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In April 1998, Cendant disclosed a restatement in 1997 results, including a reduction of net profit of 100 million U.S. dollars because of accounting irregularities. Then on July 14, 1998 Cendant a further adjustment of the financial results for 1995, 1996 and 1997, including all quarters through the recognition of fictitious revenue and cookie-cutter Reserve mismanagement. Cendant announced in late August SEC report to a reduction in operating income of 500 million U.S. dollars, a decline in net income before taxes in the amount of $ 297 million and the impact on earnings per share. As a result, the market price of the stock fell from a peak of $ 35. in April to $ 11 per share in August. The rule is a 10% decline the share price after a negative message is enough for a class action within 72 hours. Here was the precipitous decline: 69%.

Fifty cases were in the U.S. District Court, which were approved by the judge with several institutional investors as lead plaintiff. Hundreds of thousands of documents by Cendant, Ernst & Young and the various defendants. An investment banking firm and a forensic team were considered experts. Cendant for $ 2.8 billion. Ernst & Young settled for $ 335 million. This settlement was followed by even bigger ratings in the cases of WorldCom ($ 6.2 billion) and Enron ($ 7.1 billion, pending a final court approvals).

Enron directors agreed to collective action against it for $ 168 million as a share of the settlement. Insurance, the bulk of the costs, but they did with regard to the directors personally paid $ 13 million. WorldCom directors settlement had to make to their proportionate share, $ 54 million, so that it $ 18 million compared to a personal liability basis. The directors in the settlement, which no maladministration.

Backdating stock options

The backdating scandal, which we just read in the Wall Street Journal may be academics, affect up to 3,000 public companies. Defense attorneys and plaintiff experts are beginning to mobilize. This potentially massive range of process and expert testimony occurred, because the practice in the last ten years in the possession of public companies the share options granted to executives, in-the-money ", but not correctly, as an expense and thus violating GAAP, misstating and taxes, as well as every three months, since the practice started. In other words, dates were set for the options with hindsight, that the earlier data than the actual date of allotment. The SEC has just started an investigation in about eighty companies, and the list grows daily. The Ministry of Justice and the U.S. Attorney offices and logistical decisions, such as the allocation of cases predicted. Several prosecution were filed. At the very least, companies that deal with civil charges by the SEC massive restatements and the guarantee for the virtual class and derivative suits. The suits have that the concerned companies and their executives and boards of directors have established themselves in the breaches of fiduciary duty, gross mismanagement, unjust enrichment and violations of the SEC Act of 1934. Back-of-the defendants have options to pull millions of dollars in illegal profits at the expense of society. One firm alone, recently submitted 34-derivative suits. It is the largest area of civil litigation in the history that is beginning to unfold before our eyes.

Shareholder Derivative Suits

Shareholder derivative suits are always in connection with class actions. A major concern is that the directors and officers are without coverage for defense costs, prices for the plaintiff attorney's fees and a monetary settlement. Director & Officer insurance sometimes exclude payments for non-civil litigation in which certain types of fraud, the SCIENTER exist. Even if this were the case, usually the cover is not until an indictment is brought. Another area of the elements of the danger is that often the payments on a first-come, first serve basis. In other words, in order that claims are filed. This can often lead to a shortage in the event of a solution.

There is an upward trend in applications for derivative suits, which acts primarily in the state courts, as opposed to class actions in federal district courts. State courts often allow applicants to non-unanimous decisions (in the Federal Republic) and some laws allow lower standards for the purposes of exploitation of the results. This stand-alone derivative suits are generally for breach of fiduciary duty, proxy violations, excessive compensation and a violation of duty of care or the duty of loyalty.

The Business-Judgment Rule actively supports decisions of the Board of Directors, but it does not refer to these violations. For example, breach of duty of care not stupid decisions, ill-advised actions or illegal violation of federal laws. The representations of non-compliance issue management is a further example of this type of injury.

