Options Backdating Becomes Major Concern
NCEO founder and senior staff member
Dozens of companies may be under investigation by the Securities and Exchange Commission for backdating stock options. The Manhattan U.S. District Attorney's Office has also issued several subpoenas in launching a criminal probe. Shareholder lawsuits are starting and promise to rival the post-Enron suits over company stock in 401(k) plans as new sources of corporate litigation.
The story has been making front-page business headlines for the last few weeks, and new companies seem to be coming under investigation daily. In theory, the Sarbanes-Oxley Act should prevent these practices because it requires companies to disclose grants with two days. But now new concern about the practice has been spurred by a study commissioned by the Wall Street Journal, which reports that an analysis of 1,000 companies by M.P. Narayanan and H. Nejat Seyhun of the University of Michigan found that options granting practices between 2002 and 2004 often failed to comply with the Sarbanes-Oxley requirement that grants of awards to executives be reported within two days of board approval ("The Dating Game: Do Managers Designate Option Grant Dates to Increase Their Compensation?", working paper, April 2006). Backdating is not per se illegal, but failure to disclose it can be. Backdating without proper shareholder approval also can cause delisting, shareholder lawsuits, and investor flight. Executives and companies may face tax consequences as well.
Now a new study reported in the Los Angeles Times (5/30/06) reports that an analysis of 191 companies between October 2001 and the end of 2003 finds that "10b5-1" sales may not be as automatic as they seem (10b5-1 sales are pre-set trading programs under which executives sell shares on a regular schedule). The data show that 10.4% of the sales came just before negative earnings reports and only 5.2% before positive reports, a pattern very unlikely to have occurred by chance.
For a more detailed look at backdating and related issues, see my May 26 special column on this issue.