SafeNet's hidden pay not trivial at $20 million

October 01, 2006|By JAY HANCOCK

In case you thought all the hubbub about "backdating" stock options was bookkeeping trivia, see the figure that SafeNet Inc. disclosed Thursday: up to $20 million.

That's how much previously undisclosed compensation that CEO Anthony Caputo and other employees at the Belcamp encryption and security outfit reaped from 2000 to 2005 in the form of incorrectly dated options.

Net profit for the five years was already less than zero. That makes $20 million not trivial but large, although it has no effect on SafeNet's future financial health. Or look at it another way: $20 million is 40 percent of SafeNet's stated administrative expenses for the whole five years.

The company must go back and correct its earnings statements to record the expense, which will make its five-year loss even bigger.

Now that we know the rough size of the hidden pay, the question is: Who was responsible? Who approved it? Why wasn't it disclosed? Negligence? Or something worse?

At a few other companies with options-dating problems, heads have rolled and law enforcement officials have acted. But at SafeNet and scores of other companies under scrutiny by federal regulators, internal and external inquiries are still under way, and it's too soon to draw conclusions.

For the overall options backdating scandal, "we're still pretty early when it comes to the legal process," says Erik Lie, the University of Iowa professor who did more than anybody to blow the whistle on backdating. "Everybody's trying to figure out what will happen."

It is possible that SafeNet's board approved the problematic options, which would be questionable but not necessarily illegal, and the company simply didn't account for them properly. That's a serious disclosure issue but not as potentially grave as other scenarios.

Company inquiry

The company is investigating the matter but hasn't announced results. J. Carter Beese, the independent director and former SEC commissioner helping conduct the inquiry, and Bruce Thaw, head of SafeNet's compensation committee, didn't return my calls.

Stock options give the right to buy shares at a stated price. The option price is generally the same as the market price on the date of the grant. The higher the market price rises beyond the option price - known as the "strike" price - the more options are worth.

At SafeNet and other companies under investigation, options were repeatedly granted with strike prices that were equal or close to the lowest market price for a whole year or the market price just before the stock jumped. That raises questions about whether the options were actually issued on those days or instead had their issue dates changed to give recipients a bigger payoff.

SafeNet has said that certain options issued between 2000 and 2005 "were or likely were accounted for using incorrect measurement dates."

Under rules in place until recently, options whose market and strike prices were the same on the date of issue did not have to be booked as expenses on the income statement. But if the strike price was below the market price, then a cost had to be recorded.

That's why SafeNet is restating its earnings. Options reported to have been issued, say, on May 19, 2004, when the stock was $21.70, close to a yearly low, evidently were issued before or after that date, when the market price was higher than the strike price.

SafeNet an exception

Much options backdating activity disappeared after the Sarbanes-Oxley legislation of 2002, which requires companies to quickly disclose grants made to senior executives. That limits opportunities to change the strike price after an option is issued.

SafeNet, however, is an exception. Its scrutinized options include grants made well after Sarbanes-Oxley took effect. Earlier this year SafeNet disclosed how that could have occurred: On more than 40 occasions from 2002 through 2005, CEO Caputo and about a dozen other executives and board members simply failed to file the "Form 4" disclosure forms required when insiders change their positions in company stock.

Top bosses weren't the only ones at SafeNet receiving problem options, company officials say.

"These grants that are in question were given to employees as well as senior management," says Ian Dix, SafeNet's chief marketing officer. "The grants are given to everyone on the same date."

For example, in 2004 Caputo and the other top four managers received options for 335,000 shares out of a total of 946,000 issued.

Assertion disputed

SafeNet disputes my assertion that $20 million is a huge restatement. Investor relations chief Gregg Lampf says that, of two dozen companies that have disclosed the size of options-backdating restatements, the average figure is $55 million. (He didn't include Broadcom, which has said it will take a backdating charge of $1.5 billion!)

But of course, SafeNet, with $263 million in revenue last year, is smaller than many of the companies with options-dating problems.

The $20 million charge, which SafeNet has said may be reduced due to options cancellations for employees who left the company, is not just a figment; it came indirectly from shareholders' pockets. The company is blowing millions more to investigate the problem.

Ironically, SafeNet's business is going quite well but is overshadowed by the options issue.

The company gets credit for moving quickly on its internal review and appointing Beese as a reputable figure to help handle it. Now it needs to identify exactly who approved the questioned options, and how.

For everybody's sake - shareholders, employees and customers - the sooner that question gets answered, the better.

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