Options backdating probe grows

Kai Ryssdal Jun 12, 2006

KAI RYSSDAL: It’s about a month now that Wall Street’s been falling. In fact, today the Nasdaq officially entered what’s called a correction. A 10-percent fall from its most recent high. The Nasdaq’s off 11.7 percent from a month ago. But for some corporate executives that’s not such a big problem. They stand to make some real money, thanks to some curious timing of stock-option grants. We’ve got our New York bureau chief Bob Moon on the line. Hey, Bob.

BOB MOON: Hi, Kai.

RYSSDAL: Bob, make us smart here. What is it exactly that these companies did?

MOON: Well, you have to understand the concept behind a stock-option grant, first of all. Stocklholders authorize these grants as an incentive to make the company successful. And, of course, that improves the value of their shares. They give these executives and workers and option to buy shares at what’s known as a strike price. That’s normally set on the day that the option is granted or awarded — the idea being that at some point in the future those shares can be bought at that price, they’ll have increased in value so the holder can cash in and pocket the difference between the strike price and the market price when they finally sell the shares.

RYSSDAL: And the question at issue in all these investigations is backdating of those options. It’s not really as simple as the company going back and changing a date, is it?

MOON: Well, it can be. Let’s take the example of Monster Worldwide, that’s being reported in today’s Wall Street Journal. The Journal’s analysis shows that numerous option grants were dated just ahead of sharp run-ups in the company’s share price. And the paper says that the odds of that happening are about 1 in 9 million, happening in a random way . . . And The Journal says that that means the grants may have been approved at some other time and then backdated to take advantage of the earlier, lower prices.

RYSSDAL: OK, so it looks questionable. But is it necessarily illegal to change the options grant date, the strike date.

MOON: Well, some experts have told me that the act itself might not be illegal but the problem is keeping it a secret from the shareholders. That might well be because that could be viewed as fraud: The shareholders thought they were approving one thing, the executive was actually making even more money than intended. There are also some questions about tax liability here. If you figure that the option grant was in the money, so to speak — it had a value right from the start — then there are tax liabilities.

RYSSDAL: The SEC, Bob, is looking into a whole bunch of companies for doing this. Obviously, SEC investigations are never a good thing for a company. What are the possible ramifications here?

MOON: Well, you think about how much money some of these big companies make and it might seem like a drop in the bucket, if an executive shaves a little bit off the top. But I spoke with Erik Lie, a professor at the University of Iowa — his research project helped trigger this new round of corporate investigations — and he says what we’re really talking about here is, if there was manipulation going on, you’re having somebody unethical leading these companies.

ERIK LIE: You know that some of these executives are behaving that way . . . Well, what does that tell you about all the things they might have done? Not only that, now you’re going to have all kinds of disruptions in the business. You’re going to have, maybe, top management turnover. It might affect how the suppliers and the customers perceive the company. And, therefore, it might have real effects on the revenues of the company, and the profits of the company.

MOON: So one of the big questions here is whether you’re going to have the expense of management turnover.

RYSSDAL: Well, refresh my memory here, though, Bob. Didn’t we have a law to deal with unethical CEO’s and unethical corporate governance? It’s called Sarbanes-Oxley. It came after Enron. We’ve just come out of that trial down in Houston. Are we looking at, perhaps, more reform here?

MOON: Well, the Senate Finance Committee is scheduled to hold hearings on this tomorrow. They want to know exactly how big this problem might be, from the Justice Department. But I might say that I spoke to one of the researchers who’s been looking into this, who says maybe hundreds of companies might be involved. Maybe 10 percent of all US companies might be involved. But that the problem seemed to be happening before Sarbanes-Oxley, that the new accounting rules may have already taken care of this. We’re hearing about problems that happened before the reform went into effect.

RYSSDAL: Alright, our New York bureau chief Bob Moon. Thank you, Bob.

MOON: Thanks, Kai.

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