A solution to an adequate D & O coverage is an A-side policies, which protect directors and officers of losses is generally not compensated. These policies generally cover even under adverse conditions, including bankruptcy, if the boundaries of the traditional policy are exhausted, and under normal circumstances when the policy excludes payments. Some states do not allow compensation of corporate unsuccessful defense against derivative suits and in these cases, an A-side is just the cover.

The Private Securities Litigation Reform Act of 1995, the changes and a safe harbor for companies in one aspect of derivative suit - the forward-looking statements. Weak conclusions are not allowed in plaintiffs pleadings. Allegations have specificity to falseness or why the statements from the company were misleading. In the context of the Safe Harbor provisions of the Reform Act, a company is not liable for the forecasts, which are not correct, if these statements are properly identified and accompanied by a cautionary statement which indicates that actual results may from projected results, and the liability can not exist if the plaintiff does not, the forward-looking statement was with the knowledge that they are misleading. Forward-looking statements are often orally to analysts conferences, so this is a measure of security for the Department of Corporate Public Relations. However, in view of the option backdating practice, there is no safe harbor.

Trading Models

The economic base of these settlements is an area of adversarial testing. In a monograph in the early 1990s, several authors criticized the use of trading models to estimate the total economic damages in class action lawsuits claiming that the results were not reliable and often exaggerated damages of up to 74%. Daubert grounds have been called into question a variety of proposed models. In Daubert directed the Supreme Court of the Federal courts to consider four factors in the evaluation of expert testimony under Federal Rule of Evidence 702: (1) the general acceptance of the economic model, (2) potential errors of precision, (3) or peer-reviewed publication, (4) whether the theory has been tested. In recognition that different models are proposed, the trade does not meet the standards, the court is concerned about whether the model was tested and whether the model was developed by professional economists.

The Journal of Legal Economics is a good starting point for the preservation of sound evaluation methods. It is a double-blind study, refereed journal. Each manuscript will be of at least three qualified persons, in addition to the editor. It was conceived as a forum for authors, both from the profession of lawyers as well as the quantitative professions Accounting, Economics and Finance Ministers, to offer constructive knowledge to colleagues. It is designed so that a useful research tool for the application of the theory as well.

In theory, the "out-of-pocket" loss is the measure of damage in open-class matches. Therefore, a defrauded buyer may return his share to the class member of the damages, less attorneys' fees in the range of 15-30%. However, this actual trade data is buried in repositories, models have to produce tangible results. The Private Securities Litigation Reform Act of 1995, it remains for the court to the most reliable method of proof that damage is available. Two-dealers, there are also models, which assume, probably correctly, that there are passive investors, and there are traders. dealer naturally have a higher probability for the purchase and sale of shares, and thus this model uses parameters for the damage estimated the damage using depositary receipts data. One trader models are often significantly overstated damage by 90-98%. assumptions can therefore lead to prejudice. Three-dealers, there are models that investors with high activity, low activity, investors and intraday traders (who do not use on items). Often, these traders may be granted up to one third of the total trade.

Recommendations

A strategy that is sometimes effective is the formation of a special litigation committee (SLC), the content and form of independence. The Committee has the responsibility to preserve forensic teams to thousands of pages of documents and hundreds of interviews of witnesses. One company alone has 2 million documents to review and expects to pay $ 70 million only an assessment report. The purpose of the Committee is to provide the court with the "business-judgment rule," confidence to the derived measures. However, this process is not as simple and straightforward as it sounds.

Delaware and other states one of the Executive Board in response to complaints by the appointment of an SLC, consisting of independent directors. As long as the SLC is in progress, for the disposal of remains. However, in the adversarial process is that still in progress, submitted applications are often true that the question of the objectivity of the SLC. Delaware courts often slam the door to the SLC by ruling against them and for letting go. If the SLC members with strong social ties to the defendant in relation to the past or future relationships, is a disqualification. Another reason is a public declaration of the head of the SLC at any time prior to the submission of the report reveals that prejudice. It is hard to believe, but this would in some cases it has been destroyed, and it has the company's defenses from the beginning.

