Risk & Compliance

Backdating: Are the Lawyers to Blame?

A general counsel brought the idea of misdating stock option grants from one company to another, says the SEC. Could it have happened elsewhere?
Sarah JohnsonAugust 28, 2007

Since the backdating scandal began unfolding nearly two years ago, regulators and outsiders have been wondering why so many public companies — many of them in the technology industry — began issuing undisclosed, misdated stock options grants around the same time. Was it spread through word of mouth between directors who served on different boards? Could it have been shared between executives on cocktail napkins at a local bar in California? Or was it simply a coincidence, driven by Silicon Valley’s zeal for stock options before the dotcom bust?

In the case of two Golden State tech companies, the concept of granting undisclosed, “in the money” stock options to executives could have originated with their general counsel, according to the Securities and Exchange Commission. On Tuesday, the SEC charged Lisa Berry, former in-house corporate attorney of KLA-Tencor Corp. and Juniper Networks, with backdating option grants from 1997 to 2003. She “devised the improper backdating scheme while serving as general counsel of KLA and then implemented similar practices after assuming the position of general counsel for Juniper,” the SEC said in its complaint filed with the U.S. District Court in San Jose, Calif.

“When we started looking at the players [of these two cases] and saw they had the same general counsel, we said ‘Wow,’” Marc Fagel, associate regional director in the SEC’s San Francisco office, told CFO.com. “That certainly raised our eyebrows.”

While at KLA, a San Jose semiconductor equipment company, Berry “routinely” used hindsight to pick dates when the company had had historically low stock prices and chose the corresponding prices for option grants given to KLA employees, the SEC alleges. These grants were given without proper disclosures, and thus hid true compensation numbers from investors, the SEC adds. Moreover, Berry acknowledged in a 1998 memorandum that repricing executive stock options with an earlier grant date’s lower price would result in KLA having to take “a charge to its P&L,” the SEC said.

When Berry, who studied accounting in college, switched jobs and went to another technology company, Sunnyvale, Calif.-based Juniper, just before its 1999 initial public offering, she boasted about her experience in stock administration, the SEC contends. While there, she oversaw the stock option granting process and allegedly backdated grants for new employees and current executives to capture lower stock prices. By not disclosing these changes, her practice went against Juniper’s stated policy of granting stock options at fair market value, the SEC notes. She also allegedly created minutes of compensation committee meetings that had not occurred in order to justify misdated option grants. Her alleged scheme resulted in more than $300 million in expenses not being disclosed by Juniper, according to the SEC.

Berry’s attorney, Melinda Haag of Orrick, Herrington & Sutcliffe, disputes the commission’s findings. “This case is unfounded, and the SEC’s allegations don’t make it otherwise,” she told CFO.com. “Lisa had no responsibility for accounting at either company, had no idea that either company violated options accounting, and did not personally benefit from misdated option grants at either company.”

Both KLA and Juniper have settled related charges with the SEC without admitting or denying guilt. However, both have restated their financials to correct how they had accounted for stock options: KLA took a $370 million non-cash expense for more than a decade’s worth of financial results, and Juniper took a $900 million non-cash charge for options granted between mid-1999 and the end of 2003. KLA did not return CFO.com’s request to comment on this article, and Juniper referred CFO.com’s reporter to a press release. Both of their statements about their separate settlements with the SEC note that they did not pay a monetary penalty to the commission, but rather agreed to a permanent injunctions against future violations of the reporting, books and records, and internal-control provisions of the federal securities laws.

Both companies were also implicated early on in the scandal, which was first unveiled in an academic research report. The number of companies associated with the controversy spread as more revealed they were conducting internal investigations or that they had received inquiries from the Department of Justice and SEC about their stock option granting practices.

But no one has been able to pinpoint exactly where the idea of backdating stock options originated. Was it just a coincidence? A report released last year from corporate governance firm The Corporate Library said it wasn’t. The organization tried to connect the dots by making correlations between directors who served on the boards of 51 implicated companies, including KLA and Juniper. The report named director Kenneth Levy as serving on both of the companies’ boards, implying that he may have spread the idea. Levy left Juniper’s board earlier this year and KLA’s last October, and has not been implicated in any wrongdoing. A CFO.com analysis of the report, however, showed that it contained multiple errors and that some of the connections cited were unlikely to have resulted in backdating because they did not coincide with periods when backdating had occurred.

Another theory bandied about is that because so many of the nearly 150 companies formerly implicated in the backdating controversy are technology companies in California, word must have spread between colleagues at high-level positions at those companies. Indeed, the SEC has noticed commonalities between the people who worked at these companies. The concept could have been shared by employees switching jobs during the time period when most backdating occurred — the late 1990s and first few years of this decade. During new job negotiations, a person may have said, “‘I had an interesting options package that was oddly dated and now that I’m moving to another company, and I want my options at last week’s price,’” theorizes Fagel. “It’s hard to say.”

As for the theory that it was spread through directors, that could be valid as well, Fagel told CFO.com. “We are tracing interlocking boards,” he says. “[In these investigations] you’ll have a director at one company sitting on the board of another company. We are paying attention to that.” Fagel says the SEC’s investigations are not necessarily looking for links between the people working at implicated companies but are rather concentrating on the behaviors of each person and whether he or she has conducted fraud. “We’re not going to seek out that information, but when we do an investigation we’re very aware of who serves on the boards of other companies,” Fagel says.

While headlines about backdating have concentrated on the top executives at the implicated companies, a handful of former internal attorneys have also been mentioned, such as Berry, Nancy Heinen, who settled charges with the SEC that she participated in fraudulent backdating of options while she was general counsel at Apple, and William Sorin, the former Comverse general counsel who in May became the first executive involved in the options-dating scandal to be sentenced to prison this past May.

Fagel notes that in most cases of financial fraud, such as improper practices related to revenue recognition, the SEC doesn’t find that internal attorneys are behind the wrongdoing. But backdating is a different story, as company attorneys are often involved in decisions about employees’ compensation. In Berry’s case, she served on Juniper’s three-member stock option committee along with the company’s CEO and CFO and reviewed the company’s annual reports.