Backdating: A little less than meets the eye
I'm not defending it, but ...
In a recent conversation about options backdating that I had with Stanford law professor Joseph Grundfest, who heads its Rock Center on Corporate Governance, he kept having to use that phrase as he explained an interesting point I hadn't really appreciated until then. Now I'll need to make liberal use of that phrase too.
Though recipients of backdated options received unfair gains, and shareholders were deceived--and I'm not defending either injustice--in each case the extent of the harm may be a little less than some of us are assuming.
Suppose a company gave you, in 1999, one option to buy one share of stock whose closing price that day was $20. Suppose further that the company backdated the grant by a week, so that it could give you an exercise price of only $19. You haven't received $1 of profit yet, however, because your option won't vest for at least a year, and you don't know what the price will be then. In Silicon Valley, options typically vested over a four or five year period, with a one-year "cliff" before the first of them started vesting. Because of the bursting of the tech bubble, a great many, if not most, were out-of-the-money and worthless by the time they vested.
One way to measure what you've received would be to calculate the difference between a Black-Scholes valuation of the $20 option and a Black-Scholes valuation of the $19 option. When we were talking, Grundfest then went to one of the many Black-Scholes calculators on the web, filled in some hypothetical parameters--the calculation will vary a little depending on factors like volatility and expiration date--and found that the fair market value of his hypothetical backdated option (with a $19 exercise price) would have been $13.31, while the fair market value of the non-backdated $20 option would have been $13.06. So, in a sense, you were given about a quarter, not a dollar. Of course, a lot of quarters can mount up to real money, so I'm not defending this practice.
When it comes to trying to figure out the degree to which shareholders were deceived, the computations are difficult, in part because, at the time, the biggest piece of the accounting deception was lawful: companies could pretend that at-the-money options bore no cost at all, requiring no expensing at all. In addition the accounting methodologies for expensing in-the-money options in 1999 and at-the-money options today are different, making comparisons difficult.
Indeed, just doing the proper calculation for in-the-money options in 1999--a process called variable accounting--was hellishly difficult. The company theoretically would have had to recalculate the amount to expense each quarter, based on the fluctuations of the stock price vis-a-vis the strike price. The process was so complex that most companies avoided having to do it, and many accountants still aren't sure about how to handle certain details of the process.
For a company now to do a retroactive restatement applying that methodology over a period of years for multiple grants of thousands of options will typically require that it miss its quarterly filing deadline. Missing the filing requirement will probably cause the company to receive a delisting warning from its stock exchange and put it in technical default on its bank loans. So there is a snowball effect that, in some cases, may be disproportionate to the crime.
But I'm not defending it.
The Grasso judge's other comp case
Judge Charles Ramos, who ruled yesterday that former NYSE chairman Dick Grasso should cough up a large chunk of his controversial $187 million compensation package, authored another famous ruling in which he tried to pare down someone else's giant payday. In that case, however, his ruling was opposed by Attorney General Eliot Spitzer, and Ramos was also ultimately reversed.
The tale is recounted by Reynolds Holding in his forthcoming article about Judge Ramos, which is scheduled to appear on the new Web site www.judicialreports.com on Monday afternoon (October 23). Dirk Olin, the director of Institute for Judicial Studies, which runs that site, has kindly agreed to let me publish excerpts here. (Holding is a contributing writer there.)
Ramos's other famous comp case arose out of the $206 billion global tobacco settlement of 1998, in which state attorneys generals, assisted by private contingent-fee plaintiffs attorneys, had sued the major tobacco companies seeking Medicaid reimbursement. For the New York portion of the award, an arbitrator had awarded six NY law firms $625 million, which came to a payment of about $13,000 an hour.
