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The premise that the author would've landed in jail for implementing the backdating scheme is flawed. His CFO went to jail, but because in the process of choosing favorable dates for backdating her stock options, she ended up deliberately misstating her income for certain years on her tax returns.

By and large, people do not go to jail for simply picking the wrong plausible interpretation of tax or accounting law. There's even a Supreme Court case about this: http://en.wikipedia.org/wiki/Cheek_v._United_States ("The Court held that an actual good-faith belief that one is not violating the tax law, based on a misunderstanding caused by the complexity of the tax law, negates willfulness, even if that belief is irrational or unreasonable.")

With something like backdating, you're essentially going around saying that something happened on one date (the options grant), when it actually happened on some other date. While that may be kosher for the purposes of accounting, and PWC or E&Y will happily sign off on that, it doesn't mean that those assertions are thus okay in any other context. And that's not a subtle legal gotcha, it should be plainly obvious.

I'm not sure why it matters that much which day options were granted on that it is worth putting people in jail for. The company has right to compensate their workers any way they like. Including giving options for free or for any price they see fit, and doing that any day at any time. Of course, our tax code being as weird and byzantine as it is, that may mean that some ways of giving options may end up in people paying less tax than other ways, and thus we have even more complex and byzantine system of laws that prevent people from taking advantage of it. But I see it as a deficiency of the tax code, which allows you to pay different depending on the various tricks and loopholes.

Now, the part where backdating is hidden from the people who have to have control over the matters - like shareholders - is another matter. That is violation of trust, embezzling and fraud. But I see no sign of it in the story we were told - I see no sign that the dating that was proposed were to be hidden from workers or shareholders.

The articled linked in HN leaves out the actual basis of the indictment: http://www.justice.gov/usao/can/news/2010/2010_09_16_abrams.... ("In April 2002, her joint federal tax return for the tax year 2001 was filed with a Form W-2 that included a 2001 taxable income that was calculated in part on a number of her Mercury stock options being exercised on April 4, 2001. When her joint 2001 tax return was filed in April 2002, she knew that on April 4, 2001, she had not yet told Mercury what options she was exercising. She also knew that on April 4, 2001, there had not yet been a written action by the Mercury Board of Directors that formally approved the executive loan to pay for the options. Abrams was aware that Mercury’s Stock Option Plan required notice of exercise and payment before a stock option could be considered exercised. She also knew that on April 4, 2001, her stock option exercises had not met those requirements. By failing to meet the requirements of the Plan, Abrams endeavored to claim an exercise date on which the company’s stock price was lower than on later dates. This caused her to file a tax return and amended tax return that understated her wages and caused the IRS to assess an incorrect amount of tax for 2001, thereby obtaining a tax benefit for which she was not entitled.")

Basically, she said on her tax return that she had exercised her options on April 4, 2001, when not only had she not done that, but she hadn't yet met the requirements for being able to exercise her options at that time. This is not being burned by some esoteric rule where she checked Box A when she should've checked Box B. She filed a tax return that said something happened on a certain date that not only didn't happen on that date, but couldn't happen on that date.

That's why Horowitz's premise is false. He wouldn't have gone to jail for implementing the same backdating scheme. Tons of companies did it, very few went to jail, and those who did went to jail because they let the backdating fiction cause them to either lie on their tax returns or commit affirmative fraud on investors.

Also: to make a more general point--companies are entitled to compensate executives in whatever manner the shareholders will tolerate, but public companies aren't entitled to be deceptive about it. That was the problem with backdating: while the process itself was legal from an accounting standpoint, the fact that it was built on a fiction made it easy to cross the line into outright deception. The wikipedia article actually has a great sentence that captures the whole situation: http://en.wikipedia.org/wiki/Options_backdating ("To be legal, backdating must be clearly communicated to the company shareholders, properly reflected in earnings, and properly reflected in tax calculations.")

sounds like she was punished for a disruptive innovation - "backdating of stock options exercise". Backdating of grant is cheating at the expense of shareholders whereis backdating of exercise - at the expense of IRS :)

I'm not sure what's the point of exercise backdating anyway - once the option is granted, the base price is fixed (and thus the base from which the tax is calculated), and all you can do is to change the resulting stock price, but the result of exercising at date X and holding to date Y and just exercising on date Y seem identical to me - you still have a stock priced at the spot price of date Y. Maybe some tax law details matter here - which would reinforce my point that it's too complex for its own good.

there are differences. For example, the profit from the grant date to the date of exercise is ordinary income - taxed at your bracket rate, while any profit coming from holding for longer than 1 year after exercise is at long-term capital gain - 15%.

