ParfumGigi@aol.com

Scott Graham
The Recorder
02-21-2007

A fourth-year associate at Orrick, Herrington & Sutcliffe inadvertently disclosed a sensitive document about stock option backdating that the firm has spent the last five months fighting to keep under seal.

The document -- a complaint in a shareholder derivative action against former executives of Mercury Interactive Corp. -- contains explosive allegations against the executives and quotes extensively from e-mails in which the executives allegedly discuss backdating their own stock options.

"What do you want to do about [Chief Financial Officer Douglas Smith]'s option since the price is going up?" former General Counsel Susan Skaer is quoted asking CEO Amnon Landon in one e-mail. "Keep waiting?"

The complaint, Morillo v. Abrams, 1:05-cv-50710, had been filed under seal on Sept. 22 as part of a confidentiality agreement with the executives' lawyers -- but without judicial approval. The Recorder and two other news organizations have been trying since then to unseal the complaint and its supporting exhibits.

But a Dow Jones News Service reporter discovered Friday that Orrick associate M. Todd Scott had inadvertently filed the complaint publicly with a motion to stay the derivative action in October. The Wall Street Journal posted the complaint on its Web site over the weekend and wrote a story about it on page A-4 of Tuesday's print edition.

In a filing for an emergency hearing on Tuesday, Orrick partner James Kramer wrote that Scott thought the complaint had been filed under seal when Scott included it as an exhibit to his own declaration.

"At the time the exhibit was filed, counsel for Ms. Skaer intended for the exhibit to be filed under seal, and, indeed, believed the exhibit had been filed under seal," Kramer wrote. "Counsel continued in this belief until the afternoon of Feb. 16, 2007, at which time the court clerk notified all parties that the exhibit had not been filed under seal and was publicly available."

The Mercury executives -- represented by Orrick; Wilson Sonsini Goodrich & Rosati; Shearman & Sterling; and Farella Braun & Martel -- have been fighting vigorously against The Recorder, the San Francisco Chronicle and Bloomberg to keep the complaint confidential. The executives succeeded in January in getting the derivative action dismissed for lack of standing, but shortly thereafter Santa Clara County, Calif., Judge James Kleinberg ordered that the complaint be unsealed nevertheless.

The Mercury executives last week obtained an emergency stay from the 6th District Court of Appeal. Orrick also asked U.S. District Judge Jeremy Fogel to block Judge Kleinberg's order unsealing the motion.

On Tuesday, Kleinberg resealed the complaint, but only after it had been published by the Journal. He noted that it apparently had been "present and unsealed" among the 25 volumes of files held by the clerk's office for the past four months.

The complaint alleges that four former Mercury executives "grossly enriched themselves at the expense of Mercury by granting themselves (and their colleagues) millions of underpriced options to purchase Mercury stock."

The complaint, by Lerach Coughlin Stoia Geller Rudman & Robbins partner Amber Eck, alleges that Skaer, Smith, former CFO Sharlene Abrams and former COO Kenneth Klein caused the company "to improperly pay out $164 million to themselves in unwarranted stock-option based compensation." The complaint states that $54 million of that $164 million is directly attributable to backdating.

It also states that Mercury spent $70 million in attorney fees investigating its stock option backdating problem.

Mercury was one of the first companies to publicly admit problems with its options grants. The company was forced to restate earnings by $570 million following an internal investigation. Its board of directors took the rare step of joining plaintiff lawyers in a shareholder suit seeking damages from ousted executives. That changed after Hewlett-Packard Co. announced it had acquired the company last year.

The complaint accuses all four former executives of acting improperly. As for former GC Skaer, it alleges that she "created and falsified documents regarding the backdated options, personally selected backdating dates based on stock price, took minutes in the board and committee meetings where backdating was discussed, and was involved in covering up the backdating."

In one instance, Skaer was granted 25,000 options and Smith got 400,000 at a Feb. 12, 2002, board meeting. The options were backdated to Nov. 2, 2001, when the stock was trading some $12 lower. "This difference ... equates to a $4.8 million benefit to Smith, and a $303,500 benefit for Skaer," the complaint alleges.

Smith had begun lobbying for a low strike price in October 2001, when he sent an e-mail to CEO Landon with a blind copy to Klein, stating, "[A]ssume a $25 strike for new options (could we go back to the lows??). ..." The board voted to grant Smith his 400,000 options on Nov. 6, 2001, but put off pricing the grant because by then the company's stock was trading above the price Smith had suggested, according to the complaint.

"What do you want to do about Doug's option since the price is going up," Skaer e-mailed CEO Landon on Nov. 14. "Keep waiting?" The next month, Smith himself sent Skaer an e-mail proposing various dates that could be chosen, according to the complaint.

On Jan. 11, 2002, Landon e-mailed the compensation committee members, with a "cc" to Skaer, asking them to fax their "unanimous written consent" for the option grants to Skaer. The consent forms were dated Nov. 5, 2001, according to the complaint. The committee members faxed the forms to Skaer's office, but either Skaer or "someone at her direction" altered the forms by whiting out the Jan. 20, 2002, fax dates at the top of the pages, according to the complaint.

"Skaer's intentional deception is revealed, however, by the fact that, because one of the [consent forms] was apparently sent upside down, the actual fax date is listed on the bottom of the document -- a detail that Skaer overlooked and thus did not alter as planned."

At the actual Feb. 12 board meeting -- which Abrams, Klein, Smith and Skaer all attended -- the compensation committee members backed up the date by another three days, to Nov. 2, 2001, which locked in an additional $2.50 per share gain for Smith and Skaer, according to the complaint.

When Smith filed his so-called Form 5 listing the grant, he listed the previously agreed date of Nov. 5. In 2003, a legal assistant noticed the discrepancy and proposed filing an amended Form 5. But Skaer told him not to because the amount was "de minimus," the complaint alleges -- even though the difference was worth more than $1 million.

The complaint also quotes several other e-mails that seem to suggest knowledge of backdating. Payroll manager Susie Fregoso e-mailed Abrams on May 5, 1999, "[W]hat is the date for the April grant going to be? Right now I have it as April 7 with a price of $27.125. You had mentioned that this might change, any news?"

In an Aug. 3, 2000, e-mail to Fregoso about an employee's stock options that had already been granted, Assistant Controller Kathy Hawkes wrote, "I betcha that Sharlene [Abrams] will overrule these type of things ... and we will use her magic backdating ink. Let's see what happens!"

And another e-mail from Fregoso stated, "The reason the paperwork was not sent out is because the stock price drop made us change the grant date so that you could get the lower price. The 'new' grant is being approved next week by Sharlene[Abrams]/Amnon [Landon]. I know it has been a while, but believe me, you will be happier with the new price." The sentence concluded with a smiley face.