Holdings continues: "In 2002, the arbitrators' award was submitted to Ramos. But instead of confirming the award, Ramos challenged it, a move opposed by the lawyers, the tobacco companies, and Attorney General Spitzer. Spitzer's office argued that challenging the fees might jeopardize the entire settlement, but Ramos would not budge. 'A legal fee must pass the test of reasonableness,' he wrote in an opinion freezing the payments. . . . The New York Appellate Division ruled unanimously that Ramos lacked the authority to review the fees . . . ."
The JudicialReports article analyzes Ramos's reversal rate as follows: "From 2000 through 2005, 267 of the judge's rulings were appealed. Higher courts affirmed 182 and reversed 85, a [reversal] rate of 31.8 percent that ranks him 22nd of 62 judges, or within the top 35 percent, in the Manhattan civil term."
But whether Ramos's new ruling on Grasso's compensation holds up or not, it at least appears to assure Eliot Spitzer that he'll make it through the election without any major embarrassment in the case.
Vioxx suit tally: 23,800 cases for 41,750 plaintiffs
This morning Merck announced the number of Vioxx-related lawsuits that had been filed against it as of September 30, 2006. That date is crucial, because it represents the second-year anniversary of the company's withdrawal of Vioxx from the market, and the vast majority of states have either one- or two-year statutes of limitations for personal injury suits. According to Vioxx plaintiffs lawyer Mark Lanier, only seven states remain with statutes of limitations that have not yet expired. So we're getting close to the grand totals.
As of September 30, 2006, Merck had been hit with 23,800 suits on behalf of 41,750 "plaintiff groups." (A plaintiff group might include the spouse or dependents of a victim, who might be alleging "loss of consortium" or other damages related to the loss of a loved one or breadwinner.) In addition, the company now faces 275 class actions, either for personal injury or economic damages (including consumer fraud suits, seeking reimbursement for patients' costs of buying a drug that was allegedly misrepresented as being safer than it really was, even if nothing bad ever happened to the purchaser as a result.)
The September 30 date is important for another reason. Because most of the filing is complete, Merck can realistically begin to consider moving toward a settlement strategy without worrying that its willingness to settle would entice a deluge of suits by lawyers and clients seeking quick and easy money. Though the company is still pledging to fight every one, that might be a posture it can begin relaxing. Says Lanier in an email: "Merck is going to have to come up with another strategy than to try every case. Aside from the fact it abuses the court system (the corporate version of lawsuit abuse), the next 12 months Merck will sustain some real significant losses."
Merck also announced today that it would increase its reserves for Vioxx-related legal defense costs from $685 million to $958 million, and said it had spent $325 million on defense costs during the first nine months of 2006. The company has not yet allocated any reserves toward paying Vioxx-related judgments or settlements.
MERCK REPLY: I solicited a received a comment from Kent Jarrell, a spokesperson for Merck's outside law firm, Hughes Hubbard & Reed. Here his comment in its entirety:
"You are correct that in most states the statute of limitatations has now run. But by our count when it comes to personal injury lawsuits, there are still 28 states with longer limits and in death cases, there are 16 more states.
"The last minute increase of filings just before Sept. 30th 2006 is not unexpected. Generally this tide of 'deadline beater' cases turn out to be comprised of weaker cases. Plaintiff lawyers faced with a filing deadline want to avoid malpractice claims from their clients for failing to follow through and actually filing their cases.
"As we examine cases, we are finding, time after time, that the allegations are not backed up by facts. The claims of over 3,000 plaintiff groups have been dismissed to date. More specifically, there have been over 1,100 plaintiff groups whose claims were dismissed with prejudice either by plaintiffs themselves or by the courts. Over 2,000 additional plaintiff groups have had their claims dismissed without prejudice. Almost 800 plaintiff groups had their claims dismissed by courts because plaintiffs did not submit fact sheets or were dismissed by plaintiffs themselves after Merck noted their failure to submit fact sheets.
