The Scandal of the Options Prosecutions

Larry Ribstein has an excellent blog post on the end of what is probably the last backdating trial, that of Bruce Karatz, former CEO of KB Homes. Although the government had sought a prison term of six and half years, Judge Otis D. Wright sentenced Karatz to five years’ probation.

And so to recap the whole alleged scandal: In 2005 and 2006, Professor Erik Lie of the University of Iowa did some statistical analyses of corporate option grants and concluded that approximately one third of all American corporations (approximating 2000 companies) had engaged in “backdating”options, that is, they set the nominal date of issuance at a point prior to the actual date. In that, they did nothing wrong. But for various reasons, relating to an utterly absurd accounting theory, corporations engaged in backdating should have listed greater noncash expenditures, yet many did not. The Justice Department investigated more than 100 companies, resulting in criminal sentences for 12 executives, 5 of them prison terms. The longest, 2 years in prison, was given to James J. Treacy, the former COO of Monster Worldwide, by the leftist judge Jed S. Rakoff of the Federal District Court in Lower Manhattan.

Writes Ribstein: “The corporate crime lottery was never cranked up more than it was in the backdating cases. Concern about justice becomes most intense when you’re talking about criminal violations, and you don’t really want randomness.” But randomness there was, and with a vengeance. In fact, it was in response to the backdating prosecutions that Ribstein formulated the Apple Rule: “The Apple Rule provides for an exception from corporate criminal liability when a popular business executive is accused of, or presides over a company that is accused of, misconduct. ‘Popular’ is defined as ‘liked by journalists.’”

I am currently researching one of the most appalling of the backdating prosecutions, that of Brocade CEO Greg Reyes, and expect to be writing an extensive examination of it.

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