A defense against the backdating charges

Roger Parloff is skeptical of a “nervy” defense argument in the Brocade backdating case that the backdating wasn’t material because

"investors deciding whether to purchase a technology growth stock like Brocade . . . analyzed revenues and revenue growth, cash flows, and cash operating expenses," which Brocade correctly reported.

The brief also argues that

[employee stock option] expenses were widely regarded as having little or no relation to the economic value to employees of the [options] issued or the costs incurred by the companies issuing them.

Moreover, Brocade disclosed the impact of options expensing assuming the options were at the money, and these charges to earnings were actually higher than would have had to have been reported for in-the-money options under the then non-Black-Scholes method of accounting for those options.

Parloff says

I think [the defense] motion goes far toward explaining what people in Silicon Valley have been trying to tell us when they've protested that there's something trumped up and ex post facto about the furor over backdating. At the same time, it's hard to believe Marmaro's arguments will really get anyone off the civil or criminal hook. Seems like reasonable investors might have attached material significance, for instance, to knowing that Brocade was routinely granting in-the-money options to its employees, if for no other reason that such options don't serve the incentivizing purposes that at-the-money options are supposed to. It's also just hard to believe that top corporate executives would have jumped through so many hoops to avoid having to disclose something, if they'd truly regarded it as immaterial to investors. Sometimes legal arguments just seem too clever to win. I'm dubious of this one.

I’ve been arguing in this blog for many months that the financial injury caused by backdating has been trumped up in the media, partly because the important financial effects were disclosed.

I would add that the defense argument at least indicates the complex background that contributes to the dubiousness of criminalizing this conduct. Can we say that we understand the institutional factors that produced backdating? Can we assume that investors cared about the marginal incentive effects of at-the-money vs. in-the-money options? Can we say that investors cared much less about the use of backdated options as a way to compete for the best people, as seems to have been the case in Brocade? Before having a clue how to answer those questions, we’ve thrown these cases into the criminal courts, where we're no more likely to get meaningful answers than we’ve gotten from Enron.

Seems to me that what’s really “nervy” here isn’t the defense argument, but criminally prosecuting these cases in the first place.