Option backdating updates

By:  Cydney Posner

A couple of interesting updates in the option backdating arena:

Many of you may have already seen the article from the San Jose Mercury News regarding the press release and Form 8-K filed by Mercury Interactive reporting on the completion of its restatement resulting from problems with its option backdating practices. (You may recall that Mercury was one of the first companies to be scrutinized in connection with option backdating. In its 10-K/A, the company reported material weaknesses in that it "did not maintain controls adequate to prevent or detect instances of intentional override or intervention of our controls or intentional misconduct by certain former members of senior management. Also, there was a lack of attention to identifying and responding to such instances." In addition, three outside directors who were on the compensation committee have received Wells notices from the SEC, indicating that the SEC is contemplating civil enforcement actions against them charging violation of the federal securities laws. The charges under consideration would allege that each of these directors knew or should have known about the manipulation of grant dates and that each knew, or was reckless in not knowing, the impact that option backdating would have on the company's financial results. The company's special committee found that "[q]uestions should have been raised in the minds of the Compensation Committee members from 1998 to 2002 ... as to whether grants they approved were properly dated. The Special Committee also concluded that it appears that the Compensation Committee members reasonably, but mistakenly, relied on certain former members of senior management to prepare the proper documentation for the option grants and to account for the options properly…." The 8-K also indicates that these directors have withdrawn from their positions as board committee members.

Second, notwithstanding the admonition from the PCAOB's Advisory Committee that, as soon as possible, the PCAOB issue an "audit alert" on option dating issues to guide auditors struggling with the problem, the SEC appears to have taken a somewhat different view, as indicated in a recent WSJ article. According to the article, the SEC has asked the PCAOB to hold off on publishing any guidance on the issue until the SEC has reformulated its executive compensation disclosure rules, now expected to be submitted to the full Commission for approval in August. The SEC's chair has stated explicitly that the SEC intends to address the issue in its new disclosure rules. The goal would be to issue guidance form both regulators contemporaneously, to avoid potential confusion. Interestingly, the article contends that the SEC wants the PCAOB to limit its guidance to current and future options grants, rather than advising auditors to revisit past practices.

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