Hypotheticals

United States v. Mike Gerhardt

Summary

In 2007 Mike Gerhardt, former legal counsel of a major security software company was charged by the United States Government for devising a scheme to defraud the shareholders of the company by granting himself and others valuable “in-the-money” stock options while also hiding the true nature and value of the stock option grants from the board of directors, shareholders, auditors, and the United States Securities and Exchange Commission.

Fact Pattern

Joining a long list of executives charged with stock backdating between 2005–2008, Gerhardt was indicted by a federal grand jury on seven counts of fraud for improperly backdating options between 2000 and 2002. According to the indictment, the board granted Gerhardt the option to buy 20,000 shares of stock at the strike price of $29.62, which was the price at which the stock closed on Feb. 14, 2000. In late 2000, the Government claimed that Gerhardt became concerned that his options were "under water" (the exercise price of the grant was more than the market price for stock). Gerhardt then allegedly requested that the company’s then-controller to change the grant date and exercise price to April 14, 2000, with a new exercise price of $19.75. The government also alleged that Gerhardt altered board meeting minutes to change the date on which options were granted to the company’s then-CEO and Chairman from Jan. 15, 2002 when the stock closed at $27.19, to Jan. 16, 2002 when it closed at only $25.43.

In order to successfully prosecute Mr. Gerhardt, the government had to prove two things:

  • That Mr. Gerhardt took an action, AND
  • He knew at the time that what he did was wrong at the time 

Could the government prove the first element? Yes.  In fact, no one really contested the facts around the acts.  What about the second element? While regulations regarding the dates of stock options have become clear over time, at the time these actions occurred stock backdating was a complicated but typically legal action to take and there was no reason for Mr. Gerhardt to believe that his actions were not in accordance with the US Securities and Exchange Commission regulations.

Furthermore, other executives and board members for the company became so concerned about their own actions that they conspired to provide selective information to the US Government in order to protect their own interests. They went so far as to name this plan “Project Shield” and many of the participants in this plan performed the exact same actions that were alleged against Mr. Gerhardt.

Lastly, Mr. Gerhardt made absolutely no money as a result of any of the alleged actions. The US DOJ’s selective prosecution of Gerhardt, willingness to accept partial information from the board of directors, and inability to prove that he knew at the time that his actions were wrong resulted in one of the few acquittals of any executive charged with stock backdating.

Hypotheticals