Internal review unearths major compliance, accounting errors
Canada’s high-tech darling Research in Motion (RIM) has made some humbling announcements of late in an attempt to rectify errors made around its stock option grants. After a seven-month internal review that looked at more than 700,000 electronic and paper documents, a special committee at the Waterloo, Ont.-based company found several accounting errors.
“The company failed to maintain adequate internal and accounting controls with respect to the issuance of options in compliance with the company’s stock option plan,” RIM said in a release. “The grant process was characterized by informality and a lack of definitive documentation and lacked safeguards to ensure compliance with applicable accounting, regulatory and disclosure rules.”
Stock options have been a phenomenal program for attraction and retention, particularly when there were no disclosure requirements and no need to report them in financial statements, said Cal Barber, a Toronto-based compensation consultant.
“The aura of the high technology sectors, the whole mystique of being in it, was you could get these mega rewards,” said Barber.
But RIM found that some “new-hire grants” and “periodic grants” used an incorrect measurement date, so the exercise price of the option was less than the fair market value.
“In many instances…hindsight was used to select grant dates with favorable pricing on grants, resulting in grantees receiving an in-the-money benefit that was not recorded in the financial statements as stock-based compensation,” said the release.
Various executives at RIM reported that they understood options could be granted at a chosen date within the applicable period for reporting option grants to Canadian regulatory agencies, but “their understanding was incorrect,” said the release. Before Dec. 14, 1999, Canadian rules required insiders to report option grants within 10 days after the end of the month in which the grant was made. After that date, insiders were required to report within 10 days of the grant. However, RIM said it did not find “intentional misconduct” on the part of any director, officer or employee.
Despite RIM’s protests that it’s a growing company and didn’t know the rules, Sam Labell, an analyst with Veritas Investment Research in Toronto, said the rules of disclosure are pretty clear and have been in place for years.
“They’re the first Canadian company to really take action publicly on this so they probably realized they did have a problem,” said Labell. “They were sitting on a time bomb.”
And because they filed in the United States, RIM may have been worried about U.S. investigations into high-tech companies such as Apple.
All stock option grants, except to co-CEOs, were made by or under the authority of co-CEO Jim Balsillie, “to attract and retain skilled personnel to a rapidly growing technology company in an intensely competitive environment. The informality of the option granting process was, in part, a reflection of the stage of development of the company and the rapid growth occurring within the organization at the time.”
Labell cited the decentralization of granting activity at RIM as a big problem.
“The board delegated the authority to Balsillie and he delegated down the chain to individual executives and managers who could choose which options to grant,” he said. “The problem is it allowed a lot of leeway for people to name grant dates and set prices and awards without oversight and approval of the board of directors. They also didn’t have very good documentation of how the options plan worked.”
Veritas has looked into the area of back-dating stock option grants in Canada and found, despite the 10-day rule, many companies are filing late, said Labell. The penalties are also very low so there’s little incentive to comply. But he said it’s unlikely many other companies will follow the lead of RIM and make similar admissions of guilt because RIM is such a high-profile company and because of the nature of its business.
“High-tech is the one area where a lot of compensation is stock option-based because the stocks are volatile and tend to be growth stocks,” said Labell.
RIM is now trying to determine the appropriate measurement dates for each affected grant and all directors and C-level officers have agreed to return any benefit on previously exercised options and to re-price unexercised options that were incorrectly priced. The company will also restate its historical annual financial statements for fiscal 2004, 2005 and 2006 and for the first quarter of fiscal 2007.
To fix things going forward, RIM has established a new oversight committee, comprised of independent directors, to oversee executive compensation, the use of stock options as a compensation mechanism, trading by insiders, hiring practices and to review accounting and financial activities. The company is also hiring two new employees, one with expertise in U.S. generally accepted accounting principles (GAAP) and another in securities disclosure and compliance.
“We believe that the resulting enhancements to governance and controls will make RIM even stronger,” said Jim Estill and John Richardson, members of the audit committee.
Balsillie also voluntarily stepped down from his role as chairman.
“Those are long overdue,” said Labell. “That’s one of the first things they teach you in corporate governance is the chair and the CEO should be separated.”
