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Scandal over stock options widens

As the scandal widens involving stock options, investors are wondering anew the role of corporate directors in questionable practices.
/ Source: The Associated Press

As the scandal widens involving stock options that may have been manipulated to enrich top executives, investors are wondering anew whether corporate directors have been complicit or negligent in allowing questionable practices yet again.

With a single vote, the directors of Cyberonics Inc. are said to have approved options grants that netted the chief executive a paper profit of $2.3 million overnight. At other companies ensnared in the affair, executives may have acted without board approval to improperly grant themselves stock options, or may have recorded dates differently from what the board approved.

Already, 15 senior executives or directors — including four CEOs, four finance chiefs and three general counsels — have been fired or have stepped down at seven companies.

“Boards are going to be forced to seize more control from management” and give executives less leeway in setting compensation, said Ted White, a consultant to the Council of Institutional Investors and a former California pension fund official.

A “deeply troubling” aspect of the stock options controversy, he said, is “the possibility that some boards were complicit in this.”

A growing number of public companies — there are at least 31 — are being investigated by the Securities and Exchange Commission or federal prosecutors for possible improper backdating of options grants to executives.

But in a new twist, the Cyberonics case is said to have involved a different sort of timing: not backdating options to a low point in the company’s stock price, but granting them shortly after the company received positive news certain to boost the share price. Many academic studies have shown that options grants often appear to have been carefully timed around good and bad news.

Cyberonics, a medical-device maker based in Houston, on Thursday called the assertions of unusual timing made by Wall Street analyst Amit Hazan “inaccurate and without merit.” Company shares tumbled in trading after the comments by Hazan, who also downgraded the stock, were published.

The SEC has begun an informal inquiry into stock options practices at Cyberonics, The Wall Street Journal reported online Friday, citing an unnamed person familiar with the matter.

Wave of scandals since Enron collapse
The responsibility of directors as corporate watchdogs — and the apparent breach of that duty in many instances — came into sharp focus during the wave of company scandals that began with Enron Corp.’s collapse in late 2001.

Board members at many companies were sued by shareholders in the aftermath. Regulators and shareholder advocates have decried what they see as a trend in recent years toward autocratic chief executives, their decisions rubber-stamped by docile directors.

Directors are seen as the first line of defense in protecting shareholders’ interests, since the SEC can’t be inside the boardroom to watch for questionable dealings.

Now again, in the stock options debacle, some company boards — specifically their compensation committees — may have relinquished their duty to oversee how their top executives were paid.

This is the Council of Institutional Investors’ policy on timing of option grants: “Except in extraordinary circumstances, such as a permanent change in (executive) performance cycles, long-term incentive awards should be granted at the same time each year.”

At issue in most of the cases so far is whether executives manipulated option grants by backdating them to a point where the company’s stock was at or near a low point, boosting the value of those awards.

Stock options are generally issued with an exercise price equal to the current market price, and therefore have no immediate value. By choosing an earlier date when the stock was lower, the options are instantly worth the difference between the strike price and current price.

While stock options are used as an incentive for executives to boost a company’s performance and stock price, improper backdating can mean that executives reap bigger profits with no relation to their individual performance.

In a speech Thursday night in New York, SEC Chairman Christopher Cox asserted that backdating appeared to break the link between pay and performance that is supposed to underpin options. He also indicated that backdating, even if the actual practice wasn’t illegal, may have broken the law if there wasn’t proper disclosure to investors or the options weren’t accounted for properly.

In other new developments:

  • Software maker McAfee Inc., which recently fired its general counsel for what it said was improper conduct involving stock options, disclosed Friday it had received an SEC subpoena for documents related to its options practices.
  • Semiconductor designer Semtech Corp. said Friday it would have to delay filing its quarterly financial report because of its internal review of stock options. The company received an informal SEC request for documents in mid-May.
  • Mercury Interactive Corp. said Friday an internal panel has recommended that the software maker nullify some 2.6 million options granted to former CEO Amnon Landan between 1997 and 2002. Mercury had revealed last year it would have to restate earnings back to 2002 because of errors in recording dates of option grants.
  • RSA Security Inc., a provider of computer-security software and hardware, said Friday it has been named in a shareholder suit that alleges it violated state and federal laws regarding stock option practices from October 1999 to the present.
  • Michaels Stores Inc. said Thursday it would delay filing its first-quarter financial report because of an internal review of its options-granting practices from 1990 to 2001.