Stock options investigation

Bob Moon Jun 9, 2006


MARK AUSTIN THOMAS: Federal investigators this week broadened their probe into possible manipulation of stock options at roughly 30 companies. They want to know what outside auditors may have known about it. The practice has touched off the largest multi-agency investigation into possible corporate wrongdoing in the last two years. Marketplace’s Bob Moon explains.

BOB MOON: Let’s say stockholders decide to give the head of the company an incentive to juice-up the value of their shares. They set aside a block of stock the CEO gets at a “locked-in” price — whatever the stock is selling for on that particular trading day.

But what if the CEO could rewind just a few weeks, to a day when the stock was selling at a much lower price, assign that date to this deal on paper, and now on the day it was really issued, the stock is worth, say, twice as much? The boss has magically given himself a bonus.

As Columbia University professor John Coffee sees it, it’s a sleight of hand that steals a little from every other shareholder. But, worse than that, the trusted CEO is pulling a fast one on his own investors.

JOHN COFFEE: You meant to give him the value of maximizing the firm, so that if he got the stock price from 20 to 40, he gets a certain portion of that. And he actually is backdating the option so he’ll get a bonus that you didn’t approve. It may be that’s not material to 10 million shareholders, but it is corrupt.

A few CEOs have already been fired at a handful of companies where stock-option backdating has been uncovered.

Researchers at the University of Iowa and Indiana University suspect hundreds of companies might be involved. Indiana University professor Randall Heron believes lax accounting rules may have encouraged dishonest executives. Until a few years ago, they had 45 days to officially report such stock option grants:

RANDALL HERON: Because we had such a big lag when they didn’t have to be reported, that’s what enabled companies to be able to back date and cherry pick the best dates, because they could look back, choose that date and nobody could figure it out.

The corporate reforms imposed by the Sarbanes-Oxley law tightened up the reporting time to just two days, and since then, the suspicious activity has nearly dried up.

HERON: And that was the most compelling evidence that backdating was responsible for pretty much everything beforehand.

The number of companies implicated so far is small, but investigators are just getting started. Dennis Beresford is former chairman of the Financial Accounting Standards Board:

DENNIS BERESFORD: I would suspect that this would be a topic of conversation at most board of directors’ meetings these days: This isn’t an issue for us, is it?

Widespread or not, University of Iowa professor Erik Lie, whose research project triggered this new round of corporate investigations, says wrong is wrong.

ERIK LIE: The sad part of it is, I think, is that there’s so much unethical behavior take place. Whether it’ll turn out to be fraud in a legal sense or not, in my mind it’s certainly unethical.

Lie fears investors will be the ones to suffer if companies have to go through costly follow-up audits and management shakeups.

In New York, I’m Bob Moon for Marketplace.

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