SEC's Cox Stalls Options Crackdown by Delaying Vote

By Otis Bilodeau
January 31, 2007

The U.S. Securities and Exchange Commission's crackdown on fraudulent stock options is stuck because Chairman Christopher Cox hasn't ruled on how to penalize the companies involved, people with direct knowledge of the situation said.

Brocade Communications Systems Inc., the first corporate target in the options probe, has been waiting since July for the agency to approve a $7 million settlement. SEC commissioners are divided over whether to fine companies for backdating stock options and Cox has held off putting the case to a vote, said the people, who declined to be identified because the deliberations aren't public.

The delay is bogging down the biggest government probe of corporate wrongdoing in America. The SEC, the nation's top financial-market regulator, is scrutinizing more than 100 companies in addition to Brocade to determine if the grant dates on employee stock options were falsified to inflate their value at shareholders' expense.

``At some point, there are costs to proceeding too slowly,'' said Joel Seligman, president of the University of Rochester and author of a book about the history of the SEC. If the commissioners can't agree soon on how to handle a precedent- setting case like Brocade, ``the agency's ability to move in other cases is stultified,'' he said.

The SEC's four other commissioners are split along party lines, Republicans against Democrats. Cox, who didn't respond to a written request for comment, told reporters Dec. 4 that he was prepared to resolve internal disagreements on ``tough issues.''

Battle Over Fines

``I have never been committed to unanimous votes no matter what,'' he said. ``What I am committed to is every commissioner having significant input into the decisions at the SEC.''

Commissioners at the Washington-based agency have battled in recent years over corporate fines. Republicans oppose them as harmful to shareholders, while Democrats support the practice as a deterrent to misdeeds and a means to recover ill-gotten gains.

Cox's predecessor, William Donaldson, a Republican, consistently sided with the commission's two Democrats to fine companies. Cox, who served as a Republican congressman for California for 17 years, succeeded Donaldson in August 2005.

A year ago, Cox, 54, brokered an accord that set guidelines for corporate penalties in enforcement cases. The commissioners agreed that fines were more likely to be appropriate in cases where the company benefited financially from its misconduct.

Cases Have Languished

Republican commissioners Paul Atkins and Kathleen Casey and Democrat Annette Nazareth declined to discuss the Brocade case. Roel Campos, the second Democratic commissioner, didn't reply to an e-mail requesting comment. Linda Thomsen, the SEC's enforcement chief, also declined to comment. Brocade's new CEO, Michael Klayko, said in an interview he isn't concerned by the delay.

Brocade's isn't the only case to have languished at the SEC because of internal disagreements over company fines.

Earlier this month, MBIA Inc., the world's largest bond insurer, received approval for a $75 million settlement with the SEC and other regulators more than a year after it was first negotiated with the agency's staff. A separate case against Veritas Software Corp., now a unit of Symantec Corp., remains unsettled more than a year after the company agreed to pay a fine to resolve an SEC accounting investigation. Neither case involved options.

Cost of Consensus

Brocade, the world's largest maker of switches for data- storage networks, said in July that it had reached a tentative settlement with SEC investigators. The same day, the agency accused the company's former chief executive officer of masterminding an illegal scheme to inflate the value of options granted to employees.

By backdating the options to days when the stock was low, San Jose, California-based Brocade overstated its earnings by more than $1 billion, the SEC said.

In the Brocade matter, Atkins and Casey have questioned whether and how the company profited, the people with knowledge of the deliberations said. The SEC's office of economic analysis, which initially concluded that backdating yielded a financial benefit, is now re-examining the issue.

``The application of fines to backdating options is new, and taking the time to get the first one right isn't unprecedented,'' said Seligman, who wrote ``The Transformation of Wall Street: A History of the Securities and Exchange Commission and Modern Corporate Finance'' (Aspen, 2003). ``If by remanding to the economic types you're able to find a basis for consensus, that's probably a good thing,'' he said. ``Clearly there is a point at which it takes too long.''

Waiting for Approval

Cox last week postponed for a third time an unrelated vote on new rules for director nominations at public companies.

Campos said in December that the commissioners couldn't reach a consensus on the ``divisive'' topic. In a Jan. 22 statement, Cox said the agency was ``taking advantage of this opportunity to consider more fully the questions raised'' by a recent court decision on the issue and would ``work on crafting a carefully considered proposal that will ensure there is one, clear rule to protect investors' interests.''

The SEC said in July that Brocade deceived investors about its finances and gained an unfair advantage over competitors by backdating options and using them to lure new hires. Earlier this month, Brocade's former CEO, Gregory Reyes, argued in a court filing that he used the options in the company's best interest. Reyes, who was charged with criminal fraud, has pleaded not guilty.

Brocade lawyer Nina Locker said at a San Francisco court hearing in October that she was waiting for the SEC to approve the company's settlement agreement.

``It has gone to the commission and that's where it is sitting,'' Locker said.

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