This excerpt taken from the NYFX 10-K filed Mar 7, 2007.
SEC Investigation and Related Contingencies
We filed a current report on Form 8-K on February 25, 2005 indicating our belief that the informal investigation related to certain stock option grants initiated by the SEC in October 2004 had become formal. We are cooperating with the SEC with respect to this matter. We believe we are substantially complete with regard to producing all documents responsive to document requests and a subpoena. The SEC staff has taken testimony from current and/or former officers and/or directors, as well as from third parties, including Deloitte, in this investigation.
In May 2006, we received a grand jury subpoena from the U.S. Attorney for the Southern District of New York. The subpoena sought documents relating to our granting of stock options. With the agreement of the Assistant U.S. Attorney, we are responding to the subpoena by producing the documents we produce to the staff of the Division of Enforcement of the SEC. The U.S. Attorney has also conducted interviews with at least one of our current employees and one of our former employees and with at least one employee of our former independent registered public accounting firm.
We are a nominal defendant in two separate consolidated shareholder derivative actions, one in the Superior Court for the State of Connecticut (the State Court Consolidated Complaint) and the other in U.S. District Court for the District of Connecticut (the Federal Court Consolidated Complaint). The complaints assert counts for an accounting of stock options granted to certain of the individual defendants and counts against all individual defendants for violation of Section 14(a) of the Exchange Act, breach of fiduciary duty, abuse of control, gross mismanagement, constructive fraud, corporate waste, unjust enrichment, and breach of contract.
In November 2006, we received a document request from the IRS relating to stock option grants and exercises in connection with the IRS examination of our returns for the years 2001 and 2004. Since certain of these options were granted at a price below the fair market value of our stock on the date of grant and have other documentation issues, they do not qualify for Incentive Stock Option tax treatment under Section 409A of the Internal Revenue Code. As a result, we have certain tax exposure, as the Company, under former management, did not properly withhold income and payroll taxes. We also have certain tax exposure, under Section 409A, for employee taxes potentially due on option grants made with exercise prices below fair market value on the date of grant. In 2006, we remedied the 409A exposure with respect to directors and executive officers by increasing exercise prices of affected grants. The remedies that can be taken prior to December 31, 2007 with respect to rank and file employees are currently being evaluated. The overall tax exposure could be significantly higher than the $0.7 million reserve recorded as of December 31, 2005 if the IRS seeks more than the amounts involved in a recently proposed settlement offer for the years 2003 through 2005 and if the IRS does not accept our position on the exercise date for the exercise of options and warrants by certain officers and directors with non-recourse loans.
Due to the fact that we are not current with our SEC reporting obligations, we have not issued shares to employees and directors in connection with the exercise of stock options since July 2005. Certain employees (and former employees) have notified us in writing of their intent to exercise; however, we have not honored such exercises at this time. We may have exposure if our stock price drops after employees have notified us in writing of their intent to exercise. As of December 31, 2005, we had been notified of intents to exercise aggregating 69,492 shares. The range of fair market values for our common stock on the dates of these notifications was from $4.25 to $6.75, with a weighted average fair market value for such shares on the notification dates of $5.60. We have recorded a liability as of December 31, 2005 of $93,000 based on the closing fair market value of $4.26. During 2006, we were notified of additional intents to exercise aggregating approximately 1.0 million shares. As of December 31, 2006, the cumulative notifications of intents to exercise aggregate approximately 1.1 million shares. The range of fair market values for our common stock on the dates of the cumulative notifications was from $4.20 to $7.10, with a weighted average fair market value for such shares on the notification dates of $5.93. Our potential exposure as of December 31, 2006 for declines in our stock price after such notifications is approximately $70,000 (based on the closing fair market value of $6.30 at December 31, 2006). We may have additional exposure if we cannot settle pending exercises with our stock prior to their expiration. While the final settlement amounts as to pending exercises are unknown, as of March 1, 2007 options for approximately 130,000 shares are beyond their original ten-year life. The intrinsic value of these options on the notification date is approximately $500,000.
As noted separately in the Consolidated Statements of Operations, we have incurred costs of $3.1 million, $1.3 million and $0.1 million for the years ended December 31, 2005, 2004 and 2003, respectively, relating to the stock option investigation, subpoenas and derivative actions and the related financial restatements, together with an earlier SEC inquiry into former managements accounting for NYFIX Millennium, related litigation and restatement. In addition, we incurred $11.7 million of costs in 2006 related to these matters and will likely incur material amounts going forward. These costs include outside counsels, contract attorneys and forensic accountants, other consultants and the cost of re-auditing previously issued financial statements following the resignation of Deloitte as our independent registered
public accounting firm. These costs do not include any portion of time that our employees have dedicated to these matters.
Other than the amount described above for employee-related taxes for stock options and pending exercises, we have not recorded any liability with respect to these matters, as we are currently unable to predict the outcomes and reasonably estimate the amounts of loss, if any. With respect to the SEC investigation of stock option grants, the grand jury subpoena, the State Court Consolidated Complaint, and the Federal Court Consolidated Complaint associated with such matters and other related matters, we could be subject to penalties, fines or regulatory sanctions or claims by current and former officers, directors or employees for indemnification of costs or losses they may incur and such amounts, individually or collectively, could have a material impact on our financial condition. In addition, other actions may be brought against us related to the matters described above.
Please see Item 3. Legal Proceedings and Note 10 to the Consolidated Financial Statements for a more detail description of these matters.