Backdating Probe Widens as 2 Quit Silicon Valley Firm --- Power Integrations Officials Leave Amid Options Scandal; 10 Companies Involved So Far
By Charles Forelle and James Bandler
6 May 2006
The Wall Street Journal
(Copyright (c) 2006, Dow Jones & Company, Inc.)
The stock-options backdating scandal continued to intensify, with the announcement by a Silicon Valley chip maker that its chairman and its chief financial officer had abruptly resigned. That brought to eight the number of officials at various companies to leave their posts amid scrutiny of how companies grant stock options.
Power Integrations Inc., of San Jose, Calif., said Chairman Howard Earhart, who is a former chief executive, and finance chief John Cobb had resigned. It also said it probably will need to restate nearly seven years of financial results because of options-granting problems.
So far, at least 10 companies have been caught up in the stock-options-dating matter, with several already in effect acknowledging that some improper dating occurred. A number of companies are conducting their own investigations or are the subjects of Securities and Exchange Commission probes. In one case, company practices have attracted the attention of federal prosecutors examining possible fraud violations.
The matter also is drawing concern from investors, who have bid down the stock prices of some of the companies caught up in the various probes. Chip maker Vitesse Semiconductor Corp. has seen shares fall about 40% since suspending three executives, while shares in giant health insurer UnitedHealth Group Inc. have fallen 18% since questions about its options-granting practices surfaced in mid-March, shaving more than $13 billion off its market capitalization. The shares of Power Integrations rose slightly yesterday, amid a powerful market rally.
UnitedHealth, Comverse Technology Inc. and Vitesse were among six companies whose options practices were examined in a March article in The Wall Street Journal. The article found that the CEOs of the companies routinely received grants dated ahead of sharp rises in share price, and that the likelihood of those beneficial grant dates having occurred randomly was minute. All six companies have since said they've begun probes by outside directors and lawyers into their granting practices. (The Journal contacted Power Integrations for the March article but didn't cite it.)
Nina Beattie, a criminal defense lawyer with Brune & Richard LLP in New York, said the matter is shaping up to be a big issue at a time of rising shareholder attention to high executive compensation. "There will be pressure on the government to take a hard look at it and conduct investigations, criminal and regulatory," she said.
Stock options give the recipient a right to buy shares at a set price, known as the exercise price or strike price. If the stock later rises, the recipient can cash in the option for a profit, as long as he or she has held them long enough for them to "vest." The lower the exercise price, the greater the gains. Stock options grew especially popular in the 1990s as a way to compensate executives and eventually other employees.
Typically, stock options are granted by boards of directors. They are generally supposed to carry exercise prices equal to the fair market value of the company's stock at the time of the grant. But at a number of companies, grants to top executives show an unusual pattern: They're frequently dated just before sharp rise in the share price, and at or near the bottom of a steep dip. The patterns, statistically unlikely, raise questions about whether there has been backdating or other gaming of the system.
Three companies in recent weeks appear to have reached at least preliminary conclusions that they have significant options-related trouble. Both Power Integrations and Comverse, a New York maker of telecommunications software, have said their reviews indicate that some options grants carried dates that "differed" from the grants' actual dates.
Both companies, whose reviews continue, said they expect to restate financial results to record "additional noncash charges." Under accounting rules, companies need to report an expense for grants of "in the money" options -- those that carry an exercise price below the market price at the time of the grant. Any options backdated to a day when the stock was lower would be in-the-money.
Another company, Vitesse, has suspended three executives, including CEO Louis R. Tomasetta, because of issues relating to "integrity of documents" in the options-granting process.
Securities lawyers said backdating could result in various thorny legal problems for companies and executives. Besides the need to restate financial results, companies could face bills for past income taxes. That's because any options found to have been backdated wouldn't qualify for compensation-related tax deductions that may have already been taken.
It's possible any executives who participated in backdating could be open to civil or criminal fraud charges of enriching themselves through false or misleading records or filings. Lawyers cautioned that any such criminal charges would require that an executive who took part in backdating did so intentionally. In past corporate-fraud cases, executives have often said they relied on advice of lawyers or other experts.
Corporate general counsels, who often oversee the mechanics of options programs or sign other executives' disclosure forms, have resigned at Comverse and at Mercury Interactive Corp. Mercury was targeted by an SEC probe of options dating last year.
A key question is what role, if any, directors played in any backdating scheme. Joseph Grundfest, a professor of law and business at Stanford University, said he doubted any board would approve a mechanism that allowed backdating. "Unless the board was informed that executives could backdate options and pick the lowest exercise price," he said, responsibility might well lie with the executives.
Comverse, for one, acted swiftly. Within days of beginning a probe led by outside directors, it said it would probably have to restate results. Within weeks, the investigation led to the resignation of Kobi Alexander, who founded Comverse more than two decades ago and built it into a major supplier of voice-messaging software and other products. Two other executives also resigned.
On Thursday, Comverse said it had received a subpoena from the U.S. Attorney's office for the Eastern District of New York, where federal prosecutors have begun a corporate-fraud probe. Prosecutors are examining the role of the departed executives, a person familiar with the matter said. Mr. Alexander's attorney hasn't returned phone messages.
At many companies, it's common practice to grant options to several top executives, or even all eligible employees, with the same date. That suggests that companies with timing problems mi ght find that those problems run deep.
At UnitedHealth, at least 11 executives, including CEO William McGuire and the company's general counsel, received at least one option grant dated on the lowest price of a quarter in 2000. Many executives also shared propitious option dates with Dr. McGuire through the years. The company has called its granting practices "appropriate," but its board is conducting a probe. UnitedHealth also has stopped giving option grants to some senior executives, including Dr. McGuire. He held $1.6 billion in unrealized options gains at the end of last year.
Timothy Main, chief executive of Jabil Circuit Inc., one of the companies cited in the Journal article, has strongly defended its options-granting practices and said that no backdating occurred.
At Affiliated Computer Services Inc., a Dallas tech outsourcer also examined in the article, CEO Mark King has said a preliminary review leads the company to believe there was no "intentional" granting of "look-back" options. The SEC is looking at both Jabil and ACS. The sixth company, Brooks Automation Inc., has begun a review and will delay securities filings because of options-granting problems.
The SEC began examining options backdating more than a year ago. Its attention apparently was piqued by academic research that found unusual patterns of stock activity around the time of options grants, suggestive of possible backdating. The research indicates that a dating problem could go beyond the cluster of companies already under scrutiny.
But David Aboody, another academic who has studied stock-options timing, said backdating would be such a "brazen" attempt to line one's pockets that he'd be surprised if it was widespread. "It's like stealing money. How many CEOs steal money from their company?" said Mr. Aboody, an associate professor at the Anderson School of Management of University of California, Los Angeles.
Joe Shiffler, a spokesman for Power Integrations, said it was "fair to say" that the shakeup was related to the stock-options grant timing matter. Mr. Earhart, the ex-chairman and former CEO, received four options grants between 1998 and 2002, a year when securities-law changes sharply curtailed the possibility for backdating. Three grants were dated before substantial run-ups in the company's share price over the next 20 trading days. For instance, shares leapt more than 75% in the 20 trading days after a grant dated in April 1999, on what was the lowest closing price of the month. Neither Mr. Earhart nor Mr. Cobb could be reached.
Balu Balakrishnan, the company's current chief executive, received five grants with the same dates as one or both of the two officials who resigned. Mr. Shiffler said Mr. Balakrishnan's status at the helm of the company is "not expected to change."