Here you go. Same person, same profits, same amounts, different laws. Why? Because.

the risk isn't the same. Instead of capital gain a capital loss may happen - for example when you own stock, like, in particular, after exercise. Whereis in case of stock options there is no risk of loss before exercise. The stock options may be worth 0 - that is the lowest possible outcome, and you wouldn't be charged a dime if the options are underwater. Just like bonus - company pays to you when things are great, yet you don't pay to company when the things aren't. Thus the same ordinary income tax treatment for stock options exercise profit as for bonus.

It's like living in the same apartment with alcoholic gorilla prone to random outbursts of violence. One day it eats too much of fermented fruit and you're toast. And you have no way of knowing when it happens. Maybe you'll get lucky and you'll be out that day. Maybe you won't.

That's pretty much it.

I remember not feeling any sympathy for my friends who ran in to tax problems. It's easy to assume that this stuff is well understood and it must be their fault for failing to do it properly.

What I found out later is that even if you make every effort to pay your tax correctly, you will still get screwed eventually.

Provisional tax law, for example, requires literally knowing the future to avoid penalties.

I'm in New Zealand and I thought it was complex here. Then I encountered the US tax system. Holy crap!

Even hiring expensive US accountants our company still managed to get a 20k fine out of nowhere for reasons I don't understand. Supposedly this is being appealed and our accountant assures us that we will get the fine rescinded, but there you go.

As a funny example, I read the 1040 instructions each year and some interesting points are included regarding "claiming kidnapped children" and "whale captains deducting specific expenses." If they are devoting time to these sections in the general instructions, then it's gotten out of hand.

There's a big difference between going to your general counsel and asking "Is this legal?" and going to your accountants and saying "Find me a way to make this legal enough." I think the options-backdating was an example of the latter.

In the case described in the story, I don't see any signs of the former. The CFO proposes certain practice, it is not obviously illegal (like not paying taxes or stealing office supplies from competitors at night), hundreds of companies do it, hundreds of lawyers approve it. If the CEO asks the council if it's OK and the council says yes, like hundreds others did, he goes to jail. If he's lucky and the council says no, he gets to write a book "how I almost went to jail but my super-smarts saved me". In both cases I don't see how this situation is good.

Sorry to be a nitpick, but just FYI in the case of legal advice, it's "counsel" not "council" :)

Theoretically, your legal counsel might consist of a council of lawyers. ;-)

You're right, I noticed it after I wrote it that I used the wrong word but was too lazy to fix it until it was too late :) Also, the "former" should be "latter" in the post. Too late to fix that too. But I think the meaning was clear anyway.

hmmh... a manager changing the date on a contract after the fact so it generates more money for him/her is actually pretty obviously a red flag. Kudos to Ben for doing the right thing. If the government couldn't prove beyond a reasonable doubt to a jury that it was wrong, she wouldn't have gone to jail. (Not saying innocent people never go to jail, but it's not like she was an indigent defendant, she had a lot of resources and incentives to fight if it was defensible)

That's not true at all. This is a federal system, and she probably plead guilty because her choices probably were plead guilty and get 3 months in jail or plead innocent, go to trial, and get 20 years. The federal system is beyond fucked up, and they are making it worse every year.

Exactly.

Someone decided that this individual needed to be made into an example and go to jail for some nominal amount of time. Period.

Go to trial, and they would find some statement made in hours of interrogation that wasn't 100% accurate, and convict her of lying to a Federal officer.

This is the USA, don't talk to the authorities without a lawyer, and don't say anything if you can't say the truth. If she doesn't know that she has no business being a CFO.

If the contract is to create another contract effective at a specific date based on what makes more money for the employee, that raises no red flags in my mind from a legal perspective or an accounting principles perspective.

Unfortunately those are not the only things at issue. One key thing involved is uniformity from an investor's perspective and I think that's where the idea runs off the rails.

I'm not sure that conclusion is warranted. Here's what we know:

1. Loads of companies were doing it. 2. When this company wanted to do it, their counsel said it was illegal, so they didn't.

