The government is aggressively investigating the suspicious timing of stock options granted to top executives at scores of companies, federal officials said Wednesday.
Shareholders and employees have been “ripped off by senior executives who rigged stock option programs ... to further enrich themselves,” the chairman of the Senate Finance Committee said at a hearing.
The tax-writing committee, led by GOP Sen. Charles Grassley of Iowa, is considering reducing or eliminating a deduction that encourages companies to award executives with stock options. This kind of compensation is linked to a company’s stock prices and by, extension, performance.
The Securities and Exchange Commission chairman expressed support for the idea.
Companies are required to pay taxes on compensation that exceeds $1 million a year received by each executive. There is an exception for pay tied to a company’s financial performance; all of this can be deducted. This requirement has led companies to dole out stock options.
SEC chief Christopher Cox told the Senate Banking Committee that this rule “deserves pride of place in the Museum of Unintended Consequences.” He said the $1 million threshold was “an unworkable price control.”
At least 79 public companies, including UnitedHealth Group Inc., The Home Depot Inc., personal-finance software maker Intuit Inc. and Barnes & Noble Inc., have publicly said that they are under scrutiny by the Justice Department or the SEC, or both, for possible fraudulent reporting of stock option grants.
The Internal Revenue Service is conducting its own investigation for possible tax-law violations in option grants.
“We will apply our resources to this area with full rigor,” IRS Commissioner Mark Everson said in testimony at the hearing.
Cox and the SEC’s enforcement director, Linda Thomsen said the agency is investigating more than 100 companies. The number may include companies that haven’t disclosed that they are under investigation.
This summer, the Justice Department and the SEC charged former officials of two technology companies, Brocade Communications Systems Inc. and Comverse Technology Inc.
With only two cases brought so far out of the scores of companies under investigation, the government is sending a message that “most don’t have to worry about it,” Lynn Turner, a former SEC chief accountant, said at the Banking Committee hearing.
At issue in many investigations is a practice known as backdating: Stock options are issued retroactively to coincide with low points in a company’s share price. This can fatten profits for options recipients when they sell their shares at higher market prices.
Backdating options can be legal as long as the practice is disclosed properly to investors and approved by the company’s board. In some cases, however, the practice can run afoul of federal accounting and tax laws.
It can outrage company shareholders and the public when they see lavish compensation for executives, unrelated to their performance, even as companies stumble and lay off employees.
A new academic study found that corporate executives gained an average of $600,000 a year each from backdating of stock options between 2000 and 2004. By contrast, shareholders were hurt by an average loss in market value of 8 percent, or $500 million, for each affected company from the negative publicity of being under government investigation, the researchers at the University of Michigan found.
About 120 companies — many of them in the technology sector — are the subjects of government or internal inquiries into whether corporate insiders rigged options, without the proper disclosure or accounting, to ensure larger windfalls. The fallout: Shareholders have sued and some companies say they may have to restate earnings because past option grants may have distorted their financial results.
The SEC is focusing on cases of serious fraud, with elements such as deliberately lying, forging documents or deceiving directors or investors. In addition, the agency this summer adopted rules for what public companies must disclose regarding the dating of stock option grants to executives.
Possible tax issues in the IRS inquiry include whether deductions were taken correctly by companies regarding options that were backdated and whether executives who received options accurately reported their sale profits.
Everson also said the IRS’s examination of compensation paid to executives of charities, begun in late 2004, has found problems with compensation reporting and loans made to executives and other officials.