An SEC Investigation Can Be A Bad Day, But It Can Get Worse

An SEC Investigation Can Be A Bad Day, But It Can Get Worse

 Becoming involved with an SEC investigation is a bad day for any company and its executives. There are things that can be done to make it better. There are also ways to make it worse, much worse. Executives at Vitesse Semiconductor Corporation, when face with a possible option backdating investigation, are an example of how to make it worse.

Yatin Mody, initially the controller and later CFO of the company, contacted outside counsel in November 2005 regarding a press inquiry about the stock option practices of the company. Then current SEC filings of the company represented that stock options were granted at fair market value as of the date of the grant.

Following a review of company documents outside counsel raised a number of concerns. Specifically, outside counsel questioned whether the company had properly accounted for its stock options. Some grants appeared to have been backdated. For example:

April 12, 2001: The Compensation Committee meeting minutes for this date reflected grants for about 7.6 million shares with an exercise price of $17.438, the April 6, 2001 closing price, not the $25.70 price for the date of the meeting;

October 25, 2001: The Compensation Committee meeting minutes for this date reflected option grants for 15.3 million shares with an exercise price of $7.27, the October 2, 2001 closing price, not the $11.35 price on the date of the meeting.

Mr. Mody then held discussions with company founder and CEO Louis Tomasetta and former CFO Eugene Hovanec about the matter. Following the meeting, Mr. Mody created minutes for telephonic Compensation Committee meetings dated April 6, 2001 and October 2, 2001. The minutes were provided to outside counsel, noting that they had been created in November 2005.

In November 2006 the Wall Street Journal ran an article about stock option backdating. It cited the company. Outside counsel met with the board and senior management, raising concerns regarding the option practices at the company and the years later prepared minutes. The company was informed that there was a significant possibility of an SEC investigation.

In April 2006 the Audit Committee retained counsel. Audit Committee Counsel was directed to conduct an internal investigation regarding the option practices of the company. Audit Committee counsel requested access to the computer where the minutes of for the Compensation Committee were prepared.

Subsequently, on April 12, 2006 Messrs. Tomasetta, Hovanec and Mody created documents that purported to be minutes of meetings of the Compensation Committee on April l6, 2001 and October 2, 2001. The minutes authorized stock option grants. The electronic version of these minutes was then transferred to the computer where the minutes of the Compensation Committee were prepared. The internal clock of the computer was reset to make it appear that the minutes had been created at an earlier time.

Messrs. Tomasetta and Hovanec were named in an SEC option backdating complaint along with the company and others. SEC v. Vitesse Semiconductor Corporation, Civil Action No. 10 Civ. 9239 (S.D.N.Y. Filed Dec. 10, 2010)(the company settled on filing; the officers later settled; see Lit. Rel. No. 3295 (Sept. 27, 2013)). The two men were also named as defendants in a multi-count criminal indictment. It charged conspiracy, securities fraud, false entries in books and records of an issuer of securities, false filings with the SEC, false certification of financial reports and false statements to auditors. It also contained a forfeiture claim.

Messrs. Tomasetta and Hovanec each pleaded guilty to a superseding information charging conspiracy to destroy, alter, or falsify records relating the Vitesse’s April and October 2001 stock option grants. Last week each man was sentenced to serve three years probation. Each will also pay a $30,000 fine. U.S. v. Tomasetta, 10 crim 1205 (S.D.N.Y.).

Mr. Mody pleaded guilty to charges of securities fraud, making false entries in the financial records of a company and conspiracy under a cooperation agreement. He is awaiting sentencing.

 For more commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.

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