Why I Did Not Go To Jail

A lot of people have been asking me what my upcoming book, The Hard Thing About Hard Things, will be like. Here's a piece that I wrote for the book that did not make the cut. I still think it's a pretty good story and gives you a flavor.

I just tell the truth so I'm cool in every hood spot
21 years and I ain't ever met a good cop
—Drake, “I’m Goin In”

Drake - I'm Going In | Listen for free at bop.fm

After we transitioned the business from Loudcloud to Opsware, we needed a head of finance. Therefore, when the CFO from one of the best-run enterprise software companies became available, I jumped at the chance to hire her.

Michelle (note: her name has been changed) comprehensively understood software accounting, business models, and best practices, and she was beloved by Wall Street in no small part due to her honest and straightforward reporting of her previous company’s business. In my reference checking, at least a dozen investors told me that they made far more money when the numbers disappointed than when the company outperformed, because they trusted Michelle when she said that things were not worse than they appeared and bought on the dips.

Once she came on board, Michelle rapidly reviewed all of our practices and processes to make sure we were both compliant and competitive. One area where she thought we were less than competitive was our stock option granting process. She reported that her previous company’s practice of setting the stock option price at the low during the month it was granted yielded a far more favorable result for employees than ours. She also said that since it had been designed by the company’s outside legal counsel and approved by their auditors, it was fully compliant with the law. 

It all sounded great: better incentives for employees at no additional cost or risk. However, after nearly four years of disastrous surprises, nothing made me more nervous than things that sounded great. On top of that, changes related to accounting law always worried me.

They worried me, because every incentive that we put in place as a company was designed to encourage people to achieve their goals. All these incentives had the caveat that the goals must be achieved while obeying the law. Now that may sound simple, but in virtually every meeting every day people discuss their goals and how they will achieve them. They almost never discuss accounting law. In a sales forecast meeting, you will often hear, “What can we do to get this closed by the end of the quarter?” You never hear, “Will the way we made the commitment comply with Statement of Position-97-2 (the critical software accounting rule)?”

Beyond that, U.S. accounting law is extremely difficult to understand and often seems illogical and random. For example, the law in question with respect to stock options, FAS 123, is filled with paragraphs such as this:

“This Statement does not specify the measurement date for share-based payment transactions with nonemployees for which the measure of the cost of goods acquired or services received is based on the fair value of the equity instruments issued. EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services”, establishes criteria for determining the measurement date for equity instruments issued in share-based payment transactions with nonemployees.”

And that is the clear part.

To guard against employees purposely or accidentally breaking the law in pursuit of their goals, I took two broad measures. First, when we started the company, Marc and I agreed that the company’s General Counsel would always report directly to me. This is different than in many technology companies where the General Counsel reports to the Chief Financial Officer. That way, there would be no way for another executive to subvert the law in pursuit of the number. Secondly, I would regularly give a speech to the finance employees that went like this: 

“In this business, we may run into trouble. We may miss a quarter. We may even go bankrupt, but we will not go to jail. So if somebody asks you to do something that you think might put you in jail, call me.”

With that as a backdrop, I told Michelle that a better stock granting process sounded great, but I needed Jordan Breslow, my General Counsel, to review it before making a decision. Jordan lived in my hometown of Berkeley and he certainly belonged there. With hippie sensibilities, Jordan was nearly allergic to corporate politics, showmanship, or any behavior that covered the truth. As a result, I knew that what he said was 100% what he believed and had nothing to do with anything else. I could trust it. 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.” I told Michelle that we were not going to implement the policy and that was that. 

Well, that was that for a while. Then, almost two years later, the SEC announced that it was investigating Michelle’s previous company for stock option accounting irregularities. This started a massive investigation of all Silicon Valley companies and their stock option accounting practices. All told, more than 200 companies were found guilty of some sort of irregularity.

In November of 2005, Michelle’s previous employer announced that it was removing most of its management team in an admission of wrongdoing. The SEC issued Michelle a Wells notice, a letter stating that it planned to recommend enforcement action against her personally. It was not an indictment, but it was a formal investigation, and it would be very distracting. I had to ask her to step down. In some ways the choice was obvious—we could not put the entire company at risk for one person. Still, firing somebody who had done nothing wrong at Opsware was tough. Nonetheless, Michelle graciously resigned as she did not want to bring negative attention to the company.

In the days that followed, I carefully positioned the change to both protect the company and not put Michelle in a bad light. I told our employees that there was a difference between accounting fraud and accounting mistakes and I believed that Michelle made mistakes at her previous company, but did not commit fraud. I explained to our investors who loved Michelle that I also thought very highly of her, but I had no choice. The company came first.

Michelle ultimately served 3½ months in jail for her part in the other company’s stock option practice—the same practice that we nearly implemented at Opsware. Since we had the same head of finance, we almost certainly would have been investigated. I obviously don’t know what happened at the other company, but I do know that Michelle had no intention of breaking any laws and no idea that she’d broken any laws. The whole thing was a case of 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.” Once the SEC decided that most technology company stock option procedures were not as desired, the jail sentences were handed out arbitrarily. 

In retrospect, the only thing that kept me out of jail was some good luck and an outstanding General Counsel, and the right organizational design.

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