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.