The newest intrigue in corporate America, the apparent backdating of stock options to boost top executives’ compensation, is rapidly taking on the dimensions of a major scandal.
The number of public companies under investigation by the Securities and Exchange Commission or federal prosecutors has grown to more than 30 and executives at several companies have been fired.
Optical switch maker Sycamore Networks Inc. disclosed this week that it received a subpoena from federal prosecutors in Massachusetts, high-tech firm Rambus Inc. said it had launched an internal investigation, and Quest Software Inc. and drug company Sepracor Inc. reported SEC inquiries. Antivirus software maker McAfee Inc. fired its general counsel for misconduct involving company stock options.
Yet to be determined is whether federal prosecutors will bring criminal charges against any of the companies or executives. Subpoenas have been issued by U.S. attorneys’ offices in several cities including New York, which led off the wave of criminal investigations.
“The sheer number of cases that are out there makes it much more likely that somebody is going to be charged” in a criminal case, said Tim Coleman, a former federal prosecutor who is an attorney at Dewey Ballantine in Washington. The flock of company executives and directors being ousted, he added, “increases the likelihood that somebody’s going to be prosecuted.”
At issue is whether company insiders manipulated the timing of stock option grants to bring big payoffs to executives by improperly backdating the grants to coincide with low points in stock prices. As first noted in a series of groundbreaking articles in The Wall Street Journal, these patterns of almost too-good-to-be-true timing took place in the late 1990s and early years of this century.
Stock options become more valuable as the market price rises above the exercise price, so backdating fattens the spread — and executives’ payoff when they eventually sell their stock.
Unlike the byzantine financial schemes concocted by Enron and other poster companies of the corporate scandals of recent years, options backdating is fairly easy to comprehend and goes straight to the issue of whether executive remuneration is out of control.
“The common man on the street is going to see this and understand it far better” than the complex corporate shenanigans, said Richard Hans, an attorney and partner at Thacher Proffitt & Wood in New York who works on securities law and corporate governance. “In some ways this can be viewed as the greed of executives.”
In some instances, shareholders are suing the companies, their top officials and directors, alleging manipulation to enrich executives at the expense of the bottom line.
Among the companies that have disclosed receiving subpoenas or SEC requests for documents are big, well-known names like UnitedHealthGroup Inc. and Caremark Rx Inc. Many are from the world of high-tech, where stock options have long been a prized perk and incentive for executives and employees alike: Affiliated Computer Services Inc., Juniper Networks Inc., KLA-Tencor Corp., OpenWave Systems Inc., Vitesse Semiconductor Corp., McAfee, Quest Software, Rambus, Sycamore Networks and others.
The SEC, with power to impose civil fines and sanctions, is looking at whether plans to backdate options to a specific date were properly approved by a company’s board and disclosed to shareholders in regulatory filings. Some options backdating is legal, and even is touted by companies as an incentive to executives they seek to recruit, securities experts say.
Regulators draw a line between negligence or recklessness and deliberate fraudulent intent — a bit like accidentally hitting someone with a car versus intentionally using a car to kill or injure them.
Was it sloppy bookkeeping and confusion, or an intent to deceive shareholders for monetary gain?
If it is the latter case, it has “all the badges of fraud,” said John C. Coffee, a professor of securities law at Columbia University. “It’s cheating the corporation in order to give the CEO more money than was authorized” by the board.
An army of lawyers, both civil and criminal law specialists, have been hired by companies and executives.
The apparent wave of options backdating at issue now, starting in the late 1990s, pretty much came to a halt in the summer of 2002, when the Sarbanes-Oxley anti-fraud law born of the scandals went into effect. One of its requirements cut from 30 days to two business days the time that company insiders have to report to the SEC the options grants they receive with the effective date. That makes it much harder to manipulate the options price, shrinking the window of time for “looking back” to choose an earlier, more advantageous date.