Clearly, the Enron trials have not closed the book on corporate fraud. A new boardroom scandal is roiling Wall Street: stock options backdating.
Dozens of companies – including UnitedHealth Group, Comverse Technology, Vitesse Semiconductor and Affiliated Computer Services – have caught the eye of the Securities and Exchange Commission and the Department of Justice for the timing of their stock option grants.
The question: did these companies backdate options grants – and falsify records – to make them more lucrative for their top employees? Or did a lot of CEOs just have amazingly good luck?
A stock option gives the recipient the right to purchase stock at a set price. That exercise price, or strike price, usually takes one of three forms: the closing price on the day of the grant; an average of the highs and lows of the day; or the closing price from the previous day.
The lower the strike price, the greater the potential for making money when exercising the options.
Take this example, from The Wall Street Journal, which began investigating the practice last fall: “Suppose an executive gets 100,000 options on a day when the stock is at $30. Exercising them after it has reached $50 would bring a profit of $20 times 100,000, or $2 million. But if the grant date was a month earlier and the stock then was at, say $20, the options would bring in an extra $1 million.”
Such backdating is not necessarily illegal. But it could lead to a false disclosure, which may, in turn, violate federal securities laws. Company stock option plans are on file with the SEC, with a description of how the strike prices are calculated. But if the company later provides options at another price without further disclosure, then the company is violating its own plan.
Backdating may also violate accounting rules because the stock options, which are equal to extra pay, affect the company’s bottom line. By failing to include these options in their books, companies may be overstating their profits – and may, ultimately, have to restate their financials.
Plaintiffs’ law firms have already filed a number of securities class actions and derivative lawsuits on the backdating issue.
“It’s pretty sad to see that so many executives, after convincing their shareholders to approve stock incentive plans, thought they could get away with rewriting the terms,” said Peter Pease, a partner at Berman DeValerio. “That’s just plain theft, and it makes the incentive plans meaningless.”
The Journal, for example, analyzed the stock options grants of Jeffrey Rich, CEO of Affiliated Computer Services. All six of his option grants between 1995 and 2002 were dated prior to a rise in stock price. The odds of this happening are about one in 300 billion. The odds of winning the Powerball lottery, meanwhile, are one in 146 million, the newspaper reported.
Corporate board members, who are notorious for self-promotional back scratching of chief executives, are guilty of either approving these excesses or looking the other way. The auditors who failed to notice or to stop these potential violations may be equally culpable.
A number of chief executives already have been forced out or have resigned over the backdating issue. Some observers have said this is just the tip of the iceberg.
*In August 2017, our firm name changed to Berman Tabacco. Case references and content published before that date may refer to the firm under our prior name, Berman DeValerio.