
Why I Did Not Go to Jail (2014) - eruditely
https://a16z.com/2014/02/06/why-i-did-not-go-to-jail/
======
smacktoward
_> 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](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.

~~~
hayksaakian
Quick reminder for anyone who might have missed it:

Accenture is a spinoff from Anderson Accounting.

Do with that knowledge what you will:
[https://en.wikipedia.org/wiki/Accenture#Emergence_of_Accentu...](https://en.wikipedia.org/wiki/Accenture#Emergence_of_Accenture)

~~~
AJC-Official
This is a useful bit of knowledge, but to guard against people making
irrational judgments about Accenture, it's important to note that (1) It was
primarily Anderson's consulting divisions that went to Accenture, and (2)
these large auditing firms have offices all over the US and world, and in
these types of cases, it was really only a branch or two that were complicit
in the fraud.

In the same way that we shouldn't condemn the employees of <INSERT TECH
COMPANY> because senior leaders decided to <Censor/Abuse/Manipulate users> we
shouldn't condemn otherwise ethical accountants because of the misdeeds of
their colleagues - especially when they pass more stringent ethical
requirements than developers.

Ironically, people couldn't differentiate the isolated incident, and AA
liquidated/sold because no one wanted to do business with them. [0]

[0] en.wikipedia.org/wiki/Arthur_Andersen#Demise

~~~
rossdavidh
"Ironically, people couldn't differentiate the isolated incident, and AA
liquidated/sold because no one wanted to do business with them."

"Ironically" is not the word you should be looking for, there. "Fittingly", or
"Unsurprisingly", perhaps. Even if you know not all the apples in the barrel
were bad, you know that it was a barrel with more than one bad apple, so you
throw that barrel out.

~~~
SilasX
Ironically, people often dismiss the scale of a problem by saying it was
limited to a few "bad apples", when the point of the apple/barrel metaphor is
that one bad apple can spoil the whole bunch, so having one bad apple in it is
just as bad as every apple being rotten.

Does that one work?

------
noonenowhere
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...](https://a16z.com/2011/02/23/is-it-ok-to-hire-people-from-your-friends-
company/)

~~~
Scaevolus
Violating California labor law is unlikely to land you in jail-- most of the
penalties are financial.

~~~
emodendroket
I mean, given the tone of this post and the talk of how important it is to run
everything by the counsel, "not committing a crime that literally leads to the
executives being jailed" is a pretty low bar.

~~~
rossdavidh
...albeit a higher bar than many of his peers could clear.

------
cletus
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...](http://retheauditors.com/2014/02/13/vc-horowitz-implicates-
auditor-pwc-in-story-about-dodging-backdating-bullet/)

~~~
zeroname
> 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.

Except the intention here obviously was not to defraud, but _to follow the
law_ , which was so incomprehensible as to make even professionals fall into
its traps. And it's not "the rich" going to jail here, but the professionals
that are responsible for making that mistake. Maybe that professional happens
to be "rich", but most people involved will walk free, as long as there's a
scapegoat.

No, people shouldn't go to jail for this. These regulations shouldn't even
exist. Even "socialist Europe" isn't as bad as the US in this regard.

~~~
emodendroket
Other than the assertions in the blog post it's not really clear why we should
believe this version of events. Consider this article, which suggests the
opposite:
[https://web.archive.org/web/20150108121957/http://go.bloombe...](https://web.archive.org/web/20150108121957/http://go.bloomberg.com/market-
now/2014/02/12/dont-worry-ben-its-a-long-way-to-san-quenti/)

------
phonon
"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...](https://web.archive.org/web/20150108121957/http://go.bloomberg.com/market-
now/2014/02/12/dont-worry-ben-its-a-long-way-to-san-quenti/)

[1]
[https://web.archive.org/web/20130530050608/http://www.justic...](https://web.archive.org/web/20130530050608/http://www.justice.gov/usao/can/news/2010/2010_09_16_abrams.guiltyplea.press.pdf)

------
tptacek
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.

~~~
lacker
_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._

For what it's worth, options that are not "in the money" are still worth a lot
of money and have intrinsic value. I'm not making a ridiculous claim here,
this is what the Black Scholes model would say for example and it's why
companies don't just hand out options freely to anyone. Yet according to our
tax law they do not have value and are not taxable. (This is why options exist
in the first place.) So, IMO the whole thing is complicated because the tax
law has a somewhat arbitrary rule for determining what options are taxable.

IANAL but it is also not required to give out strike prices that match the
exact day someone is hired. You have some flex in the time period. So these
rules just aren't as simple as one might hope.

~~~
tedunangst
An option that is not in the money has no intrinsic value by definition. It
has time value.

~~~
lacker
I don't think it's accurate to say that it has no intrinsic value by
definition. If you do a fundamental analysis on the options without reference
to their market value, the Black Scholes formula will tell you that an option,
even an option out of the money, is worth something. That is the definition of
intrinsic value.

Options out of the money also clearly have a market value, for public
companies at least.

~~~
mrfredward
Intrinsic value has a very specific meaning in the options world (different
from the everyday meaning you are referring to):
[https://www.investopedia.com/terms/i/intrinsicvalue.asp](https://www.investopedia.com/terms/i/intrinsicvalue.asp)

~~~
lacker
According to the first sentence in the article you link, "Intrinsic value is
the perceived or calculated value of a company, including tangible and
intangible factors, using fundamental analysis." That's precisely what I am
talking about.

~~~
mrfredward
Read more than the first sentence before you double down.

------
lordnacho
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.

------
jhpriestley
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.

