Backdating stock options, and the law
The Justice Department’s crackdown on stock-option backdating took a thunderous hit this month when U.S. District Judge Cormac J. Carney dismissed charges against three former Broadcom executives -- only one of whom was on trial at the time. The judge was so upset with the prosecutors’ behavior, he even dismissed the Securities and Exchange Commission’s lawsuit against the company.
Carney’s accusations of witness intimidation and tampering are serious enough to warrant an internal investigation by the Justice Department, and one is underway. More disturbing is that prosecutorial misconduct also led an appeals panel in San Francisco to throw out the backdating conviction of former Brocade Communications Systems chief Gregory L. Reyes. The government’s errors in the Broadcom and Brocade cases, however, don’t provide a blanket excuse for undisclosed backdating. It may need to reexamine the cases it has brought in light of Carney’s rebuke. But if the SEC or Justice finds credible evidence that companies deliberately deceived investors, it should take action.
It is legal for companies to grant stock options whose price is tied to a previous day’s lower price, a move that makes them potentially more lucrative. But companies must disclose what they have done and deduct the options’ estimated value from their revenue. During the period when backdating apparently flourished -- from the late 1990s until 2002 -- some companies disguised the value of the options by lying about the date they were issued or about the price. Those deceptions enabled them to report lower expenses and higher earnings. Executives at some companies, including KB Home, also allegedly concealed efforts to enrich themselves. And in at least one case -- Mercury Interactive -- the company circumvented a shareholder mandate not to grant “in the money” options.
Critics of the government’s efforts argue that there were no victims when companies disguised backdated stock options. After all, the awards were often aimed at retaining talented employees on the cheap -- they merely cost a company some of the revenue it might make from future stock sales. The issue, however, isn’t how companies compensated their workforces or how much they paid them. It is whether investors received the data they were entitled to -- including an accurate picture of a company’s profitability and its compensation packages. The financial markets rely on complete, honest disclosures, and investors rely on the government to make sure companies deliver them.
[Full disclosure: Times Publisher Eddy W. Hartenstein joined Broadcom’s board of directors in 2008.]
