Almost two years after the Wall Street Journal first broke the story of alleged options backdating, the backdating scandal continues to dominate the financial press. Now is a good time to take stock of the scandal and its potential fallout. As of early February 2007, almost 150 companies had been named as nominal defendants in shareholder derivative actions alleging options backdating. Two recent decisions by the Delaware Court of Chancery will likely complicate the defense of many of these suits. In Ryan v. Gifford, 2007 WL 416162 (Del. Ch. Feb. 6, 2007), Chancellor Chandler denied a motion to dismiss derivative claims based on alleged backdating. In a harshly worded opinion, he rejected defenses based on the lack of demand, the statute of limitations, and the business judgment rule, defenses that many thought would be formidable obstacles to plaintiffs in backdating cases. Similarly, in In re Tyson Foods, Inc., 2007 WL 416132 (Del. Ch. Feb. 6, 2007), Chancellor Chandler had some harsh words for the practice of “spring-loading,” which involves issuing options immediately before an expected rise in the company’s stock price.
Also as of early February 2007, more than 20 companies had been named as defendants in securities class actions. The relatively small number of such suits is probably explained by the lack of cognizable damages, as the market has not tended to punish significantly a company’s stock when allegations of backdating are disclosed. Backdating has also kept the Securities and Exchange Commission busy, with the SEC announcing last fall that it was investigating more than 100 companies. While the SEC has warned that it may pursue enforcement actions against corporations where there is no clear evidence of an intent to defraud, to date it seems to be focusing on the most egregious cases of backdating. Indeed, SEC Enforcement Director Linda Thompson noted recently that “[w]e do not expect to bring 100 enforcement cases regarding stock options - we are focusing on the worst conduct.”
For some companies, the biggest cost of the backdating scandal may not be litigation or governmental investigations, but the expenses associated with the internal investigations often instituted once such allegations are leveled. The Hunton & Williams Corporate and Securities Litigation team remains involved in advising companies in connection with backdating litigation and investigations