Ousters can raise chance of charges
By ousting KB Home chief Bruce Karatz over inflated stock option awards, the Los Angeles company’s board instantly made the executive a high-profile potential target for federal prosecutors, legal experts say.
More than 50 corporate officers nationwide have resigned or been fired in the continuing scandal over alleged option manipulation, but most of those have been at relatively small companies.
As the head of a business with $10 billion in annual sales, Karatz automatically would present a higher priority to government investigators than executives who ran much smaller firms, several attorneys said.
“Especially if it’s someone senior, I think those go to the top of the list” for prosecutors, said John Olson, a partner at Gibson, Dunn & Crutcher in Washington.
Authorities have not accused Karatz of wrongdoing, and spokesmen for both the U.S. attorney’s office and the Securities and Exchange Commission declined to comment Wednesday on Karatz or KB Home. The company in August disclosed that the SEC was conducting an informal investigation of its option practices.
On Sunday, the company’s board announced that Karatz had resigned following an internal investigation that determined he was responsible for setting “incorrect” stock option grant dates from 1998 to 2005. The effect was to boost the value of those grants for Karatz and other KB Home executives.
“It’s a huge thing for a board to kick out a CEO,” said Thomas Curran, an attorney at Ganfer & Shore and a former assistant district attorney in New York.
The directors said that Karatz and Gary A. Ray, who had been the company’s human resources chief, chose the option grant dates.
Ray also was fired Sunday, and the company said that Richard B. Hirst, its chief legal officer, had resigned.
Karatz, 61, had served as chief executive of KB Home since 1986.
“Bruce Karatz believed he was acting properly, with the knowledge and approval of legal counsel,” his attorney, Daniel Bookin, said Wednesday.
The mispricing of option grants is at the heart of company and government investigations now covering more than 150 firms nationwide.
Options are rights to buy stock at a set price within a certain time period. Securities regulations generally require that the purchase price of an option be the stock’s market price on the day the option is granted by the company’s board.
The probes are focusing on so-called backdating, whereby some executives looked back weeks or months and reset grant dates to coincide with their stock’s lowest price in a particular period. Doing so could give the executives instant paper gains on their options. It could also understate a company’s compensation costs and overstate earnings.
Thus far, the SEC and Justice Department have filed civil and criminal cases against executives of two companies.
At a number of companies, however, board investigations have concluded that options were mispriced because of sloppy bookkeeping rather than intentional misconduct, and that there was no reason to fire executives even if previous earnings had to be restated.
Legal experts say companies naturally would prefer not to dismiss executives because doing so can imply wrongdoing by the company and invite lawsuits from angry shareholders.
“What company puts a gun in their mouth unless they really didn’t have a choice?” Curran asked.
Directors’ decision to fire executives, many attorneys say, is primarily motivated by a desire to show federal authorities that the firm is serious about fixing what went wrong. The hope is that the company can avoid a government lawsuit if it forcefully addresses alleged abuses.
“The reason that companies typically terminate executives is to take a step to avoid prosecution of the company itself,” said Matthew Jacobs, a criminal defense lawyer at McDermott Will & Emery in Palo Alto.
But by conducting a detailed probe that exposes possible wrongdoing by executives, companies may also increase the likelihood of government charges against the dismissed officers, lawyers say.
In recent years, the SEC and the Justice Department have made it clear that they expect companies to aggressively investigate alleged executive wrongdoing -- and to share that material with prosecutors. That can give government investigators a head start if they choose to pursue cases against individuals.
“It’s a great advantage to a company to have a thorough investigation, and it’s also a great benefit to regulators,” said James Doty, a partner at Baker Botts in Washington.
Still, the act of mispricing option grants alone doesn’t give the government a slam-dunk case of securities fraud, legal experts caution. One major hurdle is showing that an executive had an intent to deceive the company’s directors and shareholders, and knew that the mispricing broke the law.
“It’s one thing for a company to cut the cord to an executive and restate earnings, but it’s not a straight line between that and the ability to indict and convict,” Jacobs said.
