In Tennis they would say "time". In tech stocks they say what?
Backdating probe had surprises for investigators
SEC team behind stock-options cases think abuses have been corrected
SAN FRANCISCO (MarketWatch) - For Marc Fagel's team of government investigators, what began as an accounting and stock market puzzle turned into a major fraud probe that they believe has lifted the veil on the tech industry's shadier side.
Fagel has led a team of about 30 attorneys, accountants and paralegals with the U.S. Securities and Exchange Commission office in San Francisco, who have combed through millions of e-mails and conducted dozens of interviews in a stock-options backdating scandal.
Their work is now seen as having shed more light on how many tech companies manipulated stock-option grants by filing false financial information and sometimes even doctoring or making up meeting minutes -- even as some other legal experts argue that the agency has overreached by mistaking record-keeping and administration glitches for fraud.
One of the investigation's first major cases ended this week when a federal judge in San Francisco sentenced ex-Brocade
CEO Gregory Reyes to 21 months in prison and ordered him to pay a $15 million fine. See full story.
Reyes is the first CEO to be sentenced to jail time for his role in stock-options backdating. Several other executives have struck plea agreements and paid hefty civil fines.
In an interview last month, Fagel's team talked at length about the investigation, which has led to legal action, including criminal indictments, against top executives from well-known tech firms such as Apple Inc. , Juniper Networks Inc. and Broadcom Corp.
Stock options give employees the right to buy shares in the future at the market price on the date a grant is approved. If the stock rises later, the recipient can cash in the option to take profit. Backdating a grant to a prior date when the price was lower increases the award's value. A company can legally do that, but the transactions have to be reported in public filings.
Fagel described stock-options backdating "just another fraud case," although he said the scandal also turned up some surprises for the agency. Members of the team, who have also worked with the U.S. Justice Department on backdating issues, declined to discuss specific cases or ongoing investigations.
Tipped by the press
When the issues first came up, Faglel said his team didn't exactly know what it was dealing with. The agency was alerted to the issue thanks to the work of academics, analysts and news organizations (particularly the Wall Street Journal, which first broke the story), who described how many companies appeared to be granting stock options at a time when their shares were trading low.
Fagel said the reports talked about "how unusually lucky a lot of companies seem be on the timing of their options grants."
At first, the agency thought the scam involved classic insider trading, which occurs when company executives make trades based on knowledge about their company that has not yet become public.
But Fagel said the SEC eventually came to "an increasing realization that the companies were in fact lying about the timing of the grants."
To prove their cases, the SEC combed through e-mails and documents and interviewed executives and rank-and-file employees at the various companies involved.
A critical part of the scam, said Cary Robnett, the SEC's assistant regional director in San Francisco, was doctoring minutes of meetings to change the date of stock options grants.
"For me, the practice of a lot of people involved in creating bogus minutes, high level people, shocks me," she said.
The SEC team also relied on so-called V-charts, which they prepared to get a visual idea of when stock options were granted in relation to the company's stock. Options granted at the bottom of the "V" -- where the stock was at a low point before shooting up -- typically triggered more suspicions that the company was doing something wrong.
"You see a dramatic picture," said Sheila O'Callaghan, a branch chief with the enforcement arm of the SEC's San Francisco office. "The stock prices were telling us a story."
Surprised by lawyer involvement
The SEC and other agencies have, so far, filed complaints against 10 chief financial officers, nine CEOS and eight attorneys, according to Robnett. The involvement of attorneys caused the most surprise for the team.
"One striking thing is how many lawyers have been sued and how critical a role that lawyers were playing in this fraud," said Michael Dicke, assistant regional director for enforcement at the SEC's office in San Francisco.
These lawyers, who were often the top-ranking legal experts at their respective companies, "had the necessary knowledge that what they were doing was wrong, and they were doing these things. That's surprising and disturbing," Dicke said.
Fagel said many corporate attorneys were "critical to the backdating process" and were "involved in very complex decisions about stock-option grants and what they mean for the company's financial statements."
The most prominent corporate attorney accused of playing a lead role in the options backdating scandal was Nancy Heinen, the former general counsel of Apple Inc. She was accused of filing false paperwork, including bogus board meeting minutes, in connection with an options grant to CEO Steve Jobs.
In a January 2001 e-mail to Jobs, she purportedly suggested a specific date for his options grant, saying, "To avoid any perception that the board was acting inappropriately for insiders prior to Macworld announcements, I suggest we use Jan. 10, the day after your Macworld keynote, at $16.35. That was one of the lowest closes of the month."
"It was somewhat surprising that a general counsel for a large corporation -- a previously respected general counsel -- would do the things that we believe she did," Dicke said.
Heinen has denied the charges and is fighting the case.
"Everything that Nancy Heinen did was fully transparent to the board and to the finance team, and she didn't deceive anybody," said her attorney, Miles Ehrlich.
Another Apple executive, Chief Financial Officer Fred Anderson, settled with the SEC.
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