Directors often institutional and social connections on the basis of board service. This makes it particularly difficult to find objective third party. Warren Buffet explains it this way: "Why have intelligent and decent directors not so miserably? The answer lies not in lack of laws - it's always been clear that the directors are obliged to protect the interests of the shareholders - but in what I called" boardroom atmosphere. "board membership are requested, and went in record numbers because of the time perception of risk that a director in this environment. However, corporate governance rules are much more seriously and since Sarbanes-Oxley mandates them, these recent revelations almost guaranteed his place in history.

Stock options backdating: CORPORATE REORGANIZATION

From 17 August in the "Wall Street Journal, a study of 87 companies, which have probes, announced restatements had executive resigns or Justice Department investigations into its stock options practices. The SEC has civil charges against executives of public companies, alleging that they were in a decade long fraudulent scheme is not open to grant in-the-money options to themselves and to others by backdating stock option grants to coincide with historically low closing prices of their stock. These complaints have alleged that former executives jointly realized millions of dollars unlawful compensation through the exercise of the option granted retroactively illegal and the subsequent sale of the relevant shares.

In a separate question, U.S. Attorney's Offices have unsealed criminal complaints collection executives with conspiracy against the anti-fraud provisions of federal securities laws, wire fraud and mail fraud. It was claimed that the option granted retroactively and secret election slush funds "deception of the highest order" to the shareholders. Executives, according to the SEC, repeatedly used to collect data retrospectively, if the closing price of the shares was at or near a quarterly or yearly low. The complaints further allege that the under-settled accounting principles in effect at the time that companies, in-the-money "options have been invited to an expenses and amounts in such applications with the Commission. The executives were also violations of the Sarbanes-Oxley officer certification provisions of federal securities laws. An injunction, civil penalties, disgorgement, with interest rates of compensation, and officer and director bars against each defendant has been requested.

HOW THE backdating OCCURRED

It is helpful to examine how the practice emerged in the redevelopment of their own internal policies effectively take place. The executives and controls the granting of options and initiates the backdating are. Among other things, they are specially selected retroactively granting data interface with the Compensation Committee. Grant documents with false data obtained were approved by the Compensation Committee. Unscheduled grants have been the modus operandi. A table that lists the proposed grantees. At some point, the executives' Cherry-back "date of grant using back at historical stock prices and with the benefit of hindsight, chose a grant date, was a time when the stock was trading at a relatively low. The master list was then submitted to the Committee for approval.

Unanimous written consent forms in relation to the proposed grant was Compensation Committee members for signature. It was known among the executives that those dates were the "low-ball" look-back dates it had previously chosen. Compensation Committee members were generally not aware of an impending grant from the master list. The members of the Committee, but not their day copies of the permits and will be returned. Based on their participation in the option grant process, each of the defendants knew, or were not aware, ruthless, that the unanimous written consent wrong, because the "how" data contained in the permits and in the company's books and records are not the real data.

The executives knew that no company should be approved, the options were actually granted on the "how" day. She knew this because they are the ones who had the grant data by the use of the look-back tables, with the benefit of hindsight. They had studied historical trade and for a day with a low rate. Options with data entered into force retroactively accelerated the vesting schedule as the company retroactively the deadline for vesting purposes, not the actual date of Compensation Committee. A large number of scholarship grants have been at or near the lowest price for the quarter or year. In an article published by the Wall Street Journal, the patterns of stock options granted were analyzed and astronomically high rates, approaching an approximately six billion, were to exist, that these grants would be at a time shortly before the strong gains in the corporate Share by coincidence.

The secret backdating schemes allowed the defendants to the fact that the companies pay higher compensation for executives and employees by awarding them in-the-money options, and to avoid the expense of in-the-money - options as an expense and thereby avoid reductions for the company's net income and EPS. In addition, some large institutional investors have long been against the stock option plans, the possibility of granting options under the fair value of the underlying stock on the date of grant. This is the basis for the tens of billions of dollars of derivative suits in recent weeks against the related businesses of law firms on behalf of large institutional investors.

