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SCO's Latest SEC Filings - Director Indemnification & Compensation
Saturday, July 09 2005 @ 11:32 AM EDT

SCO has filed with the SEC an 8K about the new directors and with information on director compensation and indemnification, and a 424B3, a Prospectus Supplement, supplementing "the prospectus dated June 2, 2005 relating to the offer and sale by the selling stockholder identified in the prospectus of up to 2,105,263 shares of common stock of The SCO Group, Inc." and which "should be read in conjunction with, and may not be delivered or utilized without, the prospectus dated June 2, 2005, and the prospectus supplement dated June 3, 2005. This prospectus supplement is qualified by reference to the prospectus and the prospectus supplement, except to the extent that the information in this prospectus supplement updates or supersedes the information contained in the prospectus dated June 2, 2005, or the prospectus supplement dated June 3, 2005."

Got that? It reminds me of the old Marx Brothers contract routine in A Night at the Opera:

Driftwood: "The party of the first part shall be known in this contract as the party of the first part. . . What do you mean? The party of the first part?"
Fiorello: No, the first part of the party of the first part.
Driftwood: All right. It says the, uh, "The first part of the party of the first part shall be known in this contract as the first part of the party of the first part shall be known in this contract" - look, why should we quarrel about a thing like this? We'll take it right out, eh?
Fiorello: Yeah, it's a too long, anyhow. (They both tear off the tops of their contracts.) Now, what do we got left?
Driftwood: Well, I got about a foot and a half. . . .
Driftwood: Well, your word's good enough for me. (They rip out another part.) Now then, is my word good enough for you?
Fiorello: I should say not.

Etc. But assuming we are supposed to understand the new filings, let's try. If you put them, and their exhibits, together, and really work hard at it, you will find that there are some small differences in director compensation. And there is a change in language regarding indemnification of their directors, which one might suppose SCO calculates they may have occasion to need someday. SCO had the two new directors acknowledge, in their Indemnification Agreement, that they are aware of the the following:

Indemnitee understands and acknowledges that the Company has undertaken or may be required in the future to undertake with the Securities and Exchange Commission to submit the question of indemnification to a court in certain circumstances for a determination of the Company's right under public policy to indemnify Indemnitee.

Why might they need to do that? They explain in the Mutual Acknowledgement clause:

 Both the Company and Indemnitee acknowledge that in certain instances, federal law or applicable public policy may prohibit the Company from indemnifying its directors, officers, employees, agents or fiduciaries under this Agreement or otherwise.

I think that may be understating it. And in fact, if you go back in time, you'll find that the SEC has already taken a position, and they notified SCO of that position very clearly. Here's what you find in a SCO filing from July 8, 2003 on this matter:

Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers, and controlling persons of the Company pursuant to the foregoing provisions, or otherwise, the Company has been informed that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable.

Unenforceable. So now SCO promises its directors that if push comes to shove, they'll litigate to get a ruling that the SEC is wrong. Maybe they couldn't get anyone to agree to serve without that commitment. And they also get the new directors to acknowledge that they know this is an issue, which covers SCO's back if they litigate and lose.

I'd wonder, if I were offered that indemnification package, how SCO will pay for it on my behalf and I'd probably wonder how much the indemnification for liabilities under the provisions of the Securities Act is worth, under the circumstances. If it were me, and it never would be, I'd be mighty careful not to need such indemnification. They seem to be such gamblers, these SCOfolk, though, so maybe they like to live dangerously.

Of course, you have to dig a bit to figure all this out, because they don't make it easy. I'll explain how, step by step, so you can reproduce the steps and come to your own opinions from the documents themselves.

Both the 8K and the 424B3 include this description of the agreement, except they use the plural:

Indemnification Agreements

        On June 28, 2005, the Company entered in Indemnification Agreements with each of its two newly elected directors, Omar T. Leeman and J. Kent Millington. The Form of Indemnification Agreement entered into with these directors and officers is substantially the same form previously executed by all other directors, including Ralph J. Yarro III, Edward E. Iacobucci, R. Duff Thompson, Darcy G. Mott, Daniel W. Campbell and Darl C. McBride, who is also the Chief Executive Officer of the Company, and other officers, including Bert B. Young, Chief Financial Officer, Jeff F. Hunsaker, Sr. Vice President and General Manager, UNIX Division, Christopher Sontag, Sr. Vice President Business Development and Ryan E. Tibbitts, General Counsel and Corporate Secretary.

        The Indemnification Agreements provide that the Company will indemnify the Company's officers and directors, to the fullest extent permitted by law, in relation to any event or occurrence related to the fact that such officer or director is or was a director, officer, employee, agent or fiduciary of the Company, or any subsidiary of the Company, or is or was serving at the request of the Company as a director, officer, employee, trustee, agent or fiduciary of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise by reason of any action or inaction on the part of such officer or director serving in any capacity set forth in this paragraph. In addition, the Indemnification Agreements provide that the Company will make an advance payment of expenses and losses to any officer or director who has entered into an Indemnification Agreement, if such officer or director requests such advance payment of expenses and losses, in order to cover a claim relating to any fact or occurrence arising from or relating to events or occurrences specified in this paragraph.

