Wednesday, August 09, 2006

Catching Up on Options Backdating

Molex Execs Repay Pay: In one of the more interesting (and speediest) resolutions by a company of options timing concerns, 12 executives of Molex, Inc. agreed to repay the company a total of $685,000 to cover gains they realized on misdated options. The executives also agreed to have the prices raised on their unexercised options, reducing the options’ value and ensuring that the executives would not benefit in the future from the misdating. The Company’s press release states that the misdating was due to clerical error that in some instances had the effect of diminishing the value of certain options awards to the executives. The August 3, 2006 Wall Street Journal article describing the company's action points out that no other company involved in the options backdating investigations has ordered a repayment from the executives who profited.

The D & O Diary notes that D & O insurers would likely contend that the Molex executives’ payments, which represent a return to the company of compensation overpayment, would not be covered under the typical D & O policy, because it would not constitute covered "loss." Interestingly, the "personal profit" exclusion typically found in most D & O policies would not appear to preclude coverage for the payments even if the payments were otherwise covered "loss," because the payments were not made pursuant to an "adjudication" that the executives were not legally entitled to the excess payments. (To be sure, many policies allow insurers to trigger the exclusion by obtaining a judicial declaration that amounts paid represented "remuneration" to which insured persons were not legally entitled.)

Hat Tip to Adam Savett of the Lies, Damned Lies blog for the Molex link.

Yet Another Variant of Options Timing Manipulations? As The D & O Diary has noted in prior posts, the current options timing scandal encompasses several different types of options timing practices: options backdating, which involves the retroactive setting of the grant date to an earlier date when the company’s share price was lower; options springloading, where the grant date is set ahead of the release of positive news expected to raise the company’s share price: and hiring-related options grants, which can involve setting options award dates at a time prior to an employee’s hiring, or simply at a false hiring date, to increase the value of the new hires’ options.

A July 20, 2006 article in The Economist (subscription required) identifies yet another variant of options timing: "bullet-dodging," which involves delaying an option grant until after the bad news is announced. The value of an award made prior to the bad news announcement would diminish if shares declined in reaction to the news; waiting until after the bad news to make the award averts the decline and increases the award recipients profits if the company’s share price later rebounds.

The D & O Diary believes that it is important to distinguish these distinct options practices, as each involves different sets of issues and its own sets of concerns. For example, the profits for backdated options are locked in; profits from springloading or bullet dodging are far less certain. By the same token, hiring-related options practices lack the element of self-dealing that may characterize the other options timing practices. These differences are significant and potentially could substantially affect investigative outcomes, as well as the resolution of any civil litigation based on allegations of options timing manipulations.

One further note about hiring-related stock options: the August 9, 2006 criminal complaint is entered against three former Comverse Technology officials alleges an interesting variant of the hiring-related options timing manipulations. The complaint alleges that the defendants created a slush fund of backdated options granted to fictitious employees and later used these options to recruit and retain key personnel. One of the ficticious names allegedly used was "I.M. Fanton."

Options Investigations and Company Share Prices: Notwithstanding the media barrage surrounding the options backdating scandal, relatively few of the companies involved in the various investigations have been sued in securities fraud lawsuits – to date, only 11 companies. (The D & O Diary is tracking Options Backdating related litigation here.) One possible reason why the plaintiffs’ bar may be shying away from suing more companies is the lack of share price decline for companies involved in the investigations.

An August 7, 2006 Forbes article reports its analysis of stock prices of 65 firms that announced financial restatement or government investigations related to their options-granting practices. Though some companies saw dramatic share price declines, the group as a whole saw no abnormal drop compared to the wider market. The companies’ share prices fell an average of 7.4% since the announcements (most of which have taken place in the last three months) compared to a 9.4% decline in the NASDAQ Composite Index since May 1. The article does note important difference; for example, companies that have lost senior executives have suffered more than others. The companies with the most significant price declines are listed here.
The absence of significant share price declines for most of the companies involved in the scandal supports The D & O Diary’s view that the scandal will not be a "severity event" for the D & O insurance industry.

Hat tip to the Vangal blog for the Forbes link.

Cooperman Paintings: For those D & O Diary readers who were interested in my prior post about the Cooperman Paintings heist and its impact on the Milberg Weiss indictment, you may want to visit the post again. I have added images of the paintings.

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