The Securities and Exchange Commission today filed civil fraud charges in federal district court for the Northern District of California against California-based software maker Mercury Interactive, LLC (formerly known as Mercury Interactive Corporation) and four former senior officers of Mercury — former Chairman and Chief Executive Officer Amnon Landan, former Chief Financial Officers Sharlene Abrams and Douglas Smith, and former General Counsel Susan Skaer. The SEC alleges that the former senior officers perpetrated a fraudulent and deceptive scheme from 1997 to 2005 to award themselves and other employees undisclosed, secret compensation by backdating stock option grants, failing to record hundreds of millions of dollars of compensation expense, and falsifying documents to further this scheme.
The SEC also alleges that during this period Mercury, through Landan and at times Abrams, Smith or Skaer, made fraudulent disclosures concerning Mercury's "backlog" of sales revenues to manage its reported earnings, and structured fraudulent loans for option exercises by overseas employees to avoid recording expenses. Mercury, which was acquired by Hewlett-Packard Company on Nov. 8, 2006, after the alleged misconduct, settled the matter by agreeing to pay a $28 million civil penalty and to be permanently enjoined. The SEC's case against the four former officers is being litigated.
"The $28 million corporate penalty in this case, together with a permanent injunction, should send a clear signal that fraudulent stock option backdating and other financial fraud will be severely punished," said SEC Chairman Christopher Cox. "The Commission's Enforcement Division will reinforce that principle by vigorously pursuing the charges against the individuals who were responsible. In this case as well as those that will follow, the SEC will do everything within our power to see to it that illegal options backdating is stamped out."
Linda Chatman Thomsen, Director of the Commission's Division of Enforcement, said, "The array of fraudulent conduct at Mercury Interactive over an eight year period, including backdating dozens of stock option grants, backdating senior executive stock option exercises, structuring of overseas option exercises to conceal expenses and concealing the true nature of its earnings, deprived Mercury Interactive's shareholders and the market of accurate information regarding executive compensation and the company's accounting for stock options. The widespread and pernicious misconduct — including lying to shareholders, intentionally false accounting, and fraudulent stock options backdating — in this case warrants the significant sanctions imposed on the company and sought from the former executives."
Christopher Conte, Associate Director of the Commission's Division of Enforcement, said, "The individual defendants charged today are alleged to have realized millions of dollars in illicit compensation and stock sale profits through their secret backdating scheme and to have deceived Mercury Interactive investors through repeated misrepresentations about the company's stock option practices and compensation costs. The Commission's first ever use of Section 304 of Sarbanes-Oxley — which allows the Commission to seek the repayment of bonuses and stock sale profits received by CEOs and CFOs where financial results are later restated — reflects the Commission's willingness to use all available remedies to deprive such senior officers of illicit gains."
The SEC's complaint alleges that from 1997 to 2002, Mercury, acting through Landan and at various times Abrams, Smith and Skaer, backdated the date on which stock options were granted to executives and employees. The backdating made it appear that the options were granted at times corresponding to low points of the closing price of the company's stock — despite the fact that the purported grant date bore no relation to when the grant was actually approved — and resulted in artificially and fraudulently low exercise prices for those options. The senior officers used hindsight to select the purported grant dates of the options, backdating the grants by anywhere from days to as much as over four months and making the grants in-the-money from 40 cents to $60 on the date they were actually approved. The complaint alleges that from 1997 through 2005, the accounting consequences of these benefits were then concealed as Landan, and at various times Abrams, Smith, Skaer and others, caused Mercury to fail to record over $258 million in compensation expenses and to provide false and misleading compensation disclosures to Mercury's shareholders in filings with the Commission. Mercury and the senior executives continued the backdating for years in spite of a specific change mandated and approved by shareholders in 1998 that required the exercise price of all employee options to be 100% of the fair market value of the company's stock on the grant date.
The SEC alleges that the company backdated 45 different stock option grants to executives and employees, representing every grant made by the company to executives and employees during 1997 to April 2002. As alleged in the complaint, Skaer, or others at her direction, prepared false documentation memorializing the grants, including false written consents and meeting minutes. The complaint alleges that Landan, Abrams, Smith and Skaer each personally benefited by receiving backdated stock options that were in-the-money by, in the aggregate, millions of dollars through the fraudulent scheme.
