Probe of KB stock options
KB Home said Friday that federal prosecutors were conducting a criminal investigation into its stock option grant practices, but the home builder said it was not a target of the probe.
The disclosure suggests that the Justice Department investigation is centered on former KB Chief Executive Bruce Karatz, who left the company last fall after an internal review found that he and human resources chief Gary Ray used “hindsight” to boost the value of stock option grants.
Ray was fired, but Karatz is still negotiating whether he officially resigned or was fired.
Karatz, 61, a three-decade veteran of KB Home, was one of the nation’s highest-paid executives. In the last three years, he collected more than $232 million in compensation, much of which came from cashing in stock option grants.
Westwood-based KB Home already is the subject of a Securities and Exchange Commission civil investigation. A criminal probe raises the stakes because it could lead to indictments.
It wasn’t clear when the federal criminal probe began, and no charges have been filed. The U.S. attorney’s office in Los Angeles declined to comment.
Ray’s attorney, Mark E. Beck of Los Angeles, said Friday that he voluntarily spoke with prosecutors on Ray’s behalf this year, contending that his client committed no wrongdoing.
As a non-financial executive, Ray didn’t know the proper way to grant or account for stock options, Beck said. Ray “was not on the financial side of things” and never knowingly violated any laws, the attorney said.
Meanwhile, Karatz last month hired San Francisco-based attorney John Keker, considered one of the nation’s top white-collar criminal defense lawyers. Keker represented former investment banker Frank Quattrone in a long-running obstruction-of-justice case that was eventually dropped. Karatz also hired Christopher Lehane, who worked in the Clinton administration, as his spokesman.
Karatz “has retained one of the finest lawyers in the country for this sort of case,” said Jan Handzlik, a former federal prosecutor who is now a partner at law firm Howrey in Los Angeles. He said that hiring Keker “reflects good judgment, not a consciousness of guilt.”
Neither Karatz nor Keker was available Friday and Lehane declined to comment.
KB Home on Friday reiterated that it had been cooperating with government authorities. Many experts believe that authorities already possess an internal report prepared by KB Home’s board last year that cleared Karatz’s successor, Jeffrey Mezger, and other top executives, as well as other significant corporate documents.
Working with investigators could help keep the company from being fined or criminally charged, some experts say.
“When a company does cooperate, there’s generally a presumption not to charge the company,” said Jack Fernandez, a former federal prosecutor now with law firm Zuckerman Spaeder in Tampa, Fla.
The probes come at a crucial time for the home builder. KB Home, along with the rest of its industry, is struggling to bounce back from a deep housing slump. Last week, KB Home reported its first quarterly loss in a decade, and the stock option mess forced it to restate seven years’ of financial results to account for $36 million in understated stock-based compensation.
At issue is the so-called backdating of stock option grants given to senior KB executives from 1998 to 2005.
Some 200 companies have disclosed government or internal investigations examining the alleged manipulation of stock option grants to enhance their value through backdating.
Options are often used by companies to provide top performers a chance to profit from rises in a company’s stock price. Backdating involves timing the dates on grants to coincide with low points in the stock price. Doing so increases the potential profit for the recipient.
Backdating is legal as long as it is disclosed to shareholders and properly accounted for, but the period for such disclosure was tightened in 2002. Defense attorneys say the large number of backdating cases demonstrates that confusion over the proper accounting for options was widespread, especially before the law changed in 2002.
So far, only seven executives at four companies have been criminally charged in backdating cases. To make their case, prosecutors have to show that individuals or companies intentionally deceived shareholders.
“These are tough cases to make,” Fernandez said. “Here you have a relatively novel theory of prosecution and everyone is trying to figure out what you can and can’t do.”
According to KB Home’s proxy filed this week, Karatz has been barred from exercising his options from the most recent fiscal year, the result of a court order stemming from shareholder lawsuits.
What’s more, the company and its former chief executive are still hashing out the terms of his departure to figure out whether he was fired or he officially retired. If Karatz was given the ax, it could open up further legal challenges for the former CEO and would save the company from paying him millions of dollars in severance.
Under his last employment agreement, Karatz would be eligible for as much as $175 million in severance and stock awards if he retired.
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scott.reckard@latimes.com