"From the beginning, Merck has said it would look at this litigation on a case by case basis. That is exactly what we have been doing. It takes resources to back up our ongoing strategy and that is what this reserve increase is all about. We face a rigorous trial schedule for the rest of this year and into next year. We have the legal infrastructure in place across the country to ensure that we continue engaging in a vigorous defense of this litigation.
"Remember, it is the plaintiffs who are responsible for filing cases. They
now seem to be frustrated by the very fact that Merck is closely examining each one on an individual basis and is prepared to go to court to defend the cases."
Is AMD an American company?: expert feedback
Among the interesting reader responses to my earlier entry concerning the recent ruling in AMD's antimonopolization case against Intel was one from an expert in the field. I thought I'd highlight excerpts here, although you can read his entire post there.
The commenter is Jonathan Rubin, Senior Research Fellow at the American Antitrust Institute in Washington, D.C. The AAI describes its members as "post-Chicago centrists dedicated to the vigorous use of antitrust as a vital component of national and international competition policy." I.e., the AAI tends to fall on the pro-antitrust enforcement side of the political spectrum, as opposed to those who are more fearful of government intervention and more trusting in the power of markets to right themselves. Full disclosure: Among the long list of contributors to AAI is AMD itself. The head of AAI tells me that he does not believe any contributor accounts for more than 5 percent of the organization's funding. Here are excerpts from Mr. Rubin's comment:
"I am following the AMD v. Intel litigation for what the case may ultimately signify for antitrust policy. Unfortunately, as often happens when the news media report on such arcane matters the public can get the wrong message. . . . As the blog entry correctly points out, the judge's ruling means only that the 'U.S. court [in Delaware]ha[s] no subject matter jurisdiction over portions of AMD's complaint.' Where the news media have gone wrong, in my view, is by reporting this ruling as reflecting poorly on the merits of AMD's case, or at least a substantial portion of it.
"For example, Reuters reported that the judge had dismissed 'a large portion' of AMD's case. FT.com called the ruling a 'significant setback.' The AP said the judge dismissed a 'key component' of AMD's case. And, while your blog entry is for the most part quite accurate you nonetheless raise the specter that because of this ruling 'AMD may not even be able to prove its case at all.'
"It is possible for a single preliminary procedural ruling to sink a lawsuit, but that is clearly not the case here. The court's recent ruling has little to do with the merits of AMD's claims against Intel, anything that AMD 'failed to prove,' or even AMD's country of residence, as the titular question of your post suggests ('Is AMD an American company?'). Raising the prospect of a faltering case on the basis of this interim ruling is not justified.
"Judge Farnan found that the [1982 law] deprived the court of jurisdiction over certain of AMD's independent, stand-alone foreign antitrust claims. Doing so does not disparage any of AMD's antitrust claims, foreign or domestic. . . .
"Two further issues arise. . . . The first is whether, when the relevant market . . . is global, the judge's interpretation of the [1982 law] is correct. . . . There was in the early-1980's significantly less interconnectedness than in the years since that have witnessed tremendous globalization. . . . It is not at all clear how the international legal regime should handle the issues of duplication and overlap that arise when the relevant antitrust market exceeds jurisdictional and political boundaries. There is no facile answer. . . .
"The second issue apparently is being raised by Intel, which argues that the court's . . . ruling means that AMD will not be able to avail itself of foreign discovery. In my view, the court is unlikely to so constrain AMD. If the domestic claims not affected by the ruling require international discovery, the . . . ruling provides no legal basis for denying it . . ."
Pellicano Case: Moment of Truth for Bert Fields
Speaking of investigations into investigations, the NYT has an interesting piece today suggesting that prosecutors are coming to the put-up-or-shut-up point as to whether they will charge legendary entertainment lawyer Bert Fields in connection with their probe of alleged illegal wiretapping by private detective Anthony Pellicano. (Click here for that article.)
