Options backdating, tax shelters, and corporate culture.

(33) It should be noted that if vesting was subject to additional performance goals other than continued employment, in-the-money options may nonetheless be considered performance-based pay. Such performance goals might include maintaining a certain market share, sales figure, earnings per share, or a performance goal tied to a particular business unit or division of the company. See Treas. Reg. [section] 1.162-27(e)(2)(vi) (1996).

(34) Disqualifying the entire amount of compensation when the options are only slightly in-the-money creates a punitive result. But the regulations explicitly provide an all-or-nothing rule. If the option is in-the-money, "none of the compensation attributable to the grant or award is qualified performance-based compensation." Id. Given the statutory ambiguity in section 162(m), courts would defer to any reasonable interpretation by the Treasury as part of its delegated law-making authority. It is possible, though unlikely, that companies may succeed in getting courts to declare this portion of the regulations invalid. In sum, while one can spin some creative yarn in hindsight, no one--not a single law firm that I'm aware of--advised that in-the-money options qualified as performance-based pay under section 162(m). Executives did this on their own, without the advice of counsel.

(35) See I.R.C. [section] 421(a).

(36) See I.R.C. [section] 422(b)(4), (d).

(37) There is a thin silver lining: employers may be able to deduct the amount from disqualified ISOs. Cf. I.R.C. [section] 421(b) (allowing deduction for ISOs disqualified by reason of violating holding period requirements).

(38) See Prop. Treas. Reg. [section] 1.409A-l(b)(5), 70 Fed. Reg. 57,930, 57,959-64 (Oct. 4, 2005).

(39) In fact, I struggle to think of any tax professor who supports current law.

(40) The New York Times reported that Micrel Inc. has alleged that it received accounting advice from Deloitte & Touche that a thirty-day window pricing approach was okay. Eric Dash, Inquiry into Stock Option Pricing Casts a Wide Net, N.Y. TIMES, June 19, 2006, at C1. The story notes the involvement of outside counsel, Morrison & Foerster, only extended to the form of the disclosure plan filed with the SEC, which stated that the exercise price would not be less than the fair market value on the date of grant. Id. Deloitte has denied any wrongdoing. Id. In 2004, Micrel settled with the Service; a Service auditor involved quit in protest. See David Cay Johnston, Tech Company Settled Tax Case Without an Audit, N.Y. TIMES, Aug. 10, 2004, at C1.

(41) See Text of Bed, Bath & Beyond Filing, supra note 17.

(42) Form of Nonqualified Stock Option Agreement (on file with author).

(43) Outside counsel may have been involved in some cases. In 1999, the directors of Novell Inc., including Larry Sonsini, awarded themselves 50,000 options apiece; the grant came on October 26, when the price was at a seventeen-month low. By the end of the year, the stock price would more than double, making the options worth more than $1 million per director. Novell announced unusually positive financial news shortly after the grant, raising the possibility that the off-cycle grant to the directors was either spring-loaded or backdated. See Justin Scheck, Sonsini Received Questionable Novell Options, RECORDER, Oct. 3, 2006, available at http://www.law.com/jsp/article.jsp?id=1159792523355 ("'It doesn't smell good,' said Boalt Hall School of Law Professor Jesse Fried, an expert in corporate governance and insider trading. 'This was at the annual low and was an off-cycle grant, and it's highly likely that this was spring-loaded.'"). Even in this case, however, it is unclear what Sonsini knew. Many practitioners I have spoken with, including competitors with no reason to sing his praises, state that Sonsini would not knowingly have allowed backdating to take place. On the other hand, circumstantial evidence of Sonsini's involvement is mounting. See Peter Lattman, Wilson Sonsini & the "Time Machine" Email, WSJ Law Blog, Mar. 29, 2007, available at http://blogs.wsj.com/law/2007/03/29/wilson-sonsini-the-time-machine-email.

(44) See Michael S. Sirkin & Andrea S. Rattner, Backdating Stock Options: Intentional Fraud or Carelessness?, CORP. COUNS., Sept. 13, 2006, available at http://www.law.com/jsp/ihc/PubArticleIHC.jsp?id=1158051922878 ("This is really the result of sloppiness and casualness in procedures, not of fraudulent intent. Most option backdating probably falls into this category.").

