> Michelle was surprised, as her previous company had run this practice for years with full approval from PricewaterhouseCoopers, its accounting firm. I said: “That’s all fine and good, but I still need Jordan to review it first.”

Jordan came back with an answer that I did not expect: “Ben, I’ve gone over the law six times and there’s no way that this practice is strictly within the bounds of the law. I’m not sure how PwC justified it, but I recommend against it.”

One of the foundational reasons for the spectacular implosions of both Enron and WorldCom was the behavior of their common auditor, the ginormous accounting firm Arthur Andersen (https://en.wikipedia.org/wiki/Arthur_Andersen). Andersen was willing to certify pretty much anything these companies wanted to do as fully legal and above-board, because these were big clients and Andersen didn't want to lose them to some other accounting firm by inconveniently insisting that they keep honest books. So they were free to rip people off in all sorts of creative ways for years, protected from close scrutiny by Andersen's seal of approval.

All of which is to say that, if you represent serious cash flow and you're tempted to push the legal envelope, you probably shouldn't expect a Big Four accountant to be the one to talk you out of it.

Here is Ben 3 years previously recommending that executives break the law to preserve their standing with each other:

"It is important to note that just about all of these kinds of policies violate the Right to Work laws in California. Specifically, if you block a hire based on this kind of policy and the employee loses their job and cannot find work, your company is liable for his wages. As a result, the business relationship with the other company must be extremely important for you to employ any kind of “hands off” policy."

https://a16z.com/2011/02/23/is-it-ok-to-hire-people-from-you...

Others mentioned that Sharlene Abrams is "Michelle" here and posted links but this link seems to be better [1].

Interestingly, this case was about backdating _executive_ options _including her own_. I can't claim any knowledge of what PWC did or didn't approve of and some casual searching hasn't found any action taken by the DOJ or the SEC against auditors in relation to SV option backdating (please correct me if I'm wrong).

A quick search found that at one point option grants needed to be reported within 2 months but the SEC changed this to 2 business days and some companies and individuals were indicted because they failed to do so. Was this after this case or before? I'm not sure on the timing.

Whatever the case, this seems pretty wilful non-compliance (and, arguably, fraud) so I'm not surprised some went to jail. I'd also be surprised if anyone thought backdating anything that affected tax and legal obligations was legal, particularly a CFO.

As for anyone who thinks those who commit this kind of fraud shouldn't go to jail, I'd say jail is about the one thing the rich are afraid of. If you have $20m then a $3m fine might suck but it's not the end of your world. A year in jail in so much worse.

[1] http://retheauditors.com/2014/02/13/vc-horowitz-implicates-a...

"Abrams did not actually go to jail for backdating stock options. What she pleaded guilty to in a criminal case[1] was listing a false exercise date for her options on her tax returns. That meant more of her profits got taxed as capital gains (at a lower rate), less as ordinary income. Lowering your marginal tax rate is a silly reason to risk jail, but that’s a separate question. In his post, Horowitz says, “Michelle ultimately served 3 1/2 months in jail for her part in [her old employer’s] stock option practice — the same practice that we nearly implemented at Opsware.” Well, sort of. Certainly the charges against Abrams were a consequence of the backdating investigation.

It’s safe to guess, though, that backdating company loans to executives (something else that happened at Abrams’ earlier company) and switching around exercise dates to cut his own taxes weren’t practices Horowitz was planning to implement. You don’t need a great general counsel to steer clear of this. Just following the instructions on TurboTax would probably do it."

https://web.archive.org/web/20150108121957/http://go.bloombe...

[1] https://web.archive.org/web/20130530050608/http://www.justic...

I don't think the rule that was violated here is very complicated at all. I'll get the technical details wrong, I'm sure, but the underlying ethic of the situation is obvious:

If you issue a stock option with a strike price equal to the day's market price of an option, it's "at the money". These options are tax-favored, presumably because it doesn't have intrinsic value (until it's "in the money", when the company shares later appreciate).

What you can instead do, if you're a cheat, is to pretend you're issuing tax-favored incentive options "at the money", but backdate them so that their price at issuance is the low price within some window. These options are effectively "in the money" (whatever the difference is between the low price set for the option and the current higher price is locked-in profit) when issued, have intrinsic value, and should be fully taxable, but you're falsely claiming otherwise.

Not sure how to feel about this.

Story seems to be that this lady went to jail from a knock-on effect of a stock option backdating scheme, which led to taxes being wrong. But many firms seemed to have done this, presumably with somewhat independent legal advice.

I'm not close enough to the details to really understand it, or even understand whether it smelled.

But I can remember a time when accountants were shopping around tax-saving schemes in the City of London, and I came across one of the sales guys. There would be all sorts of strange schemes, for instance involving the schemers "advising" P Diddy on his lyrics. Or publishing a book of their own poetry. And the explanation diagram would always fill up entire A4 pages with various sorts of entities. I'd get told the scheme was sound, approved by top lawyers, etc.

But I never participated, it just seemed too contrived to make sense. The stuff was always marketed as "you'll save tax" but everyone knows whether they're making an income, and what the rough tax rate is. So if you're paying a lot less something smells.

Michelle got actual jail time for a simple, honest accounting mistake? I don't buy it. Rich, connected people don't serve time for white collar crimes in the USA unless the criminality is severe.

(2014)

Previous discussion: https://news.ycombinator.com/item?id=7191642

The idea of a GC reporting to a CFO is a lunacy. It is like a controller reporting to a CRO.

