SEC Broadens Stock Option Investigation

Times Staff Writer

In a broadening investigation, the Securities and Exchange Commission is examining whether companies timed stock option grants so executives would benefit from company news.

Much of the recent scrutiny of the alleged misconduct has centered on whether companies backdated grants to periods when their companies’ stock prices were lower, in hopes of providing profits for executives.

But authorities confirmed that they also were looking into possible instances of so-called spring-loading. In this practice, a company purposely schedules an option grant ahead of expected good news or delays it until after it discloses business setbacks that are likely to send shares lower.

In both cases, the idea is to “spring-load” the option to increase its value to the recipient.


“Going forward, we will be very interested in both kinds of spring-loading,” said SEC Chairman Christopher Cox , acknowledging that it could be difficult to prove an improper connection between the timing of news and option grants. “Backdating is more easily determined than spring-loading, because of the nature of the evidence.”

Many companies offer stock option grants on the same date each year, in part to guard against allegations of manipulation. But a recent study by the research firm Corporate Library suggested that companies could be timing the public release of news, if not the options themselves.

In one possible scenario, a company might hold off on releasing favorable news until shortly after options have been granted, hoping that the public release of information will boost its share price and make the options more valuable.

Cox said a forthcoming rule on executive compensation might be revised to require companies to explain how they chose particular dates for granting stock options to senior corporate officers.

The recent furor over stock options has centered on allegations that companies backdated grants to days when the stock traded lower. But regulatory changes now on the books, including the Sarbanes-Oxley corporate reform law, have made backdating more difficult.

“A good deal of what you’re reading in the press about backdating relates to the ‘90s, because in ’02 and ’04, doors were slammed shut,” Cox said.

Along with eliminating any potential for backdating, Cox said, the SEC “is equally concerned with misbehavior in using inside information to time the granting of options.”

Since March, nearly 50 companies have come under scrutiny by the SEC or federal prosecutors for their options grants. Many of these companies, including Broadcom Corp. of Irvine and Vitesse Semiconductor Corp. of Camarillo, are high-tech companies, a sector in which stock options have long been a favored way to motivate employees and reward them for a company’s success.


The investigations have sparked a flurry of shareholder lawsuits and spread anxiety across a growing swath of corporate America. A Justice Department official recently testified that fraud in options grants could bring lengthy prison terms and fines in the millions of dollars.

“In my 20 years of practice, this issue has swept across public companies as an area of concern like no other,” said Ronald O. Mueller, an attorney at Gibson, Dunn & Crutcher in Washington.

Stock options give the recipient the right to buy shares for a set price in the future. The lower the option price, the more a person profits when the options are later sold at a higher price.

By giving executives options, supporters of the practice say, top managers have a strong incentive to raise the value of the company’s shares. But it’s a different story if the option grants are rigged to help ensure an easy profit, and investigators have been examining the practice closely after disclosures in the Wall Street Journal that many companies granted options on dates that turned out to be very lucrative for their executives.


Backdating option grants may be allowable in certain cases, including if a company has fully disclosed the practice and accounted for it as additional compensation.

To critics, however, backdating smacks of deception, misconduct and an unfair advantage for insiders.

“Option backdating is totally unfair to shareholders who don’t have the luxury of a time machine to go back and purchase stock at historic lows,” said Brandon Rees, assistant director of the AFL-CIO’s Office of Investment.

Critics also say that options manipulation in any form skims value from rank-and-file shareholders and undermines the very meaning of options as a reward to employees who have built up a company.


“It just reduces the value that’s left behind for everyone else,” said James C. Allen, a senior policy analyst at the CFA Centre for Financial Market Integrity, a think tank in Charlottesville, Va.

Backdating used to be easier to accomplish. Before the Sarbanes-Oxley corporate reform law, companies could have several weeks or even months in which to report their options grants. But the 2002 law cut those deadlines to two business days, greatly reducing wiggle room on the dates.

Randall A. Heron, an Indiana University finance professor who has looked closely at the options matter, said a review of nearly 8,000 public companies from 1996 to 2002 suggested that as many as 800 might have backdated stock options for their top executives.

“This is a big issue,” Heron said. “There are a lot of firms involved. I think in the next couple of months we’re going to see the size of the list [under investigation] grow dramatically.”


Heron and Erik Lie of the University of Iowa conclude in a forthcoming paper that backdating subsided sharply after the two-day reporting rule took effect Aug. 29, 2002.

Recent studies have further stirred the issue of options manipulation. A Stanford University analysis, for example, concluded that executives who sold stock through predetermined trading programs were more likely to sell in advance of negative earnings reports that would lower share values than in advance of favorable news that would tend to send shares higher.

Some observers are now urging the SEC to require much more transparency around stock option grants, and the SEC has signaled it is moving in that direction.

The executive pay rule, expected sometime in the summer, probably will be accompanied by guidance to clarify “when it is appropriate or not appropriate for a company to grant options while in possession of material nonpublic information,” Cox said.


The chairman said he could not speak definitively about actions the SEC had yet to rule on. But he also sounded ready to clamp down on what he called “egregious” stock option abuses in which investors were cheated by managers who unfairly exploit inside information.

“To the extent that our mission is to protect investors from abuses of trust, this is a perfect example of when commission action is needed,” he said.