Thursday, May 11, 2006

Options Backdating: This Year's Model?

Every day seems to bring fresh media outrage on the topic of executive compensation. Yesteday, the New York Times ran this article questioning executives’ personal use of corporate aircraft. (See a useful discussion of this article on the CorporateCounsel.net blog).

Among the more interesting media analyses on the topic of executive compensation is the series of articles that the Wall Street Journal has published on the topic of options backdating. The first article (via wsj.com, subscription required) in the series, entitled "The Perfect Payday," appeared on March 18, 2006. The article reported an apparent (but statistically unlikely) pattern at several companies of options grants to senior executives dated just before a sharp rise in the share price, and at or near the bottom of a steep dip.

In a subsequent article (via wsj.com, subscription required) on May 6, 2006, the Journal reported that a number of the companies named in the original article have had (or will have) to restate prior year's financials as a result of options backdating. The restatements were required because the restating companies have to record "additional noncash charges," because accounting rules require companies to report an expense for grants of "in the money" options. The article also explained that companies that backdated options may face bills for unpaid income taxes because backdated options wouldn't qualify for compensation-related tax deductions that may have already been taken.

This recent media attention follows an SEC inquiry looking into alleged options backdating that has been proceeding since November 2004 and that according to some media reports has involved more than a dozen companies. The SEC investigation has resulted in Analog Devices agreeing to pay a civil money penalty of $3 million in November 2005 . In addition, three senior officers at Mercury Interactive resigned in November 2005 and the company was delisted from NASDAQ after the SEC investigation uncovered backdated options grants.

Perhaps inevitably following the front page publicity of the issue in the Journal , the securities class action lawsuits raising option backdating allegations have begun to arrive. Since the March 18 Journal article, three of the seven companies identified by name in the Journal series of articles have been named in separate securities class action lawsuits raising allegations pertaining to alleged options backdating. The three companies named so far are Comverse Technology, Vitesse Semiconductor and United Health Group. In addition to these purported shareholder class actions, United Heath Group has also been sued in a separate purported class action raising substantially similar allegations on behalf of United Health Group employees in connection with their 401(k) plan. A detailed discussion of Comverse Technology's recent woes, including separate shareholder derivative litigation that recently has been filed against the company in connection with these issues, appears at this post. (In addition to these three lawsuits, Mercury Interactive was named in an August 2005 securities class action complaint, but the complaint does not contain options backdating allegations.)

The alacrity with which the plaintiffs' lawyers have jumped on this issue makes me wonder if the plainitffs' bar will try to turn the options backdating story into"this year's model", along the lines of the successive litigation onslaughts we saw in the recent past following, for example, the bursting of the Internet bubble, the IPO laddering conflagration, the telecom industry collapse, the energy industry implosion, etc.

As the quotation below may suggest, the alleged practice of backdating options may not have been widespread. We can, however, be certain that we are going to be hearing a lot more from the media about executive compensation issues -- and I expect that we will also be hearing more about options backdating. Whether or not additional companies will be named in shareholder lawsuits raising options backdating allegations of course remains to be seen.

Quotation of Note:

In the May 6 Journal article, commenting on how widespread options backdating may be, David Aboody, an associate professior at the Anderson School of Management at UCLA, said "It's like stealing money. How many CEO's steal money from their company?"

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