Thursday, July 06, 2006

Options Backdating Securities Litigation Update (and other Notes and Comments)

Options Backdating Securities Litigation: On June 29, 2006, a putative securities fraud class action was initiated against KLA-Tencor. This brings the number the number of companies sued in securities fraud class action lawsuits based on options timing allegations to eight. Background on the other seven companies previously named can be found on prior D & O Diary posts here and here. In addition, Apple Computers announced on July 5, 2006 that it had been sued in two derivative action based upon its awarding of stock option grants.

Mercury Interactive Restatement: A sense of the magnitude of the problems that options backdating can cause can be found in Mercury Interactive’s July 3, 2006 release of its restated financials. Among other things, the company reported that as a result of problems surrounding its options practices it would restate its earnings before taxes for the period 1992 through 2004 downward by $566.7 million. All told, the company’s special investigative committee found 55 instances in which “the exercise price of stock options was established based on a stated grant date that was different from the actual grant date.” Jack Cielski has a detailed review of Mercury’s options practices and the resulting accounting mess in a July 6, 2006 post on the AAO Weblog.

Mercury Interactive also announced that on June 23, 2006, the SEC staff provided three of the company’s outside directors with “Wells” notices, signifying the staff’s intent to pursue charges against the individuals. A July 6, 2006 post on the ISS Securities Litigation Watch blog points out that it is "quite unusual" for the SEC to pursue outside directors in connection with financial problems at the company on whose board they serve, but that appears to be the direction the SEC is headed in connection with the Mercury Interactive mess. (The SEC also served Wells notices on outside directors of the Hollinger Corporation, as discussed here.) The July 5, 2006 Wall Street Journal (subscription required) article describing Mercury Interactive’s restatement and its directors receipt of Wells notices may be found here.

In a related development, on July 5, 2006, Opsware announced that its CFO had received a “Wells” notice pertaining to her prior service as Mecury Interactive’s CFO.

Ken Lay’s Death and the Resurrection of D & O Coverage? It may be an idle question on my part, but a July 5, 2006 note on Professor Peter Henning’s White Collar Crime Prof blog has left me wondering about the D & O insurance implications arising from the legal effects of Ken Lay’s death. Professor Henning reports that under established Fifth Circuit precedent, a criminal defendant’s death during the pendency of an appeal “abates, ab initio, the entire criminal proceeding.” Under United States v. Estate of Parsons, 367 F.3d 409) (5th Cir. 2004), “the appeal does not just disappear….Instead, everything associated with the case is extinguished, leaving the defendant as if he had never been indicted or convicted.” Now, it may well be that the available D & O insurance was exhausted long ago, and it may be that the applicable policy language differs in a way that avoids this whole line of analysis. But assume for the sake of discussion that the applicable policy had the standard “after adjudication” language in the criminal conduct exclusion, pursuant to which the exclusion precludes coverage only upon final adjudication of criminality. There is no question that a jury of 12 persons good and true found Ken Lay guilty of multiple criminal acts. But if his death operates to leave him “as if he had never been indicted or convicted,” does the exclusion apply? Or would his death resurrect coverage, or rather remove the obstacle to coverage? The entire question may be moot due to the exhaustion of coverage, and because the lead plaintiff in the pending civil securities action against Lay (as quoted in the July 6, 2006 Times of London), has stated publicly that it does not expect to pursue the case against Mr. Lay’s estate. But it is still an interesting question, albeit based upon a fact pattern that presumably will not frequently recur...

A July 7, 2006 Wall Street Journal (subscription required) article discussing the legal effects of Ken Lay's death, as well as the financial condition of his estate, can be found here.

2 Comments:

Blogger ProLiabProf said...

Yet another blow struck for "in fact" wording in fraud exclusions!

9:49 AM  
Blogger Gracchus said...

I agree with your conclusion. I believe there is case law to the effect that (depending on the wording, of course) appeals and sentencing proceedings must be paid out of D&O insurance (Bergonzi comes to mind, but I could be wrong, and there are certainly others).

In any case, Lay apparently spent about $20M from the policy before it was exhausted by the directors settlement. But an interesting question, for sure.

11:09 AM  

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