Monday, March 15, 2010

White Collar and Securities: Government Focuses on Personal Gain in Backdating Trial

As the United States government prepares for the beginning on Tuesday, March 16, 2010, of the trial of Bruce Karatz, the former CEO of KB Home, on charges stemming from his backdating of stock option bonuses, it is focusing on proving his motive, namely personal gain. The government has alleged that Karatz fraudulently received millions from his receipt of backdated stock options. Interestingly, the federal prosecutors have not alleged the exact amount of his alleged fraudulent gains.

The government's trial of Karatz is its sixth one alleging securities fraud based on individuals receiving backdated stock options. In most of the prior cases, the government did not focus the proof and the juries' attentions on the personal gains received by the defendants as motive for the crimes charged. Of the five prior prosecutions two resulted in convictions. A third conviction was overturned on appeal due to prosecutorial misconduct. A fourth was thrown out at trial due to prosecutorial misconduct, and the fifth resulted in an acquittal.

Defendants in the past urged juries to accept the argument that the backdating of options was a common practice among many companies. More specifically, defendants have argued that all of the actors within their corporations aware of the backdating, including the corporations' accountants and attorneys. Moreover, the argument relies on the fact that the accounting rules are arcane, and defendants relied on their accounting and legal professionals who allowed the backdating to occur. By drawing attention to the motive of personal gain, the federal prosecutors are attempting to focus the jury's attention on the result of the alleged crime, the receipt of the money by the defendant Karatz.

Previous trials had focused on Accounting Principles Board Opinion No. 25, which requires public companies to disclose in their public filings expenses incurred when granting "in the money options." "In the money" options are those below the current market value. Expenses incurred for options granted at the current market price did not have to be disclosed. Thus, there was an incentive to grant options at the lowest possible price and to reflect the date of the granting as the date when the market price was actually at that low level. By focusing on the personal gains of the defendants the prosecutors are trying to make the case less esoteric for the jury.

The indictment charges Karatz with seven counts of mail fraud, five counts of wire fraud, three counts of securities fraud, four counts of making false filings to the Securities and Exchange Commission, and one count of lying to the company's accountants.

The government will try to streamline its proof to show that Karatz knowingly and intentionally backdated his options to put money in his pocket at the expense of the company and its shareholders. The defense will argue that Karatz lacked the criminal intent to defraud the company and its shareholders, believing that the treatment of the options was lawful and appropriate. While the government would like to avoid a discussion of Opinion No. 25, it will probably be a centerpiece of the defense.

For more about the Karatz trial please see, "Prosecution in KB Home Backdating Case Takes a New Tack: Personal Gain," March 8, 2010,

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