        The foregoing summary of the Indemnification Agreements is subject to, and qualified in its entirety by, the Form of Indemnification Agreement, which has previously been filed as an exhibit and is incorporated herein by reference to Exhibit 99.1.

So there is apparently more than one indemnification agreement, the one the new directors signed and the one the old guard did, and in this description, they seem to mention only the parts that are the same. (I see poor Blake Stowell isn't indemnified, or at least isn't listed. You may say that's because he isn't a director. But neither is Sontag or Tibbitts or others on the list.)

Saying a contract is "substantially the same" as another isn't the same thing in legalese as saying it is identical. So that made me sit up and pay closer attention. What might the differences be? I noted there wasn't a word about the SEC's position in this description. But I remembered it from writing an article a year ago. So I started to dig, to see if it had changed and what there might be that is not identical to the old agreement Yarro and the rest signed. The Exhibit Index for the 8K says this about Exhibit 99.1:

Form of Indemnification Agreement for Officers and Directors (incorporated by reference from Exhibit 10.36 to Post-Effective Amendment No. 1 to Form S-3 on Form S-1, File No. 333-116732, filed May 18, 2005).

They haven't attached the Indemnification Agreement to this form, in other words, so you have to find it attached to the earlier referenced filing. If you go to find it in the May filing, as I did, you'll find these interesting paragraphs in the indemnification agreement:

4.    Additional Indemnification Rights; Nonexclusivity.    

        (a)    Scope.    The Company hereby agrees to make Expense Advances to, and indemnify, the Indemnitee to the fullest extent permitted by law, notwithstanding that such Expense Advances and indemnification are not specifically authorized by the other provisions of this Agreement, the Company's Certificate of Incorporation, the Company's Bylaws or by statute. In the event of any change after the date of this Agreement in any applicable law, statute or rule which expands the right of a Delaware corporation to indemnify a member of its board of directors or an officer, employee, agent or fiduciary, it is the intent of the parties hereto that Indemnitee shall enjoy by this Agreement the greater benefits afforded by such change. In the event of any change in any applicable law, statute or rule which narrows the right of a Delaware corporation to indemnify a member of its board of directors or an officer, employee, agent or fiduciary, such change, to the extent not otherwise required by such law, statute or rule to be applied to this Agreement, shall have no effect on this Agreement or the parties' rights and obligations hereunder except as set forth in Section 9(a).

 (b)    Nonexclusivity.    The rights to Expense Advances and indemnification for Losses provided by this Agreement shall be in addition to any rights to which Indemnitee may be entitled under the Company's Certificate of Incorporation, its Bylaws, any other agreement, any vote of stockholders or disinterested directors, the General Corporation Law of the State of Delaware, or otherwise. The indemnification provided under this Agreement shall continue as to Indemnitee for any action taken or not taken by Indemnitee while serving in an indemnified capacity even though Indemnitee may have ceased to serve in such capacity. . . .

    7.    Mutual Acknowledgment.    Both the Company and Indemnitee acknowledge that in certain instances, federal law or applicable public policy may prohibit the Company from indemnifying its directors, officers, employees, agents or fiduciaries under this Agreement or otherwise. Indemnitee understands and acknowledges that the Company has undertaken or may be required in the future to undertake with the Securities and Exchange Commission to submit the question of indemnification to a court in certain circumstances for a determination of the Company's right under public policy to indemnify Indemnitee.

The Scope and Nonexclusivity clauses would say to me, if I were a director, that SCO will try to cover me by hook or by crook, no matter what the SEC finally rules. If they back off and SCO wins or the law changes to allow SCO to indemnify all matters, the clause says the director will benefit. If the agreement is found unenforceable in certain respects, there are other ways to cover expenses and losses. I'd also understand that if I leave SCO and am no longer a director, they'll still cover me for whatever I did, short of fraud, while I was a director.

Next, I used Groklaw's search function to find that older article I remembered that mentioned the SEC position. SCO filed, on July 8, 2003 a Registration Statement on Form S-3, relating to "the public offering or distribution by selling stockholders of up to 305,274 shares of common stock, par value $0.001 per share, of The SCO Group, Inc." The shares were being sold by Vultus, Inc., The Canopy Group, Inc., Angel Partners Inc., Michael Meservy, Bruce K. Grant Jr., Ty D. Mattingly and R. Kevin Bean. The price for SCO stock back then, on July 3, 2003, was considerably higher than it is today: "the last price for our common stock, as reported by the Nasdaq National Market, was $10.71."