Fields frequently hired Pellicano as an investigator, but has maintained that he never knew that Pellicano was doing anything illegal (assuming, for the sake of argument, that Pellicano was). Reporter David M. Halbfinger reports that "at least 10 members" of Fields law firm, Greenberg, Glusker, Fields, Claman & Machtinger, have been called before the grand jury in recent weeks.
The definitive article about Fields and his connection to the Pellicano matter was Ken Auletta's fascinating profile in The New Yorker. (You can read it here.) Personally, Auletta's story left me feeling that Fields was probably guilty, though most of the evidence pointing me in that direction was totally inadmissible--including daring tactical gambits he'd employed in unrelated cases and the behavior of a fictional, non-squeaky-clean lawyer-protagonist in novels written by Fields.
A detail I've always found intriguing about the case is that in 1995 an attorney from Fields's firm registered, on Pellicano's behalf, the trademark for a device called Telesleuth, which is described in the Pellicano indictment as "a computer software program to be used for the purpose of intercepting telephonic communication." The indictment also alleges that Pellicano did, in fact, use Telesleuth illegally for that purpose.
H-P charges beset with hurdles
An odd subtlety in the facts underlying the criminal "pretexting" case against former Hewlett-Packard chairman Patricia Dunn and others may pose a hurdle to California Attorney General Bill Lockyer's office as it tries to prove the "computer crime" charge it has lodged in that case.
The statute cited makes it a crime to "knowingly access without permission and take, copy, and make use of data from a computer." (The provision is California Penal Code Section 502, which can be found be scrolling down the page linked here.) The potential problem is that both Dunn and the H-P inhouse counsel supervising the probe--Kevin Hunsaker, who is also charged as a defendant--appear to have believed that the phone records were obtained entirely through oral conversations between investigators and telephone employees, not through any techniques resembling computer hacking. Dunn got her information largely from Hunsaker, and Hunsaker expresses this misunderstanding repeatedly in the internal H-P memos that were made public last month by a subcommittee of the U.S. House of Representatives Energy and Commerce Committee.
In reality, we now know that the subcontractors who actually did the pretexting resorted to other techniques as well, some of which certainly look like the crime alleged here. To access the phone records of former H-P director Tom Perkins, for instance, a subcontractor (who is also charged) allegedly went online and gained access to his account by entering his phone number and the last four digits of his social security number into a dialog box. Such a procedure looks and feels more like the computer crime described in Section 502 than simply speaking to a live phone company employee over the phone. Of course, even the orally deceived phone employee would presumably then fetch the desired information out of a computer, but that wouldn't be what we'd typically think of as a computer crime. (Or would it? What do people think?)
(The social security numbers appear to have been gathered mainly by the subcontractors themselves, using what they have called subscription databases available to licensed investigators. In at least one internal memo, Hunsaker admits having known that social security numbers might be used in the process, though he seems to have believed that they would be used verbally. I can't find any evidence yet in the documents made public by the the House subcommittee that Dunn ever knew that social security numbers would be used.)
To be sure, Dunn, Hunsaker, and their three co-defendants--the outside security contractors and subcontractors who actually carried out the pretexting--are also charged with three other offenses besides the computer crimes provision. But, as has been previously reported to varying degrees, each of those charges also carries its own significant challenges when the attempt is made to bring "pretexting" within its ambit. Attorney General Lockyer's best bet certainly looks like the charge of "fraudulently obtaining . . . customer records" from a public utility, which is elsewhere defined to include any "telephone corporation." (California Penal Code Section 538.5 and California Public Utility Code Section 216. Section 538.5 can be found by scrolling down this page.)
Yet there are at least two potential problems with this charge, too. First, Dunn will doubtless argue--as she repeatedly did during her testimony before the House subcommittee on September 27--that she had no idea records were being "fraudulently" obtained, in that she had been repeatedly assured by both senior attorney Hunsaker and H-P's respected then-general counsel, Anne Baskins, that they were lawful. (Baskins, who resigned and then took the Fifth at the Congressional hearing on September 27, has not been charged.) The other possible problem with the public utilities charge is that, notwithstanding its broad and seemingly applicable language, it appears to have never been designed or used before to catch pretexting. In an interview, Stanford law professor Robert Weisberg says that the 1982 law may not have been intended to protect the privacy of customers, but, instead, to protect public utilities from having their trade secrets--including customer lists--stolen.
