This article is published courtesy of the September 2009 Business Law Section newsletter.
Sept. 16, 2009 – In recent years, the business media have frequently reported on companies who “backdated” executives’ stock option grants to dates when the stock price was low. Typically, this ensured the options were already “in the money” when the company granted them to employees. The practice is of dubious legality, and its widespread use led the SEC to scrutinize hundreds of companies. Perhaps the highest profile of these cases was the SEC’s investigation of Apple Inc., its former general counsel and its iconic CEO, Steve Jobs.
The media’s coverage of the stock option scandals caused the public to strongly associate backdating with corporate malfeasance. To the layperson, the term “backdating” is merely another word for lying, cheating, and stealing. Yet, for the business lawyer, backdating documents is often not only permissible, but is a regular and necessary part of everyday practice. The challenge for the business lawyer is determining when backdating is legitimate and when it is not.
Misrepresentation versus memorialization
Whether backdating a document is appropriate depends on the backdating’s “purpose and effect.” Backdating to perpetrate a fraud is obviously unethical and illegal. However, backdating to memorialize a prior act or event is a legitimate and necessary practice. Past acts and events can – and often must – be documented. To protect themselves, their firms and their clients, attorneys should always be certain their backdating falls into the latter category.
Perhaps the most fraudulent form of impermissible backdating is documenting and dating an act that never occurred. This is always inappropriate. Additionally, backdating is impermissible when the backdated document describes an act that actually occurred, but at a date subsequent to the date of the document, in order to secure benefits to which a party is not entitled. For example, an attorney should never enhance the value of a client’s tax deductions by backdating documents to fraudulently indicate the client purchased the deduction-generating property on an earlier date.
Drafting and executing a document after an event occurs, but in a manner that accurately reflects the date on which the event transpired, is a permissible form of backdating. This is backdating that memorializes, something the United States Court of Appeals for the Seventh Circuit has recognized as a legitimate practice. For example, if parties clearly reach an agreement on Dec. 31, 2009, but do not execute a contract formalizing their agreement until Jan.3, 2010, the contract may be dated as of Dec. 31, 2009. This is simply the accurate memorialization of a past event, something that is essential to legal practice. Another example of backdating that memorializes is drafting and executing records of action of a corporation’s board of directors after the board has adopted resolutions or taken other action. Additionally, as a matter of law, parties to a contract can make their agreement effective on a date of their choosing, as long as no third party’s rights are implicated. Each of the above are examples of situations where attorneys may legally backdate documents.
Staying in bounds
Staying on the right side of the misrepresentation-memorialization line is critical. Attorneys who inappropriately backdate documents can face ethical sanctions, lawsuits and even criminal prosecution. Unfortunately, it is sometimes difficult to determine whether backdating misrepresents or memorializes. There are several reasons for this difficulty, including that ambiguous law might govern the time of an event and relevant facts may be uncertain. Because they can create uncertainty regarding the date of an agreement, both present challenges for a lawyer considering backdating a document.
As a matter of contract law, it is not always easy to determine when parties reached an agreement. An agreement is typically the product of various oral and written negotiations, which often take place over weeks or months. That the parties reached an agreement is usually clear. However, the exact date of the agreement often is not, and the law may be ambiguous as to the moment when an agreement is reached. Consequently, backdating the document formalizing the agreement to the date the parties struck the deal can be precarious. If the agreement was reached earlier than the document’s date, the backdating memorializes; if the agreement was not reached until a later date, the backdating misrepresents. Ambiguity in the law can cause seemingly innocuous backdating to inadvertently become inappropriate fabrication.
In addition to ambiguous law, a lawyer may also be faced with uncertain or unverifiable facts. Insufficient or nonexistent records, human errors in recalling past events and injudicious reliance on the observations of others can all lead to backdating that misrepresents. A lawyer should be certain of the relevant facts before backdating a document. Even when dealing with a trustworthy, longstanding client, an attorney should not backdate documents without first seeking some independent confirmation the acts occurred on the stated date (while being careful not to appear to be questioning a client’s honesty). If such confirmation is unavailable, the attorney must exercise sound discretion based on his or her knowledge and past experiences with the client. An erroneous assessment of a client’s veracity, even if made innocently, can lead to severe consequences if the backdating perpetrates a fraud. Prudent lawyers should refrain from backdating if they are uncertain about when the relevant acts took place.
Even backdating that memorializes can misrepresent, if it misleads a court, government agency or other third party. For example, when a document memorializes an earlier event and is backdated to the date of the event, it may mislead a court to believe the document was actually executed on that date. However, such confusion may generally be avoided by disclosing on the face of the document that it was executed after the stated date. This will normally ensure that backdating that memorializes a prior event does not unintentionally misrepresent such event.
Although there are various ways of disclosing that a document is backdated, the use of so-called “as of” dating is perhaps the most effective. “As of” dating is the drafting practice of disclosing backdating by qualifying the document’s date with the modifier “as of” or “effective as of.” For example, rather than stating an event occurred “on Feb. 15, 2009,” the backdated document would instead state the event occurred “as of Feb. 15, 2009.” The “as of” modifier notifies the reader that although the date accurately reflects the actual or effective date of the agreement, the document may have been executed later.
By using “as of” dating, a lawyer can generally minimize the risk that backdating will mislead a court or other third party. It “belies any intent to hide the backdating and effectively invites any third party to whom the actual date of execution might be relevant to inquire about that date.” Some courts have confirmed this conclusion, going so far as to indicate it does not even constitute backdating.
When considering whether to backdate a document, a lawyer should adhere to the following best practices:
Never assume backdating is harmless. Carefully assess each situation to ensure backdating is proper and that it is carried out in a thoughtful manner.
Never backdate a document with the intention of deceiving a third party, a court or other government authority.
Never engage in backdating that misrepresents where the backdating could violate the law or adversely impact a third party’s rights, even if there is no ill intent. This type of backdating is particularly troublesome, because it is frequently difficult to identify all third parties who could be harmed and analyze backdating’s impact on their rights.
Never backdate to memorialize a prior act unless it is certain the act occurred on the specified date. If, after making a thorough legal and factual evaluation, it is uncertain when or if an act transpired, carefully consider whether backdating would constitute fabrication.
Always proceed under the assumption that a backdated document will not remain private. Because the possibility of litigation always looms, an attorney’s backdating should always be legitimate and defensible.
Always disclose backdating by using “as of” dating or another appropriate method that will prevent a court or third party from being misled.
By following these best practices, business lawyers can ensure they accurately memorialize legally significant events without placing themselves or their clients at risk. Backdating is not always the stuff of scandal. Done appropriately, it is a legitimate and essential part of the business lawyer’s practice.
Sam Hamilton is an attorney in the Milwaukee office of Reinhart Boerner Van Deuren s.c. where he focuses on assisting senior attorneys with mergers and acquisitions and securities matters, as well as general business representation.
This article is published courtesy of the September 2009 State Bar Business Law Section newsletter. The State Bar offers its members the opportunity to network with other lawyers who share a common interest through its 26 sections. Section membership includes access to newsletters, email lists to facilitate information sharing, and other resources.