Why I did not go to jail (2014)
a16z.com
a16z.com
Then there is outright negligence, which would make things even worse. If compliance is an ugly word to you then please go and do something that just involves you and that does not expose others (shareholders, employees, customers) to the risks that you apparently are comfortable with but that they are probably not comfortable with.
As much as I applaud the writer for covering for Michelle and putting her actions in the best light: a 3.5 month non-suspended sentence is not something that is handed out lightly for a white collar issue. Both Michelle and the other execs at that company profited from doing this at the expense of the other shareholders, but that's not what landed her in jail. Keep in mind that nobody died, and that the difference between the worst and the best date within a month to backdate those options to could not have been so massive that we're looking at huge differences in pay-out compared to the total value. It is the principle that matters, ask Martha Stewart (a billionaire) how her attempt to save $45K ended up to see why this is so, and check out what mobster Al Capone got convicted of. Also note that even asking for outside counsel may not be enough to get you off the hook, and that no matter what your accountant tells you in the end you are responsible for your actions.
Don't go to jail. If your boss tells you to do something that might land you in jail: resign.
And take legal compliance serious, as serious as though your company and your future depend on it, one day they just may.
Sometimes I wonder, why this nobel idea become so currupt ? May be it is failure of Govt/System. When Govt wastes tax-payers money (e.g. f35) and not held accountable, layman doesnt have choice than cheating.
It's basically a legacy software that is kept alive with patches upon patches until it collapses.
Also where hackers can lobby against some bugs getting fixed.
If you only have your paycheck as an income and living expenses as, well, expenses, then 1040 form can be filled under one hour.
Why is it not filled automatically is a good question, but irregardless of that no, it's not complicated.
Business expenses is when the fun starts - and rightly so, because pretty much every accounting rule was introduced to close some loophole.
Come next week, the project manager called an all-hands meeting to tell us that guy had been fired because he cheated on his reported hours.
So I'd add a little more to your advice to resign if asked to do something illegal. If your company, or industry, seems to be the new whipping post for some Federal agency, consider a new place. Assuming you're in a spot that could be a scapegoat.
I don't think the government had any vendetta against this particular person. (ie: Martin Skherli) However, she was probably investigated for money matters (ie: her tax reports) as she probably was shadier than Ben would like to admit.
Looking at https://www.sec.gov/spotlight/optionsbackdating.htm the person being talked about likely didn't have any sense it was happening, but it did become pretty clear, later (2006/7) that the SEC was on the warpath about it.
Only a single American banker saw jail time from the 2008 mortgage crisis https://ig.ft.com/jailed-bankers/
Let me make it better: resign, but also take precautions, in case after your resignation, your boss offloads some guilt to you.
And it's not just corporate tax law. Health care is a dumpster fire. Lots of overly complicated modern bureaucracies. We're not as smart as we think we are.
We are, that's the problem. We find loopholes, we find edge cases, we bend rules to our benefit. Thus the bureaucracy must become ever more complicated to deal with our cleverness.
Personally I think these things are scaling problems. I'd argue that we are not smart enough to centrally organize these things for 330+ million people.
Perhaps the problem is that the federal government was never designed to do so much (tenth amendment). The federal government was designed to answer to the states, not 330+ million people. Look how much better smaller countries do with this stuff. We give the "bigger is better" government too much credit. Historically "bigger is better" causes all the big problems.
I'm 100% for progressive policies at the state level. I'm 100% opposed to progressive policies at the federal level. Government should be "by the people", not by some rules written by career politicians and civil servants a thousand miles away.
Maybe that means we should go smaller? Swiss cantons average 330k people each (8.5 million population, 26 cantons), and each canton has responsibility for their own healthcare, welfare, law enforcement, public education, tax policy, its own constitution, and can enter into treaties with other cantons and even foreign countries. Their federal government is very limited. The seem to do a pretty good job. When they have a minority problem they can't fix, they split them off a new canton.
In my prior comment I had been thinking of the balance of powers between the states and the federal government. I think the tenth amendment is important, that the division of powers between the states and the federal government is just as fundamentally important as the balance of powers between the three branches within the federal government. As the federal government grows larger it grows more corrupt, dysfunctional, and disconnected from the people, as all unchecked powers tend to do.
