Stock options cloud lingers over Bay Area companies

0 Comments | Oakland Tribune, May 13, 2007 | by Barbara Grady

Investigations into backdating of stock options have swept across corporate America, engulfing 264 U.S. companies in probes either by their own boards or the government, ruining the careers of 89 executives and wiping $5.3 billion out of the stock market value.

The Securities and Exchange Commission is investigating at least 140 companies and the U.S. Justice Department is probing 60.

Meanwhile, 139 companies have restated earnings - often eight or nine years' worth - adding $13.1 billion in expenses to account for backdated options, according to Glass, Lewis & Co.

Shareholders at many companies are angry, with suits filed against 133 companies.

Their anger -- and caution -- is what wiped out the $5.3 billion in stock market value, Glass Lewis calculated.

A stock option is a document giving the holder the right to buy a stock at a set price -- usually the market price of the stock on the day the option is granted -- in the future when presumably the stock will be higher. Companies began the practice of granting stock options in the 1980s as a way to reward executives and employees and align their interests with shareholders.

Practice crept in

Backdating crept in sometime in the mid-to-late 1990s, based on earnings restatement filings, during the height of the dot-com frenzy when competition for hiring talent was stiff and the stock market was flying. Backdating means when some other date is put on the option instead of the grant date.

The SEC, in its broad investigation of the practice, has found that options were usually backdated to coincide with dates when a company's stock was trading lower than on the date the option was actually granted.

That lower price benefits recipients because they can sell the stock -- which they bought cheaply as an option -- for a higher price. For instance, if an executive got

100,000 options with a stated price of $20 a share and the stock was trading at $25 a share, the recipient could make $500,000 by selling it. But the recipient could make $1 million on a stock backdated to $15 a share.

The SEC and various shareholder lawsuits say backdating and the resulting unreported expenses are harmful to shareholders.

As SEC Chairman Christopher Cox told Congress last September, backdating in various cases the SEC is pursuing "had the effect of concealing millions of dollars in expenses from investors."

A shareholder-employee class action suit lodged against KB Home of Los Angeles expresses it this way, "By engaging in this scheme, defendants were able to conceal that KB Home was not recording material compensation expenses and was materially overstating the Company's net income and understating its net loss for 1996-2005."

But the stock market has generally yawned at the growing backdating scandal, with only slight dips in share value.

Some companies seem to have avoided any taint whatsoever.

Apple Inc. -- among the highest-profile companies under investigation by the government -- has seen its stock dip only slightly after several revelations about backdating.

The Cupertino company announced that an internal probe found it backdated 6,400 options on 42 occasions between 1997 and 2002. It also found that records were falsified to indicate a meeting took place to approve options. The stock fell on some of this news, hitting a low of $50.16 in July.

But since then, as the investigation widened to include government probes and executive departures, the stock climbed, closing at $99.47 on May 1 as the company's ever popular iPod product pushed to new successes. On April 24, the SEC filed civil charges against Apple's former general counsel, Nancy Heinin, and its former chief financial officer, Fred Anderson. Apple's internal probe found that Chief Executive Steve Jobs knew about the backdating but did not personally benefit.

Dozens of other Northern California companies investigated for stock options backdating have not been so resilient.

KLA-Tencor Corp. of San Jose, under investigation by the SEC, fired its CEO and accepted the resignation of its general counsel after an internal probe led the company to say it needed to add up to $400 million in unreported expenses.

Linear Technology Corp. of Milpitas is under investigation not only by the SEC and Justice Department but also by the Internal Revenue Service and has been hit by a shareholder lawsuit.

Executive turmoil

McAfee Inc. of Santa Clara fired its president, Kevin Weiss, and announced the resignation of its chairman and chief executive officer, George Samenuk, after an internal probe found that past backdating practices will require it to restate earnings to add up to $150 million in expenses. In August it announced a grand jury subpoena from the U.S. Attorney's office.

Trident Microsystems Inc. of Sunnyvale and CNET Networks Inc. of San Francisco each accepted resignations of their top executives after revelations of stock option backdating and related government probes.

Nationwide, some 48 companies had image-tarnishing executive resignations after investigations revealed improper backdating of stock options.