Under the headline, “The Man to See in the Valley,” I profiled Larry Sonsini, the Silicon Valley superlawyer, for the current issue of Fortune. (That’s the issue with Hank Paulson on the cover; it’s dated November 27, 2006 on the spine). The whole profile is now posted online here.
Not to spoil the suspense, but my story tends to exonerate Sonsini with respect to many of the criticisms and innuendos he’s been enduring with respect to both the Hewlett-Packard leak probe fiasco and the options backdating scandal. I’d be very interested in hearing readers’ comments on the profile. For those who just want to turbo right to the options backdating portion, here’s that excerpt:
Then there’s the options-backdating scandal. That kicked off in March 2006, when a Wall Street Journal article showed that many stock option grants during the late 1990s and early 2000s had been exquisitely well timed, suggesting that their grant dates must have actually been chosen retrospectively – i.e., backdated. As a result, the Securities and Exchange Commission launched an inquiry.
Options were a particularly important form of compensation for startup technology companies and a central pillar of Valley culture. They were routinely given not just to directors and top officers, but also to members of the rank and file. Of the 120 companies now being scrutinized for backdating, either by government officials or internal auditors, 42 are Silicon Valley companies (35 percent), and of that subset, at least 40 percent were Wilson Sonsini clients during the relevant period.
These numbers look ominous, but for two reasons may not be. First, Wilson Sonsini’s clients are no more heavily represented among the companies under scrutiny than those of any other law firm, once you take into account the firms’ relevant market shares and niches.
The premier East Coast technology firm, Boston’s Hale & Dorr – now WilmerHale – represented five of the 13 Massachusetts-based companies on the list of accused backdaters, or 37 percent. Similarly, six of Wilson Sonsini’s leading Bay Area competitors represented multiple Silicon Valley clients on the list, seemingly in rough proportion to their shares of Valley business.
The second reason, according to nine Silicon Valley public company board members, CEOs or outside lawyers, is this: While outside law firms may be involved in drawing up a stock options plan for a public company, they very rarely administer it.
And that’s where all the problems have been showing up so far: missing documentation, misdated or forged records, faulty accounting. “I’ve never seen it done by outside counsel,” says tech investor Roux, of Silver Lake Partners, who has served on many boards and compensation committees.
“How to give options is well known,” says Rodgers, the Cypress CEO. “You hire outside counsel, they have their word processor kick up a bunch of documents, and they charge you 50,000 bucks. Then you and your HR person give out options according to the plan. You administer it; they’re not involved. You don’t want them involved, because you don’t want to be sent a bill for $2,000 every time you give out stock options.”
Sonsini’s more direct link to the backdating scandal is through his board ties: He was a director at two companies that have encountered options problems. One was Brocade Communications (Charts), whose former CEO Greg Reyes and former human resources chief have both been charged with criminal backdating violations by federal prosecutors in San Francisco. Though the prosecutors theorize that Reyes defrauded the company’s board of directors, Sonsini has been tainted by the association.
Because Sonsini was on Brocade’s audit committee one year, he has also been named as a defendant in private class-action suits. Sonsini was on the board of Novell (Charts) too, which has initiated a voluntary audit of its options practices. Like all Novell directors, Sonsini received options himself. He never exercised his, according to a firm spokesperson, and they expired three months after he left the board in 2002. Sonsini declines to discuss either Novell or Brocade.
What has been offered as the smoking gun implicating Sonsini in the scandal is that he allegedly recommended that Brocade’s board make Reyes a “committee of one,” with power to grant options without the full board’s approval. That’s what Reyes himself told Business Week in February.
In an interview with Fortune, Reyes’ s criminal defense lawyer, Richard Marmaro, seems to implicate Sonsini via gushing praise: “Sonsini at all times acted totally above board and with the highest ethics of the profession, and my client relied on his sage advice.”
A Wilson Sonsini spokeswoman says that Brocade’s committee of one was actually set up by a different law firm, which she declines to name.
In any event, committee-of-one arrangements are neither as rare nor as intrinsically reckless as they may appear. The “committee” at Brocade could award options only to rank-and-file employees, not to officers and directors, so there was no opportunity for self-dealing.
In that context, the practice was – and remains – pervasive, since it’s not practical to have full boards constantly approving options grants to scores of employees.
“If you’re moving quickly in a hot job market,” says former SEC commissioner Joseph Grundfest, who co-heads Stanford’s Rock Center for Corporate Governance, “and there’s an employee you want, boards would delegate to CEOs the authority to make offers for grants up to a certain size or for a certain total number of shares. That would not be rare in the least. And creating a committee of one never gave anyone the right to backdate. That said, in hindsight it clearly would be better practice to have crisper controls on that process, particularly to make sure that grant dates are appropriately and timely documented.”
The remaining thing Sonsini might be faulted for is sitting on the boards of his clients. That’s another practice that’s more common on the West Coast than in the East, and one that some corporate-governance watchdogs denounce.
“The duties of a lawyer and a board member are fundamentally different,” says Minow, of the Corporate Library. “You can’t be the third base coach, the umpire and the batter at the same time.”
Here the watchdogs appear to have won their argument. Though Sonsini sat on nine public boards in February 2002, today he’s down to just one, and he says he expects to phase out that one soon too. He’s come around to the view that “the presumption” should be against sitting on public boards. “It’ s a question of the evolution of independence and objectivity in corporate governance,” he says.