SEC Commissioner: Potential Outside Director Liability for Options Backdating?
Finally, let me discuss briefly stock option backdating cases. So far, the SEC has brought two cases, against Brocade and Comverse, and we're likely to bring more in the future. As yet, we have charged only officers in option backdating cases. However, if the facts permit — and I want to emphasize that all of our Enforcement cases are very fact specific — it wouldn't surprise me to see charges brought against outside directors.
I also think that the backdating cases can provide a few lessons in terms of "do's and don'ts" for directors. In my opinion, the two big "don'ts" are: (1) don't use "as of" dates unless you have carefully thought about the consequences and have explicit approval from legal counsel that it is acceptable to use an "as of" date; and (2) don't assign critical board functions to "committees of one," unless you're extremely careful to adopt procedures to ensure that there are appropriate checks and balances in place. In terms of "do's", let me highlight one: do pay attention to procedures and processes — such as properly signing and dating Actions by Unanimous Written Consent — because simple logistics can get you into trouble.
The D & O Diary finds a couple of points of interest in these remarks. First, the Commissioner is discrete about the possibility that outside directors might face exposure to SEC enforcement actions in connection with options backdating, saying only that he wouldn’t be surprised if it happened, but The D & O Diary reads that to mean that it probably will happen. Indeed, the Commissioner seems to overlook that “Wells notices” already have been served on three outside directors of Mercury Interactive. (A prior D & O Diary post discussing the Mercury Interactive Wells notices may be found here.)
Second, the Commissioner may not have anything in particular in mind in his reference to the Committee of One, but The D & O Diary believes that this could be a reference to the situation at Brocade Communication, where Silicon Valley legal giant Larry Sonsini, who was an outside director of Brocade, for a time allegedly operated as a Brocade board compensation committee of one. A prior D & O Diary post commenting on the circumstances at Brocade may be found here. A WSJ Lawblog post commenting on Sonsini's service as a committe of one may be found here. The Commissioner’s further remarks with respect to Committees of One are interesting in light of the situation at Brocade:
Comment on ABA's Thompson Memo Resolution: In a prior post, The D & O Diary commented on the American Bar Association's recent resolution calling for revision of policies embodied the Thompson Memo. An August 14, 2006 post in the SEC Actions blog has the following interesting comment on the ABA's action:
I think my advice to "don't assign critical decisions to committees of one" is fairly self-explanatory, but apparently it's advice that's also been ignored. Again, I'm not suggesting that committees of one are per se wrong — Delaware law permits it, after all. However, at best, it's far from being a "best practice" in good corporate governance. And at worst, it's a signal to the company's officers that directors are not taking their obligations as a director seriously and are willing to let expediency guide their decision-making.
In view of the continued actions by the government that are eroding fundamental rights in the name of effective law enforcement, the ABA positions represent a good start, yet more is necessary. What is needed here is a recognition by the government - both DOJ and the SEC - that it cannot effectively enforce the law by eroding it. In fact, eroding fundamental rights disrespects the law. Rather, both DOJ and the SEC need to reform their standards for evaluating cooperation to focus on what they need: the basic facts involved and reasonable assurances that the questionable activity has been halted and will not reoccur. If good prosecutors are satisfied on these points they should have what they need in most cases to evaluate cooperation and make whatever prosecutorial decisions are necessary without eroding fundamental rights of the company and its employees.
The D & O Diary couldn't agree more.