(45) The Comverse complaint, for example, acknowledges that of Kobi Alexander's $138 million gain on the sale of backdated options, only $6.4 million is attributable to the in-the-money cushion. See Complaint, SEC v. Alexander, No. 06 Civ. 3844 (GJ) (E.D.N.Y. Aug. 8, 2006), available at http://www.sec.gov/litigation/complaints/2006/comp19796.pdf.

(46) Telling a story solely about greed ignores the evidence that backdating was widespread (surely not all executives are greedy), concentrated in the technology sector (why would technology executives be greedier than, say, oil and gas executives?), and extended to rank-and-file employees (why would executives be greedy on behalf of others?).

(47) More research is needed before we can draw any firm conclusions about regulatory design; quantitative evidence from backdating is still emerging, and space constraints prevent me from providing as much qualitative evidence as would be useful.

(48) See George A. Akerlof & Rachel E. Kranton, Identity and the Economics of Organizations, 19 J. ECON. PERSP. 9, 11 (2005).

(49) The relationship between deal structure and brand image is complex. Elsewhere, I describe how the design of corporate deal structures can affect the way that consumers view a firm. See Victor Fleischer, Brand New Deal: The Branding Effect of Corporate Deal Structures, 104 MICH. L. REV. 1581 (2006) [hereinafter Fleischer, Brand New Deal]; see also Victor Fleischer, The MasterCard IPO: Protecting the Priceless Brand, HARV. NEGOT. L. REV. (forthcoming 2007) [hereinafter Fleischer, The MasterCard IPO]; D. Gordon Smith, The "Branding Effect" of Contracts, 12 HARV. NEGOT. L. REV. (forthcoming 2006). When Google went public, it was widely believed to have left money on the table by structuring the deal as an Internet auction rather than relying on the traditional, underwriter-led book-building process. But the deal structure, while costly, allowed Google to underscore its brand image as a creative company where the nerds were still in charge and were eager to thumb their noses at Wall Street. See Fleischer, Brand New Deal, supra, at 1596. Similarly, when MasterCard went public, it used a charitable foundation to put a more positive spin on what might be characterized as regulatory gamesmanship. See Fleischer, The MasterCard IPO, supra. Other companies like Apple, Ben & Jerry's, Morningstar, Trader Joe's, and Whole Foods have similarly decided to "leave money on the table" by employing innovative deal structures that, while getting the job done, also provide consumers with a sense of the firm's brand identity.

Deal structure may reflect not just a firm's external brand image, but also its internal brand image with managers and rank-and-file employees. When employees and managers are trying to figure out "the way we do things around here," one place they may look to is the way a company structures its deals. It also may work in the other direction. The design of contracts reflects the already-existing corporate culture. Rather than serving as a form of intra-firm advertising, the content and design of contracts reflects the processes and values of the firm shaped by other means. Research about the relationship between corporate culture and the design of contracts is relatively undeveloped; this Essay is a small contribution to what is becoming a much larger conversation. Research by legal academics includes William W. Bratton, Enron and the Dark Side of Shareholder Value, 76 TUL. L. REV. 1275 (2002); Donald C. Langevoort, Opening the Black Box of "Corporate Culture" in Law and Economics, 162 J. INSTITUTIONAL & THEORETICAL ECON. 80 (2006). For a brief comment that suggests a similar approach as this Essay, see Olufunmilayo B. Arewa, Corporate Governance Events: Legal Rules, Business Environment, and Corporate Culture, 55 CASE W. RES. L. REV. 545, 547-48 (2005). There is, of course, a rich transaction cost economics literature on the relationship between norms and the design of incomplete contracts.

(50) See CHRISTENSEN, supra note 8, at 407-14. Size is positively correlated with the adoption of innovation, but the product innovations that result from large firms tend to be the sustaining technologies rather than disruptive technologies favored by Silicon Valley firms. See id.

(51) See EVERETT M. ROGERS, DIFFUSION OF INNOVATIONS 149-50 (5th ed. 2003) (describing the development of the Macintosh computer at Apple).

(52) See Ashby Jones, Silicon Valley's Outsiders: In-House Lawyers?, WALL ST. J., Oct. 2, 2006, at B3.

(53) Id. at B3 (quoting Mark Michael, general counsel of 3Com from 1986 to 2003).

(54) Id.

(55) Id.