Bruce Karatz, who helped turn Westwood-based KB Home into one of the nation’s most successful home builders during two decades as its chief executive, was convicted Wednesday on four felony charges related to the manipulation of executive stock options.
A federal jury in Los Angeles convicted Karatz of two counts of mail fraud, making false statements in a regulatory filing and lying to the company’s accountants. The panel acquitted him of 16 other charges.
The jury rejected the government’s claim that Karatz intentionally defrauded shareholders by backdating stock option grants from 1999 to 2005 to make them more valuable. But they found him guilty of lying about the backdating to KB accountants and in a 2006 quarterly report.
“It was sort of like Nixon with Watergate. There was no evidence that he planned it, but he certainly covered it up,” said juror Ron Dick, a 72-year-old retired aerospace worker who lives in Harbor City.
Karatz, 64, is one of the most prominent corporate executives to be charged criminally in the government’s long-running crackdown on options backdating. His character witnesses during the month-long trial included former Los Angeles Mayor Richard J. Riordan and billionaire philanthropist Eli Broad.
As a courtroom clerk announced the jury’s decision, Karatz sat stone-faced between two of his lawyers, and then left the courthouse without comment.
“This is personally a challenging time,” he said in a statement later. “What I continue to value from my time as the CEO of KB Home is the fact that we successfully built a strong company, created more than 5,000 good-paying jobs and executed upon a business strategy that created very, very significant shareholder value.”
Defense attorney John Keker said Karatz intended to appeal the convictions. “The jury got 80% of it right,” the lawyer said. “We’re very disappointed about the other four charges. We’ll continue to fight those counts because he was innocent.”
The four charges carry a maximum possible sentence of 80 years in federal prison, a U.S. attorney spokesman said. Legal experts said Karatz probably would face a sentence of anywhere from probation to 10 years in prison. Sentencing is scheduled for Sept. 8.
U.S. District Judge Otis D. Wright II said Karatz could remain free on $2-million bond, secured by his Bel-Air home, until sentencing.
During the trial, prosecutors sought to portray Karatz as a greedy, scheming executive who deceived shareholders and federal regulators while inflating the value of his stock options from 1999 to 2005. The scheme enabled him to make more than $6 million in “secret pay,” Assistant U.S. Atty. Alexander A. Bustamante said in his opening statement.
Stock options allow employees to buy a certain amount of stock at a set price, typically the date on which they are granted. Companies can boost the value of these options by backdating them to dates when the stock price was lower than the actual grant date.
“This is a victory for the Justice Department, not so much in the backdating issue, in which they weren’t successful, but more in emphasizing the need for corporate truthfulness,” said Peter Henning, who teaches securities law at Wayne State University Law School in Detroit. “I think he’s going to go to jail. This case may be more about executive hubris than anything else.”
The Karatz trial came only a few months after federal prosecutors suffered a significant setback in the options backdating prosecution of Broadcom Corp. co-founders Henry Samueli and Henry T. Nicholas III. A federal judge in Santa Ana dismissed charges against both men and against two other company executives, saying prosecutors and unfairly influenced witnesses, making it impossible for the defendants to receive a fair trial.
Even without the backdated options, Karatz was one of the nation’s highest paid executives, making more than $230 million in compensation during his last three years at the company. Revenue soared under his watch, reaching a record $11 billion in 2006.
His success enabled Karatz to become a major philanthropist, contributing to efforts to rebuild Los Angeles after the 1992 riots and New Orleans after Hurricane Katrina.
In 2006, facing increased scrutiny of stock option grants by the Securities and Exchange Commission and the Justice Department, KB Home hired an outside law firm to investigate its options policies. After that investigation, Karatz retired under fire from KB Home and the company agreed to restate earnings, accounting for $36 million in undisclosed options-related compensation.
Karatz later settled a lawsuit with the SEC by agreeing to pay more than $7 million in fines and restitution to KB Home. A federal grand jury indicted Karatz on the 20 felony charges in March 2009.
Backdating options is not illegal, so long as companies account for it in public filings. Prosecutors alleged that Karatz secretly backdated options for himself and other employees, sharing his plan with only one other employee, Gary Ray, KB’s former vice president of human resources.
Ray, who pleaded guilty to conspiracy to obstruct justice and agreed to testify against Karatz, said his former boss told him to backdate options and to keep the practice secret from others, including the company’s compensation committee. Ray said he thought there was something improper about what he was doing, but he went along regardless.
But during cross-examination, Ray said he initially told FBI agents that he didn’t think there was anything wrong with way the company timed its stock options. Asked about the discrepancy by Karatz’s lawyer, Ray explained, “I lied.”
During his closing argument, defense attorney Keker told the jury of nine men and three women that the prosecution’s case hinged on Ray’s testimony, which he said lacked credibility because of Ray’s admitted lies. He said Ray changed his story to please prosecutors and to get them to give him a plea bargain.
“Ray is not worthy of your trust. He’s not worthy of your belief. He’s simply lied too much,” Keker said.
He also argued that Karatz never intended to defraud shareholders and was acting with the knowledge of company accountants and lawyers when he set option grant dates.
Dick, the juror, said he hoped that the judge would give Karatz probation and a big fine, but not jail time. “If he had just said, ‘I did it, I didn’t realize it was wrong’ … there never would have been a trial,” he said.
Of the backdating counts Karatz was acquitted on, Dick said most jurors believed the actions were “sleazy and unethical, but we couldn’t find the evidence” to convict.