Exploring Corporate Governance Around the World

By Allison Garrett, Senior Vice President for Academic Affairs at Oklahoma Christian University

Thursday, August 31, 2006

Backdating: Collateral Damage

In the last few weeks, we have started to see some of the fallout from the backdating scandal. I thought I'd take a couple of minutes to jot down some observations about the collateral consequences of the backdating issue to issuers. Some of these are the obvious results, such as SEC investigations. Other results are more attenuated, but nevertheless significant.

1. SEC investigations: The number of investigations continues to grow, prompting companies to hire expensive Wall Street law firms to handle both the SEC's investigation, and any related internal investigation.
2. Shareholder suits: Shareholders will file class actions alleging fraud in connection with any misstatements of the financial statements that result from the backdating issue. Companies that must restate financials to treat the difference between the strike price and the FMV at the date of grant as a compensation expense can expect to see class action lawsuits, and defending against these suits will also be expensive.
3. SEC suits against outside directors: SEC Commissioner Campos warned recently that the SEC may bring suits against outside directors in connection with the backdating scandals. See my earlier posting here.
4. Delisting: Apple and other companies are in technical violation of the listing standards due to the late filings of quarterly financials and face possible delisting as a result. See, for example, the Forbes article on the topic.
5. Bond default: If an issuer files its 10-Qs late, it may be in technical default under its indenture. See this article from CFO.com for more.
6. S-3 unavailable: The final point is that companies may lose their eligibility to file S-3 registration statements. These are the short-form registration statements that companies typically use when doing shelf offerings or bond deals. The registrant requirements in the general instructions state that the registrant must "have filed in a timely manner all reports required to be filed during the [prior] twelve calendar months." Losing S-3 availability is very significant because issuers will have to file a longer form registration statement or obtain financing from sources other than the capital markets. If the registrant filed a Notification of Late Filing (Form 12b-25), and then does make its late filing within 15 days of the due date for a 10-K and 5 days of the due date for a 10-Q the registrant may still use the S-3. I think it's unlikely that registrants with significant issues can meet even these extended due dates, though.

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