuit; plaintiffs still may be able to request more evidence about two Cnet board members they believe may be biased.

Last July, Cnet disclosed that it expected to restate its results to correct errors related to accounting for stock-based compensation from at least 2003.

In October, the company announced that co-founder, chairman, and chief executive officer Shelby Bonnie had resigned after a special committee concluded “there were deficiencies with the process by which options were granted” at CNET, including backdated option grants, from the company’s initial public offering in 1996 through at least 2003. The company added that Bonnie, as well as the former chief financial officer, general counsel, and senior vice president of human resources, “bear varying degrees of responsibility for these deficiencies.”

In January, Cnet finally restated its results, recording charges of $105.7 million to correct the measurement date for approximately 40.8 million options granted between July 1996 and December 2005.