But RIM’s troubles are far from over. The Ontario Securities Commission and U.S. Securities Exchange Commission are investigating the stock option grants, and the Ontario Ironworkers Pension Fund, which owns a small stake in RIM, alleges the company’s board members have a conflict of interest.
“The company failed to maintain adequate internal and accounting controls with respect to the issuance of options in compliance with the company’s stock option plan,” RIM said in a release. “The grant process was characterized by informality and a lack of definitive documentation and lacked safeguards to ensure compliance with applicable accounting, regulatory and disclosure rules.”
Stock options have been a phenomenal program for attraction and retention, particularly when there were no disclosure requirements and no need to report them in financial statements, said Cal Barber, a Toronto-based compensation consultant.
“The aura of the high technology sectors, the whole mystique of being in it, was you could get these mega rewards,” said Barber.
But RIM found that some “new-hire grants” and “periodic grants” used an incorrect measurement date, so the exercise price of the option was less than the fair market value.
“In many instances…hindsight was used to select grant dates with favorable pricing on grants, resulting in grantees receiving an in-the-money benefit that was not recorded in the financial statements as stock-based compensation,” said the release.
Various executives at RIM reported that they understood options could be granted at a chosen date within the applicable period for reporting option grants to Canadian regulatory agencies, but “their understanding was incorrect,” said the release. Before Dec. 14, 1999, Canadian rules required insiders to report option grants within 10 days after the end of the month in which the grant was made. After that date, insiders were required to report within 10 days of the grant. However, RIM said it did not find “intentional misconduct” on the part of any director, officer or employee.
Despite RIM’s protests that it’s a growing company and didn’t know the rules, Sam Labell, an analyst with Veritas Investment Research in Toronto, said the rules of disclosure are pretty clear and have been in place for years.
“They’re the first Canadian company to really take action publicly on this so they probably realized they did have a problem,” said Labell. “They were sitting on a time bomb.”
And because they filed in the United States, RIM may have been worried about U.S. investigations into high-tech companies such as Apple.
All stock option grants, except to co-CEOs, were made by or under the authority of co-CEO Jim Balsillie, “to attract and retain skilled personnel to a rapidly growing technology company in an intensely competitive environment. The informality of the option granting process was, in part, a reflection of the stage of development of the company and the rapid growth occurring within the organization at the time.”
Labell cited the decentralization of granting activity at RIM as a big problem.
“The board delegated the authority to Balsillie and he delegated down the chain to individual executives and managers who could choose which options to grant,” he said. “The problem is it allowed a lot of leeway for people to name grant dates and set prices and awards without oversight and approval of the board of directors. They also didn’t have very good documentation of how the options plan worked.”
Veritas has looked into the area of back-dating stock option grants in Canada and found, despite the 10-day rule, many companies are filing late, said Labell. The penalties are also very low so there’s little incentive to comply. But he said it’s unlikely many other companies will follow the lead of RIM and make similar admissions of guilt because RIM is such a high-profile company and because of the nature of its business.
“High-tech is the one area where a lot of compensation is stock option-based because the stocks are volatile and tend to be growth stocks,” said Labell.
RIM is now trying to determine the appropriate measurement dates for each affected grant and all directors and C-level officers have agreed to return any benefit on previously exercised options and to re-price unexercised options that were incorrectly priced. The company will also restate its historical annual financial statements for fiscal 2004, 2005 and 2006 and for the first quarter of fiscal 2007.
To fix things going forward, RIM has established a new oversight committee, comprised of independent directors, to oversee executive compensation, the use of stock options as a compensation mechanism, trading by insiders, hiring practices and to review accounting and financial activities. The company is also hiring two new employees, one with expertise in U.S. generally accepted accounting principles (GAAP) and another in securities disclosure and compliance.
“We believe that the resulting enhancements to governance and controls will make RIM even stronger,” said Jim Estill and John Richardson, members of the audit committee.
Balsillie also voluntarily stepped down from his role as chairman.
“Those are long overdue,” said Labell. “That’s one of the first things they teach you in corporate governance is the chair and the CEO should be separated.”
But RIM’s troubles are far from over. The Ontario Securities Commission and U.S. Securities Exchange Commission are investigating the stock option grants, and the Ontario Ironworkers Pension Fund, which owns a small stake in RIM, alleges the company’s board members have a conflict of interest.
