SEC Enforcement looks at stock option problems

By: Cydney Posner

You may recall that SEC Enforcement representatives have previously warned that they were investigating whether companies may have granted stock options shortly before material positive news announcements and therefore understated the value of the compensation in proxy statements and other public disclosure. The inquiry was reportedly focused on several technology companies. The SEC's concern was not insider trading, but rather whether public disclosure regarding the value of the option compensation was inaccurate. See a recent press release for Analog Devices regarding a proposed settlement on this issue.

With respect to the issue of disclosure regarding grants of options to employees and directors prior to the release of favorable information, in this case, favorable financial results, the settlement would provide that ADI should have made disclosures in its proxy filings to the effect that ADI priced these stock options prior to releasing favorable financial results. In addition, it appears that ADI made some "adjustments" to the grant dates for options granted in 1998, 1999 and 2001. The settlement would conclude that the appropriate grant dates were different from the ones actually used and would require that the options granted to directors and certain executives, but not other employees, be repriced. However, the earnings charge involved was determined not to be material and, therefore, no restatement was required. Penalties included a cease-and-desist order and monetary penalties and disgorgement of profits.

This second issue in the ADI matter may be similar to the problems that arose with Mercury Interactive. In response to an inquiry that was initiated by the SEC in November 2004, the board of that company formed a Special Committee to conduct an internal investigation relating to past stock option grants. The Special Committee determined that, beginning in 1995, there were 49 instances in which the stated dates of stock option grants were different from the date on which the option appeared to have actually been granted. In almost every instance, the price on the actual date was higher than the price on the stated grant date. The Committee found that the CEO, CFO and GC (all of whom resigned) were each aware of and, to varying degrees, participated in, and benefited personally from, these practices. The Special Committee concluded that each of them "knew or should have known that the practices were contrary to the options plan and proper accounting. While the Special Committee is appreciative of and sympathetic to the far-reaching demands of these executives’ positions during this critical period, missing or overlooking a practice as basic and important as the proper granting of options is not acceptable." The Special Committee was also critical of Compensation Committee members who approved, by unanimous written consent, six grants that were improperly dated: "It appears that the Compensation Committee members reasonably, but mistakenly, relied on management to draft the proper documentation for the option grants and to account for the options properly." The Special Committee believed that questions about the dating "should have been raised in the minds of the Compensation Committee members...."