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Options Backdating Cases Strain Enforcement Division's Resources

The SEC's Enforcement Division currently is investigating in excess of 100 options backdating cases, which is putting a strain on the Division's resources, according to director Linda Chatman Thomsen. In many of these cases, the companies came to the SEC with information about their option grant practices. The staff has given credit to these companies, she said, but has not offered amnesty in any instances. Thomsen discussed Division trends and priorities at a recent Practising Law Institute conference.

The staff does not bring enforcement actions in all options backdating cases. Thomsen said that many companies have already received closing letters from the Division indicating that no further action will be taken by the SEC.

The underlying conduct is ultimately what governs whether there is an enforcement action or not, Thomsen said. Some cases involve very profound lying and cheating, she noted, while in other instances the conduct is not that far-reaching. The cases where closing letters have been issued are those where the issues are minor or the staff found that there was really nothing amiss, she said.

She noted that every time there is a restatement of financials, there is a violation of the securities laws. The division does not bring every case, however, because it is looking only for the worst kind of conduct, where there are indicia of recklessness and fraud, she said.

"The amount of money involved is among the least significant factors," Thomsen said. "The staff is looking at how intentional the conduct was --how intent the company was on giving options that look like they are at the money when they are actually in the money." She noted that directors are intrinsically part of the option grant process, so the staff is looking closely at their behavior, as well as at the actions of a company's lawyers and auditors.

Thomsen said that between October 1, 2005 and September 30, 2006, the Division brought 574 enforcement actions. Of those, 24% involved financial disclosure and reporting, and 16% were investment adviser cases, including market timing and late trading. She said that 13% of the cases involved broker-dealers and 8% were insider trading cases.

Insider trading is an ongoing focus of the Division, according to Thomsen, particularly with respect to trading by hedge funds prior to M&A transactions. In these cases, it is easy to identify suspicious trading, but harder to determine whether it is insider trading. It is a focus area for the staff, but she expects it to be difficult investigatory work.

Former enforcement director Stephen Cutler, now a partner at Wilmer Cutler, asked Thomsen about the impact of the recent case against the officers and directors of Spiegel Inc., and whether the industry can expect to see more cases against outside directors. She said that there is no particular focus at the Division on directors or lawyers, but she did not rule out future actions.

She noted that in the Spiegel case, the outside directors were actively involved in encouraging the company not to comply with the securities laws. "We don't want to chill the important role of outside directors for companies, but if there is egregious behavior we have to look at it," she said. When the staff examines these cases, she advised, it is looking for active involvement and participation by outside directors.

Cutler also asked about a recent case against three German nationals and whether that might dissuade foreign investors from using the U.S. markets. Thomsen said that in instances involving foreign nationals, the Division feels that it is within its jurisdiction if there are securities trading in the U.S. market. Cases like the recent one help to keep U.S. markets safe and fair, she noted, and that provides a competitive edge at a time when more business is going offshore.