The Centre for Corporate & Public Governance has a statement at its website concerning the most recent revelations of stock option irregularities at RIM. Company chiefs may be caught up not so much in a Catch-22 as a Catch-52, since that is the form U.S. securities laws require that CEOs and CFOs sign attesting to the accuracy of financial statements and disclosure. Both co-CEOs Jim Balsillie and Mike Lazaridis, and CFO Dennis Kavelman, routinely certified the results of RIM’s quarterly statements and annual filings.
In our previous comments on this company, we predicted there would be more surprises. But it is still hard to believe that there was such a prevalent culture of ignorance at the top management and board levels about proper disclosure and accounting of stock options. Yet that’s what the internal report is claiming. That may be a rather generous interpretation.
Finlay On Governance will have more on this breaking story in upcoming posts.
This highly valued company enjoys a global reputation for technological innovation. The chair of its board helped to found a think tank to examine issues of global governance, and heads that board. Yet the company’s own governance falls well below best practices, with three members of management sitting on its small board of seven, a stock options plan for directors, and its insistence on having its co-CEO also head the board to which he reports.
When the company launched its internal investigation into possible stock option irregularities last September, it established a committee of four outside directors who are also members of its audit committee to conduct the review. The company assured shareholders at the time that no material restatements would be required –despite not having completed the investigation. During the course of the review, with no explanation to investors and a stunning disregard for the optics of such a move, the co-CEOs exercised more than 750,000 stock options even while the company was in default of its statutory financial filings for the second quarter. Shortly after, the company advised the Ontario Securities Commission that it had found hundreds of thousands of additional documents as part of its investigation and that the restatement anticipated would be “substantially larger” than previously projected.
Late last Friday, in yet another surprising twist, the company announced that two directors would be stepping down from the probe over matters involving the “perception” of objectivity in the investigation, leaving only two others to complete the review that has already produced too many surprises. The board itself continues to be headed by a co-CEO who is a central figure in its stock options investigation. These matters have been the subject of continuing attention at Finlay On Governance.
It would be hard to imagine a more clumsy approach to an important issue from a board and a company that should have done much better. All of this reflects a persistent undervaluing of both principles of sound governance and common sense that have compromised the integrity of the internal investigation and the reputation of the company in ways that were entirely avoidable, which makes this latest episode in Research In Motion’s mishandling of its stock options fiasco the Outrage of the Week.
In light of the comprehensive nature of the Company’s management-initiated, voluntary internal review of stock options, including the past and future role of the Compensation Committee of the Board of Directors in respect of stock option grants, the audit committee believes it is important that the internal review not only be objective in fact, but also be perceived by RIM’s stakeholders as being objective.
–RIM press release, January 5, 2007
The board probe into possible irregularities in the handling of stock options at Waterloo-based Research In Motion takes yet another surprising turn, and one of several we continue to follow at Finlay ON Governance. The latest involves the announcement that Douglas Wright and Kendall Cork, two directors on the audit committee who also serve on RIM’s compensation committee, have recused themselves from the company’s internal stock options investigation. This was done, the company claims, to avoid even the appearance of conflict. Such a decision so late in the review raises the inevitable question: Was something more troubling discovered?
The two directors who have stepped down from the probe because they were also members of the compensation committee were members of that committee when the investigation began in September of last year. They have been part of the investigating committee all through October, November and December. They have sat on the compensation committee for several years. Yet, if we are to believe the company, no potential conflict was even considered until January of 2007.
The fact that only now, months after the investigation began, the company has come to realize that it is important that the review also be “perceived by RIM’s stakeholders as being objective” is a staggering admission, to say the least. The issue of “appearance” in connection with RIM’s board and the makeup of the committee heading the options probe was raised on these pages here in early December, when we said:
…the fact that RIM’s independent directors share an options deal with its management directors raises serious questions about how independent they really are and suggests at least the appearance that they may be unduly beholden to the founders of the company for a substantial part of their own (the independent directors’) wealth.
This is not the first surprise RIM has presented to investors. In December, it advised the Ontario Securities Commission that it had uncovered hundreds of thousands of new documents it needed to review. It also hinted that many had been destroyed in computer systems and had to be reconstructed. Before that, RIM’s co-chairs applied to the OSC to have the ban on insider stock trades lifted so that Jim Balsillie and Mike Lazaridis could exercise the purchase of more than 750,000 RIM options. This struck us at the time, and still does, as an odd thing for the OSC to permit given that it was the awarding of stock options to top management that was the subject of the investigation in the first place and the reason why RIM had failed to make its statutory financial filings.
