(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

Google, General Counsel Charged in Registration Case

The SEC charged Google, Inc. with failing to register the issuance of option grants to employees or provide required financial information to the option recipients. As alleged, the search engine technology company issued over $80 million in stock options to its employees in the two years preceding its initial public offering without registering the securities or making financial disclosures mandated by federal securities law.

The company and its general counsel agreed to cease and desist from violating the registration and related financial disclosure requirements. No other sanctions were imposed by the SEC, reflecting in part the company’s cooperation with the agency and the fact that investors were not harmed. Neither the company nor its general counsel admitted or denied any wrongdoing.

The Commission found that between 2002 and 2004, Google, which was privately held at the time, issued over $80 million worth of stock options to its employees as part of their compensation. Rule 701 provides a registration exemption for certain issuers offering and selling stock options or other securities to employees and consultants under compensatory benefit plans. However, companies issuing over $5 million in options during a 12-month period must either provide detailed financial information to the option recipients or register the securities offering and thereby publicly disclose financial and other important information. The rule is intended to allow privately-held companies to compensate their employees with securities without incurring the obligations of public registration and reporting, while ensuring that essential information is provided to employees.

According to the SEC, the company exceeded the $5 million disclosure threshold, but was reluctant to make the disclosures or register the offering because the required information disclosed to employees could leak to its competitors. The agency also found that the company’s general counsel was aware that the registration and related financial disclosure obligations had been triggered.

The Commission claimed that the general counsel believed that the company could be exempt from the registration and disclosure requirements under other statutory provisions and SEC rules, including the Regulation D exemption for certain sales to accredited investors and Securities Act Section 4(2) concerning private securities offerings. Finally, the SEC stated that the general counsel determined that if his analysis of the applicability of other registration exemptions was incorrect, the company could make an offer of rescission to the option holders.

The critical finding by the SEC was that the general counsel advised the board that it could continue to issue the options without disclosing that the registration and disclosure obligations had been triggered or that there were risks in relying on the exemption. The Commission action is significant in that emphasizes the increased emphasis the Division of Enforcement is placing on scrutinizing the activities of "gatekeepers" such as attorneys.

This action is also important, however, because the complaint did not allege any intentional misconduct by the general counsel. While his legal conclusions concerning the availability of the exemptions may have ultimately been flawed, he was not charged with knowingly advising the board to engage in any unlawful conduct. The possibility of enforcement action against attorneys that counsel boards will require a careful balancing of the amount of detail supporting their legal conclusions and their level of certainty the attorney discloses to the directors with the desire to provide the board with concise and authoritative advice.

Stephen M. Cutler, director of the Commission’s Enforcement Division, said that "the securities laws exist to ensure full disclosure to investors, including employees accepting stock options as compensation" and that "companies cannot freely decide that they don’t need to comply with the law." Added Helane Morrison, district administrator of the Commission’s San Francisco District Office, "attorneys who undertake action on behalf of their company are no less accountable than any other corporate officers." She concluded that "by deciding Google could escape its disclosure requirements and failing to inform the board of the legal risks of his determination," the general counsel "caused the company to run afoul of the federal securities laws."