Given those facts, we can't say that the other 200 companies were simply flummoxed by a too-complex regulatory framework. They may just have well had their own meetings and said, "This looks fishy, but everyone else is doing it, and we get more money." Or maybe they did no due diligence at all, and just did it anyway. Once caught, obviously many people would claim an honest misunderstanding, whether or not there was one.

Frankly, I'm skeptical of the whole, "the jail sentences were handed out arbitrarily" angle. It seems the opposite of arbitrary -- the person who instituted an illegal policy in multiple companies was punished. The law may be complex, but when you're making C-level salaries, I'm sorry but you're expected to figure out if you're committing a crime or not.

Yes. Don't discount that #2 follows from #1.

I'm not saying it was arbitrary from regulator's side. I am saying it would be arbitrary for you because you won't know if you're in the wrong or not.

>>> but when you're making C-level salaries, I'm sorry but you're expected to figure out if you're committing a crime or not.

I'm not sure how it has anything to do with the salary. I'm sure whichever lawyers OKed this practice - and I would find it very hard to believe hundreds of companies would just decide to wing it without asking a lawyer - I'm sure they were paid enough. They just thought it'd be OK, but they were wrong. How the salary helps to deal with that? Unless you're claiming the salary is just compensation for the possibility of being jailed for something you have no idea you were doing wrong. In which case I'd prefer a system with more transparent laws and lower CEO salaries.

The "arbitrary" I was referring to was from the article -- a direct quote from Horowitz.

I'm saying that if knowing things like the legal requirements for running a company isn't expected to be part of your job, then you should pay someone a hell of a lot less to do the job than most executives are paid. If you just want someone to wing it, give me a call -- I'll work for probably 10% of the salary.

It's not that the salary is compensation for the possibility of going to jail. It's that compensation correlates with responsibility. If you hire a programmer for $250,000 a year, you damn well expect him or her to be better, more responsible, and more independent than one you're paying $50,000 a year. If not, then what are you paying 5x as much for? So if I hire a CFO at say, $3.5 million a year plus stock options and all the other perks (that's Google's CFO compensation at the moment), what am I paying for if I can't assume that they won't have bothered to figure out the accounting laws?

Also, you're assuming that companies would be innocent, unknowing participants here. That's an assumption that, very often, turns out to be false when we have occasion to check. I don't think all those valley companies thought they were allowed to enter into those wage-dampening agreements, but they still did it. I don't think that was an honest mistake or misunderstanding of the law. I don't think Enron, Tyco, Global Crossing, AIG, and a million other examples thought they were shining beacons of moral virtue victimized by a complicated legal system either. People, and by extension corporations, will quite often break or at least flirt with breaking the law in exchange for money. You're asking me to just take your word for it -- sort of a "well obviously we didn't mean to do anything wrong" defense. It isn't obvious.

That's what I am saying - responsibility is in finding what is right to do and doing the best you can in the situation. But what if the situation is such that there's literally no way of knowing what is right and what is not? If the law is so impenetrable that basically asking a lawyer is akin to going to an psychic - he gives you the answer, charges a lot of money, but you have no idea where it came from, is it true and if you can rely on it or not. How you can be a responsible CEO if you have to rely on psychics to do your jobs?

>>> what am I paying for if I can't assume that they won't have bothered to figure out the accounting laws?

Again, that's what I am talking about - I think it would be much better if the laws were such that you don't have to hire 3.5 mln/year CFO and still not be sure if that all won't end up in trouble.

>>> . I don't think all those valley companies thought they were allowed to enter into those wage-dampening agreements, but they still did it.

That is entirely different topic, but I see you presume you have the right to tell companies how they should pay the workers. I have no idea where that came from to you, and if you do, you're the part of the problem. That is exactly the reason why these laws are so bad and convoluted - because everybody wants to pull a bit of it to their side and carve a little loophole in the law to add a bit more power to himself. I want to be paid more (no matter I'm already paid well into six figures and am in one of the best paid professions in the world) - so I want a law that tells the companies to pay me more. Then the company comes and makes their private law that makes a loophole for them so they don't have to. And then you come and carve another little loophole for yourself. And pretty soon you need a 3.5mln/year professional to figure out what your employees should be paid, and you still get sued for millions because apparently some bureaucrat disagrees.

True, I presume to tell employers that they are responsible for following the law.

