‘Catch Up 10-K’ Backdating Help To Come

For companies numbed by the prospect of multiple restatements because of problems with historical stock option grants, the Securities and Exchange Commission is poised to offer instructions on an alternative: a catch-up 10-K disclosure that creates an escape from daunting restatements, but not the long arm of enforcement officers.

In an address to the American Institute of Certified Public Accountants, Carol Stacey, deputy chief accountant with the SEC’s Division of Corporation Finance, said her office is putting the finishing touches on guidance that will give companies instructions on how to do a “comprehensive, catch-up 10-K” if they’re looking at multiple periods that require adjustments.

The guidance will instruct companies on how to revise their data and their management discussion and analysis surrounding stock-compensation expenses both for current periods and for prior periods to sidestep the restatement process, she said.

Companies shouldn’t view it as a holiday gift, however. “The guidance does not foreclose an enforcement action, nor does it mean Corporation Finance won’t comment on it or ask for changes in the filing,” she said. “It’s just to help you catch up on this.”

Stacey said more than 200 companies now are under investigation either internally or by the SEC for improperly granted stock options, which usually were backdated upon issuance so that recipients were getting options that had instant value. SEC Director of Enforcement Linda Thomsen said the SEC has more than 100 of those companies on its inspection radar.

Thomsen

“We have investigations being conducted out of all offices, coordinated and tracked in Washington, and the U.S. attorney general’s office also is interested in this topic,” she said. Criminal cases, for example, already have been established in relation to SEC enforcements actions against executives at Brocade Communications Systems and Comverse Technologies, Thomsen said.

She assured the accounting audience that the SEC is looking broadly at companies across the country, at professionals in all positions, and at all types of actions. “We’re focusing on the worst conduct, the most fraudulent conduct, that caused the most harm with the most intentionality,” she said. “And I can assure you, there’s plenty of it.”

Thomsen said not all of the 100-plus investigations will lead to enforcement actions, “but I can assure you we also expect to bring more than the four cases that have already been brought.”

The SEC issued guidance on Sept. 19, in the form of a letter from SEC Chief Accountant Conrad Hewitt to accounting industry leaders that spelled out how companies should investigate whether they have a problem with historical grants and what to do if they identify a problem.

Stacey also reminded the AICPA crowd that Hewitt’s letter specified that any companies finding problems and not planning on amending earlier statements should expect a conversation with the SEC staff about the wisdom of that decision—a clear signal that the SEC will be looking for restatements where companies discovered problems with historical grants.

Still, worried that her office “would grind to a halt” answering questions and dealing with the number of restatements that could result, Stacey said the staff decided to develop the additional guidance to avoid undue burden for all involved.

For companies with as many as 10 years of financial statements at risk for backdating errors, the amendment process could involve as many as 50 or more filings, Stacey continued. “We are concerned that filing all those filings may adversely impact the ability of investors to easily and fully understand the impact,” she said. “We had some sympathy for those companies ... to go back and restate all of that.”

“We are concerned that filing all those filings may adversely impact the ability of investors to easily and fully understand the impact. We had some sympathy for those companies ... to go back and restate all of that.”

— Carol Stacey, SEC’s Division of Corporation Finance

Stacey said the guidance will prescribe a method for disclosing the full effect of backdated stock options regardless of how far back in time the options were issued, and it will result in restated net income and earnings per share figures. It also will address tax consequences. She said the significance of the restatements and the dollars involved command a full look back. “A lot of people will be interested in those numbers, even outside our building,” she said.

The guidance will be issued as soon as the staff can resolve a few lingering issues, she continued. “We’ve been trying to get it out for longer than I care to remember,” she said. “We hope soon.”

Thomsen said companies may have become caught up in backdating habits as a result of changing rules and conditions that applied pressure on management from different fronts simultaneously. In the 1980s and 1990s, when companies feared hostile-takeover attempts, they often issued in-the-money options to employees to motivate them to help fend off such bids. Then other regulatory developments emerged that created a distinction between in-the-money and at-the-money grants for tax and accounting purposes, she said.

Companies in intense competition for talent started looking for creative ways to issue in-the-money grants that looked like at-the-money grants, Thomsen said, and “they achieved this slight of hand by backdating,” she said.

“The good news is that this is a problem which I hope is largely historical,” Thomsen said. Citing the September guidance, the SEC’s new disclosure rules regarding executive compensation, and the faster filings surrounding stock option grants ushered in with Sarbanes-Oxley, Thomsen said it seems unlikely that backdating will continue to occur.