Edit: I am fascinated by the downvote.

The job of GC is to prevent a company from doing things that would create legal issues for the company. Both CEO and CFO have a reason to push the company to take risks, including legal risks. Neither should be able to fire the GC. Therefore GC should report to the board of directors not to the CEO and definitely not to the CFO.

The job of a controller is to oversee accounting. The top level person who is likely to engage in creative accounting is the head of sales/chief revenue officer. Controller reporting to the CRO creates an incentive of a controller to take CRO positions rather than purely accounting positions. Therefore controller should either report to CFO or CEO.

Read about this form of fraud, and more, in the book "financial shenanigans" !

Quoting from this review of the book: https://100investmentbooksayear.wordpress.com/2014/12/17/rev...

> Failure to proper account for stock option backdating expense, where management secretly give themselves stock options that had already increased in value. By not reporting the compensation expense resulting from these “in-the-money” stock options grants, companies are overstating their earnings. Look out for unusually “lucky” timing on the issuance of stock options.

Edit: from the old thread, here's the SEC's statement:

https://www.sec.gov/litigation/litreleases/2009/lr20964.htm

> On May 31, 2007, the Commission charged Abrams and three other former senior Mercury officers with perpetrating a fraudulent and deceptive scheme from 1997 to 2005 to award themselves and other Mercury employees undisclosed, secret compensation by backdating stock option grants and failing to record hundreds of millions of dollars of compensation expense. The Commission's complaint alleges that during this period certain of these executives, including Abrams, backdated stock option exercises, made fraudulent disclosures concerning Mercury's "backlog" of sales revenues to manage its reported earnings, and structured fraudulent loans for option exercises by overseas employees to avoid recording expenses.

Backdating options is one thing. Failure to report the additional expenses incurred by backdating options fraudulently overstates the profitability the company, harming all other investors

>Michelle (note: her name has been changed)

Does this really obscure "Michelle's" identity? CFO at a major, well run enterprise company, worked at Opsware until ~2005, and later she served 3.5 months in prison. (Not sure if gender was randomized.)

That seems to be enough to figure out who it was.

Edit: Per romed's comment, Sharlene Abrams seems to fit those criteria:

Confirming the ~4 month sentence: https://www.law360.com/articles/229277/ex-mercury-cfo-gets-4...

https://www.reuters.com/article/mercury-plea/former-mercury-...

https://news.ycombinator.com/item?id=18027437

And I also found this, which recounts the same details of the story and confirms Abrams: https://dealbook.nytimes.com/2014/02/06/how-ben-horowitz-avo...

The general rule for startups is to innovate in product space and not in the mechanics of running (and taxing of) the business. This will put a startup at the disadvantage of FAMGA. But that is only one of many disadvantages.

The irony of this CFO example is that the innovation was ethics, run it by a lawyer, and the conventional wisdom was unethical, to backdate the options. But irony notwithstanding, the law won out.

If your inner voice says you and your C corporation might be getting away with something then you should probably run that by a lawyer. If that something involves someone else not knowing something else (the essence of fraud) you definitely should run that by a lawyer or just follow the general rule.

I am disappointed so many people seem to accept the view that Michelle is in fact substantially to blame and deserves her punishment. I have the opposite view: the government is absolutely to blame, for creating an incomprehensible tax and accounting system. It is unacceptable to me, for example, that the IRS (or SEC) does not just notify people directly and immediately if they have made a mistake - honest or otherwise - on their accounting statements. It's as if a company built an unusable software system, and also somehow had the legal power to send people to jail for making mistakes while using it.

Is there a legal equivalent of "code smell"?

Neat story. Definitely underscores the importance of not just blindly copying others. Just because "everyone's doing it" does. not. make. it. right.

Old rule: "Measure twice. Saw once."

Another old rule: "Believe none of what you hear and half of what you see and still will believe twice too much."

I learned a similar lesson in math: Intuitive descriptions and conceptions and pictures and examples are from really good up to crucial, but they are not sufficient. Instead, make strong efforts to stay really close to carefully stated theorems and proofs.

Sure, there are books, lectures, etc. on applied math that try to make the subject easier by omitting the proofs and often even the carefully stated theorems. On further inspection and more learning, what I found was that the with the easier treatments, in practice omitting the theorems and proofs also omitted crucial discipline, care, and checking and brought in too many errors.

Sometimes have to work with such "easy" sources and work too fast, but in that case try not to bet more than can afford to lose -- in the sense of the OP, don't take a chance of going to jail.

Corollary: call Jordan Breslow if you are looking for real advice, which is something rare. He has a professional web page here: https://www.gettinglegalright.com/ it seems he is the real hero.

It's neat how some rap references, lip-service to integrity, and some local color about Berkeley hippies can make a multi-millionaire's story seem sympathetic, given it's about hiring a CFO who ultimately went to jail for accounting fraud.

Reading that legal doc made me wish there was a Genius for laws.

> Michelle ultimately served 3½ months in jail ... Michelle had no intention of breaking any laws and no idea that she’d broken any laws.

There is something desperately wrong with our legal system when a situation like that is even possible.

[deleted]

this is four years old, the title should be updated.

> *the old saying: “When the paddy wagon pulls up to the house of ill repute, it doesn’t matter what you are doing. Everybody goes to jail.”

Oh yeah! That old saying! /s

That song is such a banger. The era of Drake's rise and Weezy at his best.

The whole practice of putting non-violent people in jail is just so absurd.