Speaking of shared culture, and this balance of power, things have devolved to the point where we argue every four years over the entire direction of the country personified in one person, the president, tribal leader and hopeful superman to 51% of the population, and cause of all that is wrong for the other 49%. We get our facts from the news, often nothing to do with our real lives and experiences. Details are nuances are ignored, there are too many anyways. The president is the team leader. Other people are stupid and liars and evil and all that matters is that your team wins. This is not going in a good direction! This isn't a problem with the voters, it's a problem with the system.
My two cents :-)
Here the more difficult one: if you tax income of companies, most will close down, so you need to allow tax deductions. Then what about tax deduction for IP fees? Of course nobody wants them, but IP is a big part of the US economy (worldwide) so should IP be protected, and expenses on IP be tax deductible?
After a while you probably end up with a similiar system as of today.
I agree with you that the tax code should be simpler. But it's about money in Washington, not what people like you and I think. The tenth amendment is there for very good reasons, part of the checks and balances. Bigger is not always better.
Wasn’t Martha Stewart charged with obstructing an investigation and not actually securities fraud?
I believe they got her on blatant insider trading.
My gripe is when the wealthy get caught doing a crime, they might do their heavily lawyered light sentence, and come home to a warm home, and a glass of Chardonnay.
A poor, or middle class guy, does his retribution, and it might destroy any semblance of the life he had before.
I’ve felt for awhile now sentences, and more important——fees/fines do to wrong doing should be tied tightly to income, and assets.
It kills me when a corporation, or a wealthy white collar individual get the same fine as the Landscaper, who rents.
Hell—-I would like to tie all societal fees/fines to income level. A rich guy gets a $600 traffic ticket, it’s dinner banter. A poor man get’s the same ticket, it could be rent.
I would would even tie vehicle registration, patent fees, etc. to income.
I can only wish though.
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While this article is reposted every couple of years, I always feel that I'm missing something in trying to understand why the CFO went to jail.
This page from the SEC lists the huge number of companies that somehow paid a penalty or settled as part of the backdating scandal, and it's lots of big names in the tech industry. For example, the CFO of Apple at the time: https://en.wikipedia.org/wiki/Nancy_R._Heinen. However, it was really hard for me to find many people who actually ended up going to jail over their roles. So I can only conclude that either (a) the OpsWare/Mercury Interactive CFO had a really shitty lawyer, or (b) her involvement was more direct and culpable than is let on in this a17z blog post.
Why I Did Not Go to Jail (2014) - https://news.ycombinator.com/item?id=18026790 - Sept 2018 (152 comments)
Why I Did Not Go to Jail (2014) - https://news.ycombinator.com/item?id=11240717 - March 2016 (13 comments)
Why I Did Not Go To Jail - https://news.ycombinator.com/item?id=7191642 - Feb 2014 (182 comments)
Secondly, I would regularly give a speech to the finance employees that went like this:
“In this business, we may run into trouble. We may miss a quarter. We may even go bankrupt, but we will not go to jail. So if somebody asks you to do something that you think might put you in jail, call me.”I'd love to see something about ethics, too. I feel there is a need for more ethical behavior, in today's corporate world.
I have a fairly basic ethical litmus test: "If I feel like I can 'get away with it,' it's wrong." Doesn't matter, whether or not it's legal.
Wrong is wrong.
One of the most valuable assets in my life, is my personal sense of Integrity and Honor. It has nothing at all to do with whether or not anyone else is doing it. It's all about whether or not I can shave in the morning.
I'm clean-shaven.
> it's everyone's highest priority to do what's legal, rather than what's "right".
is something that can be tested and its truth discovered. Not clear if "everyone" means people in your city, state, country etc. Although "highest priority" seems a bit vague too. Does "highest priority at the end of the day" mean, what people actually do/end up doing? That sounds nowhere near true for me, or the people I know. But maybe I'm misunderstanding you.
People whose behaviour is guided by laws, rather than ethics, stand out as sociopathic jerks, e.g. internet trolls or bullies. "There's no law against it" doesn't say much at all about whether you should be doing something.
But, some academics figured out that they could show statistically that options backdating was occurring: https://www.researchgate.net/profile/Raquel-Alexander/public... and very quickly it became a huge legal issue for a lot of companies.
Is there no legal way for me as a non-lawyer to get a signed form from a lawyer saying that what I'm doing is legal? Then if it ends up to be illegal the lawyer could get in trouble rather than me. Or am I expected to know all the laws myself? And if a law is unclear, is there someway to ask for legally binding clarification from the government?
I assume if you did this as a person, not a company, it could be taken into account in sentencing - it may support the idea that you didn't intent to violate the law.
