Instant profit, possible felony

Scott Tong Jul 18, 2006

KAI RYSSDAL: It’s a nifty bit of book-keeping sleight of hand, actually. Companies want to give their top executives stock options. Usually a hefty part of the pay package. But…they want to make sure those options are worth something. Otherwise, what’s the point, right? So they issue the options. Then backdate them for a time when the share price was lower. Instant profit. Possible felony. Marketplace’s Scott Tong has the story.

SCOTT TONG: “Very soon.””In the next few days.” . . . That’s when leaders at the Securities and Exchange Commission expect to file charges against alleged backdaters. Now, this kind of advance public notice is rare, but it’s no accident.

Here’s law professor John Coffee of Columbia University:

JOHN COFFEE: Anytime you have a major scandal, the SEC doesn’t want to look like it is behind the parade and being solely reactive. It wants to be the leading force marching towards reform.

In recent scandals, he says, Eliot Spitzer, the New York attorney general, has wanted to be the drum major. SEC folks also talk of criminal charges. That’s the territory of the Justice Department. So the two enforcement agencies could be working together.

COFFEE: As Samuel Johnson said, “Nothing focuses the mind like the knowledge that you are going to be hanged in a fortnight.” If you start telling corporate officers there will be criminal prosecutions, you’ll bring the practice to a screeching halt.

The Feds are looking into at least 50 firms. But backdating may be far more widespread. A new study suggests 2,000 suspicious companies where executives got the right to buy options when stock prices happened to dip. Paul Hodgson of the corporate governance group, the Corporate Library, just did his own research. He found the implicated companies often hire the same board members.

PAUL HODGSON: There is not a huge amount of diversity amongst directors. The six degrees of separation doesn’t need to be gone to. Normally, it’s one, two or three degrees at board level.

If backdating is common, no one expects the SEC to have the resources to go after everyone. Commission watchers predict a few high-profile prosecutions.

In Washington, I’m Scott Tong for Marketplace.

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