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Firm partner's research shows that general counsel who understood backdating's accounting implications are getting hit hardest

Corporate Counsel

January 3, 2008

Why is the government taking action against some general counsel who backdated stock options, while letting others off the hook? According to John Villa, the key is whether GCs knew that backdating creates an accounting problem. If they did -- and did nothing to fix it -- they're more likely to face a civil suit from the Securities and Exchange Commission or criminal charges from the U.S. Department of Justice.

Villa, a partner at Williams & Connolly, reached his conclusion after looking at the cases of seven general counsel who face criminal or civil charges for backdating. He recently published his findings in ACC Docket, the magazine of the Association of Corporate Counsel. Though Villa's article does not name all of the seven legal chiefs that he studied, they are Lisa Berry of KLA-Tencor Corp. and Juniper Networks Inc.; Nancy Heinen of Apple Inc.; Myron Olesnyckyj of Monster Worldwide Inc.; Kent Roberts of McAfee Inc.; Kenneth Selterman of Take-Two Interactive Software Inc.; Susan Skaer of Mercury Interactive Corp.; and William Sorin of Comverse Technology Inc.

Villa recently discussed his research with Corporate Counsel senior reporter Sue Reisinger. An edited version of their conversation follows.

Q: In 2005 you looked at all SEC and criminal proceedings against in-house counsel over the past eight years. What's changed since that study?

A: The options backdating investigations exploded in 2006. Many investigations are in the SEC pipeline. Some of them directly implicate inside counsel more than the earlier financial restatement cases.

As of today, options backdating cases have resulted in SEC actions against six general counsel, and federal criminal charges against three [Olesnyckyj, Roberts, and Sorin]. One general counsel [Selterman] faces state criminal charges.

Q: There are hundreds of options backdating investigations pending at the SEC. Why are there are only seven cases against general counsel?

A: First, there may be many still in the pipeline waiting to be brought. Second, and most importantly, just because a general counsel was involved in backdating stock options is probably not enough to warrant charges. Ordinarily, there must be believable evidence showing the general counsel understood that if the backdated options were made known to the accountants, that there would be a material increase in compensation expense and a corresponding reduction of income.

Q: But ignorance of the law is no defense!

A: I won't take that bait. I will say that where the essence of the accusation is that you engaged in conduct intended to falsify the financial statements, a basic element of the charges must be that you understood how the conduct would impact the financial statements.

Q: So ignorance of the accounting is a defense?

A: That's a novel idea -- I like that.

Q: Are there factors that seem to increase the risk of the inside counsel being charged by the SEC or law enforcement?

A: As I suggested before, the cases brought seem to be ones where the inside counsel allegedly knew of the impact on accounting. That knowledge is often demonstrated by documents or even conduct, such as altering board minutes or creating a slush fund of backdated options that are issued to fictitious employees.

Q: Do you think that there are more charges to come, or have we seen the worst of it?

A: Unquestionably, there are more.

Q: Will the trend of treating GCs as gatekeepers -- and holding them responsible for the prevention of wrongdoing -- spread beyond backdating into other matters?

A: First, call me a throwback, but I am deeply skeptical of the notion of "gatekeeper responsibility," and I do not believe that it should ordinarily apply to lawyers -- inside or outside. We are advocates and advisers.

As to your question, I think that we may have hit the high-water mark of this lawyer-bashing cycle. I hope that the SEC understands and values the role of private lawyers and does not want to turn them into snitches who sell out their clients to avoid regulatory action.

Q: So you have confidence in the SEC?

A: It has shown itself to be an unusually thoughtful regulator when it comes to dealing with lawyers.