The third charge against Dunn, called "using personal identifying information without authorization," requires that the defendant "willfully" obtain the information "for an unlawful purpose, including to obtain . . . credit, goods, services, and medical information." Dunn's purpose was arguably different in kind from those listed in the statute. (This statute, California Penal Code Section 530.5, can be found by scrolling down this page.)
The fourth and final charge is "conspiracy" to commit the other three offenses, so it's viability depends on the validity of the three underlying offenses.
The reason, of course, that the prosecution's case faces so many hurdles, is that California did not enact a law specifically aimed at prohibiting pretexting until September 29 of this year--two days after the Congressional hearing. Interestingly enough, this new law only makes the offense a misdemeanor, whereas all the charges Attorney General Lockyer has brought are felonies. What do people think of the fairness of this situation? (I'm putting aside the fact that Dunn has fourth-stage ovarian cancer. That alone, of course, might lead to her acquittal due to jury nullification.)
Is AMD an American company?
On September 26, there was a surprising, potentially important ruling in the antitrust case Advanced Micro Devices has filed against Intel in federal court in Delaware. That's the case in which AMD alleges that Intel, through varying types of exclusionary or predatory conduct all over the world, has been illegally trying to preserve its alleged monopoly on the market for x86 microprocessors, which are the silicon brains running most personal computers. (Click here for a feature story about that case.)
The ruling was that the U.S. court had no subject matter jurisdiction over portions of AMD's complaint, because those allegations involved "foreign commerce." U.S. District Judge Joseph J. Farnan, Jr., was interpreting the Foreign Trade Antitrust Improvements Act of 1982, which dictates that the Sherman Antitrust Act "shall not apply to conduct involving trade or commerce ... with foreign nations unless ... such conduct has a direct, substantial, and reasonably foreseeable effect ... on import trade ... or ... on export trade." (To read Judge Farnan's ruling, click here.)
At one level the ruling might sound dumbfounding, while at another it makes perfect sense. Those who drop their teeth when they read it look at the dispute this way: AMD and Intel are each unambiguously American companies whose headquarters are about a mile-and-a-half away from one another in Silicon Valley. (AMD's exit off U.S. 101 is called Sunnyvale, while Intel's is called Santa Clara.) They are each incorporated in Delaware, where AMD sued. (It sued there because of federal appellate precedents there which its lawyers find encouraging.)
Each company competes with the other globally; i.e., they sell a large number of microprocessors to customers here in the United States, and they export the rest to foreign customers. So if Intel were, as AMD alleges, illegally leveraging its monopoly power in, say, Japanese, Chinese, German and U.K. markets -- allegedly bribing and threatening customers into filling 90 percent to 100 percent of their chip needs with Intel products -- and if it were doing so in an effort to preserve its monopoly on the global x86 market, why wouldn't a U.S. court have jurisdiction over the whole conspiracy?
In fact, Intel acknowledges that a U.S. court unambiguously would have had jurisdiction over all aspects of AMD's beefs with Intel until 2002. But in that year AMD finally phased out the last of its silicon fabrication plants on U.S. soil, and began relying exclusively on fabs set up in Dresden, Germany. So Intel argues that AMD can no longer claim to be exporting American chips around the world. Instead, it is now engaged largely in foreign commerce: Its chips are made in Germany, tested and assembled in Malaysia, Singapore and China, and then sold to customers who are, more than 70 percent of the time, according to Intel, also outside the U.S.
