Pulling a Rabbit from a Black Hat: Mercury Emails Show Brazen Self-Dealing and Use of “Magic Backdating Ink”

In the California shareholder derivative action against former executives of Mercury Interactive Corp., emails referenced in public in court filings (but otherwise under seal and subject to a confidentiality order) show the intentional manipulation of records for lower strike prices to enrich those entrusted with managing executive compensation.

The derivative suit involves Mercury’s two former chief financial officers, its former general counsel and its former chief operating officer. The complaint says the four received more than three million backdated options, totaling about $54.2 million in immediate paper gains (i.e., difference between the “lowered” strike price they chose and the value of the stock on the open market the day they backdated). When the stock options vested (most plans have options in a grant vest at 20% per year for a three- to five-year period), the complaint alleges the four executives yielded “millions in illicit profit” sold Mercury shares worth $88 million.

The executives did not do this alone, as staff apparently used “white out” to hide dates on fax pages and took other extreme measures to ensure their bosses received deep in-the-money stock option grants. We know the measures were extreme because email discussion threads going back to 1999 say so.

Inasmuch as the backdating at Mercury was open and notorious, it suggests that a culture of manipulation and self-dealing permeated the organization. Sadly, some who were accessories or accomplices to these bad acts might have believed this is how public companies operate, whereas others who knew this conduct was wrong did not bring the fraud to the attention of the board of directors. Section 301 of the Sarbanes Oxley Act requires listed companies to have anonymous, confidential systems for reporting financial misconduct for this very reason.

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