The Criminalization of Compensation Decisions: US v. Argo

Andrew Hayden, a student at the Sturm College of Law, has written a thoughtful post on this case.  Argo, the former president and CFO of SafeNet, agreed to plea to one criminal count in connection with backdating allegations.

In the category of criminalizing compensation practices, the indictment contains the usual allegations of backdating and the cover up of the practice, which ordinarily meant conforming all documents to the backdated date.  There are tantalizing hints throughout the indictment that illustrate the use of criminal punishment for what is really a civil offense. 

Argo, despite all of the allegations of covering up the practice, apparently was quite open about it.  When she was promoted to President and COO, she sent an email to the new CFO stating the following:

• Our past practice has been to aggregate options for performance awards or new hires in the quarter and pick the best price after the hire date.  We then send the unanimous consent to the comp committee and the options are approved.  I think this is a good practice because of the volatility of our stock price.  Who wants to have an option priced on your start date and then have the option underwater a month later when you are notified of the award price?

The memorandum indicates that the practice was not a secret within the company and was used as an ordinary business practice.  In other instances, she apparently informed the Compensation Committee of the Board about the practice.  As the indictment described in one instance:  

• The grant was dated October 8, 2002, but was not actually approved by the Compensation Committee until on or about October 24, 2002.  In an October 21, 2002 e-mail, ARGO told members of the Compensation Committee, "we will be able to issue options to [the Former CEO] as of October 8th 2002." 

In other instances, the Compensation Committee apparently approved the backdated options.  Moreover, to indicate the degree of secretiveness, the actual backdating was apparently referenced in the minutes to the meeting.  See Para. 59 ("Unlike prior grants, this grant was not approved by [unanimous written consent] but rather during a meeting of the Compensation Committee.  As a result, on the face of the meeting minutes it was clear that these grants had been backdated.  Member's of SafeNet's accounting department noticed the backdating and advised senior management . . . "). 

This is not an attempt to justify Argo's behavior.  She apparently backdated and the company apparently misreported.  A breach of fiduciary duty or civil securities fraud certainly seems appropriate.  But given the business purpose (albeit misguided) and the openness of the practice, criminal prosecution seems excessive.  The phenomena is not entirely the fault of the Justice Department.  To the extent courts continue to use demand excusal to dismiss derivative claims involving backdating and high pleading standards to dismiss securities cases, criminal prosecution is the only remaining mechanism for ensuring some degree of accountability.

Comments

[Francine McKenna]

Is a civil injunctive action a criminal proceeding?

"...violating the antifraud provisions of the federal securities laws, falsifying SafeNet's books and records, circumventing SafeNet's internal controls, misleading SafeNet's auditors, and causing SafeNet to issue false and misleading financial reports. By engaging in this conduct, Argo specifically violated Section 17(a) of the Securities Act of 1933 ("Securities Act"), Sections 10(b), 13(b)(5), 14(a), and 16(a) of the Securities Exchange Act of 1934 ("Exchange Act") and Exchange Act Rules 10b-5, 13a-14, 13b2-1, 13b2-2, 14a-9, and 16a-3, and aided and abetted SafeNet's violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), and 14(a) and Exchange Act Rules 10b-5, 12b-20, 13a-1, 13a-13, and 14a-9 thereunder. The Commission is seeking injunctive relief, disgorgement, pre-judgment interest, and money penalties against Argo, in addition to a permanent bar to prohibit Argo from serving as an officer or director of a public company.


1)Misreporting "in-the-money" options to the SEC is a serious offense.

"by selecting these highly favorable dates and causing options to be granted on dates when she knew the options were already in-the-money..."

2)They were so open about it because they probably had the consent of their auditors in approaching the process this way. However, claiming that "everybody does it" and ignorance of the law does not excuse the offense.