The Securities and Exchange Commission settled separate civil fraud charges with Mercury Interactive LLC and Brocade Communications Systems, two of the earliest companies to be embroiled in the stock options backdating scandal. The settlements included the first fines to stem from such cases — $28 million for Mercury Interactive and $7 million for Brocade.
The settlements are likely to set a pattern for future cases. The SEC is reported to have undertaken at least 140 backdating-related investigations.
Software maker Mercury Interactive and networking company Brocade, without admitting or denying the allegations, also agreed to be permanently enjoined against further violations.
In the case of Mercury, acquired by Hewlett-Packard last November, the SEC also charged four former senior officers of Mercury: former chairman and CEO Amnon Landan, CFOs Sharlene Abrams and Douglas Smith, and general counsel Susan Skaer.
In the Brocade complaint, the SEC said that the company committed fraud through former CEO Gregory L. Reyes and other former executives, who repeatedly granted backdated stock options, misstated compensation expenses, and concealed the conduct by falsifying documents.
The Commission alleged that Mercury Interactive and the former executives “perpetrated a fraudulent and deceptive scheme” from 1997 to 2005 to award themselves and other employees undisclosed, secret compensation by backdating stock-option grants, failing to record hundreds of millions of dollars of compensation expense, and falsifying documents to further this scheme. Through Landan and at times Abrams, Smith, or Skaer, the SEC alleged, Mercury also made fraudulent disclosures concerning Mercury’s “backlog” of sales revenues to manage its reported earnings, and structured fraudulent loans for option exercises by overseas employees to avoid recording expenses.
“The $28 million corporate penalty in this case, together with a permanent injunction, should send a clear signal that fraudulent stock option backdating and other financial fraud will be severely punished,” SEC Chairman Christopher Cox said in a statement. The SEC alleged that the company backdated 45 different stock-option grants to executives and employees, representing every grant made by the company to executives and employees from 1997 to April 2002.
It accused Skaer or others at her direction of preparing false documentation for the grants, including false written consents and meeting minutes. The complaint alleged that Landan, Abrams, Smith, and Skaer each personally benefited from in-the-money backdated stock options, in the aggregate collecting millions of dollars through the fraudulent scheme. The complaint also alleged that from 1998 through 2001 Mercury, acting through Landan, Abrams, and Skaer, fraudulently backdated the date of option exercises of certain senior Mercury officers. Through Landan, Abrams, and others, the SEC said, Mercury “secretly managed” the company’s reported earnings per share to meet or exceed financial analyst expectations by manipulating the recognition of revenue and making fraudulent disclosures concerning its sales orders. According to the complaint, Mercury stopped the shipment of its products once revenue targets for a period had been achieved, pushing the recognition of the revenue into subsequent periods.
The complaint alleged that from 1999 through 2005, Abrams, Skaer, and others participated in fraudulent structuring of loans for stock-option exercises by overseas employees, concealing the accounting consequences of those transactions and causing the company to fail to report about $24 million in required compensation expenses, which “materially overstated” the company’s reported pre-tax earnings during this period.
Landan, Abrams, Smith, and Skaer were accused of violating or aiding and abetting violations of the antifraud, record-keeping, financial reporting, internal controls, equity transaction reporting, and proxy provisions of the federal securities laws. It was alleged that Landan and Smith violated a Sarbanes-Oxley provision when they signed certifications that were false and misleading concerning Mercury’s 2002 through 2005 periodic reports.
The SEC said it is seeking permanent injunctions, disgorgement with prejudgment, interest, civil monetary penalties, and officer and director bars against each of the individuals in the Mercury case. In addition, it will seek against Landan and Smith the reimbursement of bonuses and profits from stock sales under Section 304 of the Sarbanes-Oxley Act.
In the Brocade case, falsification of reported income from 1999 through 2004 was alleged. The SEC said that Reyes routinely provided extra compensation to employees by granting valuable in-the-money stock options for which a financial statement expense was required. To avoid reporting to investors the hundreds of millions of dollars in undisclosed compensation expenses, Brocade’s former executives allegedly concealed the fact that the options had been granted in-the-money by creating records making it falsely appear that the options had been granted at a lower price on an earlier date, it added.
“Brocade is being held accountable for the egregious and long-running misconduct of its former CEO and other former executives who misled investors and obscured the company’s financial condition and performance,” Marc Fagel, associate regional director of the San Francisco regional office, said in a statement.
The Commission alleged in the complaint, and in an earlier complaint against Reyes and other former executives, that Brocade backdated dozens of grants for tens of millions of stock options. Among other things, the SEC said, Brocade personnel backdated large option grants for prized new hires to dates before the employees had even interviewed at the company, creating false paperwork to make it appear the employees had been hired months earlier. When the stock option abuses surfaced, Brocade’s audit committee conducted a thorough investigation, resulting in the resignation of Reyes and the restatement of the company’s previously-reported income, the complaint said.
Last July, the Commission charged Reyes, former CFO Antonio Canova, and former vice president of human resources Stephanie Jensen, with fraud and other securities law violations. That action is ongoing.