Options scandal looks set to spread


Mon, Jul 24, 2006 - Page 10

The US corporate world is being roiled by a scandal on bloated stock-option payments that has its epicenter in the Silicon Valley but ripples nationwide with a threat of big-wig arrests.

The first salvo of a prosecutors' campaign that may target 80 companies was fired on Thursday with the filing of securities fraud charges against Brocade Communications Systems former chief executive Gregory Reyes and former vice president of human resources Stephanie Jensen.

Allegations focus on options backdating, an obscure practice of manipulating the dates on an option that gives employees the right to buy shares at a set price to make the profits more lucrative.

Under the scheme, the options' original "strike dates" would be brought back through paperwork manipulation to a point in time when the stock price was lowest, so the recipient could reap the maximum profit at the time of sale -- a lucrative deal during the late 1990s technology stocks extravaganza.

The charges do not allege that Reyes and Jensen did this to enrich themselves, but rather to attract employees amid stiff competition for qualified computer engineers during the recent tech boom that engulfed Northern California.

But they still face up to 20 years in prison and US$5 million in fines.

"The criminal charges filed today allege that this back-dating scheme contributed to the restatements of hundreds of millions of dollars of Brocade's financial results," US Attorney Kevin Ryan said on Thursday in San Francisco.

"It is integral to the public trust in our financial markets that books and records are maintained honestly, and that the true financial condition of public companies is disclosed accurately," he said.

US Securities and Exchange Commission (SEC) Chairman Christopher Cox said the stock-option backdating scheme was carried out at Brocade for four years, ending in 2004.

The tactic doled out illicit rewards to hundreds of employees and inflated Brocade's earnings by more than a US$1 billion in one year alone, he said.

"It strikes at the heart of confidence in financial markets and deceives share holders," Cox said of stock-option backdating. "It is poisonous to an efficient marketplace."

The practice is not illegal if it is revealed to shareholders and recorded in the company's accounts. The SEC alleges this was not the case with Brocade.

Ongoing SEC investigations into reports of the practice at more than 80 companies nationwide is expected "to lead to more enforcement actions in the coming weeks and months," Cox said.

The probes are unwelcome news in a corporate world just calming from the storms created by the Enron and WorldCom scandals. The great names of US business like Apple Computer and The Home Depot have already been linked to the inquiry.

The high-tech sector clustered around San Diego may be the biggest target, with some two dozen companies all located no more than a few kilometers from each other all within the SEC's sights.

RBC Capital Markets said on Friday in a research note that stock-market repercussion from the scandal could affect the entire tech sector this year.

One recent study said 29.2 percent of US businesses had at one stage backdated or similarly manipulated their stock options between 1996 and last year.

The practice was most prevalent among small and tech-sector companies and other enterprises with volatile stock prices, said the authors of the study, Randall Heron of Indiana University and Erik Lie of the University of Iowa.

But their study concluded that only a small minority of those who practiced backdating will ever be prosecuted because of the difficulty of determining an illegal practice.

Some companies, for example, may try to cover up the practice by choosing only the second-lowest stock price for the backdate option strike date.

Others may have had several simultaneous backdated stock option plans running at the same time and may in the end have chosen one over another.

In the emerging scandal the Wall Street Journal recently suggested that some of the backdaters profited from the market plunge that followed the Sept. 11, 2001 terror attacks.

Merrill Lynch, which lost three employees in the attack on the World Trade Center, reportedly granted its president on Sept. 24 options to buy more than 750,000 shares, at a price 15 percent below the pre-attacks level.