SEC Brings Charges in Back-Dated Options Probe
In a first-page lead article of July 21, 2006, the Wall Street Journal reported that the SEC had brought fraud charges against a former CEO, human-resources director, and CFO of Brocade Communications Systems Inc. as a result of ongoing investigations into the back-dating of executive stock options.
It was stated that more than 80 companies are now involved in stock option back-dating investigations and that additional cases will be brought in “coming weeks and months.”
SEC Chairman Christopher Cox said that,
“The full weight of the federal government is being put behind this effort to stamp out fraudulent stock-option back-dating. … [back-dating] deceives investors and the market as a whole, about the financial health of companies that cheat in this way. … It is poisonous to an efficient marketplace.”
The SEC Is Not There Yet
Back-dating of options is just a side-show in the massive , on-going buyback-option programs that have defrauded long-term investors for decades and that are the force supporting equities prices today.
 Maybe a Light Will Go On
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The SEC has not yet begun to investigate fraudulent statements by corporate executives that stock buybacks are beneficial for long-term investors or the link between stock-buybacks and insider trading.
Nevertheless, the more that the SEC investigates executive options, the more likely it is that — sooner or later — a light will go on somewhere and the SEC may begin to understand the serious implications of the buyback-option schemes that now dominate the market.
Also, the more cases that are brought and argued regarding option back-dating, the more legal precedents that may be set to make it easier to prosecute fraud regarding stock buybacks or to bring class action suits in this area by tort lawyers.
Even a single investigation of fraud involving false statements and stock buyback programs could be significant for billions of dollars of capital flows in the equity markets.
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ISS, the Institutional Investors Service, has put together a wonderful overview of the options backdating scandal. What I find very egregious is the way some of the companies have exploited investors - particularly technology companies - by fattening the wallets of executives at the expensive of individual investors. I will discuss
What is Options Back Dating?
An option is the right to buy a stock at a given price. As ISS explains,
Almost all U.S. companies grant options to their top executives “at the money,” i.e., by setting the options’ exercise price (purchase price) equal to the stock price on the grant date. That exercise price often is set at the closing share price on the grant date, or at the average of that day’s high and low. Under Section 162(m) of the Internal Revenue Code, at-the-money options are generally considered performance-based compensation that is deductible from corporate tax returns, even if an executive earns more than $1 million a year.
Many people believe high tech stocks are volatile because technology is hard to understand or predict. I disagree. They are volatility because executives want cheap options. Executives of high tech companies are incentivized to create volatility in their stock prices so that they can take advantage of options back dating. The process is simple. Release bad news, make the stock go down, grant yourself options. Release good news, make the stock go up, exercise your options. Think about it. This is free money. If you were awarding yourself options, why not create volatility? If Microsoft stock stayed at the same price all the time, then how would a Microsoft executive make money?
http://mrwavetheory.blogspot.com/2006/09/high-tech-executives-create-volatility.html
Posted by Mr Wave Theory on September 18th, 2006 at 2:53 am.