(continued from previous page)
Q: Would fixing executives' grant date to, say, July 1 every year fix things?
Even if grant dates are fixed and happen at the same time every year, there's still room for shenanigans. Academics have found some evidence that CEOs time the release of negative information to happen just before a scheduled grant date, and release positive information after a scheduled grant date.
Q: How did the Sarbanes-Oxley (SOX) law change things?
After Sarbanes-Oxley took effect in August 2002, companies were supposed to report stock option grants within two days. That makes backdating more difficult and is generally thought to have curbed the practice.
But Sarbanes-Oxley probably has not eliminated backdating. A November 2005 paper (click for PDF) by M. P. Narayanan and H. Nejat Seyhun, finance professors at the University of Michigan's business schoool, analyzes grants made before and after the law's effective date.
They found that about 24 percent of stock option grants are reported late. The conclusion? "Backdating and camouflaged timing appear to be practiced even after SOX, especially by smaller firms."
In a follow-up paper (click for PDF), Narayanan and Seyhun add: "We find that executives can increase their compensation even in the post-SOX era by playing the dating game and reporting their options late. Our findings indicate that a manager receiving a large grant of 1,000,000 shares of a typical company's stock can increase the value of their grant by about $1.23 million, or 8 percent, by reporting 30 days late."
Q: Why is there this emphasis on stock options? Why don't CEOs just ask for a raise?
Blame the U.S. Congress. Sec. 162(m) of the U.S. tax code limits companies' ability to deduct pay for certain executives if the amount exceeds $1 million a year.
There's an exception in the tax code, however, for "performance-based compensation," which includes stock options. So companies can save on taxes by handing out lucrative stock options instead of lucrative salaries. In addition, executives themselves benefit by exercising the stock option and waiting a year to sell the stock. That qualifies as a capital gain and is currently subject to only a federal income tax of only 15 percent.
Why else would Apple CEO Steve Jobs, Yahoo CEO Terry Semel, and Google CEO Eric Schmidt only ask for $1 in salary? (In fact, if Congress had simplified the tax code and made CEO salaries fully deductible, it's likely that no backdating scandal would have occurred. Of course, honest CEOs would help too.)
Q: What lawsuits have been filed by investors over stock option backdating?
Apple faces a number of suits filed on behalf of shareholders and pension plans in federal and state courts in California. The complaints, which accuse company executives of manipulating stock options to maximize returns, name past and present officers, such as Jobs, Chief Financial Officer Peter Oppenheimer and even Apple board member and former U.S. Vice President Al Gore.
A handful of cases involving similar allegations and parties are pending in California federal court against chipmaker Rambus. And earlier this month, video game software company Activision revealed in a financial filing that it had been sued in Los Angeles Superior Court for "purported improprieties" in its handling of past stock option grants.
Other targets of similar suits include semiconductor manufacturer KLA-Tencor and wireless and broadcast communications site operator American Tower.
Outside the tech sphere, health care services provider UnitedHealth faces several suits in Minnesota federal court filed by individual shareholders and pension funds claiming the company's top executives and board members received billions of dollars worth of illicit stock option grants.
CNET News.com's Anne Broache contributed to this report.
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optionsscore06-full.html
San Francisco Gate
Options scandal grew out of 1990s strategy
Many Silicon Valley businesses offered the incentives to attract
and retain their top employees in a competitive market
- Carolyn Said, Chronicle Staff Writer
Sunday, July 30, 2006
Stock options were the crack cocaine of the late 1990s.
"It's the new American dream, getting rich off your company's
stock," Forbes magazine gushed in 1998. "And it's a dream
that's becoming ever more real.
"Were those who backdated stock options out to steal from the
company and shareholders?
Some experts say, in many cases, the explanation is more
benign. Sloppiness and ignorance rather than perfidy underlay
the practice at many companies.
"Because of the very rapid growth (in granting of stock options),
the infrastructure for administering and dealing with it didn't
grow as quickly," said Corey Rosen, executive director of the
National Center for Employee Ownership.
"To put it simply, you had a lot of amateurs. Professional
advisers were giving advice that may not have been very good
and stock plan administrators made mistakes."
Bottano said the software commonly used in the 1990s to
administer options grants made it easy to change records,
facilitating backdating. "You could make an edit, the program
didn't ask for any verification," he said. "It was more a tool than
an auditing mechanism. The systems weren't very advanced
because options weren't."
Some tweaking of options grants may have been inspired by a
sense of fairness.
From 1992 through 1999, Microsoft Corp. awarded employees
options that were retroactively keyed to its stock's monthly lows.
Annual awards were given in July, at that month's low point.
Awards to new employees were given at the lowest closing price
during the month after they were hired.
Microsoft disclosed and ended the practice in 1999, taking a
$217 million charge. The revelation raised nary an eyebrow.
"When Microsoft said it had to restate its earnings for
backdating, the reaction of the market was ho-hum," Koenen
said.
Microsoft's motivation appeared innocent, Rosen said.
Evening out the rewards "They were saying, 'Well, look,
someone comes to work here and the stock is $17 and someone
comes two days later and it's $24. They both do the same job
and get the same number of options. Let's try to even this out
and we'll just give everybody who comes that month the lowest
price of the month.' "
Last month, Microsoft said in a statement that its practice "did
not involve 'backdating' as we understand that term is being
used in current reports of investigations of other companies"
and said it believed its approach was legal.
Several tech insiders said Microsoft's scheme was common
knowledge and may have inspired other companies to follow
suit.