Digital River 2006 Annual Report Download - page 63

we have recorded additional non-cash stock-based compensation expense and related tax effects with regard to
past stock option grants, and we are restating previously filed financial statements in this Form 10-K.
The internal investigation identified a number of deficiencies in our internal controls that existed
primarily from 1998 through 2002. In particular, the internal investigation found that from 1998 through 2002:
• We lacked appropriate systems to ensure adequate communication among our departments, particularly
accounting and human resources, pertaining to the option grant process;
• We failed on some occasions to prepare adequate minutes of meetings of the Compensation Committee
and the Stock Option Committee; and
• There were inadequate control mechanisms in the accounting department to ensure that information
about stock option grant dates and exercise prices accurately reflected the true measurement dates for
accounting purposes.
Beginning in January 2003, we implemented improvements to procedures, processes, and systems to
provide additional safeguards and greater internal control over the stock option granting and administration
function. Management believes these improved controls have reduced to remote the likelihood that a material
error in accounting arising from the use of an incorrect stock option grant measurement date could occur and
not be detected. These improved controls, which were implemented at various times from 2003 to 2006,
include:
• The General Counsel and CFO, both experienced with public companies and stock option granting
procedures, attend all Board and Committee meetings;
• We adopted new Equity Grant Procedures, eliminating all delegated authority to management to make
equity awards; and
• We implemented a process to comply with the requirements regarding grant date determination related
to our adoption of SFAS 123(R) on January 1, 2006.
The internal investigation 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.
Management has concluded that the control deficiencies resulting in the restatement of previously issued
financial statements did not constitute a material weakness in disclosure controls and procedures, or internal
controls and procedures over financial reporting, as of December 31, 2006. In coming to this conclusion,
management considered, among other things, the impact of the restatement to the financial statements and the
effectiveness of the internal controls in this area as of the fiscal years ended 2006, 2005, 2004 and 2003.
(a) Disclosure Controls and Procedures
Based on their evaluation of our disclosure controls and procedures conducted as of December 31, 2006,
our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of
1934) were effective at reasonable assurance levels to ensure that the information required to be disclosed by
us in this Form 10-K was recorded, processed, summarized and reported within the time periods specified in
the rules and instructions for Form 10-K.
(b) Management’s Annual Report on Internal Control over Financial Reporting
Our management, including the Chief Executive Officer and Chief Financial Officer, is responsible for
establishing and maintaining an adequate system of internal control over financial reporting. This system of
internal accounting controls is designed to provide reasonable assurance that assets are safeguarded,
transactions are properly recorded and executed in accordance with management’s authorization and financial
statements are prepared in accordance with generally accepted accounting principles. A control system, no
matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the
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