Stock-option manipulation widespread, study finds

While backdating options isn't necessarily illegal, it can cause a company to improperly deduct employee-compensation expenses that could in turn exaggerate profit and lead to an underpayment of taxes. Yesterday, Securities and Exchange Commission chairman Christopher Cox told reporters after a meeting that the first civil charges related to backdating options will be brought "very soon."

The Toronto Star
July 18, 2006

Stock-option manipulation widespread, study finds
Stephanie Saul

More than 2,000 companies appear to have used backdated stock options to sweeten their top executives' pay packages, according to a new study that suggests the practice is far more widespread than previously disclosed.

The analysis, which comes amid a broadening United States inquiry into the timing of options to the stock market, estimates that 29.2 per cent of companies have used backdated options and 13.6 per cent of options granted to top executives from 1996 to 2005 were backdated or otherwise manipulated.

So far, more than 60 companies have disclosed that they are the targets of government investigations, are the subject of investor lawsuits or have conducted internal audits involving the practice, in which options are backdated to days when the company's shares traded at low prices.

They include Apple Computer, CNet and Juniper Networks.

Last week, the U.S. attorney in San Francisco announced a task force to investigate the backdating of options, which appears to have been particularly popular in Silicon Valley during the 1990s dot-com boom.

The study found that the abuse was more prevalent in high- technology firms, where an estimated 32 per cent of unscheduled grants were backdated; at other firms, an estimated 20 per cent were backdated.

While backdating options isn't necessarily illegal, it can cause a company to improperly deduct employee-compensation expenses that could in turn exaggerate profit and lead to an underpayment of taxes.

Yesterday, Securities and Exchange Commission chairman Christopher Cox told reporters after a meeting that the first civil charges related to backdating options will be brought "very soon."

One of the study's two authors said the analysis suggested that the disclosures so far about backdated stock options may be just the tip of the iceberg.

"It is pretty scary," said Erik Lie, an associate professor of finance at the Tippie College of Business at the University of Iowa.

Lie said the findings were so surprising that he asked several colleagues to check his numbers. The study, by Lie and Randall Heron, of the Kelley School of Business at Indiana University, uses information from the Thomson Financial Insider Filing database of insider transactions reported to the securities regulator to examine 39,888 stock-option grants to top executives at 7,774 companies dated from Jan. 1, 1996, to Dec. 1, 2005.

The findings were based on an analysis of whether share values increased or declined after option-grant dates.

"Half should be negative and half should be positive," said Lie. But the analysis revealed that the distribution was shifted upward.

"This is not random chance. It's something that's manipulated, clearly," Lie said.

"Overall, our results suggest that backdated or otherwise manipulated grants are spread across a remarkable number of firms, although these firms did not manipulate all their grants," the authors said.

The study concluded that before Aug. 29, 2002, 23 per cent of unscheduled grants — as distinguished from grants that companies routinely schedule annually — were backdated. Unscheduled grants are easier to backdate.

On that day, the regulator tightened reporting requirements to require that executives report stock-option grants received within two business days.

After that, the backdating figure declined to 10 per cent of unscheduled grants, the paper said.
Lie said that a number of companies simply ignored the new reporting rule.

"You still see problems. The rule is not enforced," he said.

Lie, who alerted investigators to problems with backdating after an analysis that he conducted in 2004, said his research showed some positive news.

"It has been suggested that some accounting firms have been pushing this practice more than others," he said. "There's actually very little evidence of that, which to me is very comforting.''

The study found that smaller auditors rather than larger ones were associated with a larger proportion of late filings and unscheduled grants, which most likely lead to more backdating and manipulative practices.

It also singled out two firms, PricewaterhouseCoopers and KPMG, as being associated with a lower percentage of manipulation.

New York Times
With files from The Star's wire services


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