Option-grant probes renew pressure on tech sector

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July 16, 2006|By TOM PETRUNO | TOM PETRUNO,LOS ANGELES TIMES

There's a sinking feeling among technology stock investors this summer - a feeling of history repeating.

At the start of 2002, the bear market had been raging for nearly two years. Then came a wave of corporate scandals that showed the Enron Corp. debacle of late 2001 was no one-off affair.

As shares of Tyco International Ltd., Adelphia Communications Corp. and WorldCom Inc. all collapsed in the first half of 2002 amid allegations of extensive financial fraud by their executives, demoralized investors wondered whether they could trust any number on corporate balance sheets and income statements.

The scandals helped fuel one last burst of panicked selling, driving the Standard & Poor's 500 index down nearly 30 percent in the first nine months of 2002. The tech-dominated Nasdaq composite index plunged 40 percent in that period.

Now, investors' faith in corporate accounting again is under siege. More than 50 companies - most of them technology firms - have disclosed that they were under investigation for possibly manipulating stock-option grants to boost the potential payoffs. Belcamp, Md.-based SafeNet Inc. is one of the companies that has disclosed this.

It's early in this scandal, if that's what it turns out to be. We may well find that what some companies did with options was unethical but not illegal.

Ann Yerger, executive director of the Washington-based Council of Institutional Investors, said her members were blindsided by the large number of companies that have admitted they're under investigation. "I think everyone has been surprised by how this has snowballed," she said. "It's another black eye for the corporate community."

The technology industry is at the center of this, of course, because stock options long have been the preferred type of compensation for tech executives. In the 1990s, shareholders were told over and over that even though their stakes in tech companies faced continual dilution because of the huge volume of options granted to executives, the awards were necessary to keep the industry's entrepreneurial spirit alive.

What's more, Silicon Valley leaders fought like mad for a decade to prevent accounting regulators from forcing companies to formally record options granted as a business expense. They finally lost in 2004.

If option grants were manipulated on a large scale, it would confirm for suspicious investors that tech companies had something to hide.

At a time when corporate compensation is a driving issue for shareholder activists, the option investigations also feed investors' simmering anger about what some call executive greed.

"There's something so fundamental about this," said Kevin Cameron, president of Glass, Lewis & Co., a shareholder advisory firm. Enron's book-cooking, he said, was so complex that most on Wall Street admitted it was beyond their comprehension.

But in the case of option manipulation, "this is so straightforward and so wrong that every investor can understand it," he said.

A principal focus of the probes is whether the companies routinely backdated option awards in the late 1990s and early in this decade so executives were able to buy shares at the lowest possible prices in a given period. (A change in disclosure rules in 2002 made such practices more difficult after that.)

Generally, the purchase, or exercise, price of an option is supposed to be the stock price on the date of the grant. By backdating option awards, companies could turn options into guaranteed income for recipients. That would take a large chunk of market risk out of the executives' options.

Another focus: whether companies timed option grants to precede good news that would be expected to lift the share price.

The possibility of widespread backdating of option awards was proposed by Erik Lie, an associate professor with the University of Iowa's business college, in a May 2005 research paper. He looked at nearly 6,000 option awards from 1992 through 2002, using company filings with the Securities and Exchange Commission. What he found was a pattern of abnormally large stock price gains immediately after unscheduled option grants - those that weren't awarded at the same time each year, he said.

Unless companies and executives possessed uncanny luck in deciding option award dates, Lie said in his report, the "results indicate that at least some of the official grant dates must have been set retroactively" to take advantage of a dip in the market price.

In an interview, Lie said he believed that many more companies were likely to be probed for backdating. "I'm quite confident we're talking about hundreds of companies that have done this," he said.

Investors' concern isn't merely moralistic, of course. They also fear what the investigations ultimately will cost the companies involved, and therefore shareholders.

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