~~~
romed
Right. The person in question plead guilty to criminal tax evasion, an
exceedingly rare charge. Nobody gets charged with tax evasion for reasonable
but incorrect interpretations of the tax code. In this case the evasion was
intentional, flagrant, and large.

~~~
pmiller2
I still think something is missing from the story. They state the scheme was
designed by outside legal counsel. Lawyers are paid to know the law. Under
federal law, for it to be criminal tax evasion, the conduct has to be willful.
Doing something with advice of legal counsel is almost definitely not a
willful violation of the law.

~~~
romed
The reason for this apparent paradox is that all of the key statements in this
blog post are false. Just go read the US Attorney's press releases or the
perpetrator's guilty plea if you want facts.

~~~
GLjEI4YbnGD27LB
You are only getting the story as presented by the CEO, so I assume I am not
getting the entire picture.

------
jsnell
(2014)

Previous discussion:
[https://news.ycombinator.com/item?id=7191642](https://news.ycombinator.com/item?id=7191642)

~~~
refurb
Pretty important comment in there that the person Ben is talking about didn't
go to jail for this accounting strategy but rather tax fraud!

------
notyourday
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.

------
shoo
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...](https://100investmentbooksayear.wordpress.com/2014/12/17/review-
financial-shenanigans-by-howard-m-schilit/)

> 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](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

------
SilasX
>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.law360.com/articles/229277/ex-mercury-cfo-
gets-4-months-for-tax-evasion)

[https://www.reuters.com/article/mercury-plea/former-
mercury-...](https://www.reuters.com/article/mercury-plea/former-mercury-
interactive-cfo-to-plead-guilty-idUSN0920738920100909)

[https://news.ycombinator.com/item?id=18027437](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...](https://dealbook.nytimes.com/2014/02/06/how-ben-horowitz-avoided-an-
options-backdating-scandal/)

~~~
icelancer
It is not meant to permanently obscure it; only to avoid specifically naming
them for Google Searches as a courtesy. It's not like "Michelle" didn't do
what Ben said she did; she in fact did a lot worse.

Ben was merely extending a basic courtesy.

~~~
SilasX
Fair enough, but it seems he added a lot of unnecessary detail that made her
easy to identify with high confidence. The exact length of the prison
sentence? The year of resignation? The title at current and previous job?

That seems like a lot of work that went at cross purposes to anonymization.

~~~
chris_wot
I think it is highly unlikely that more than one CFO of his company was ever
jailed. At least, I sure hope not!

------
CalChris
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.

------
d_burfoot
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.

------
csours
Is there a legal equivalent of "code smell"?

~~~
mjevans
Pretty much ethics. If there's anything that's being done or offered that
wouldn't be affording to random public joe then think very hard about why it's
being done.

For some things there's a good reason, for others it's reasonable to ask why a
specific timeframe? Why not 5% more, or 100% more.

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

------
graycat
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.

------
wslh
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/](https://www.gettinglegalright.com/) it
seems he is the real hero.

------
jonstewart
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.

~~~
jiveturkey
His entire book is like that.

On the one hand, it does rub the wrong way. I'm supposed to believe this is a
man of and from the street?

OTOH, it adds useful background color to his story. Probably finely studied
and tuned for publication, but still useful.

You should check out the audiobook.

------
lisper
> 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.

~~~
romed
The blog post is a highly misleading one-sided account of a notorious white-
collar crime. You should read more about it from other perspectives.

~~~
emodendroket
Do you have a recommendation?

~~~
romed
[https://www.reuters.com/article/mercury-plea/former-
mercury-...](https://www.reuters.com/article/mercury-plea/former-mercury-
interactive-cfo-to-plead-guilty-idUSN0920738920100909)

[https://www.sec.gov/litigation/litreleases/2009/lr20964.htm](https://www.sec.gov/litigation/litreleases/2009/lr20964.htm)

etc.

~~~
microtherion
Kind of interesting, too, that the original article talks about the backdated
options being granted to "employees", while from your links, it appears that
this was very much a thing for _executives_ only.

~~~
village-idiot
An executive risking jail time to help employees out does not sound that
plausible, to be honest.

Now an executive risking jail time to enrich themselves? Now we’re talking.

------
epa
[deleted]

~~~
dang
"Please respond to the strongest plausible interpretation of what someone
says, not a weaker one that's easier to criticize."

[https://news.ycombinator.com/newsguidelines.html](https://news.ycombinator.com/newsguidelines.html)

------
misiti3780
this is four years old, the title should be updated.

~~~
dang
Thanks, added.

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

------
bxEIGHTY8
That song is such a banger. The era of Drake's rise and Weezy at his best.

------
qwerty456127
The whole practice of putting non-violent people in jail is just so absurd.

~~~
vkou
Tax evasion is theft.

~~~
qwerty456127
Whatever. The only kind of people that should actually be jailed is those who
are prone to physical aggression or invasion into others' private space.

~~~
ufmace
I mean, you can make a case for that. But you can also make a case that not
much else seems to really deter these high net worth people from doing illegal
things. What would you propose as an appropriate punishment for willfully
breaking tax law?

~~~
int_19h
For example, massive fines, that are larger than their net worth, so that they
are forced to pay a portion of their income for a while afterwards.

But, yes, prison should not be used as a punishment, but rather to isolate
people who are physically dangerous (note that this does not equal violent
crime - it's possible for a person to commit a crime of violence, but not
actually be a danger to society afterwards).

If we really want to have a physically punitive justice system, corporal
punishment is infinitely better than years in prison: it teaches a lesson, but
people can move on quickly from that - it doesn't turn their whole life upside
down, and it doesn't put them in an environment where they're more likely to
criminalize than rehabilitate.

But ideally, the system should be preventative only where necessary (i.e.
isolate the danger), and rehabilitative otherwise.