Ah, the good old days, when the world believed them. Well, not the *whole* world. I never believed them, because of the GPL, which I knew would interfere with their stated goals. But enough of the world did believe them that the price on the stock shot up. That filing was the one that revealed the SEC position's on SCO's indemnification:

COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES

"Our articles of incorporation provide for the indemnification of our officers and directors to the full extent permitted by Delaware corporate law. Such indemnification includes the advancement of costs and expenses and extends to all matters, except those in which there has been intentional misconduct, fraud, a knowing violation of law, or the payment of dividends in violation of the Delaware General Corporation Law and could include indemnification for liabilities under the provisions of the Securities Act. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers, and controlling persons of the Company pursuant to the foregoing provisions, or otherwise, the Company has been informed that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable.

"In the event that a claim for indemnification against such liabilities (other than the payment by our company of expenses incurred or paid by one of our directors, officers, or controlling persons in the successful defense of any action, suit, or proceeding) is asserted by such director, officer, or controlling person in connection with the securities subject to this offering, we will, unless in the opinion of our counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by our company is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue."

So, after that notification from the SEC of its position, SCO stated in that filing their willingness to litigate, but naturally any new director who had done his due diligence would want it to be incorporated into the Indemnification Agreement itself. SCO pretty much had to declare this, and get anyone new to sign off that they know about the issue, so it can't get sued later by a director, if they end up not able to fully indemnify them. I pay attention any time anyone asks me to sign an acknowledgement. It's to cover the other side's back, an escape hatch. Lawyers I have worked for used to tell me to draw up such clauses any time he or she was worried about the client trying to sue them down the road and pretending to the court the lawyer didn't explain something a bit controversial fully.

Director Compensation

There is also an Exhibit 99.2 in the new filings:

Compensation of Non-Employee Directors

        The compensation and benefits for service as a member of the Board of Directors is determined by the Nominations Committee. Directors employed by us or one of our subsidiaries are not compensated for service on the Board of Directors or on any Committee of the Board of Directors. Our non-employee directors currently receive $25,000 for each year of service as a director plus an additional $5,000 per year for each committee of the Board of Directors on which such non-employee directors serve. Additionally, the chairpersons of each of the Compensation Committee and the Nominations Committee receive an additional $5,000 per year and the chairpersons of each of the Audit Committee and the Litigation Oversight Committee receive an additional $10,000 per year. In addition, Board of Directors members are reimbursed for expenses incurred in connection with attendance at Board of Directors and committee meetings. Non-employee directors also receive stock option awards under our stock option plans, which awards currently include an initial option to purchase 45,000 shares of common stock upon joining the Board of Directors as a director and thereafter each non-employee director who continues to serve on the Board of Directors automatically receives an annual grant of an option to acquire 15,000 shares upon his or her election at the annual meeting.

Here's what SCO Directors got back in 2002, according to their 10K/A filing for the fiscal year ended October 31, 2002, back when they called themselves Caldera. Darl McBride was already the CEO:

DIRECTOR COMPENSATION

        The Company's directors will receive $25,000 plus $5,000 per committee served on, for the 2003 fiscal year payable in restricted shares of the Company's common stock priced effective February 21, 2003. In addition, members will be reimbursed for expenses in connection with attendance at board and committee meetings. Directors also participate in the 1999 Plan, which provides for the award of an option to acquire 45,000 shares on joining the board and options to acquire 15,000 shares for each year the board member continues to serve.

I don't see cash for chairing a committee. Of course, there was no Litigation Oversight Committee back in 2002. I'm not sure about an Audit Committee, but I believe that is to make sure they never make any future mistakes that might get them delisted, after their near-delisting experience. But there were other committees. And here's what happened in 2003, from the same July filing:

During the quarter ended April 30, 2003, the Company’s board of directors approved a resolution to receive remaining amounts owed to them for services provided during the 2002 fiscal year in the form of stock awards.  The Company issued 27,500 shares of common stock with a fair value of $36,000.  The fair value of the stock was recorded as stock-based compensation for the nine months ended July 31, 2003.  Additionally, the Company granted 150,000 shares of restricted common stock to members of the Company’s board of directors with a fair value of $195,000.  The restricted common stock issued to the board of directors was in lieu of cash compensation for their services to the Company during the 2003 fiscal year and the restrictions lapse on October 31, 2003.

Now, it's stone cold cash, please. Of course, the new directors get stock also. Cash, not all in stock, the way they did in the hopeful days of 2002-3, when they must have imagined the stock was on its way "to teh moon". Of course, back then it was on the way up, and insiders didn't do too shabbily, as I recall. But in the sober present, cash is apparently preferred. And for the future? The indemnification might cover all contingencies or it might not. But it's fascinating that SCO seems willing to pay for more litigation, in order to indemnify their directors the way they want to rather than change the Indemnification Agreement to reflect the SEC's position. Maybe they'd have a hard time convincing anyone to serve as a director otherwise. Or maybe SCO sees the world the way it wants to, and if you don't agree with what they want, as in this case the SEC doesn't, they'll litigate. Why should indemnification be any different? And to me, it's quite telling that indemnification is that important an issue to them.


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