Suppose that you are the in-house counsel for a wildly profitable private company that plans to go public.

Suppose further that this company grants stock options routinely to employees, as Silicon Valley companies tend to do, and the result of the wild growth has been an increase in the number and value of the options granted.

Suppose that you realized that the usual exemption from securities law registration was not going to be available after the first $5 million of options was granted, so you consulted with outside counsel to see if there were other exemptions that could apply to the situation. After you determine that other exemptions are available, you advise the board to move forward in granting the options.

And suppose, finally, that when the company files a registration statement for the initial public offering, the SEC disagrees with the availability of the exemption, resulting in the company undertaking a registered rescission offering for $80 million of stock options prior to the IPO.

That was what happened to Google, Inc. and its in-house counsel, David C. Drummond. On January 13, 2005, Google and Drummond became subject to a cease and desist order from the SEC, requiring Google not to violate the Securities Act, and requiring Drummond not to “cause” any violations of the Securities Act.

How Drummond “caused” Google to violate the Securities Act suggests that the way a lawyer interacts with corporate decision makers may be important in determining legal liability.

Under SEC Rule 701, a company can have an exemption from registration for offering and selling stock options under compensatory benefit plans. Rule 701 requires that any company issuing more than $5 million in stock options over a 12-month period must provide detailed financial statements and other disclosures to the option recipients.

Google far exceeded the rule 701 limitations in the two years prior to its IPO, and, as a private company, was unwilling to provide financial statements to a broad audience.

Drummond, after consultation with outside counsel and personnel in Google's legal department, determined that other exemptions would permit Google to issue options without using Rule 701. Some options, he determined, could be granted to “accredited investors.” He also considered the statutory exemption at Section 4(2) of the Securities Act, an exemption from registration for certain private securities offerings, and the ultimate availability of an offer of rescission to the option holders if the proposed exemptions were not available.

Drummond attended Google board meetings in January and July of 2003, at which additional option grants were discussed.

According to the SEC, at these meetings Drummond did not advise the board that Google's option grants would exceed the $5 million disclosure threshold of Rule 701 or that there was a risk that the other exemptions from registration might not apply. Google issued additional options in the months following the board meetings.

The SEC determined that issuing the options without registration and without the legally required disclosures under Rule 701 resulted in Google violating the securities registration provisions of Section 5 of the Securities Act. The SEC also determined that Google's option grants did not qualify for exemption under Section 4(2).

Accordingly, the SEC determined that Google had violated the Securities Act, and that Drummond, who had not described to the board all of the risks associated with his advice, had “caused” the violation.

Apparently, had the Board been involved in a fuller discussion of the details of the legal analysis, such as Drummond most likely had with outside counsel in determining that grounds existed to believe that there were exemptions available for the issuance of the additional options, Google might still have been found to have been in violation of the Securities Act, but Drummond would not have been the “cause” of Google's violation.

Bruce Dravis is a partner at Downey Brand LLP, operating primarily in the firm's Sacramento and Roseville offices, specializing in corporate, securities and business law.