The California Public Employees' Retirement System (CALP) is the largest U.S. pension fund, with more than 200 billion U.S. dollars of total assets. They have recently in an open letter to the Chairman of the Compensation Committee of a number of portfolio companies in connection with investigations into stock option backdating practices plans. Your letter contains allegations of effects, including lack of supervision by the board of directors, weak internal controls, weak internal and external audit procedures, poor accounting, significant consequences for the income tax for individuals involved backdating options, and problems with the Executive Compensation Plan Administrator.

Senator Chuck Grassley of Iowa, chairman of the U.S. Senate Committee on Finance, has publicly stated: "It is a matter for the executive branch, to large profits, because he improved his business, but it is an entirely different thing to big profits because he plays fast and loose with the dating of stock options. Outside the corporate suite, the Americans are not in the choice share their dream. The market dictates the price. "

The CFA Institute recently published an open letter to the SEC stating "In the case of post-dating, senior executives (and possibly directors), the inside information or post-closing market prices to determine when the retroactive effective date of the share - based awards, to the return of such awards. This practice is also on the fake accounts, May circumvent financial reporting for "variable" option grants, may be contrary to governance requirements in relation to the pricing of stock options, and can ultimately lead to that criminal and tax penalties against companies that participate in these activities, thereby harming share owner value even more. "

REMEDIATION

In the real world, the best approach is a proactive remediation before any investigation begins by third parties. Materiality must be taken into account under § Bulletin No. 99 and Sarbanes-Oxley thresholds. If the materiality threshold is not exceeded, then no restatements occur. If an adjustment is made, is almost a guarantee for an SEC investigation and a finding of "material weakness" from one to a third party auditor. Material weakness findings could lead to the loss of significant blocks in terms of market capitalization on the disclosure.

The problems are not restricted to IT companies. On their return to studies conducted by researchers at the University of Iowa, and other what is on the first question, but the scope is beyond IT companies. It is estimated that nearly 3,000 companies are involved. In many cases this has no doubt his integrity, and the element of SCIENTER does not exist. The rest of the public enterprises have to study and research Sarbanes adequate procedures to ensure they are not in the future. The first studies of the proxy statements for statistics about the options before the implementation of Sarbanes Oxley is changing the reporting to 2 trading days after August 2002 to the problem has existed since 1996 with the majority of companies. Grant pattern on return to option pricing model has been largely in the mid-1990s. One company alone has almost two million documents, which must be examined to determine the extent of backdating issues. I understand powers of investigation, forensic and related training costs in this one case alone are targeted and Budget for $ 70 million U.S. dollars. This does not include the defense or settlement costs of class action and derivative litigation.

Without going into details of what is known as the Tone at the top, must be reminded of the Compensation Committee of the whole world. Directors and especially the Audit Committee and Compensation Committee members must be re-educated to governance requirements, with the spirit and letter of the law. Compensation programs should not be discouraged by polls, but through superior competitive performance over the long term. Full disclosure is necessary, proxy statements. Independent directors are a vital necessity. Experts, the compensation committees. If they are not there, you need to hire third parties who are experts. Incentive Compensation issues, dilution, performance options and structures, repricing, and a variety of tax and governance issues must be addressed. Steps must be taken to ensure that Board and committee evaluations are fair compensation, and it would be advisable to refrain from using resources to help companies with legal and taxation for executives, in the wrongdoing. This could lead to further derivative suits. Independent detailed investigations on a case-by-case basis with a strong Board of Director support is required. The impact of the Sarbanes must be fully understood and addressed. If the auditor is now a federal campaign. Insider manipulation is not tolerated by the market, or by competent authorities, Supervision. Justice officials have made clear that executives may be possible jail time for backdating stock options. Serious changes and corporate governance must now follow.

The author maintains a website with information about a book he titled "Streamlining Sarbanes-Oxley process: research and practice." "It is for executives, board members and the university use, and contains one of the most comprehensive analysis of the Enron case is available.