This most recent announcement raises a number of additional points that trouble more than they reassure. By RIM’s own admission, there are only two directors out of the company’s board of seven, who are capable of overseeing the investigation. But there may well be additional problems for those members as well. James Estill has been on RIM’s board since 1997, during which time RIM’s securities filings confirm the board’s role in overseeing compensation and stock option decisions:
The Stock Option Plan is administered by the Board of Directors and the Compensation Committee. Each of the Board of Directors and the Compensation Committee has full and complete authority to interpret the Stock Option Plan, to prescribe such rules and regulations as it deems necessary for the proper administration of the Stock Option Plan and to make such determinations and to take such actions in connection therewith as it deems necessary or advisable.
Additionally, the board as a whole played a key role in setting dates and terms for stock option decisions, according to RIM’s statements:
Options granted under the Stock Option Plan have an exercise price of not less than the closing price of the Common Shares on the Toronto Stock Exchange (“TSX”) or Nasdaq National Market (“Nasdaq”) on the business day immediately preceding the date on which the option is granted and are exercisable for a period not to exceed ten years. The term and vesting of stock options is at the discretion of the Board of Directors and Compensation Committee.
So there are some legitimate questions as to whether board members are still in the position of investigating their own decisions and oversight conduct. In these kinds of high profile situations, it is often advisable to appoint new directors, who have had no previous involvement in decisions, to supervise investigations. To make a change in an internal probe so late in the process, following on the heals of a previous announcement in which the company said its anticipated restatement would be “significantly higher” than previously revealed, does not further investor confidence and should send up some large red flags to both the SEC and the OSC. Since RIM’s legal counsel has been before the OSC on several occasions in this matter, it is rather disturbing that neither the Commission’s hearing panel nor staff evidenced the slightest concerns about any potential conflict involving RIM’s independent directors and the probe they were heading.
In my view, these most recent developments at RIM are part of a larger problem involving its corporate governance practices, the structure of its board, the practice of awarding stock options to directors, the over-presence of management on a small board, the lack of an independent director as chair or even a lead director, among other concerns. I explored these in detail previously at Finlay ON Governance.
I said in an earlier posting that we have not seen the last of surprises at RIM over its stock options probe. This is one to add to the list. There will be more to follow.
Listening to today’s late afternoon webcast of RIM’s preliminary third quarter results was like being taken back to the dot.com era when analysts acted more like cheerleaders than objective examiners of the corporation’s health and financial results. Not a single question focused on RIM’s stock option problems. No one asked why the board’s internal investigation was taking so long, why the OSC was recently told that the resulting adjustment would be “significantly higher” than originally expected or what that was likely to mean. Amazingly, the topic of whether RIM would continue to issue stock options to non-management directors in the face of IBM’s much praised move to eliminate them wasn’t even raised. Judging from this show, we have moved back to a time when corporate governance doesn’t figure into the analysts’ equations. Almost every question started off with effusive congratulations to management for their stellar accomplishments. By the soft nature of the questions and unchallenging acceptance of the answers, it seemed more like RIM’s public relations department on the call.
RIM’s short-term results were impressive. But as we have learned from painful experience in recent years, that is only part of a company’s picture. And as was so often the case in the past, it was the questions not asked about matters not considered important that caused the greatest pain to investors.
RIM’s latest news sends up a large red flag about the management of both organizations.
What a surprise. After claiming in numerous news releases that RIM did not expect any material charge as a result of its stock options probe –they estimated between $25 million and $45 million at the time– the company’s lawyers now say it will be “significantly larger”. The revelations arise from RIM’s third appearance before the OSC to give an update as to why the company has failed to satisfy its disclosure obligations. However, this recent clarification does not appear on RIM’s web site, unlike the lower estimates. So investors are left again to wonder in the dark about this, just as they are about the company’s current financial picture. RIM remains in default of its statutory filing requirements.
RIM also claims that delays in getting to the bottom of its options probe arise from the discovery of 250,000 additional documents. Wow. Everyone misplaces a document or two now and then. But it takes a special skill to lose a quarter-million and then discover them by surprise.