But a lawyer going to jail instead of you? Why would a lawyer agree to that? There is no benefit to them.
The company reports compensation expenses incurred via ESPP upfront.
Does anyone understand why having employee options set a lower price would be illegal? Or is there just more details that were left out because the specifics are not necessary for the story?
https://www.theglobeandmail.com/report-on-business/options-b...
It was because the paperwork for the option grants were being written at the end of the month with a date based on the lowest price during the preceding month, a common practice at the time, but one that misrepresented when the options were actually granted, thereby enriching grantees at the expense of shareholders.
This is roughly theft from the other stockholders.
If you look at the link in akeck's comment its actually tax evasion. There is(was?) a tax break if stock options were granted at the same price as the day they were issued. So by lying about the date they were able to get the cheaper price, and also get the tax break.
It's no more theft than paying a salary, the company could set the price at anything they wanted. They could also just give away securities for free, as long as all laws are being met. In this case they were reporting the incorrect date, and owing less in taxes because of it.
> Companies involved in backdating use the benefit of hindsight to look back and choose a date when their share price was low, then falsely claim that the options were granted on that date.
So it sounds like they -- for example -- granted options on April 15th, looked back and saw that April 8th had a better price, and claimed that they were granted on April 8th.
I don't believe this would have been a problem if the equity plan disclosed to shareholders explicitly said "the option strike price will be the lowest closing price over the 30 days prior to the grant date", but they did not say that; they lied about when they were granted.
It is like: you will have the lower price between the opening and the closing starting next week.
From that the rules are known in advance but not what will be the stock price.
From what I understand of this article case, you have a price based on past weeks, and so you already know the future, the current price 2 weeks later when they offer you the plan. And so you kind of already know if it is a good deal or not.
I was once offered part of my compensation in stock, and in what I'm sure they thought was an act of generosity (and motivation to take more stock vs cash), it included a 25% discount on whatever stock I took at the end of the contract.
I had a vague recollection about this stock backdating and other issues, so I tracked down an attorney with extensive practical & teaching experience in tax and corporate law.
One of the best moves I've ever made.
He told me absolutely to NOT accept any such discount, as it was seriously illegal to offer anything different from actual real-time Fair Market Value (with a lot of criteria for determining FMV), and the penalties were draconian, not only for the employer, but for the employee.
So draconian that my take-away was: if I got caught accepting such discounts, it would be better in every way to just give the IRS my business and personal checkbooks and tell them to just take whatever they needed and come back when they were done. An then go live as an impoverished monk.
The best value of attorneys is not to dig you out of a hole, it is that they can provide guidance to avoid falling into the pit in the first place.
2. Employee Stock Purchase Plans where you buy company stock at a discount (tax free) are a thing https://www.plancorp.com/blog/the-untold-advantages-of-your-...
2. Yes, these may be possible under some circumstances, depending on the details, e.g., perhaps the program explicitly counts the not-discounted value as real-time income and pays the taxes, or, perhaps as in the original article, the are common but not actually legal.
As I pointed out, this counsel is a top corp/tax attorney and professor in the region, he didn't say exactly what I said, but when I re-characterized it back to him, he said, 'it doesn't work that way, but it's not far off -- don't touch this stuff'.
You do what you want, but I'm listening to the expert.
https://www.equityeffect.com/blog/409a-penalties/
(Possibly they were offering you options in your story--I'm not sure).
But if the company wants to give you stock directly--say for free! You would pay tax, as regular employment income, on the difference in value between what you pay (say $0) and the FMV.
Also right, if it's straight-up realtime income, and you declare the full arms-length exchange / full & fair market value (minus whatever you paid or have as basis), and pay tax on that, you're probably ok (but IANAL, this is not legal advice).
Maybe the HN community could keep track of Horowitz' 2011 explicit embrace of law breaking the next time the 2014 performative gesture comes up?
It's the sort "near miss" that Allan MacDonald would have avoided on first principles.
For example, many crimes require a specific kind of intent. I don't know at this point how a piece of code can determine an intent.
1* Burglary is an act of breaking and entering of the dwelling place of another with the intent to commit a felony therein
The code atop the model should be an open source inference engine.
If one has a formal model for law, most bugs and conflicts can be found out via a formal verification engine itself. Like TLA+.
Recourse may not be processed
Terminate
Howard Schilit writes about the options backdating scandal from this perspective in his book "Financial Shenanigans: How to Detect Accounting Gimmicks and Fraud in Financial Reports".
