Digital River 2006 Annual Report Download - page 8

involvement of our finance staff, selected grant dates in order to obtain favorable exercise prices. This did not
occur with respect to any grants to directors or members of the Stock Option Committee, and thus did not
result in any financial benefit to those individuals. Additionally, the Special Committee determined that on
certain occasions, the Stock Option Committee unknowingly exceeded its authority in granting stock options
to Section 16 officers, which options should have been granted by the Board of Directors. In each of these
instances, the Board ratified the grants at a subsequent meeting. The Special Committee also discovered a
small number of instances where option grant dates preceded employee hire dates; such instances are
attributable to either administrative error or a practice of pricing options for certain employees as of the
employment offer date. Finally, the Special Committee identified six occasions where we did not properly
expense option grants to consultants.
More generally, the internal investigation revealed weaknesses in our internal controls and record-keeping
related to stock options during the relevant period. In particular, we lacked appropriate systems to ensure
adequate communication between our accounting and human resources departments pertaining to the option
grant process. Thus, the accounting personnel did not consistently receive accurate information necessary to
determine appropriate measurement dates. Moreover, we failed to prepare adequate minutes of meetings of the
Compensation Committee and Stock Option Committee.
Beginning in January 2003, we strengthened our internal controls and made significant improvements to
our stock option granting practices. The Special Committee did not identify any measurement date issues
associated with stock option grants since January 2003, with the exception of three dates, each of which
apparently resulted from errors in internal processes rather than any intentional backdating.
During the relevant period, we granted 1,306 employees, consultants, officers and directors options to
acquire approximately 16.8 million shares of our common stock. These option grants, awarded on 69 distinct
grant dates, consisted of one or more of the following types of grants: (i) grants to directors; (ii) grants to
Section 16 officers; (iii) follow-on grants to employees; (iv) grants to new hires; (v) grants to employees
receiving promotions; and (vi) grants to consultants.
Grants to Directors. During the relevant period, we appropriately awarded grants to directors during
Board of Directors or Compensation Committee meetings. The Special Committee discovered no problems
associated with director grants, with the exception of one grant to one director on February 13, 2003. Due to a
clerical error, the original paperwork for the February 13, 2003 Board of Director grants was misdated, which
was corrected in 2003 with the exception of one former director who had already exercised his option. We
subsequently corrected this error for all but one director. We should have recorded a charge related to the
grant price and recorded an additional charge for a subsequent vesting acceleration. These charges make up
less than $10,000 of the total $9.4 million after-tax restatement.
Grants to Section 16 Officers. During the relevant period, the Stock Option Committee awarded 540,000
stock options to nine Section 16 officers on four different specified grant dates. After a review of the corporate
record, the Special Committee determined that the Stock Option Committee was not vested with the authority
to award stock options to Section 16 officers. Outside counsel conducted interviews with the Stock Option
Committee members and certain Compensation Committee members and determined that the committee
members believed the Stock Option Committee possessed the authority to make the grants. This is
corroborated by subsequent Board ratification of the grants. However, because the requisite authority did not
exist, the measurement dates for these grants have been adjusted to the Board ratification date, and the charges
under APB 25 make up $1.0 million of the total $9.4 million after-tax restatement.
Grants to Employees and Consultants (inclusive of follow-on, new hire, and promotion grants). During
the relevant period, stock option grants to non-Section 16 employees and consultants were generally awarded
by the Stock Option Committee. Stock Option Committee documentation with respect to such grants is in
many instances inadequate, particularly from 1998 through 2002. Based on interviews and a review of all
available documentation, including relevant email archives, the Special Committee determined that employee
and consultant grants on sixteen grant dates may not have been measured on the correct date. Consistent with
accounting literature and recent guidance from the Securities and Exchange Commission (“SEC”), we
employed one of three methods to assign the correct measurement date: (i) the date of a relevant email, if the
4