I think you're exaggerating the complexity of the legal system to attempt to support a point that doesn't warrant support. In the article, Horowitz took the proposal to his company's legal counsel, and quite quickly, counsel came back with, "this proposal is illegal". It's not impossible to determine that -- it was actually determined correctly in the real world.

On the wage agreement issue, here's a quote from the recent Pando Daily article (http://pando.com/2014/01/23/the-techtopus-how-silicon-valley...) regarding Eric Schmidt:

"Later that year, Schmidt instructed his Sr VP for Business Operation Shona Brown to keep the pact a secret and only share information “verbally, since I don’t want to create a paper trail over which we can be sued later?"

This isn't a case of a company honestly trying to follow the law and being victimized. Schmidt knew that he was opening Google up to legal action, and he did it anyway because it saved him huge amounts of money.

If these companies think the laws are bad, it's not like large corporations have no political power. They're free to buy as many votes as they always do and get them changed. Until that happens, they can suck it up and abide by the anti-trust laws in force in the country they've chosen to incorporate in.

It was determined in this particular case. But in many other cases, it was not, and this scheme was approved, for example, by PWC.

>>> This isn't a case of a company honestly trying to follow the law

First of all, this is not the case that we were discussing - it has very little to do with financial law. Secondly, in current climate, where companies can be sued for basically anything, given they have enough money to be attractive targets, of course that makes executives to try and minimize the exposure. Even though company is supposed to be able to choose their worker's pay as they please, obviously it is not so - the populist politicians want to mess with it to get themselves elected. And thus a savvy executive would certainly not want to make it too easy for them. It turns into an adversarial game, and the results are not good for anyone.

>>> If these companies think the laws are bad, it's not like large corporations have no political power. They're free to buy as many votes as they always do and get them changed.

That's what they are doing. That's where the regulatory capture comes from. As a result, the law becomes more and more complex, as each company and each interest group carves a loophole in the law for themselves and pours millions into buying off politicians. As a result, we get completely corrupt politicians, the law that is trying to serve a thousand of special interests and no longer has any connection to what was the original purpose of the law - to protect people's rights, huge barriers of entry to the competition, billions spent on political squabbles instead of doing something productive (think about how many people one could feed and clothe for the cost of one election campaign) and ultimately the consumers and taxpayers paying for all this baloney. And you response essentially is - if you don't like how we do it in America, GTFO? Is this really the best you can do?

In the case described in the story, I don't see any signs of the former.

Good thing we have more than just a blog post on the options backdating scandal, as it's a well-known scandal

https://en.m.wikipedia.org/wiki/Options_backdating#Overview_...

http://usatoday30.usatoday.com/money/companies/regulation/20...

Options backdating was a big fucking deal a few years ago.

The CFO proposes certain practice, it is not obviously illegal (like not paying taxes or stealing office supplies from competitors at night)

It's not obviously illegal to lie about the date on which you granted an employee his/her options?

For an early stage startup, options value doesn't really change much month to month, since it is typically only determined at funding events. In such a scenario, the price of option grants is purely strategic.

But for a publicly traded company, backdating may change the financials presented to investors unless the math is done and the changed numbers are explicitly presented.

> financial law is so complex and unapproachable one can not reliably navigate it without landing in jail, even being a seasoned professional.

The CFO of the little company I worked for in the mid&late 90's said her colleagues were calling FAS 123 (draft in 1993, revised in 2004) stock option accounting guidelines from FASB the "aircraft carrier" document because of its size. The PDF http://www.fasb.org/pdf/fas123.pdf is only a little over 100 pages, but it's some dense dense stuff and I'd guess 10x that length has been written in interpretations.

"And he'd never known anything was wrong."

A change in the benefits to employees that doesn't result in a corresponding adjustment to the books raises a red flag to me, and I'm not an expert at all.

The author was probably giving too much benefit of the doubt to his former CFO. She was probably being a bit lazy and probably tried to be a bit too clever. I'm not saying the cleverness was greed; it may be as simple as wanting to feel like she could really contribute something to the company beyond what an ordinary CFO could do.

But accountants are supposed to be above that. Accounting regulations are there to protect investors from a million kinds of cleverness that have proved disastrous over the past few thousand years.

My only complaint is that the government itself is not held to the same standard of accounting.

This exactly what financial law is for. So anyone can be busted at any time. It is working as designed - but designed by whom for whom's benefit, you might ask.

Oh, woe be the accountants!

