Closing arguments to continue in Bruce Karatz options-backdating case

A federal prosecutor asked a jury Thursday to convict former KB Home chief Bruce Karatz of 20 felony charges, saying he secretly backdated stock options to enrich himself and other executives at the Westwood home-building company for seven years.

But defense lawyer John Keker argued that the prosecution’s case was largely based on the testimony of another former KB Home executive who has admitted lying to FBI investigators and was hopelessly flawed as a result.

He also told jurors that Karatz and other KB executives thought the company’s options practices were proper and a sign that the former chief executive acted in good faith -- not as the thief prosecutors portrayed.

Karatz, 64, is one of the most prominent figures yet to stand trial in the government’s long-running crackdown on stock options backdating -- a practice in which companies looked back in time to grant options when the stock price was low, making them more valuable.

He guided KB Home from 1986 to 2006, during which time the company’s profit -- and its stock price -- soared. The success was marred by the backdating scandal, which caused KB to restate earnings in 2007 to account for $36 million in previously unreported options-related expenses. Karatz retired amid increasing pressure of investigations by the Securities and Exchange Commission and the Justice Department, which ultimately brought the criminal charges.

Closing arguments lasted all day Thursday and will continue Friday.

Assistant U.S. Atty. Paul G. Stern told jurors that Karatz directed the company to file proxy statements that falsely stated that options had been issued “at market value on the date of the grant,” when in fact the company had looked back sometimes weeks to pick dates when the stock price was low.

Stock options are a form of incentive-based compensation through which employees are given the right to buy stock at a set price, usually the closing price on the date they’re granted.

If the stock price rises, employees can exercise their option to buy the stock at the low price and then sell at the current price for a profit. When options are linked to a date when the closing price was lower, they are more valuable to executives.

Prosecutors contend that Karatz and the company’s former human resources chief, Gary Ray, looked back to find favorable closing prices for stock options. In 1999, for instance, Karatz chose a date when the stock price was at its lowest point for the year, inflating his options’ value by $2.68 million, Stern said.

“He did it without approval. He did it without authorization. He did it without disclosing it to shareholders. And, ladies and gentlemen, that’s a fraud,” Stern said.

Backdating is not illegal, as long as companies account for it as a compensation expense in public disclosures -- something prosecutors say Karatz failed to do.

Ray, who previously pleaded guilty to conspiracy to obstruct justice, testified that Karatz directed him to backdate the options and then, in 2006, told him to lie about it to auditors. In exchange for his testimony, prosecutors have agreed to request leniency when Ray is sentenced.

Keker, the defense attorney, said Ray agreed to cooperate with the government because he was terrified about possibly going to prison. In order to satisfy prosecutors, Keker said, Ray falsely implicated Karatz.

During his testimony last month, Ray acknowledged that he lied repeatedly during his initial meetings with the FBI. Ray said he first told agents that he didn’t think there was anything improper with the way he and Karatz handled options. But ultimately, he testified, he told the FBI that he knew it was wrong and that Karatz told him to lie about it.

“The government is asking you to base a guilty verdict on Gary Ray,” Keker said. “He will say anything to please the government. . . . Nothing that came out of his mouth can be believed beyond a reasonable doubt.”

Despite Ray’s testimony that he and Karatz kept their options pricing practices a secret, several former KB employees -- including legal, accounting and compensation executives -- said they knew about the backdating and thought it was proper. Because of that, it would be improper to convict Karatz, Keker said.

“Why would you expect Bruce Karatz to think there was anything wrong with a practice that the accountants, that the human resources people, that the outside auditors thought was legal?” Keker said. “If they weren’t alarmed, how would you expect Bruce Karatz to be?”