RIM lawyers, acting for the board’s audit committee, advise that the voluminous new documents were uncovered through “forensic imaging” of company hard drives. Translation: They recovered files and records that had previously been deleted. That’s a troubling admission which again raises questions as to when they were deleted, why and by whom.
A legitimate further question, and one the OSC does not appear to have asked: When did the company become aware of these additional documents? Did RIM know about their existence when it asked the OSC on November 30th to lift the insider trading ban to permit management to exercise hundreds of thousands of stock options? The OSC granted the request.
There is often a tendency in these matters to underplay the expectation of bad news at the outset and then let it drift out during the course of an investigation in the hope that the market will not react with shock when the details finally surface. Like certain of its corporate governance practices, which were the subject of an extensive posting on Finlay On Governance, RIM’s handling of the probe from the outset raises significant issues.
First, there was the initial formal announcement on September 28th:
Research In Motion Limited (RIM) (Nasdaq: RIMM; TSX: RIM) announced today that the Audit Committee of RIM’s Board of Directors, comprised solely of independent directors, is completing a management-initiated, voluntary review of RIM’s historical option granting practices.
Notice that, on September 28th, the first time the company made mention of its internal investigation, it said the audit committee was “completing” its review.
Later in the release, the company claims:
Although the review is ongoing, it is currently expected that the potential effect of such restatement will be to increase the amount of non-cash charges associated with past option grants and thereby reduce the amount of the Company’s previously reported GAAP earnings by an aggregate amount of approximately $25-45 million over the period since the Company’s IPO in 1997.
And then it states:
The Company does not at present anticipate a material adjustment to current or future fiscal years’ operating results, including the preliminary Q2 operating results reported today in its separate earnings press release, and RIM has defined enhanced procedures and controls to address issues of this nature.
It is curious that RIM seemed to have enough information in September to estimate the $25 to $45 million charge and to assure investors that it was not material. But you have to ask, How did it arrive at that figure? How long had it been investigating the issue before it made the disclosure to investors? And why, if the audit committee was “completing” its probe in late September, did it take three more months to announce that the investigation is more complicated, that it will take longer and that its outcome will be more costly, than originally thought? Does the company’s newest position of a “significantly higher” charge than previously announced, veer into the material lane?
The investing public is entitled to more information than the company has provided or which the OSC seems to think relevant. That’s got to be a red flag regarding the management of both organizations. It is especially troubling that the OSC, after temporarily lifting its insider-only trading ban so that RIM executives could exercise their hefty number of stock options, a subject commented about here, felt it to be in the interests of the investing public to allow the company until March of next year to set its books right or report back on the status of its continuous disclosure obligations. The operative word is status. There is no ultimatum requiring RIM to get its act together or else. Indeed the OSC’s ‘drop back in a few months if the problem is not resolved’ approach seems more typical of a family doctor than a securities regulator.
I have a feeling we have not seen the last of surprises at RIM over its stock options probe. It may well highlight the need for changes in the corporate governance landscape of the company given some of the shortcomings which were raised previously on these pages.
The Centre for Corporate & Public Governance has received so many inquiries about the RIM affair, and the OSC’s role in it, that it felt it necessary to issue a statement. It will continue to monitor the progress of RIM’s investigation and the OSC’s handling of the file.
The OSC’s decision to reverse its previous order and allow RIM insiders to exercise 750,000 options while recent financial statements remain long overdue is a disservice to the investors it is mandated to protect.
There is a second chapter to yesterday’s posting about Research In Motion. You will recall that back in October RIM put out a media release to announce that it had voluntarily requested the Ontario Securities Commission issue a cease trade order against management and insiders because the company had failed to file its quarterly statements. The OSC should have done that without RIM’s requesting it, but you never know, as you will see when you read on. On November 7th the OSC issued the order stating:
…all trading in and acquisitions of securities of RIM, whether direct or indirect, by any of the Respondents cease until two business days following the receipt by the Commission of all filings RIM is required to make pursuant to Ontario securities laws.
The OSC had asserted in its statement of allegations:
It would be prejudicial to the public interest to allow the respondents to trade in the securities of RIM until such time as all disclosure required by Ontario securities law has been made by RIM.
But wait –they both got a do-over. (more…)