> Most shenanigans discussed in this book share a common theme: company executives use accounting gimmicks to show impressive results in hopes of driving up the stock price so that their shares and options become very valuable. The options backdating scandal that erupted in 2006 is on a whole different level of dishonesty. Executives were able to skip the whole part about using accounting gimmicks, showing impressive results, and driving up the stock price. Instead, they cut right to the chase and secretly gave themselves stock options that had already increased in value. In so doing, executives found a simple way to loot the company’s coffers without letting anyone know. They thought it was the perfect heist -- and it was, until they were caught.
> If you were to put options backdating on one side of a scale that weighs dishonesty, and any other shenanigan on the other side, we believe that backdating would always be heavier. Why? Because all other shenanigans are designed to enrich management in a complicated, indirect manner, while backdating does so without any serious effort at all. Look at all the “hard work” Enron executives had to do to create all those crazy joint ventures to make results appear better! Look at the acquisition activity at Tyco and the gyrations that Symbol Technologies went through in order to get positive results! And no matter how much cheating went on at these companies, there was never a guarantee that the stock price would respond accordingly.
> With options backdating, however, management barely had to lift a finger in order to cheat. And, of course, the process guaranteed a positive result. For this reason, we crown backdating as the King of all Shenanigans. The options backdating scheme was really quite simple. Before finalizing an option grant, executives pulled up the stock chart and looked back in time to find a date on which the stock price was at a much lower level. They then said hocus pocus and “backdated” the paperwork to make it seem as if the stock option had really been granted on that earlier date. And voilà, the stock options had instant value. Of course, options backdating had accounting implications as well.
> By not reporting the compensation expense resulting from these “in-the-money” grants, companies were overstating their earnings to shareholders. Few companies abused options backdating as much as semiconductor giant Broadcom Corp. The saga began when Broadcom’s board initiated a review of option-granting practices on May 18, 2006, two days after a seminal CFRA (Center for Financial Research and Analysis) survey on options backdating listed Broadcom as one of the companies “presenting the highest risk of having back-dated options”. After two months of investigating, Broadcom finally admitted what it had done and estimated that this abuse of the system had allowed the company to avoid a whopping $750 million in compensation expense. But that was not the end of the story. The following January, Broadcom shocked investors by announcing an unbelievable $2.2 billion expense, which tripled the original estimate and trumped the $1.5 billion estimated restatement record held by former backdating champion UnitedHealth Group.
> Some executives still argue to this day that the media blew the backdating scandal out of proportion and that the misdated grants were simply caused by “careless record keeping.” Au contraire. (We weren’t permitted to use stronger language in this PG-rated book.) The sheer pervasiveness of this scandal across hundreds of companies actually makes it seem that many executives considered backdating to be a perk of running a public company.
The issue is that the company is owned by shareholders.
So the wealth transfer is from shareholders, including public investors, to employees.
But here the employees gave themselves excess compensation, out of resources owned by the shareholders, and did not tell the shareholders that they did so.
That is the difference between receiving a salary from the company, and secretly adding to your salary by regularly using the corporate credit card on yourself. The first is what they agreed to, the second adds personal theft.
> The next question to ask is: are the increased compensation expenses created by options backdating clearly disclosed to the company's investors, or does the company misrepresent its compensation expenses to investors as being artificially low?
rather than with PragmaticPulp.
This was before the ruckus Ben mentions.
Worked out well financially for the beneficiary, but would be very wrong these days. May have been wrong then.
Whether it's legal or not - not my area, but this is obviously disadvantageous to the shareholders. The strike price is what you get (as a shareholder) for the newly created shares at exercise, if you lower that you have just paid your employees more.
Also, in addition to giving more to the employees rather than the shareholders this results in more short delta rather than short gamma exposure on the company/shareholder part, i.e. it makes it more like a stock grant rather than an option grant.
If you want to give your employees more compensation then just straight up give them more stock/options/money and account that as an expense. There's no free lunch.
It's not the extra compensation that's illegal, it's the lying to shareholders/IRS that's illegal.
This sentence could replace all the ethics training in the case majority of corporations.
outstanding General Counsel +10 LUCK
right organizational design +6 LUCK
roll twice, add totals
A lawyer and a client are discussing an agreement. The lawyer says: here we f* them; here we f* them; here they f* you. Here also. And the client is left asking: why when we f* them it's us, and when they f* us it's just me?
