EXITING UNDER A CLOUD, WITH $175 MILLION
When KB Home Chief Executive Bruce Karatz retired last week amid a stock option controversy, he agreed to give up $13 million in disputed stock gains. But that doesn’t mean he will leave the company empty-handed.
Karatz is walking away with as much as $175 million in severance pay, pension benefits and stock options, regulatory filings show.
The windfall is possible in part because Karatz was not fired for cause but simply retired, making him eligible for his severance pay and pension unless the company’s board of directors blocks payment, compensation experts say.
“It’s like he hit the jackpot,” said Patrick McGurn, general counsel of Institutional Shareholder Services, which advises large investors such as pension plans and mutual funds. “He might not like the hit to his reputation, but he’s certainly not going to take one to his bank account.”
Karatz, 61, stepped down as head of the Los Angeles home-building company Nov. 12, after an internal probe found that he had picked stock option grant dates that inflated the value of the options to himself and other executives.
Under his employment agreement, Karatz would get a severance payment equal to the sum of what he earned in salary and incentive pay over the last three years, according to KB Home’s proxy statement. That adds up to nearly $80 million.
Karatz also has a special executive pension plan that guarantees him $1 million a year for up to 25 years in retirement, making it potentially worth $25 million.
And Karatz has vested stock options that aren’t in dispute, which are worth about $70 million based on KB Home shares’ closing price Friday of $49.07.
Add it all up, and it comes to $175 million.
“What’s perverse about this is Karatz may actually do better by getting fired than he would have done if he had stayed with the company,” McGurn said.
He noted that Karatz’s compensation from 2002 to 2005 -- on which his severance is based -- was boosted by the strong housing market, because his pay was tied to KB’s profit. In 2005, the company reported profit of $842 million.
Mark Fabiani, an attorney representing the KB Home board, declined to say whether directors would move to revoke Karatz’s severance pay or retirement benefits.
“The employment agreement will be the subject of discussions with the board and Mr. Karatz’s representatives,” Fabiani said. “The board is going to enter into discussions with Mr. Karatz about that situation, and those discussions have not yet begun.”
Lawyers for Karatz declined to comment.
By stepping down, Karatz joined more than 50 corporate officers who have been fired or resigned in the option backdating scandal. Nearly 200 companies have disclosed federal or internal inquiries into their option practices.
Options are the right to buy stock at a set price within a certain time period.
Government and internal investigations are focused on whether executives improperly looked back weeks or months to set grant dates to coincide with their stock’s lowest recent price, which would boost the value of the options.
KB Home disclosed in August that the Securities and Exchange Commission was reviewing its option practices. Legal experts said last week that Karatz’s resignation could also draw the attention of the Justice Department, which has filed criminal charges against former executives of two companies accused of backdating.
In a statement Nov. 12, KB Home’s board said its internal probe concluded that Karatz and former human resources chief Gary A. Ray had set “incorrect” option grant dates, but the board did not directly accuse them of wrongdoing. The company said Karatz had retired, Ray’s employment had been terminated and chief legal officer Richard B. Hirst had resigned.
Company representatives declined to elaborate on the statement, which also said that Karatz would surrender $13 million he had realized based on flawed option grant dates.
Karatz’s contract guarantees him severance except under only a few circumstances, including being fired for a specific cause such as fraud or misappropriation of funds, said Paul Hodgson, a compensation expert with Corporate Library, a research firm.
“The problem is that these contracts are written so loosely that it’s tough to terminate without paying,” he said.
Hodgson also noted that by saying Karatz had retired, KB Home implied that the separation was voluntary, which could make it more difficult for the company to deny Karatz his severance pay or pension.
Hodgson and other experts said that lucrative severance agreements were common for top corporate executives, even those who leave under a cloud.
“No one should shed any tears for CEOs who are forced out because of their role in backdating scandals,” said Amy Borrus, deputy director of the Council of Institutional Investors, which represents large shareholders.
“In most cases, they will walk away with lavish severance packages that will more than offset any ill-gotten gains that the board presses them to return.”