Auditor Must Face Backdating Suit

Stock back-dating cases are not dead yet. The 9th Circuit Thursday resurrected the shareholder suit against auditors Ernst & Young in options back-dating case that hit Broadcom Corp.   A federal judge in Los Angeles earlier dismissed the suit, but the 9th Circuit has other plans.

Investors alleged that Ernst & Young, as auditors for Broadcom, allowed the company to overstate its net earnings and understate its compensation expense (through backdated stock options for execs.)  This was to the tune of $2.2 billion between 2000 and 2006, according to the allegations.  The question was whether the investors produced the minimum amount of evidence needed to let the suit go to trial.

The trial judge, U.S. District Judge Manuel Real in Los Angeles said no.  The Ninth Circuit overruled him Thursday, sending the case back for a trial.

Recall back in 2006 the stock options backdating had hit many companies and become the topic of national discussion in the business world. (That was before things got really ugly with banks and home mortgages.) 

Broadcom was accused of using stock options as part of compensation for officers and directors, which isn’t a problem.  Failing to report the cost to shareholders and backdating them to give the execs the biggest financial benefit did become a problem for the Securities and Exchange Commission and the Justice Department.

The appeals court describes backdating options as “akin to betting on a horse race after the horse has already crossed the finish line.” 

For Ernst & Young, the suit alleges the company either knew or was reckless in not discovering the alleged backdating fraud by Broadcom.  The appeals court said the details in the complaint, taken together, give a “strong inference” that the auditors should have known about the backdating fraud.  It doesn’t mean E&Y did anything illegal, just that the investors should be able to put the question to a jury.

 Case:  New Mexico State Investment Council v. Ernst & Young, 09-55632 (Ninth Circ.)

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