Senators Cite Law’s Failure to Curb Pay Excess

Members of Congress on Wednesday said they might seek to repeal a measure that was meant to put a lid on executive pay but may have instead triggered ever-richer stock option deals.

At issue is a 1993 tax provision that barred companies from deducting salaries above $1 million as a business expense unless they were tied to performance. In response, many companies curtailed executive salaries and made up the difference with the stock option grants that are at the heart of an unfolding controversy.

“It was well-intentioned, but it really hasn’t worked at all,” Sen. Charles E. Grassley (R-Iowa), chairman of the Senate Finance Committee, said of the measure. “Companies have found it easy to get around the law. It has more holes than Swiss cheese. And it seems to have encouraged the options industry.”

Grassley’s remarks came as two Senate panels held hearings into reports of corporate abuse of stock option benefits. Christopher Cox, chairman of the Securities and Exchange Commission, said his agency was investigating more than 100 companies for possible misconduct in their options programs.

A stock option gives its owner the right to buy a certain number of shares at a set price within a designated time. The current scandal centers on allegations that companies secretly manipulated the timing of their option awards to boost their value -- a practice known as backdating.

“Of course, not all of these investigations will result in enforcement proceedings,” Cox told the Senate Banking Committee on Wednesday. “At the same time, we have to expect other enforcement actions will be forthcoming in the future.”

Most of the alleged wrongdoing, Cox noted, occurred at least a few years ago, before the government imposed stricter rules on handling options.

The simultaneous hearings by the Senate Finance and Banking committees suggested that the scandal has hit a political nerve, particularly at a time of public dissatisfaction with lofty executive pay.

In addition to backdating, federal investigators are looking into a practice called springloading, in which companies may have timed option awards to exploit inside knowledge that stock prices would later rise on favorable news.

Timing ploys are not always illegal. But they may run afoul of rules governing financial disclosure, accounting, insider trading and taxation. Law enforcement officials have recently pursued criminal fraud cases involving former executives of Brocade Communications Systems Inc. and Comverse Technology Inc.

Erik Lie, a finance professor at the University of Iowa who has done influential research on the matter, said Wednesday that timing ploys appeared to be more common among technology firms, smaller companies and those with highly volatile stock prices.

From 1996 to 2005, he said, 29% of a large sample of firms that granted options to top executives engaged in one or more forms of manipulation.

The revelations are hitting investors in their pocketbooks, since news of potential manipulation often hurts a company’s stock price. In a study out this week, professors from the University of Michigan business school said the market value of 48 companies under scrutiny for their option awards had fallen an average of $510 million since the disclosure of the probes. . The average benefit to the executives from option manipulation, meanwhile, was $600,000, the study said.

“It appears that the potential benefit to executives from clandestine backdating is minuscule compared to the potential damage” to shareholders when such practices are revealed, the scholars said.

In a statement Wednesday, Grassley assailed the abuse of options as “disgusting and repulsive” -- and greedy. “Even worse in this situation, most of the perpetrators had already gotten ‘theirs’ in the form of six- and seven-figure compensation packages of which most working Americans can only dream,” he said. “But apparently that was not enough for some.”

Several lawmakers expressed regret Wednesday that the 1993 measure to limit the tax deductibility of executive salaries might have inadvertently helped usher in the freewheeling era of stock options.

“We may in Congress have created an unintended incentive to cheat,” Sen. Robert F. Bennett (R-Utah) told the Banking Committee. He added quickly: “That doesn’t excuse the people who cheat.”

At that point, Sen. Richard C. Shelby (R-Ala.), the panel’s chairman, weighed in: “Just for the record, I voted against that package,” he said.

Cox, sitting at the witness table, derided the tax measure as “an unworkable price control” that had earned a prominent place in “the museum of unintended consequences.”

“I think we can now agree with perfect hindsight that the purpose was not achieved,” he said.

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Times staff writer Kathy Kristof contributed to this report.

jonathan.peterson@latimes.com