The complaint also alleges that from 1998 through 2001, Mercury, acting through Landan, Abrams and Skaer, fraudulently backdated the date of option exercises of certain senior Mercury officers. According to the complaint, senior executives were given preferential treatment and on multiple occasions were permitted to backdate the date of exercise of stock options with the company. The complaint alleges that these executives, including Landan and Abrams, backdated option exercises to dates consistent with low-points of the company's stock, in order to minimize their taxable gain on exercise or receive more favorable long-term capital gains treatment on profits they earned upon the later sale of the stock acquired through exercise. For example, the complaint alleges that in connection with three backdated exercises, Landan was able to underreport over $18 million in gains upon exercise. In fact, Landan and Abrams at times backdated the exercise of backdated option grants. The company concealed from its shareholders the benefits reaped by these executives by making fraudulent proxy disclosures relating to officer stock option exercises, while Landan, Abrams and Skaer also concealed the backdated exercises in Forms 4 filed with the Commission.
In addition, the complaint alleges that during at least 1997 through 2001, Mercury, through Landan, Abrams and others, secretly managed the company's reported earnings per share ("EPS") to meet or exceed financial analyst expectations by manipulating the recognition of revenue and making fraudulent disclosures concerning its sales orders. According to the complaint, Mercury stopped the shipment of its products once revenue targets for a period had been achieved, pushing the recognition of the revenue into subsequent periods. Between 1998 and 2001, this practice allowed the company to shift material amounts of revenue between reporting periods (from between $35 million to approximately $182 million in revenues). The company concealed the effect of this stop-shipment practice from the public through fraudulent and misleading statements and omissions concerning the "backlog" of its product bookings. Landan and Abrams understood that the backlog of revenues was material information that was being concealed from analysts and investors. For example, a 1999 PowerPoint presentation by Abrams to Landan and others concerning the company's financial picture stated in a slide: "Our Hidden Backlog . . . What Any Analyst Would Love to Get Their Hands On!"
Finally, the complaint alleges that during 1999 through 2005, at various times Abrams, Skaer, and others participated in the fraudulent structuring of loans for stock option exercises by overseas employees of the company in order to conceal the variable accounting consequences of those transactions, causing the company to fail to report approximately $24 million in required compensation expenses, which materially overstated the company's reported pre-tax earnings during this period.
Without admitting or denying the SEC's allegations, Mercury agreed to pay a $28 million civil penalty to settle the Commission's charges. Mercury also agreed to an injunction that permanently enjoins it from violating Section 17(a) of the Securities Act of 1933, Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), and 14(a) of the Securities Exchange Act of 1934, and Exchange Act Rules 10b-5, 12b-20, 13a-1, 13a-13, and 14a-9.
The complaint alleges that Landan, Abrams, Smith and Skaer violated or aided and abetted violations of the antifraud, record-keeping, financial reporting, internal controls, equity transaction reporting and proxy provisions of the federal securities laws. The complaint also alleges that Landan and Smith violated Exchange Act Rule 13a-14 by signing certifications required by Section 302 of the Sarbanes-Oxley Act of 2002 that were false and misleading concerning Mercury's 2002 through 2005 periodic reports. The SEC's complaint seeks against each of the individuals permanent injunctions, disgorgement with prejudgment interest, civil monetary penalties and officer and director bars. In addition, the complaint seeks against Landan and Smith reimbursement of bonuses and profits from stock sales pursuant to Section 304 of the Sarbanes-Oxley Act.
The Commission’s investigation is continuing.
Cephalon, Inc. (Nasdaq:CEPH) of Frazer, Pennsylvania, will become a component of the NASDAQ-100 Index(r) (Nasdaq:NDX), the NASDAQ-100 Equal Weighted Index (Nasdaq:NDXE), and the NASDAQ-100 Ex-Tech Sector Index (Nasdaq:NDXX) prior to market open on Friday, June 1, 2007. Cephalon, Inc. will replace MedImmune, Inc. (Nasdaq:MEDI). 