Accordingly, argues Intel, the U.S. court now has antitrust jurisdiction only over those portions of the case that involve chips returning to this country -- either because they are sold to computer makers here (e.g., Dell, HP, or an American subsidiary of Sony), or to retail consumers here (e.g., someone entering a Circuit City in Peoria and emerging with, say, an AMD-powered Hitachi notebook).
AMD protested, among other things, that it actually was still in the business of "exporting" chips, in that it continues to design its chips in this country, though it has set up its manufacturing facilities abroad. (AMD is not outsourcing its chip manufacture; AMD's German fabs are owned by a wholly-owned AMD subsidiary.)
"We live in a world economy," AMD's lead outside counsel Chuck Diamond argues to me in an interview, "where the U.S. is very much involved in the export business although [actual] encasing its intellectual property in physical manifestations may be the last, and a small part, of the value-added stream. To say AMD is not an exporter of American made product because the silicon packing occurs abroad is like saying Warner Bros. is not in the business of exporting motion pictures for home viewing because its DVDs are stamped in Mexico." (Diamond is with O'Melveny & Myers in Los Angeles.)
Nevertheless, in applying the 1982 Act, Judge Farnan agreed with Intel, and struck more than 20 meaty paragraphs from AMD's complaint. The parties don't yet know how important, in practice, the ruling will be. At one extreme, the ruling could mean that the foreign commerce allegations that have been stricken from the complaint have been knocked completely out of the case and that AMD cannot, therefore, even seek discovery about those acts in order to show a jury the role they allegedly played in harming AMD in this country. In that case, AMD may not be able to prove its case at all.
Alternatively, a very narrow interpretation of the ruling would allow AMD to still prove all aspects of its case, while simply limiting its damages recovery if it were ultimately to win its case many years down the road. In that event, for instance, AMD might be limited to recovering damages relating to lost sales in the United States--which could still be a very big number, especially when trebled as antitrust damages awards can be. Moreover, AMD would still be able to pursue its foreign damages in foreign forums.
At a hearing on September 27, Intel's outside counsel Peter Moll, of the D.C. office of the Howrey law firm, said that Judge Farnan's ruling should "dramatically narrow" the scope of discovery, though he did not get into specifics. Only after a special master rules on the crucial discovery impact of the ruling will we really know what Judge Farnan's ruling means, and only then will AMD decide whether to seek to appeal it. (Judge Farnan has set an "immovable" trial date for April 27, 2009.)
What do people think of this 1982 Act, and Judge Farnan's interpretation of it so far? When Congress passed the act, it evidently wanted federal courts and enforcement authorities to show deference to the competition authorities of our foreign trading partners. There's little question that AMD's case against Intel implicates many of the precise concerns Congress had at that time. In addition to the Delaware case, AMD has brought two civil cases against Intel in Tokyo, and has voiced grievances about Intel's practices to government regulators with the European Commission's Directorate-General Competition, the German Federal Cartel Office, the Japanese Fair Trade Commission, the Korean Fair Trade Commission, and maybe others. (The WSJ also reported on October 4 that the EC is now vetting a draft of formal charges investigators would like to bring against Intel before an internal "devil's advocate" panel of legal experts. These proposed charges are apparently the culmination of an on-again, off-again probe that EC investigators have pressed for more than five years. Click here for that story.)
Obviously, there does need to be some mechanism to prevent double recoveries and the like. But is the 1982 Act the right solution? Did Judge Farnan correctly interpret it? What should the special master do? What do people think?
This is the first entry in my new blog, about legal matters of interest to people who care about business. I'm Fortune's legal correspondent - my formal title is senior editor (legal affairs) - and I practiced law for five years before becoming a full-time journalist many years ago. Like everything I write for Fortune, the blog is intended for nonlawyers and lawyers alike. Please join in with suggestions, contributions and temperate comments, or e-mail me with the same at firstname.lastname@example.org. I'll be feeling my way for awhile in this new medium, so please bear with me.
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