This is just to say that, most likely, PwC didn't pay anything, nor any of their lawyers or consultants go to jail.
It’s not obviously a bad thing, unlimited liability is pretty rare these days (people have unlimited liability but usually act through limited liability companies. Lloyd’s underwriters (used to?) have unlimited liability. I can’t think of other examples. Maybe partnership structures were good for keeping people honest but I don’t really understand why a partnership is different from an LLC, and I feel like they don’t scale well to large organisations.
Technically I believe there's an exception for things that are very clearly the responsibility of a single partner (i.e. done without anyone else's knowledge or consent).
> It’s not obviously a bad thing
Disagree. We've seen a huge surge in accounting scandals since these accounting firms became limited-liability; the field has become dominated by these "too big to fail" companies who make massive profits while paying tiny penalties for their wrongdoing.
> Lloyd’s underwriters (used to?) have unlimited liability. I can’t think of other examples.
I believe there's a New York commercial law firm that's still structured as a traditional partnership.
> I feel like they don’t scale well to large organisations.
Maybe that's a feature rather than a bug.
I do wonder what is the point of that. It takes 2 minutes of searching to find it out.
[0] https://www.bloomberg.com/opinion/articles/2014-02-06/martom...
Yet we only saw a small number of arrests come out of the 2008 housing crisis, despite widespread fraud. The few cases that were successfully prosecuted involved 9 and 10 figure fraud operations.
At the core of the issues is the idea that ignorance of the law is no excuse. It may sound unfair that everyone can be bound by the law regardless of whether or not they understand every line, but the alternative requires that we let people off the hook for simply claiming they didn't understand the law.
In this case, the crime wasn't a simple mistake. The Michelle character in this story thought it was a creative loophole in the law that allowed her to fudge the accounting numbers in favor of the company by arbitrarily using the lowest share price of the month instead of the share price at time of issue.
This isn't the type of decision that one accidentally makes. It requires deliberate effort to search out and use the monthly low share price instead of the share price at time of issue. Ben Horowitz was fortunately skeptical, and consulted the general counsel for a proper reading of the law.
(But the "probably" is there for a reason: it really does depend on the specific topic at hand and whether you actually tried hard enough to comply with the law)
Many regulatory crimes require no mens rea at all. And even more criminalize things that no reasonable person would expect to be a crime. Criminal punishment is supposed to be for despicable conduct, not morally innocent behavior.
https://www.sec.gov/Archives/edgar/data/1360951/000119312506...
In particular, what the CFO was recommending was backdating the grant date of the option, which was fairly common (if not legal) among tech companies back then. What she went to jail for was backdating the exercise date of her personal options, which is kind of trivially obviously illegal to anyone who has ever filled out their tax returns. It's like if you sold stock on Dec 20th, but pretended you really sold the stock on Dec 10th when it had a lower price so you'd pay less in capital gains taxes.
Rich people (or middle class founders who dream of getting rich) get to deal with incomprehensible tax and accounting laws where no one can ever really be sure that they're compliant. Ben Horowitz had the luck to receive good legal advice and the wisdom to listen to it. No doubt some others who had the latter, still went to jail for lacking the former.
How does one even reform something like this? Some kind of legibility requirement applied to all written law? Has such a proposal ever gained traction?
> “Ben, I’ve gone over the law six times and there’s no way that this practice is strictly within the bounds of the law. I’m not sure how PwC justified it, but I recommend against it.”
Toward the end, about the CFO's sentence ostensibly for breaking the law referred to above at another company:
> Once the SEC decided that most technology company stock option procedures were not as desired, the jail sentences were handed out arbitrarily.
Emphasis mine. I don't think that word means what author thinks it means.
The article is written that way, but that view contradicts all the facts. As summarized in the other comments:
- Really large numbers of executives were guilty of the same conduct described in the article. They didn't go to jail.
- Michelle was not charged with anything related to the conduct described in the article. She was charged with evading her personal taxes.
It seems unlikely that she had PwC audit her personal taxes. So the main point of the article seems to be that Ben Horowitz wrote it without bothering to learn what had happened.
> Michelle ultimately served 3½ months in jail for her part in the other company’s stock option practice
So this is just a lie?
The choice of who to jail was basically arbitrary, given that almost everyone was guilty.
see #2:
I read that to mean the court didn't look at individual cases with much consideration and just handed out jail sentences to everybody involved. What do you think the author meant to say?