It's difficult to take this opinion seriously when the comment author is so unread about the law that they don't know the difference between "council" and "counsel"! It's a very strong opinion which is devoid of any learning or context whatsoever -- has the author never heard of Arthur Andersen?

Did you really just write 40ish words belittling someone's opinion because they picked the wrong homophone?

I concluded that someone who can't distinguish counsel and council has probably not read a lot about legal issues, and probably has an uninformed opinion on them. So it's probably not meaningful when they decide that government and law enforcement are like an angry, unpredictable gorilla.

What would you conclude?

I can distinguish them - I just noticed I used the wrong one when I already submitted and was too lazy to fix it as I assumed everyone intelligent would deduce what I meant. I type fast and sometimes make typos and sometimes use wrong words if they sound alike because my fingers run ahead of my brain. Usually I catch it before submitting, sometimes I do not. This was the time where I didn't. If it prevents you from understanding the text - well, I'm sorry, I guess I can't get everyone. Some would just zero in on typos and ignore the message. Protip: I probably also used a bunch of articles wrong (my native language has none) and maybe some other grammar errors crept in too. It's OK for you to dismiss everything I wrote as nonsense.

A typo is an error which results from the fact that you are typing. Consistently using the word council in place of counsel -- not even once getting it right, suggests to me that you have not even read enough about legal issues that you have seen the word in print. I understand that it can be difficult to parse the phrase "the council considered the counsel of the counselors before counseling the councilors" -- yes they are homophones in some dialects of English.

In this case, coupled with your exceptionally unsophisticated understanding of the law, and not even a passing familiarity with the issue at hand, I'm more inclined to believe that you didn't actually know the difference until it was pointed out to you. I mean, you said in your comment that it doesn't seem "obviously illegal" to lie about the date when an option was granted. I don't think you even understand what options backdating is, or what was happening in the accounting world at that time. You just seem like a guy who wants to complain that government is arbitrary. Your only evidence for this is that a reasonable CFO would have looked at other CFOs and copied their behavior, therefore nobody could possibly be held responsible.

It amazes me how you were able to deduce the depth of my knowledge about the tax law and financial law and English and current events from one comment and one typo (albeit repeated a bunch of times). Obviously, you have a direct access to my brain. That makes further discussion completely redundant, as you already know all my answers as soon as they form in my brain, thus eliminating the need for me to spend time on typing anything. It is only a pity that I can not possess the same ability - I'm sure you had very interesting and insightful comments on the topic itself, as opposed to my spelling, but being busy with the latter, could not find time to get to the former. My fault entirely, of course.

I like how you completely sidestepped the rebuttal of your argument which I also added in there. And how you've failed to respond to the question of why someone who can't demonstrate that they can distinguish council and counsel should be taken seriously on such a matter -- especially when they are making such bombastic claims. If we look further on in the thread, you make even more ridiculous claims, for example, that companies should be able to compensate their employees with free options.

Don't you think it's incumbent on someone who takes these positions to demonstrate that they understand why the law requires proper dating of options, or FFS why income tax exists even, as your proposals have very broad reaching implications?

There's a flip side to your loud and persistent focus on his misspelling. Why should anyone take you seriously on the matter when you refuse to address his points? At least he was writing about the topic at hand. All you've done is throw a temper tantrum about "ci" vs. "se".

Nice distraction though, are you a politician? They're really good at the whole "all sizzle and no steak" thing.

> What I take from this story is that the financial law is so complex and unapproachable one can not reliably navigate it without landing in jail, even being a seasoned professional.

Because this story was written by a liar and/or idiot.

Option accounting law is simple and clear. Market value – exercise price = loss taken by shareholders. This goes in the quarterly report so the shareholders know how much they spent on employee compensation.

The financial planner "Michelle" was trying to simply not report the cost, to fraudently make the numbers look better. This is one of the oldest frauds in the book. Frankly I am amazed she did not get multiple life sentences for her crimes.

The story author falsely tried to make it look like some sort of terrifying subtlety, an accounting landmine that nearly blew off his leg. It is not. Every responsible accountant would start shitting kittens if confronted with this fraud in their company.

Edit: From other comments, the story was not even about the actual crimes. So the author is not an idiot, but manufacturing a scare story Daily Mail style.

Strangely, at the time that this all occurred, there was a glut of feral kittens wandering around Mountain View. I always wondered where they had come from, but now I've got a good explanation!