July 26, 2006 4:00 AM PDT

FAQ: Behind the stock options uproar

The tech industry's stock option backdating scandal appears to be gathering steam.

Last week, federal investigators announced criminal charges against former executives of Brocade Communications Systems, and they're hinting that more cases may be on the way. Meanwhile, Silicon Valley's top lawyers are scrambling to assuage their clients' fears, and the U.S. Security and Exchange Commission has said that the investigation will expand beyond technology companies to other publicly traded outfits. Already, some companies have begun restating years worth of financial results.

To try to answer some questions about what's going on, CNET News.com has compiled the following list of frequently asked questions.

Q: What is stock option backdating?
Backdating, which refers to the practice of altering the dates of grants, is a way for employees of a company to make additional money from stock options. While it's not necessarily illegal, in many cases it could be.

Q: Which companies are under investigation?
The Securities and Exchange Commission said last week that at least 80 companies are the subject of a probe.

Also, some companies have independently confirmed that they've been contacted by federal investigators. Those include Altera, Applied Micro Circuits, Asyst Technologies, CNET Networks (publisher of CNET News.com), Equinix, Foundry Networks, Intuit, Marvell Technology Group, RSA Security and VeriSign. In addition, other companies, such as Apple Computer and The Cheesecake Factory have announced their own, preemptive investigations.

Q: How do stock options work?
Stock options give the recipient the right to buy a share of a company's stock at a price called the strike price, which is equal to the value of the stock on a certain date. If, for example, the strike price is $10 and the shares now trade at $15, each option would be worth $5. (The options would be worthless if the stock fell to, say, $7.)

Think of options as coupons you can sell. If you have a coupon to buy a Ferrari for $110,000, and the market price of the car is $120,000, your coupon is worth $10,000. But if you're lucky enough to have a coupon that lets you buy a Ferrari for a mere $50,000, your piece of paper would have a far more handsome market value of $70,000.

The same goes for stock options. If an executive is able to change the grant date of an option retroactively--for instance, to when the stock was trading at a lower price--the options become more lucrative. That's what some corporations allegedly did.

Stock options by themselves are not problematic or controversial. They're a way to recruit and retain good employees, and they tend to align employees' interests with those of shareholders. Millions of Americans hold stock options. What's at issue here is whether some top executives--typically CEOs--committed fraud when obtaining them.

Q: How widespread is the practice of backdating?
Nobody knows for sure. One method academics have used to measure the pervasiveness of backdating is to review stock option grants to executives to see if an unusual number are clustered around dates when the stock is trading at a low value. Then, when the stock increases, the executives benefit.

Q: What has this technique shown?
Erik Lie, a finance professor at the University of Iowa's College of Business, has evaluated thousands of option grants and found that it was statistically improbable for them not to have been backdated at many companies.

A paper (click for PDF) that Lie and Randall Heron, an associate professor at Indiana University's business school, published on July 14 estimates that 18.9 percent of unscheduled grants to top executives from 1996 through 2005 were backdated or manipulated. The pair estimates that 29.2 percent of firms manipulated grants to top executives at some point between 1996 and 2005.

Q: Under what circumstances is backdating legal or illegal?
Backdating is not necessarily illegal. If a company's executives are up-front about it with shareholders and the government, everything's probably fine.

The problem, though, is that the allegations that have come to light have not included full disclosure to shareholders, payment of extra applicable taxes, and earnings statements that reflect the modified grant dates. Any of those three categories could yield civil (and perhaps criminal) legal action.

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Microsoft & Stock Option Back Dating Scandal 1990s : $217 million charge
<a class="jive-link-external" href="http://online.wsj.com/public/resources/documents/info-" target="_newWindow">http://online.wsj.com/public/resources/documents/info-</a>

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

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
Posted by Llib Setag (951 comments )
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Eric Schmidt is the biggest Mafia puppet in the US. He is bad news for apple users. http://endmafia.com
Posted by geo11101 (76 comments )
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