The growing US row over options backdating has already claimed more in-house careers than all the post-Enron collapses combined. Michelle Madsen reports on the scandal that raises awkward questions for corporate counsel

Scandals have become so woven into the fabric of modern corporate culture that in-house lawyers could be forgiven for thinking that dealing with the latest incident of boardroom controversy is all in a day's work.

However, among all the cases of white-collar abuse to hit the US in the past 10 years, it is the fallout from the recent backdating share options scandal that has rocked the in-house world and seen an unprecedented number of general counsel given the chop.

While previous scandals have, for the most part, hit chief executives and financial directors, a series of investigations has put general counsel firmly and uncomfortably in the spotlight. By the end of 2006, at least 15 senior corporate counsel had exited their jobs in the wake of backdating investigations.

The scandal has unfolded rapidly. The row over backdating share options can be traced back to 2005 and the publication of a paper by an academic at the University of Iowa, professor Erik Lie.

Lie's research into share options showed that the tactic of using backdating to boost the value of share options granted to corporate executives was rife in US companies in the late 1990s and early 2000s.

This form of compensation is not illegal in itself – though investors have long criticised it for making a mockery of the concept of aligning executive incentives with shareholders' interests – but becomes so when improperly disclosed.

A later study by Lie and his colleague Randall Heron showed that an estimated 29% of US companies manipulated grants to top executives at some point between 1996 and 2005.

Silicon Valley tech companies have been particularly hard hit by the scandal because of the industry's fondness for using share options as a means of compensating executives in high-growth but often cash-poor companies.

The highest profile company to be subject to a probe by the Securities & Exchange Commission (SEC) is iconic computer giant Apple, whose general counsel Nancy Heinen left the company last year. William Sorin, general counsel at Comverse technologies, became the first general counsel to plead guilty to criminal charges relating to backdating. He was fined $3m (£1.5m) in January and could face up to five years in jail.

Other general counsel to have left or lost their jobs in the wake of internal investigations or SEC enquiries include McAfee's Kent Roberts, recruitment giant Monster's Myron Olesnyckyj and CNET's Sharon Le Duy.

Even lawyers in private practice have become embroiled in the scandal. Larry Sonsini, the celebrated and well-connected chairman of Palo Alto leader Wilson Sonsini Goodrich & Rosati, represented a large proportion of the technology companies that are being investigated by the SEC. He also sat on the board of Brocade Communications, one of the first companies to be investigated for problematic grants, and is alleged to have advised on the 7.5 million share option grant to chief executive Steve Jobs at the heart of the Apple investigation.

So have general counsel been actively engaged in criminal activity, or are they simply the scapegoats in an investigation which has demanded blood?

In a survey conducted in 2002, the Association of Corporate Counsel (ACC) found that more than half of corporate counsel (57%) said that they should play as important a role as the chief executive, chief operating officer or chief financial officer in preventing fraud and two-thirds believed there would be less financial and accounting fraud if corporate counsel had more access to the chief executive and board of directors.

Contrary to these findings, in most of the cases where general counsel have been charged with fraud in relation to share options, they have sat on the board of directors.

As the profile and operational powers of general counsel increases, so does their responsibility for ensuring that such controversial practices as options backdating are properly handled and disclosed.

A regulation partner at White & Case comments: "This sort of fraudulent activity should have been blindingly obvious to general counsel. It was done out of pure greed and from tax-avoidance purposes. The fact that general counsel went along with it beggars belief."

However, Susan Hackett, general counsel for the ACC, argues that while some general counsel may have been guilty of criminal activities, others were simply drawn into the fray.

"Stock options backdating is clearly illegal if it is a 'hide the ball' situation, but in a lot of these cases, general counsel were quite open," she says. "In scandals such as these, and in a post-Enron climate, everyone is out for their pound of flesh. The really high-profile cases have been when the general counsel was positively engaged with the decision-making team. It is a question of who is left holding the bag."

Although more than 130 companies are currently being investigated by the SEC, most general counsel do not think this scandal will drag on for more than a year or so, partly because it does not look likely to generate the kind of securities litigation that followed the post-Enron corporate collapses.

With the introduction of the tighter legislation surrounding disclosure and professional conduct under the Sarbanes-Oxley Act, the potential for illegal backdating to occur on such a scale has been greatly reduced.

Larry Mowell, associate general counsel at United Technologies, which has not been involved in the investigations, comments: "It is largely a public accounting issue. Accounting is in fact being changed to take away the incentive to do it. People tend to do what they have an incentive to do."

Mowell warns as well that the investigation has shown that prosecutors are increasingly targeting corporate counsel: "There is a trend in the US to make in-house counsel more of a pressure point for various issues. Prosecutors have picked on general counsel as a pressure point."

Relatively little effect from the scandal has been felt on these shores to date. Financial Services Authority spokesman Joseph Eyre explains why: "We have rules which prevent this happening. A listed company in the UK cannot give discounted options to employees without the consent of its shareholders."

In the UK, companies have to gain shareholder consent to grant options at a price other than market value. On top of this, performance conditions typically apply to stock options for executives in the UK which means even if options are backdated, other targets often have to be met before options can be granted.

For the moment, UK general counsel look to be largely unaffected by the issue, but the scandal has highlighted failings in corporate governance which could hold valuable lessons for in-house counsel in the UK. Where Sarbanes-Oxley changed the regulatory climate in the US, the Proceeds of Crime Act 2002 has increased due diligence and reporting regulations on regulated firms in the UK. With the forthcoming Companies Bill, further regulation issues loom on the horizon for UK general counsel.

Hackett says the backdating scandal has brought up universal issues which hold lessons for all in-house lawyers, regardless of their jurisdiction. "This has taught general counsel to be extremely attuned to compensation issues," she says.

The episode also acts as a reminder that, while it is easy for general counsel to make blithe claims that their greater involvement in corporate decision-making will in itself ensure better governance and risk management, the reality is somewhat more complex.

The White & Case partner adds: "It is vitally important that the general counsel maintains the soul of the company – they have to be above any sort of scandal."

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