Integrity Matters
July 12, 2006
Options dating opens the door to abuse
Question: (E-248)
Dear Jim:
U.S. investigators are examining more than 50 companies'
option-granting practices, including back-dating and spring-loading
options. Even though this is not illegal - yet - it seems
to lack integrity.
Response:
Cheating investors confirms, again, a breakdown in the
social contract that needs to exist between and among
all stakeholders: customers, owners, investors, employees
and government agencies. Manipulating options seems to
be widespread. If it is not yet at the Enron and WorldCom
level, soon we will learn how pervasive this option-cancer
has spread. Backdating involves changing the grant date
of a stock option from the day it was actually granted
to an earlier date when the stock was trading at a lower
price. Not fraudulent on its own, backdating may be considered
fraud if the company granting the options does not properly
disclose that it backdated the options.
Spring-loading is different
from back-dating in that it is not retroactive. Rather,
a company will set an option grant date and exercise
price on a day shortly before the company intends to
release news expected to boost the stock price.
The stock options are immediately worth more because
the exercise price is lower than the current share price.
Spring-loading can involve insider trading violations,
or trading on non-public material information to realize
an unfair gain. Backdating can also lead to accounting
fraud if a company does not properly record the difference
as a compensation expense. Experts describe backdating
as essentially giving the option holder free money because
the options are immediately worth more.
Investors' faith in corporate accounting again is under
siege. Over the past few months, 50 companies, and counting
- most of them technology firms - have disclosed that
they were under investigation by federal authorities
for possibly manipulating executives' stock option grants
to boost the potential payoffs. Even so, stocks of many
tech firms have taken steep hits in recent months as
the probes have been reported. With memories of 2002
still fresh, some investors appear to be selling first
and asking questions later.
When businesses fail in their values, they decay from
the inside. In the late 1990s, values came to be viewed
as expensive and conservative relics of the old economy.
Many of today's option-probes involve those granted before
the 2002 Sarbanes-Oxley corporate reform law. Prior to
that, companies had 40 days after the grant date to file
a Form 4 with the U.S. Securities and Exchange Commission
reporting a stock option grant, giving a company a 40-day
window to pick a grant date. Sarbanes-Oxley cut that
reporting deadline to 48 hours.
Fattening the "pay packages" of a special few
erodes public trust and investor confidence. Corporate
leaders, "wake up" and exercise appropriate
compensation integrity.
